<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the fiscal year ended December 31, 1998
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________________ to ________________
Commission file number 333-64663
NETWORK PLUS CORP.
- --------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3430576
- ----------------------------------------- -------------------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
234 COPELAND STREET
QUINCY, MASSACHUSETTS 02169
- ----------------------------------------- -------------------------------
(Address of Principal Executive Offices) (Zip Code)
(617) 786-4000
- --------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The registrant had no voting or non-voting common stock held by non-
affiliates as of March 26, 1999.
The number of shares of the registrant's Common Stock ($0.01 par value)
outstanding on March 26, 1999 was 10,000,000.
Documents Incorporated By Reference
None.
<PAGE> 2
Part I
Item 1. BUSINESS
This Annual Report on Form 10-K includes "forward-looking statements",
including statements containing the words "believes", "anticipates",
"expects" and words of similar import. All statements other than
statements of historical fact included in this Annual Report including,
without limitation, such statements under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and
"Business" and elsewhere herein, regarding the Company or any of the
transactions described herein, including the timing, financing, strategies
and effects of such transactions and the Company's growth strategy and
anticipated growth, are forward-looking statements. Important factors
that could cause actual results to differ materially from expectations are
disclosed in this Annual Report, including, without limitation, in
conjunction with the forward-looking statements in this Annual Report and
under the heading "Certain Factors That May Affect Future Operating
Results" under Item 7.
Overview
Network Plus, founded in 1990, is a facilities-based integrated
communications provider ("ICP") offering integrated local, long
distance, data and enhanced telecommunications services. The Company's
customers consist primarily of small and medium-sized businesses located
in major markets in the Northeastern and Southeastern regions of the
United States. The Company also provides international wholesale
transport and termination services to major domestic and international
telecommunication carriers. The Company serves customers representing in
excess of 200,000 access lines and 30,000 toll-free numbers. All
customers are directly invoiced by the Company on a convergent Network
Plus bill. The Company has a 220 person sales force located in 12
regional offices, and in 1998 had total revenue of $106 million. In July
1998, Network Plus Corp. was incorporated in Delaware as a holding
company. All of the Company's operations continue to be conducted through
its wholly-owned Massachusetts operating subsidiary, Network Plus, Inc.
The Company has Northern Telecom, Inc. ("Nortel") telecommunication
switches in Quincy, Massachusetts, Orlando, Chicago and Los Angeles. In
addition, the Company is currently deploying Lucent 5ESS switches in both
New York City and Cambridge, Massachusetts, which are scheduled for
initial operations in mid-1999. The deployment of additional Lucent or
Nortel switches is currently being evaluated by the Company.
In 1998, over 63% of the Company's revenue was generated by customer
traffic carried on its network, and the Company expects this percentage to
increase as the Company further expands its facilities-based
infrastructure. In 1998, the Company entered into two 20-year
indefeasible right-of-use ("IRU") agreements pursuant to which it
acquired 625 route miles of dark fiber (1,830 digital fiber miles), that,
when fully deployed and activated, will form a redundant fiber ring
<PAGE> 3
connecting major markets throughout New England and the New York
metropolitan area and provide the Company with significant transmission
capacity.
The Company believes that, because of its large and highly focused sales
force and superior customer support, it will be successful in acquiring
new customers and in cross-selling local services, Internet, data and
enhanced telecommunications services to its existing customers.
The Company's business strategy is to leverage its extensive operating
history, existing customer base and substantial regional experience to (i)
provide a one-stop ICP offering integrated local, long distance, data,
Internet and enhanced telecommunications services, (ii) acquire and retain
market share through its direct sales force and focused customer service,
(iii) enhance its facilities-based infrastructure where economically
advantageous and continue the migration of traffic to its network, (iv)
build and retain market share through advanced technologies and an
advanced operational support system, (v) target the under-served market of
small and medium-sized businesses, with a focus on the Northeastern and
Southeastern regions of the United States, (vi) increase international
wholesale sales and (vii) expand through strategic acquisitions and
alliances.
Network Infrastructure
The Company pursues a capital-efficient network deployment strategy that
involves owning switches and acquiring or leasing fiber optic transmission
facilities on an incremental basis to satisfy customer demand. By owning
network components, the Company is able to generate higher operating
margins and maintain greater control over its network operations. The
Company structures its network expansion decisions in a manner designed to
(i) reduce up-front capital expenditures required to enter new markets,
(ii) avoid the risk of stranded investment in under-utilized fiber
networks and (iii) enter markets and generate revenue and positive cash
flow more rapidly than if the Company first constructed its own
facilities. Where market penetration does not economically justify the
deployment of its own network, the Company utilizes the networks of
alternative carriers.
In addition to its redundant fiber ring, Network Plus owns and maintains a
Nortel international gateway and interexchange switch in Quincy,
Massachusetts, a Nortel interexchange switch in Orlando, Florida, a Nortel
international gateway and interexchange switch in Los Angeles, California
and a Nortel interexchange switch in Chicago, Illinois. The Company has a
Network Operations Center in Quincy, Massachusetts, which monitors the
Company's entire network from a central location, increasing the security,
reliability and efficiency of the Company's operations. In addition, the
Company is currently deploying Lucent 5ESS switches in New York City and
Cambridge, Massachusetts and additional fiber optic cable in the New York
to Boston corridor, which are scheduled for initial operations in mid-
<PAGE> 4
1999. The Company intends to further expand its network in geographic
areas where customer concentrations or traffic patterns make expansion
economically advantageous.
Services
Network Plus offers retail telecommunications services primarily to small
and medium-sized businesses. Retail offerings include local, long
distance and toll-free services (both with and without Advanced
Intelligent Network ("AIN") features), multiple access options, calling
and debit card, paging, data, and custom management control features. The
Company also offers international wholesale services primarily to
interexchange carriers ("IXCs") and international telecommunications
carriers. In 1998, retail and wholesale offerings accounted for
approximately 72% and 28%, respectively, of the Company's total revenue.
Large and Growing Sales Force
Network Plus has a 220-member, sales force; its members focus on direct
retail sales, international wholesale sales and agent and reseller sales.
The Company's sales approach is to build long-term relationships with its
customers, with the intent of becoming the single-source provider of their
telecommunications services. The Company trains its sales force in-house
with a customer-focused program that promotes increased sales through both
customer attraction and customer retention. The sales force currently is
located in 12 offices and, by year-end 1999, the Company intends to expand
its direct retail sales force within its existing offices to over 300
members.
Management
Robert T. Hale, Jr., the Company's President, Chief Executive Officer,
Director and co-founder, has more than ten years of experience in the
telecommunications industry. Robert T. Hale, the Company's Chairman and
co-founder, has more than eight years of experience in the
telecommunications industry, is a Director and former Chairman of the 600
member Telecommunications Reseller Association ("TRA") and has been
Chairman of the TRA's Underlying Carrier Committee since 1992. The
members of Network Plus's eight-member Executive Officer group have
extensive experience with the Company and in the telecommunications
industry. The Company believes that the quality, tenure and teamwork of
its management team will be critical factors in the implementation of its
expansion strategy.
MARKET OPPORTUNITY
As a result of the Telecommunications Act of 1996 (the
"Telecommunications Act") and other Federal, state and international
initiatives, numerous telecommunications markets have been opened to
competition. In addition, the increasing globalization of the world
economy, along with an increased reliance on data transmission and
Internet access, has expanded the traditional telecommunications markets.
<PAGE> 5
According to New Paradigm Resources Group, Inc., at year end 1996 there
were approximately 8.7 million business lines in the Company's markets in
the Northeastern region (the New England states, New York and New Jersey)
and 4.8 million business lines in the Company's markets in the
Southeastern region (Florida, Georgia, North Carolina, South Carolina and
Tennessee). The Company anticipates significant demand for its services,
based on its belief that small and medium-sized businesses are not
aggressively targeted by large providers and are underserved with respect
to customer service and support.
BUSINESS STRATEGY
Network Plus has an aggressive growth strategy to become the ICP of choice
providing one-stop telecommunications solutions to customers in its
markets. The Company's future success will depend upon its ability to
implement this strategy. Unlike many emerging telecommunications
companies, the Company has a nine-year operating history. The Company
believes that the collective talent and telephony experience of its
management and employee base provide a competitive advantage and position
the Company to effectively implement its growth strategy, which includes
the following:
Provide Integrated Telecommunications Services
A key element in the Company's growth will be the implementation of a
marketing and operating plan that emphasizes an integrated voice and data
telecommunications solution. To a large extent, customers the Company
expects to target have not previously had the opportunity to purchase
bundled services from a single provider. The Company believes that these
customers will prefer one source for all of their telecommunications
requirements, including products, billing and service. The Company
intends to be the single source of, and provide a convergent bill for,
integrated local, long distance, Internet, data and other enhanced
telecommunications services, in addition to providing a single point of
contact for customer service, product inquiries, repairs and billing
questions. The Company believes that one-stop integrated communications
services will enable it to further penetrate its existing markets, expand
its customer base, capture a larger portion of its customers' total
expenditures on telecommunication services and increase customer
retention.
Expand Sales Force and Focus on Customer Service
The Company intends to significantly expand its sales force to both
acquire and support a growing customer base. The Company's sales force is
expected to grow to over 300 by year-end 1999. To support its customer
base, the Company provides customer service 24 hours per day, 365 days per
year. The Company believes that its ability to provide the customer with
a single point of contact for all product inquiries, repair needs and
billing questions will result in higher levels of customer satisfaction.
<PAGE> 6
Enhance Facilities-Based Infrastructure
The Company intends to continue the migration of customer traffic to its
own network, provision new customers to that network, and to cross-sell
new services, such as local service and Internet services, to its
customers. Expansion of the Company's facilities-based infrastructure
through the acquisition of fiber and switches will increase the proportion
of telecommunications traffic that is originated or terminated on its
network, which the Company believes will result in higher long-term
operating margins and greater control over its network operations. The
Company intends to enhance its facilities by purchasing and installing
additional Nortel and Lucent switches, expanding its number of central
office collocations and expanding its fiber network.
Continue Investing in Advanced Technologies and an Advanced Operational
Support System
Network Plus expects to continue to invest in advanced technologies that
provide strategic advantages by integrating the Company's network
facilities with its operational support system ("OSS") to enhance
service response time. The Company has installed and in mid-1999 expects
to deploy Nortel's Service Builder throughout its network infrastructure.
Service Builder will elevate the Company's network from a state-of-the-art
SS7 network to a next-generation intelligent network. To support
integrated provisioning and customer care for all products and services,
the Company is developing an open scalable client/server Oracle-based
platform that is expected to better integrate its operations, both
geographically and among departments, enable electronic flow-through of
provisioning events and enable all departments to obtain in real time a
universal view of all facets of a customer's history and services. The
Company believes that these technologies will provide a long-term
competitive advantage by allowing a more rapid implementation of switched
local services in its markets, shortening the time between the receipt of
a customer order and the generation of revenue and enabling a higher level
of focused customer care.
Target Underserved Markets with a Super-Regional Focus
Network Plus intends to continue targeting small and medium-sized
businesses in the Northeastern and Southeastern regions of the United
States, its primary service areas, while expanding into other markets in
the Mid-Atlantic region, Illinois and California. The Company will seek
to be among the first to market integrated communications services in many
of its markets. The Company believes that the Northeastern and
Southeastern regions are particularly attractive due to a number of
factors, including (i) the population density in the Northeast; (ii) a
large number of rapidly growing metropolitan clusters in the Southeast,
such as Atlanta, Miami/Fort Lauderdale and Orlando; and (iii) the
relatively small number of significant competitors to the incumbent local
exchange carriers ("ILECs"). In addition, the Company believes that
small and medium-sized businesses have been underserved by large
competitors with respect to customer service and support, and that its
<PAGE> 7
emphasis on customer service, support and satisfaction provides it with a
distinct competitive advantage. The Company also believes that ILECs,
such as regional Bell operating companies ("RBOCs"), and the largest
national carriers primarily concentrate their sales and marketing efforts
on residential and large business customers and that the market for small
and medium-sized businesses is generally less competitive.
Increase International Wholesale Sales
The Company intends to continue targeting the sale of both international
and domestic termination and transport services to wholesale customers
such as large IXCs and international telecommunications carriers. The
Company believes that the international market represents a growing
opportunity as a result of the rapidly increasing globalization of the
world economy. The Company's international efforts are to develop
offshore telecommunications relationships that provide the Company with
lower international termination costs as well as greater price stability
than can be obtained from U.S.-based carriers. In addition to a primary
role of enabling the Company to offer international termination to its
customers, these relationships have also allowed the Company to obtain
revenue through the domestic termination of offshore-originated traffic.
The Company has already made significant investments in its international
network capabilities, including Nortel international gateway switches in
Quincy, Massachusetts and Los Angeles and lease and IRU arrangements for
international submarine cable capacity in TAT 12/13 and Americas I in the
Atlantic Ocean and TPC-5 in the Pacific Ocean, as well as various
subsidiary feeder cable systems. In addition to increasing revenue, the
Company expects that its strategy of selling international wholesale
services will lower the cost of carrying all its international traffic and
result in more attractive service offerings in its core retail markets.
The Company provided its international wholesale services to numerous
domestic and foreign telecommunications carriers and in 1998 such services
accounted for 28% of the Company's revenue.
Expand Through Strategic Acquisitions and Alliances
As part of its expansion strategy, the Company plans to consider
acquisitions, joint ventures and strategic alliances in
telecommunications, Internet access, provisioning of digital subscriber
line ("xDSL") services and other related services. The Company believes
that, acquisitions of, and joint ventures and other strategic alliances
with, related or complementary businesses may enable it to more rapidly
expand by adding new customers, new services, additional customer service
and technical support capabilities, and additional cash flow. The
acquisitions and alliances could be funded by cash, bank financing or the
issuance of debt or equity securities. The Company is evaluating and
often engages in discussions regarding various acquisition opportunities
but is not currently a party to any agreement for a material acquisition.
<PAGE> 8
SERVICE OFFERINGS
The Company offers retail telecommunications services primarily to small
and medium-sized businesses. Retail offerings currently include local,
long distance, data and enhanced telecommunications services. The Company
also offers wholesale international and domestic termination and transport
services primarily to major domestic and international telecommunications
carriers.
Current Services
Retail Services. The Company provides retail telecommunications services,
primarily to small and medium-sized businesses located in the Northeastern
and Southeastern regions of the United States. Retail services are sold
through the Company's direct retail sales force and, to a lesser extent,
through resellers and independent marketing representatives. In 1998,
retail telecommunications services accounted for 72% of the Company's
revenue. The Company's retail services include the following:
Local Services: The Company is currently providing local services in
Connecticut, Florida, Georgia, Massachusetts, New Hampshire, New York
and Rhode Island. Currently, local services are offered as resold
services of the incumbent RBOC. It is the Company's intention to
begin to migrate resold local services to its own local network in
mid-1999.
Long Distance: The Company offers a full range of switched and
dedicated domestic (interstate) and international long distance
services, including "1+" outbound origination and termination in all
50 states along with global termination to over 225 countries. Long
distance services include interLATA services, and, where authorized,
intraLATA toll services. Additional long distance features include
both verified and non-verified accounting codes, collect calling,
station-to-station calling, third-party calling and operator-assisted
calling.
Toll-free Services: The Company offers a full range of switched and
dedicated domestic (interstate) toll-free services, including toll-
free origination and termination in all 50 states, international
toll-free origination from 60 countries including Canada, and toll-
free directory assistance. AIN enhanced toll-free services include
the following features: Command Routing, Dialed Number Identification
Service ("DNIS"), Area Code/Exchange Routing, Real Time Automatic
Number Identification Delivery, Day-of-Year Routing, Day-of-Week
Routing, Time-of-Day Routing and Percentage Allocation Routing.
Access Options: The Company offers its long distance and toll-free
customers multiple access options including dedicated access at DS0,
DS1, DS3 and E1 speed(s) and switched access. Dedicated access
service customers have the option of incorporating ISDN Primary Rate
Interface Protocol and switched access service customers have the
option of incorporating the ISDN Basic Rate Interface Protocol.
<PAGE> 9
Calling Card and Debit Card Services: The Company offers nationwide
switched access customized calling card services and debit card
services. Customers have the option of calling cards that are
personalized, branded or generic.
Paging Services: The Company offers advanced wireless paging
services, including digital and alphanumeric paging, personal
identification number ("PIN") services, voice mail, news and sports
feeds, and local geographic coverage through and including national
geographic coverage. Paging services offered by the Company are
provided through PageMart, Inc.
Data Services: The Company offers advanced data transmission
services, including private line, point-to-point and Frame Relay
Services. Data services have multiple access options including
dedicated access at DS0, DS1, DS3 and E1 speed(s) and switched
access. Frame relay services are designed for bandwidth needs that
vary over time and for inter-networking geographically dispersed
networks and equipment. Frame relay services offered by the Company
are provided through Sprint.
Custom Management Control Features: All of the Company's customers
have the option of customized management reporting features including
interstate/intrastate area code summaries, international destination
matrix, daily usage summaries, state summaries, time of day
summaries, duration distribution matrix, exception reporting of long
duration calls, and incomplete and blocked call reporting.
International Wholesale Services. The Company offers international
wholesale termination and transport services primarily to major domestic
and international telecommunications carriers. The Company believes its
international wholesale service offering is a strategic element in its
overall plan to expand its network and to generate and retain customer
traffic. The Company intends to build on its relationships with large
domestic and international carriers to purchase increased capacity and to
otherwise support its international service offerings. In addition, the
Company expects that its provision of comprehensive international services
will lower the cost of carrying international traffic and result in more
attractive service offerings in its core markets.
Planned Services
Facilities-Based Local Services. The Company intends to begin offering
facilities-based local service in 1999 in Connecticut, Massachusetts, New
Hampshire, New Jersey, New York, Rhode Island and Vermont. The Company
intends to deploy local facilities and enter into additional
interconnection agreements in target market areas, including the
Southeastern United States, as market conditions warrant. As part of its
plan to offer facilities-based local exchange services, the Company (i)
has obtained authority to provide local service in Connecticut, Florida,
<PAGE> 10
Georgia, Maine, Massachusetts, New Hampshire, New Jersey, New York,
Pennsylvania, Rhode Island, and Tennessee and (ii) has entered into
interconnection agreements (for the purpose of gaining access to the
unbundled network elements necessary to offer facilities-based local
exchange services) with Bell Atlantic for Massachusetts, New Hampshire,
New York and Rhode Island and with Bell South for Florida and Georgia.
The Company has commenced the negotiation of interconnection agreements in
the other states where CLEC status has been obtained.
Advanced Local Services. In connection with its facilities-based local
exchange service offering, the Company intends to offer value added local
exchange services on both a resale basis (where such services are made
available for resale) and on a switched-facilities basis, including the
following: xDSL, ISDN, Centrex, Trunk Line Service, Voice Mail (unbundled
network element only), Hunt Sequencing, Three Way Calling, Call
Forwarding, Call Waiting, Speed Dial, Voice Dialing, All Call Blocking,
Selective Blocking, Foreign Exchange, Call Trace and Caller ID. The
Company recently entered into a strategic partnership with NorthPoint
Communications, Inc. ("NorthPoint"), which included an equity investment
by the Company in NorthPoint, to provide xDSL services to businesses
currently reached by NorthPoint's infrastructure. The Company expects to
begin offering such services during mid-1999.
SALES AND MARKETING
Overview
The Company's sales force seeks to provide its existing and potential
customers with a comprehensive array of telecommunications services
customized for the increasingly convergent voice and data marketplace.
The Company's customers consist primarily of small and medium-sized
businesses that have telecommunications expenditures of less than $10,000
per month. The Company believes that RBOCs and large long distance
carriers historically have not concentrated their sales and marketing
efforts on this business segment, which the Company believes represents a
significant portion of the telecommunications market. Through its sales
force and its nine-year operating history, the Company believes it has
established itself as a recognized provider of high-quality, competitively
priced long distance services, with a reputation for responsive customer
care.
The Company's sales and marketing approach is to build long-term business
relationships with its customers, with the intent of becoming the single
source provider of all their telecommunications services. The Company
trains its sales force in house with a customer-focused program that
promotes increased sales through both customer attraction and customer
retention.
Members of the Company's sales force are assigned to one of the following
sales groups: (i) the direct retail sales force, which markets the
Company's retail telecommunications services directly to end users; (ii)
the reseller and independent agent sales force, which markets the
<PAGE> 11
Company's telecommunications services to resellers, independent marketing
representatives, associations and affinity groups; and (iii) the
international wholesale sales force, which sells the Company's
international telecommunications services on a wholesale basis to major
domestic and international telecommunications carriers.
Sales Channels
Direct Retail Sales. The Company's direct retail sales force markets the
Company's retail telecommunications services directly to end users. The
Company employs direct sales representatives working in 12 regional
offices throughout the Northeastern and Southeastern regions of the United
States. By year end 1999, the Company intends to increase its sales force
to over 300 direct retail sales personnel.
The direct sales force is divided into two regions, Northeastern region
and a Southeastern region. Each of the Company's existing sales offices
is headed by a branch manager and is further sub-divided into smaller
sales teams, each of which is headed by a team leader who directly
oversees the day-to-day sales activities of his or her team and acts as a
mentor to its members. Teams generally consist of eight to ten sales
representatives.
The Company's direct retail sales force has a proven management structure
based on a "growth from within" philosophy. As the Company opens a
sales office in a new geographic area, it identifies a branch manager and
team leader to head the new office. New branch managers are typically
chosen from among the Company's experienced team leaders, and team leaders
are typically chosen from among the Company's experienced sales
representatives. Because these new positions represent promotion
opportunities, the Company has been successful in opening new offices with
management teams having significant Network Plus work experience. As
branch managers and team leaders relocate to offices in new geographic
areas, they hire new sales representatives from the area. All new sales
representatives are required to receive formal in-house training, where
they are expected to gain a thorough knowledge of the Company's services
and the telecommunications industry. After formal training, sales
representatives are permitted to pursue customers but are required to
participate in a continuing mentoring program. The Company believes this
philosophy is a competitive advantage in the attraction and long-term
retention of sales personnel.
Reseller and Independent Agent Sales. The Company's reseller and
independent agent sales force markets the Company's telecommunications
services to various resellers, independent marketing representatives,
associations and affinity groups. The focus of the reseller and
independent agent sales force is to locate established, high-quality
organizations with extensive distribution channels in order to market the
Company's telecommunications services to both a broader geographic range
of potential customers and a greater number of potential customers than
could be reached by the direct retail sales force.
<PAGE> 12
The Company sells its services on a wholesale basis to resellers, which in
turn sell such services at retail to their customers. The Company
generally sells its services to independent marketing representatives,
associations and affinity groups on a retail basis. Use of independent
marketing representatives allows the Company to reduce its marketing and
other overhead costs. As compensation for their services, independent
marketing representatives generally receive a commission on their sales.
International Wholesale Sales. The Company's international wholesale sales
force markets the Company's international telecommunications services to
both international and domestic telecommunications providers. The
international wholesale sales force is focused on developing customer and
vendor relationships with the top tier IXCs as well as RBOCs and selected
financially stable second tier IXCs. The Company's international sales
strategy is designed to leverage its existing infrastructure and increase
margins on its retail business by sharing the cost of fixed facilities.
Marketing and Advertising
Historically, because the Company has been successful in relying upon its
sales force to obtain additional customers and increased name recognition,
the Company has refrained from undertaking significant advertising
efforts. The Company is currently evaluating plans to begin a marketing
and advertising campaign in support of the rollout of integrated voice and
data telecommunications and xDSL solutions offered by the Company. The
Company is actively involved in numerous charitable and community events,
which the Company believes increase recognition of the Company in
particular geographic regions.
CUSTOMER BASE
Retail Customers
The Company's customers are segmented by monthly revenue into (i) a
National Account segment (over $1,000 of usage per month), (ii) a Major
Account segment (between $250 and $1,000 of usage per month) and (iii) a
Small Business/Residential Customer Account segment (under $250 of usage
per month). This segmentation is designed to ensure that those customers
generating higher monthly revenues experience a higher level of proactive
customer care.
International Wholesale Customers
The Company provides wholesale international telecommunications services
to numerous national and international telecommunications carriers.
International wholesale telecommunications services include international
transport and termination services for domestic carriers and domestic
transport and termination services for international carriers. During
1998, wholesale telecommunications services accounted for 28% of the
Company's revenue.
<PAGE> 13
The Company strives to establish close working relationships with its
wholesale international customers. The Company has been tested and
approved as an authorized carrier for, and included in the routing tables
of, all of its long distance and international carrier customers.
In 1998, the Company had one wholesale customer that accounted for
approximately 13% of the Company's revenue; during each of 1997 and 1996,
the Company had one retail customer that accounted for approximately 10%
of the Company's revenue.
CUSTOMER SUPPORT
The Company maintains an emphasis on customer care to differentiate itself
from its competitors. The Company provides 24-hours-per-day, 365-days-
per-year customer support primarily through its customer service
department in Quincy, Massachusetts. At the Company's customer support
center, all customers' calls are answered by experienced customer care
representatives, many of whom are cross-trained in the provisioning
process. Support staff are trained to work with the Company's sales force
and be proactive in the customer support process. In addition to calls
made by the Company's sales department, members of the customer support
staff proactively seek to contact the Company's customers. The Company's
customer support team is organized to help ensure that the most
knowledgeable personnel handle support requests from the largest
customers.
The customer support staff utilizes a sophisticated management information
system to access all customer information including contact information,
customer rates, trouble ticket systems, accounts receivable and billing
history. In addition, the Company utilizes a provisioning system that
maintains a complete history of a customer's provisioning and allows real-
time access to information concerning each transaction with the LEC or
underlying carrier.
The Company monitors and measures the quality and timeliness of customer
interaction through quality assurance procedures. Pick-up times for
incoming calls, lengths of calls and other support information is
automatically monitored by the Company's automated call distribution
system ("ACD"). The Company's ACD also prioritizes incoming support
requests, ensuring that the Company's largest customers receive support in
the most expedient manner.
NETWORK
The Company pursues a capital-efficient network deployment strategy that
involves owning switches while adding through lease or acquisition fiber
optic transmission facilities on an incremental basis to satisfy customer
demand. The Company's strategy has been to build a geographic
concentration of revenue-producing customers through the resale of
telecommunications services before building, acquiring or extending its
own network to serve that concentration of customers. As network
economics justify the deployment of switching or transport capacity, the
<PAGE> 14
Company expands its network and migrates customers to its network. The
Company believes that this strategy allows the Company to penetrate new
markets through its resale solution without incurring the risks associated
with speculative deployment of network elements and to focus its capital
expenditures in those geographic areas and markets where network expansion
will result in higher long-term operating margins.
Current Network
Switches. Currently, the Company operates an advanced telecommunications
network that includes four operative Nortel switches. Two Lucent switches
are currently being installed for deployment in mid-1999. Switches
located in Quincy, Massachusetts and Los Angeles are both DMS 250/300
switches that combine on a single platform the DMS 250's interexchange
switching capabilities and the DMS 300's international gateway
capabilities. The switches located in Orlando and Chicago are both Nortel
DMS 250 switches.
During December 1998, the Company carried approximately 63% of total
minutes on its own network. The Company anticipates that this percentage
will increase as it further expands its facilities-based infrastructure.
The Company believes that increasing the traffic carried on its own
network will increase long-term operating margins and give the Company
greater control over its network operations.
Fiber and Transport. In August 1998, the Company entered into two 20-year
IRU agreements with two separate carriers pursuant to which it acquired
625 route miles of dark fiber (1,830 digital fiber miles). When the fiber
is fully deployed and activated, it will form a redundant fiber ring
connecting major markets throughout New England and the New York
metropolitan area, providing the Company with significant transmission
capacity. The first IRU agreement is for 293 fiber route miles containing
four dark Lucent TrueWave optical fibers. Markets connected by this
segment include New York City, White Plains, Stamford, New Haven, New
London, Providence and Boston. The second IRU agreement is for 332 fiber
route miles containing two dark Lucent TrueWave optical fibers. Markets
connected by this segment include Boston, Nashua, Springfield, Hartford,
White Plains and New York City. The Company will install and control all
electronics and optronics, including wave division multiplexing
technologies.
Where the Company has not acquired fiber, it leases long-haul network
transport capacity from major facilities-based carriers and local access
from the ILECs in their respective territories. The Company also uses
competitive access provider ("CAP") or CLEC facilities where available
and economically justified. To ensure seamless off-net termination and
origination, the Company also utilizes interconnection agreements with
major carriers.
International. The Company's network is interconnected with a number of
U.S. and foreign wholesale international carriers. The purpose of
connecting to a variety of carriers is to provide state-of-the-art least-
<PAGE> 15
cost routing and network reliability. These interconnected international
carriers are also a source of wholesale international traffic and revenue.
To further support its international interconnections, the Company has
entered into leases for international submarine cable facilities in TAT-
12/13 RIOJA in the Atlantic Ocean and TPC-5 in the Pacific Ocean. In
addition, in December 1997 the Company purchased IRU capacity in the
Americas I cable system. These arrangements support existing and planned
interconnections with telephone operating companies in foreign countries.
Other Features. The Company is also interconnected with two Signaling
Transfer Points in Waterbury and New Haven, Connecticut to provide SS7
common-channel signaling throughout its network, thereby reducing connect
time delays and enhancing overall network efficiencies. The Company's
uniform and advanced switching platform enables it to (i) deploy features
and functions quickly throughout its entire network, (ii) expand switch
capacity in a cost-effective manner, (iii) lower maintenance costs through
reduced training and spare parts requirements and (iv) achieve direct
connectivity to cellular and personal communication system applications in
the future.
Security and Reliability. The Company has a Network Operations Center in
Quincy, Massachusetts, which monitors the Company's entire network from a
central location, increasing the security, reliability and efficiency of
the Company's operations. Centralized electronic monitoring and control
of the Company's network allows the Company to avoid duplication of this
function in each region. This consolidated operations center also helps
reduce the Company's per-customer monitoring and customer service costs.
In addition, the Company's network employs an "authorized access"
architecture. Unlike many telecommunications companies, which allow
universal access to their network, the Company utilizes an automatic
number identification ("ANI") security screening architecture that
ensures only the ANIs of those users who have subscribed to the Company's
services and have satisfied the Company's credit and provisioning criteria
are allowed access to the network. The Company believes that this
architecture provides the Company a competitive advantage through its
ability to better control bad debt and fraud in a manner that is invisible
and non-intrusive to the customer. Additionally, this architecture allows
the Company to better manage network capacity, as unauthorized users
cannot access and exploit the network bandwidth.
Anticipated Network Expansion
As part of its growth strategy, the Company plans to undertake a
significant network expansion through the deployment of additional
switching and transport infrastructure to support its goal of capturing
additional market share and continuing migration of its current customers'
traffic to its own network. Expansion of the Company's facilities-based
infrastructure with international gateway, long distance and local
switches will increase the proportion of communications traffic that is
originated or terminated on its network, which the Company believes will
result in higher long-term operating margins and greater control over its
network operations. The Company structures its network expansion
<PAGE> 16
decisions in a manner designed to (i) reduce up-front capital expenditures
required to enter new markets, (ii) avoid the risk of "stranded"
investment in under-utilized fiber networks and (iii) enter markets and
generate revenue and positive cash flow more rapidly than if the Company
first constructed its own facilities. The Company intends to further
expand its network in geographic areas where customer concentrations and
traffic patterns make expansion economically justifiable.
The Company also plans to expand its business by offering a full range of
local services in the geographic regions where the Company already has an
established customer base. The Company intends to expand its local
services by (i) deploying its facilities-based infrastructure in
conjunction with ILEC unbundled network elements ("UNE"); (ii) in those
areas where the Company has not yet deployed local facilities
infrastructure, or in those areas where the Company has not yet achieved
significant market penetration, reselling the ILECs' local services
pursuant to state commission-mandated wholesale discounts; and (iii)
entering into agreements with various ILECs and IXCs for termination and
origination of traffic for the Company's on-net local customers. The
Company believes this network deployment strategy, along with its ability
to leverage its existing customer base and demonstrated sales and
provisioning expertise, will help to produce rapid penetration into local
markets. Additionally, the Company believes that the bundling of local
service with its long distance or data services will enhance customer
retention and further enhance operating margins.
Four phases of the Company's network expansion are anticipated to take
place by the end of 1999. These phases are as follows:
IXC Platform and International Gateway. In addition to the four Nortel
switches currently deployed, the Company intends to increase its IXC
footprint through expanded tandem and/or end-office trunking, deployment
of additional points-of-presence ("POPs") and, where traffic
concentration justifies, deploying additional switching facilities.
Future IXC switching sites potentially includes Texas, Colorado and the
Pacific Northwest.
Local Northeast Platform. The Company is currently deploying local
switching infrastructure in the Northeastern United States, which will
allow the Company to take advantage of its customer concentration in this
region. Specifically, the Company is deploying Lucent 5ESS switches in
both Cambridge, Massachusetts and New York City, along with numerous
circuit and fast packet access nodes located in central offices and
targeted buildings throughout its Northeastern region.
Local Southeast Platform. The Company intends to deploy local switching
infrastructure in the Southeastern United States, which will allow the
Company to take advantage of its customer concentration in this region.
While the Company is still evaluating various network configurations, it
is the Company's current intention to install Lucent 5ESS switches in
<PAGE> 17
Southeastern locations, along with numerous circuit and fast packet access
nodes located in central offices and targeted buildings throughout its
Southeastern region.
Service Builder. In 1998, the Company began the installation of Service
Builder, Nortel's next generation AIN platform, as an extension of the SS7
technology embedded in the Company's network protocol. Specific value-
added features currently supported by Service Builder include: (i) "500
number" technology; (ii) "follow me" services; (iii) local number
portability (mandated by the Telecommunications Act); (iv) mass
customization of number translation services; and (v) deployment of
virtual private networks. The Company expects to deploy Service Builder
in mid-1999.
Fiber and Transport
In addition to its current redundant fiber ring and existing transport
agreements, the Company will continue to evaluate the acquisition or lease
of additional intercity and intracity fiber routes.
Sprint Agreement
In those geographic areas in which the Company has not deployed network
elements, it contracts for and resells long distance domestic and
international services from Sprint.
MANAGEMENT INFORMATION SYSTEMS, PROVISIONING, BILLING AND COLLECTIONS
Overview
The Company is committed to the implementation of an integrated
provisioning, billing, collection and customer service system that
provides accurate and timely information to both the Company and its
customers. The Company's billing system is designed to provide access to
a broad range of information on individual customers, including their call
volume, patterns of usage and billing history.
In connection with its anticipated growth, the Company has incurred and
expects to incur significant costs to upgrade its information technology
systems. The new system being developed by the Company is built on an
open scalable client/server Oracle platform and is expected to better
integrate the Company's operations, both geographically and among
departments. There can be no assurance that the Company will realize the
intended benefits from this new system or that the Company will not incur
significant unanticipated costs in deploying this system.
Provisioning
The Company believes that a significant ongoing challenge for ICPs will be
to continuously improve provisioning systems. Accordingly, the Company
will continue to identify and focus on implementing the best provisioning
practices in each of its markets to provide for rapid, seamless transition
<PAGE> 18
of customers from the ILEC to the Company. To support the provisioning of
its services, the information platform being developed by the Company is
designed to deliver information and automated ordering and provisioning
capability directly to the end user as well as to the Company's internal
staff. The Company believes that these practices and its comprehensive
information technology platform, as developed, will provide the Company
with a long-term competitive advantage and allow it to more rapidly
implement switched local services in its markets and to shorten the time
between the receipt of a customer order and the generation of revenue.
Billing
The Company maintains, within its internal OSS, all customer information,
operational data, accounts receivable information, rating rules and
tables, and tax tables necessary for billing its customers. The Company
collects and processes on a daily basis all usage information from its own
network and from the networks of third-party providers. The actual
process of applying rating and taxing information to the millions of
individual message units generated each month, and of generating invoice
print files, is out-sourced to a third party utilizing both a redundant
high-speed IBM MVS mainframe and the proven PL/1 language. Printing of
invoices is out-sourced to a high-speed print shop, and the mailing of all
invoices is currently handled directly by the Company. To optimize both
cash flow and internal workflow metrics, the Company currently utilizes
four billing cycles per month. Additional billing cycles will be added as
dictated by customer growth. To ensure the quality of the billing
process, the Company utilizes strict quality control checks including
boundary and statistical variation testing, sample pricing matrices and
direct sampling.
EMPLOYEES
As of December 31, 1998, the Company employed 406 people. In connection
with its growth strategy, the Company anticipates hiring a significant
number of additional personnel in sales and other areas of the Company's
operations by year end 1999. As a result of the intense competition for
qualified information technology personnel, the Company also uses third-
party information technology consultants. The Company's employees are not
unionized, and the Company believes its relations with its employees are
good. The Company's success will continue to depend in part on its
ability to attract and retain highly qualified employees.
INDUSTRY OVERVIEW
History and Industry Development
Prior to 1984, AT&T dominated both the local exchange and long distance
marketplaces by owning the operating entities that provided both local
exchange and long distance services to most of the U.S. population.
Although long distance competition began to emerge in the late 1970s, the
critical event triggering the growth of long distance competition was the
breakup of AT&T and the separation of its local and long distance
<PAGE> 19
businesses as mandated by the Modified Final Judgment relating to the
breakup of AT&T (the "MFJ"). To foster competition in the long distance
market, the MFJ prohibited AT&T's divested local exchange businesses, the
RBOCs, from acting as single-source providers of telecommunications
services.
Although the MFJ established the preconditions for competition in the
market for long distance services in 1984, the market for local exchange
services has until recently been virtually closed to competition and has
largely been dominated by regulated monopolies. Efforts to open the local
exchange market began in the late 1980s on a state-by-state basis when
CLECs began offering dedicated private line transmission and access
services. These types of services together currently account for
approximately 12% of total local exchange revenue. CLECs were restricted,
often by state laws, from providing other, more frequently used services
such as basic and switched services, which today account for approximately
88% of local exchange revenue.
The Telecommunications Act, which was enacted in February 1996, is
considered to be the most comprehensive reform of the nation's
telecommunications laws and effects the development of competition for
local telecommunications services. Specifically, certain provisions of
the Telecommunications Act provide for (i) the removal of legal barriers
to entry to the local telecommunications services market; (ii) the
interconnection of ILEC networks with competitors' networks; (iii) the
establishment of procedures and requirements to be followed by the RBOCs,
including the requirement that RBOCs offer local services for resale as a
precondition to entering into the long distance and telecommunications
equipment manufacturing markets; and (iv) the relaxation of the regulation
of certain telecommunications services provided by LECs and others. The
Company believes the Telecommunications Act will promote significant
growth in the local telecommunications market as new market entrants
provide expanded service offerings.
The Telecommunications Act further increases the opportunities available
to CLECs by requiring the RBOCs and other ILECs to offer various network
elements such as switching, transport and loops (i.e., the facilities
connecting a customer's premises to a LEC central office) on an unbundled
and non-discriminatory basis. RBOCs also are required to offer their
retail services at wholesale rates for resale by other companies. By
offering such services, RBOCs also meet certain Telecommunications Act
requirements that are preconditions to obtaining FCC approval to provide
in-region long distance services.
The continuing deregulation of the telecommunications industry and
technological change has resulted in an increasingly information-intensive
business environment. Regulatory, technological, marketing and
competitive trends have expanded substantially the Company's opportunities
in the converging voice and data communications services markets. For
example, technological advances, including rapid growth of the Internet,
<PAGE> 20
the increased use of packet switching technology for voice communications
and the growth of multimedia applications, are expected to result in
substantial growth in the high-speed data services market.
This new market opportunity will permit competitive providers who can
manage the operational and marketing implementation to offer a full range
of telecommunications services, including local and long distance calling,
toll-free calling, custom calling features, data services, Internet access
and cellular services. The Company believes that customers will prefer a
single source for all of their voice and data telecommunications
requirements, including products, billing and service. Telecommunications
companies with an established base of long distance customers will have
the opportunity to sell additional services to such customers. The
Company believes that a one-stop provider of integrated communications
services will have the opportunity to penetrate its existing markets,
expand its customer base, capture a larger portion of its customers' total
expenditures on communication services and reduce customer turnover.
Furthermore, companies that develop their own networks will have the
opportunity to migrate customers from off-net to on-net, thereby
increasing long-term operating margins and giving such companies greater
control over their network operations.
The Company also believes that small and medium-sized businesses have
historically been underserved with respect to customer service and
support. Because, the Company believes, RBOCs and the largest national
carriers primarily concentrate their sales and marketing efforts on
residential and large business customers, there is a significant market
opportunity with respect to small and medium-sized businesses.
Geographically, the Company believes that the Northeastern and
Southeastern regions of the United States are attractive markets due to a
number of factors, including (i) the population density in the Northeast;
(ii) a large number of rapidly growing metropolitan clusters in the
Southeast, such as Atlanta, Miami/Fort Lauderdale and Orlando; and (iii)
the relatively small number of significant competitors to the ILECs.
Telecommunications Services Market
Overview of U.S. Market. The U.S. market for telecommunications services
can be divided into three basic sectors: long distance services, local
exchange services and Internet access services. In its February 1999
report "Trends in Telephone Service", the Industry Analysis Division of
the Federal Communications Commission's Common Carrier Bureau estimated
that, in the United States, long distance services generated revenue of
approximately $89.0 billion in 1997 and local exchange services accounted
for revenue of approximately $97.1 billion. Revenue for both local
exchange and long distance services include amounts charged by long
distance carriers and subsequently paid to ILECs (or, where applicable,
CLECs) for long distance access.
Long Distance Services. A long distance telephone call can be envisioned
as consisting of three segments. Starting with the originating customer,
the call travels along a local exchange network to a long distance
<PAGE> 21
carrier's point of presence ("POP"). At the POP, the call is combined
with other calls and sent along a long distance network to a POP on the
long distance carrier's network near where the call will terminate. The
call is then sent from this POP along a local network to the terminating
customer. Long distance carriers provide the connection between the two
local networks, and, unless the long distance carrier also provides a
local service, it must pay access charges to LECs for originating and
terminating calls.
Local Exchange Services. A local call is one that does not require the
services of a long distance carrier. In general, the local exchange
carrier connects end user customers within a LATA and also provides the
local portion of most long distance calls.
Internet Service. Internet services are generally provided in at least
two distinct segments. A local network connection is required from the
ISP customer to the ISP's local facilities. For large, communication-
intensive users and for content providers, the connections are typically
unswitched, dedicated connections provided by ILECs, CLECs or ICPs, either
as independent service providers or, in some cases, by a company that is
both a CLEC and an ISP. For residential and small and medium-sized
business users, these connections are generally public switched telephone
network ("PSTN") connections obtained on a dial-up access basis as a
local exchange telephone call. Once a local connection is made to the
ISP's local facilities, information can be transmitted and obtained over a
packet-switched IP data network, which may consist of segments provided by
many interconnected networks operated by a number of ISPs. The collection
of interconnected networks makes up the Internet. A key feature of
Internet architecture and packet-switching is that a single dedicated
channel between communication points is never established, which
distinguishes Internet-based services from the PSTN.
COMPETITION
Overview
The Company operates in a highly competitive industry and believes that it
does not have significant market share in any market in which it operates.
The Company expects that competition will continue to intensify in the
future due to regulatory changes, including the continued implementation
of the Telecommunications Act, and the increase in the size, resources and
number of market participants. In each of its markets, the Company will
face competition for local service from larger, better capitalized ILECs
and CLECs. Additionally, the long distance market is already significantly
more competitive than the local exchange market because the ILECs, prior
to enactment of the Telecommunications Act, generally had a monopoly
position within the local exchange market. While new business
opportunities will be made available to the Company through the
Telecommunications Act and other Federal and state regulatory initiatives,
regulators are likely to provide the ILECs with an increased degree of
flexibility with regard to pricing of their services as competition
increases.
<PAGE> 22
Competition for the Company's products and services is based on price,
quality, reputation, name recognition, network reliability, service
features, billing services, perceived quality and responsiveness to
customers' needs. While the Company believes that it currently has
certain advantages relating to price, quality, customer service, and
responsiveness to customer needs, there is no assurance that the Company
will be able to maintain these advantages or obtain additional advantages.
A continuing trend toward business combinations and alliances in the
telecommunications industry may create significant new competitors to the
Company. Many of the Company's existing and potential competitors have
financial, technical and other resources significantly greater than those
of the Company. In addition, in December 1997 the FCC issued rules to
implement the provisions of the World Trade Organization Agreement on
Basic Telecommunications, which was drafted to liberalize restrictions on
foreign ownership of domestic telecommunications companies and to allow
foreign telecommunications companies to enter domestic markets. The new
FCC rules went into effect in February 1998 and are expected to make it
substantially easier for many non-U.S. telecommunications companies to
enter the U.S. market, thus further increasing the number of competitors.
The new rules will also give non-U.S. individuals and corporations greater
ability to invest in U.S. telecommunications companies, thus increasing
the financial and technical resources potentially available to the Company
and its existing and potential competitors.
Long Distance Market
The long distance telecommunications industry is highly competitive and
affected by the introduction of new services by, and the market activities
of, major industry participants. The Company competes against various
national and regional long distance carriers, including both facilities-
based providers and switchless resellers offering essentially the same
services as the Company. In addition, significant competition is expected
to be provided by ILECs including, when authorized, RBOCs. The Company's
success will depend upon its ability to provide high-quality services at
prices generally competitive with, or lower than, those charged by its
competitors. In addition, the long distance industry is characterized by
a high level of customer attrition or "churn". Such attrition is
attributable to a variety of factors, including initiatives of competitors
as they engage in advertising campaigns, marketing programs and cash
payments and other incentives. End users are often not obligated to
purchase any minimum usage amount and can discontinue service without
penalty at any time. While the Company believes its customer turnover
rate is lower than that of many of its competitors, the Company's revenue
has been, and is expected to continue to be, affected by churn.
AT&T, MCI, Sprint and other carriers have implemented new pricing plans
aimed at residential customers with significantly simplified rate
structures, which may have the impact of lowering overall long distance
prices. There can also be no assurance that long distance carriers will
not make similar offerings available to the small to medium-sized
businesses that the Company primarily serves. While the Company believes
<PAGE> 23
small and medium-sized business customers are not aggressively targeted by
large long distance providers such as AT&T, MCI and Sprint, there can be
no assurance the Company's customers and potential customers will not be
targeted by these or other providers in the future. Additional pricing
pressure may come from Internet protocol ("IP") transport, which is a
developing use of packet-switched technology that can transmit voice
communications at a cost that may be below that of traditional circuit-
switched long distance service. While IP transport is not yet available in
all areas, requires the dialing of additional digits, and generally
produces sound quality inferior to traditional long distance service, it
could eventually be perceived as a substitute for traditional long
distance service and put pricing pressure on long distance rates. Any
reduction in long distance prices may have a material adverse effect on
the Company's results of operations.
One of the Company's principal competitors, Sprint, is also a major
supplier of services to the Company. The Company both links its switching
equipment with transmission facilities and services purchased or leased
from Sprint, and resells services obtained from Sprint. There can be no
assurance that Sprint will continue to offer services to the Company at
competitive rates or on attractive terms, if at all, and any failure to do
so could have a material adverse effect on the Company.
Local Exchange Market
Under the Telecommunications Act and related Federal and state regulatory
initiatives, barriers to local exchange competition are being removed. In
local telecommunication markets, the Company's primary competitor will be
the ILEC serving each geographic area. ILECs are established providers of
dedicated and local telephone services to all or virtually all telephone
subscribers within their respective service areas. ILECs also have long-
standing relationships with regulatory authorities at the federal and
state levels. While recent FCC administrative decisions and initiatives
provide increased business opportunities to voice, data and Internet-
service providers, they also provide the ILECs with increased pricing
flexibility for their private line, special access and switched access
services. In addition, with respect to competitive access services, the
FCC recently proposed a rule that would provide for increased ILEC pricing
flexibility and deregulation for such access services either automatically
or after certain competitive levels are reached. If the ILECs are allowed
additional flexibility by regulators to offer discounts to large customers
through contract tariffs, decide to engage in aggressive volume and term
discount pricing practices for their customers, or seek to charge
competitors excessive fees for interconnection to their networks, the
revenue of competitors to the ILECs could be materially adversely
affected. If future regulatory decisions afford the ILECs increased
access services, pricing flexibility or other regulatory relief, such
decisions could also have a material adverse effect on competitors to the
ILECs.
The Company also will face competition or prospective competition in local
markets from other carriers, many of which have significantly greater
<PAGE> 24
financial resources than the Company. For example, AT&T, MCI and Sprint
have each begun to offer local telecommunications services in major U.S.
markets using their own facilities or by resale of the ILECs or other
providers' services. In addition to these long distance service
providers, entities that currently offer or are potentially capable of
offering local switched services include companies that have previously
operated as competitive access providers, cable television companies,
electric utilities, microwave carriers, wireless telephone system
operators and large customers who build private networks. These entities,
upon entering into appropriate interconnection agreements or resale
agreements with ILECs, including RBOCs, could offer single-source local
and long distance services, similar to those offered or proposed to be
offered by the Company.
In addition, a continuing trend towards business combinations and
alliances in the telecommunications industry may create significant new
competitors to the Company. Many of the entities resulting from these
combinations will have resources far greater than those of the Company.
These combined entities may provide a bundled package of
telecommunications products, including local and long distance telephony,
that is in direct competition with the products offered or proposed to be
offered by the Company, and may be capable of offering these products
sooner and at more competitive rates than the Company.
Wireless Market
The Company will also face competition from fixed wireless services,
including MMDS, LMDS, 24 GHz and 38 GHz wireless communications systems,
FCC Part 15 unlicensed wireless radio devices, and other services that use
existing point-to-point wireless channels on other frequencies. In
addition, the FCC has allocated a number of spectrum blocks for use by
wireless devices that do not require site or network licensing. A number
of vendors have developed such devices that may provide competition to the
Company, in particular for certain low data-rate transmission services.
With respect to mobile wireless telephone system operators, the FCC has
authorized cellular, PCS, and other CMRS providers to offer wireless
services to fixed locations, rather than just to mobile customers, in
whatever capacity such CMRS providers choose. Previously, cellular
providers could provide service to fixed locations only on an ancillary or
incidental basis. The authority to provide fixed as well as mobile
services will enable CMRS providers to offer wireless local loop service
and other services to fixed locations (e.g., office and apartment
buildings) in direct competition with the Company and existing providers
of traditional wireless telephone service.
Other
Section 271 of the Telecommunications Act prohibits an RBOC from providing
long distance service that originates (or in certain cases terminates) in
one of its in-region states, with several limited exceptions, until the
RBOC has satisfied certain statutory conditions in that state and has
<PAGE> 25
received the approval of the FCC. The FCC has denied the following
applications for such approval: SBC's Texas application in June 1998;
SBC's Oklahoma application in June 1997; Ameritech's Michigan application
in August 1997; and BellSouth Corporation's applications for South
Carolina in December 1997 and Louisiana in February 1998 and October 1998.
The Company anticipates that a number of RBOCs will file additional
applications for in-region long distance authority in the next two years.
Bell Atlantic recently received conditional approval from the New York
Public Service Commission of its Section 271 application for New York
State.
Once the RBOCs are allowed to offer widespread in-region long distance
services, both they and the largest IXCs will be in a position to offer
single-source local and long distance service.
In addition, FCC rules went into effect in February 1998 that will make it
substantially easier for many non-U.S. telecommunications companies to
enter the U.S. market, thus potentially further increasing the number of
competitors.
The market for data communications and Internet access services is also
extremely competitive. There are no substantial barriers to entry, and
the Company expects that competition will intensify in the future. The
Company's success selling these services will depend heavily upon its
ability to provide high quality Internet connections at competitive
prices.
GOVERNMENT REGULATION
The following summary of regulatory developments and legislation does not
purport to describe all present and proposed Federal, state and local
regulations and legislation affecting the telecommunications industry.
Other existing Federal, state and local legislation and regulations are
currently the subject of judicial proceedings, legislative hearings, and
administrative proposals that could change, in varying degrees, the manner
in which the telecommunications industry operates. Neither the outcome of
these proceedings, nor their impact upon the telecommunications industry
or the Company, can be predicted at this time. This section summarizes
regulatory and tariff issues pertaining to the operation of the Company.
Overview
The Company's services are subject to regulation by federal, state and
local government agencies. The FCC exercises jurisdiction over all
facilities and services of telecommunications common carriers to the
extent those facilities are used to provide, originate or terminate
domestic (interstate) or international communications. State regulatory
commissions retain jurisdiction over carriers' facilities and services to
the extent they are used to originate or terminate intrastate
communications. Municipalities and other local government agencies may
require carriers to obtain licenses or franchises regulating use of public
rights-of-way necessary to install and operate their networks. The
<PAGE> 26
networks are also subject to numerous local regulations such as building
codes, franchises, and rights-of-way licensing requirements. Many of the
regulations issued by these regulatory bodies may change, the results of
which the Company is unable to predict.
The Federal Telecommunications Act of 1996
Statutory Requirements. On February 1, 1996, the U.S. Congress enacted
comprehensive telecommunications legislation, which the President signed
into law on February 8, 1996. The Company believes that this legislation
is likely to enhance competition in the local telecommunications
marketplace because it (i) gives the FCC authority to preempt state and
local entry barriers, (ii) requires ILECs to provide interconnection to
their facilities, (iii) facilitates end-users' choice to switch service
providers from ILECs to CLECs and (iv) proscribes the imposition of
discriminatory or anticompetitive requirements by state or local
governments for use of public rights-of-way.
The Telecommunications Act requires all LECs (including ILECs and CLECs)
(i) not to prohibit or unduly restrict resale of their services; (ii) to
provide local number portability; (iii) to provide dialing parity and
nondiscriminatory access to telephone numbers, operator services,
directory assistance and directory listings; (iv) to afford access to
poles, ducts, conduits and rights-of-way; and (v) to establish reciprocal
compensation arrangements for the transport and termination of local
telecommunications traffic. It also requires ILECs to negotiate local
interconnection agreements in good faith and to provide interconnection
(a) for the transmission and routing of telephone exchange service and
exchange access, (b) at any technically feasible point within the ILEC's
network, (c) that is at least equal in quality to that provided by the
ILEC to itself, its affiliates or any other party to which the ILEC
provides interconnection, and (d) at rates, terms and conditions that are
just, reasonable and nondiscriminatory. ILECs also are required under the
Telecommunications Act to provide nondiscriminatory access to network
elements on an unbundled basis at any technically feasible point, to offer
their local retail telephone services for resale at wholesale rates, and
to facilitate collocation of equipment necessary for competitors to
interconnect with or access UNEs.
In addition, the Telecommunications Act requires RBOCs to comply with
certain safeguards and offer interconnection that satisfies a prescribed
14-point competitive checklist before the RBOCs are permitted to provide
in-region interLATA (i.e., interexchange long distance) services. These
safeguards are designed to ensure that the RBOCs' competitors have access
to local exchange and exchange access services on nondiscriminatory terms
and that subscribers of regulated non-competitive RBOC services do not
subsidize their provision of competitive services. The safeguards also
are intended to promote competition by preventing RBOCs from using their
market power in local exchange services to obtain an anti-competitive
advantage in the provision of other services.
<PAGE> 27
Three RBOCs, Ameritech Corp., SBC Communications Inc. (formerly
Southwestern Bell Corp.) and BellSouth Corp., have filed applications with
the FCC for authority to provide in-region interLATA service in selected
states. The FCC has denied all such RBOC applications for in-region long
distance authority filed to date. The denials of certain of these RBOC
applications by the FCC are the subjects of judicial appeals and petitions
for rehearing at the FCC. Other RBOCs have begun the process of applying
to provide in-region interLATA service by filing with state commissions
notice of their intent to file at the FCC.
The Telecommunications Act also granted important regulatory relief to
industry segments that compete with CLECs. ILECs were given substantial
new pricing flexibility. RBOCs have the ability to provide out-of-region
long-distance services and, if they obtain authorization and under
prescribed circumstances, may provide additional in-region long-distance
services. RBOCs also were granted new rights to provide certain cable TV
services. IXCs were permitted to construct their own local facilities
and/or resell local services. State laws no longer may require cable
television service providers ("CATVs") to obtain a franchise before
offering telecommunications services nor permit CATVs' franchise fees to
be based on their telecommunications revenue. In addition, under the
Telecommunications Act all utility holding companies are permitted to
diversify into telecommunications services through separate subsidiaries.
FCC Rules Implementing the Local Competition Provisions of the
Telecommunications Act. On August 8, 1996, the FCC released a First Report
and Order, a Second Report and Order and a Memorandum Opinion and Order in
its CC Docket 96-98 (combined, the "Interconnection Orders") that
established a framework of minimum, national rules enabling state public
utility service commissions ("PUCs") and the FCC to begin implementing
many of the local competition provisions of the Telecommunications Act.
In its Interconnection Orders, the FCC prescribed certain minimum points
of interconnection necessary to permit competing carriers to choose the
most efficient points at which to interconnect with the ILECs' networks.
The FCC also adopted a minimum list of unbundled network elements that
ILECs must make available to competitors upon request and a methodology
for states to use in establishing rates for interconnection and the
purchase of unbundled network elements. The FCC also adopted a
methodology for states to use when applying the Telecommunications Act's
"avoided cost standard" for setting wholesale prices with respect to
retail services.
The following summarizes the key issues addressed in the Interconnection
Orders:
Interconnection. ILECs are required to provide interconnection for
telephone exchange or exchange access service, or both, to any
requesting telecommunications carrier at any technically feasible
point. The interconnection must be at least equal in quality to that
by the ILEC to itself or its affiliates and must be provided on
rates, terms and conditions that are just, reasonable and
nondiscriminatory.
<PAGE> 28
Access to Unbundled Elements. ILECs are required to provide
requesting telecommunications carriers with nondiscriminatory access
to network elements on an unbundled basis at any technically feasible
point on rates, terms, and conditions that are just, reasonable and
nondiscriminatory. At a minimum, ILECs must unbundle and provide
access to network interface devices, local loops, local and tandem
switches (including all software features provided by such switches),
interoffice transmission facilities, signaling and call-related
database facilities, operations support systems, and information and
operator and directory assistance facilities. Further, ILECs may not
impose restrictions, limitations or requirements upon the use of any
unbundled network elements by other carriers.
Methods of Obtaining Interconnection and Access to Unbundled
Elements. ILECs are required to provide physical collocation of
equipment necessary for interconnection or access to unbundled
network elements at the ILEC's premises, except that the ILEC may
provide virtual collocation if it demonstrates to the PSC that
physical collocation is not practical for technical reasons or
because of space limitations.
Transport and Termination Charges. The FCC rules require that LEC
charges for transport and termination of local traffic delivered to
them by competing LECs must be cost-based and should be based on the
LECs' Total Element Long-Run Incremental Cost ("TELRIC") of
providing that service.
Pricing Methodologies. New entrants were required to pay for
interconnection and UNEs at rates based on the ILEC's TELRIC of
providing a particular UNEs plus a reasonable share of forward-
looking joint and common costs, and may include a reasonable profit.
Resale. ILECs were required to offer for resale any
telecommunications service that they provide at retail to subscribers
who are not telecommunications carriers. PUCs were required to
identify which marketing, billing, collection and other costs will be
avoided or that are avoidable by ILECs when they provide services on
a wholesale basis and to calculate the portion of the retail rates
for those services that is attributable to the avoided and avoidable
costs.
Access to Rights-of-Way. The FCC established procedures and
guidelines designed to facilitate the negotiation and mutual
provision of nondiscriminatory access by telecommunications carriers
and utilities to their poles, ducts, conduits, and rights-of-way.
<PAGE> 29
Universal Service Reform. All telecommunications carriers,
including the Company, are required to contribute funding for
universal service support, on an equitable and nondiscriminatory
basis, in an amount sufficient to preserve and advance universal
service pursuant to a specific or predictable universal service
funding mechanism. On May 8, 1997, the FCC released an order
implementing these requirements by reforming its existing access
charge and universal service rules.
Most provisions of the Interconnection Orders were appealed. Numerous
appeals were consolidated for consideration by the Eighth Circuit Court of
Appeals (captioned Iowa Utilities Board v. FCC). On July 18, 1997, the
Court of Appeals vacated portions of the FCC's local interconnection
rules. On January 25, 1999, the U.S. Supreme Court reversed the Eighth
Circuit decision, upholding the FCC's authority to establish national
pricing rules for interconnection, unbundled network elements and resold
services. The Supreme Court overturned the FCC's rules regarding what
network elements must be unbundled by the RBOC's, and remanded to the FCC
the question of what network elements are "necessary" to competing
carriers. In addition, the Supreme Court created some uncertainty
regarding the legal status of complaints filed at the FCC to enforce
interconnection agreements by finding that the issue was not ripe for
judicial consideration. Further proceedings on remand could affect the
Company's ability to obtain interconnection agreements on favorable terms.
The Company cannot assure that it will succeed in obtaining
interconnection agreements on terms that would permit the Company to offer
local services at profitable and competitive rates.
Any successful effort by the RBOCs or other local exchange carriers to
deny or limit access to their network elements or wholesale services would
have a material adverse effect on the Company's business, results of
operations, and financial condition.
Section 706 Forbearance. Section 706 of the Telecommunications Act gives
the FCC the right to forebear from regulating a market if the FCC
concludes that such forbearance is necessary to encourage the rapid
deployment of advanced telecommunications capability. Section 706 has not
been used to date, but in January 1998 Bell Atlantic filed a petition
under Section 706 seeking to have the FCC deregulate entirely the
provision of packet-switched telecommunications services. Similar
petitions were later filed by the Alliance for Public Technology and US
West Inc. (currently Media One Group Inc.), and other ILECs are expected
to file similar petitions in the near future.
On August 7, 1998, the FCC released an Order denying requests by the
Regional Bell Operating Companies (RBOCs) that it use Section 706 of the
Telecommunications Act to forbear from regulating advanced
telecommunications services. Instead, the FCC determined that advanced
services are telecommunications services and that ILECs providing advanced
services are still subject to the unbundling and resale obligations of
Section 251(c) and the in-region interLATA restrictions of Section 271.
<PAGE> 30
On the same day, the FCC released a Notice of Proposed Rulemaking
("NPRM") proposing that ILECs be permitted to offer advanced services
through separate affiliates. The FCC recently adopted rules to strengthen
collocation requirements to assist competing carriers in providing
advanced services on a faster, more cost-effective basis; however, the FCC
did not act on the separate affiliate proposal, which remains pending.
The outcome of this proceeding could have a material adverse effect on the
Company.
On August 7, 1998, the FCC also issued a Notice of Inquiry ("NOI") to
explore the availability of advanced, high-speed telecommunications
services. On February 2, 1999, the FCC released a report finding that
advanced services are being deployed to all Americans on a reasonable and
timely basis and that there is no need for the FCC to undertake any
further regulatory efforts beyond those underway in more general
proceedings.
Other Federal Regulation. In general, the FCC has a policy of encouraging
the entry of new competitors in the telecommunications industry and
preventing anti-competitive practices. Therefore, the FCC has established
different levels of regulation for dominant carriers and nondominant
carriers. For purposes of domestic common carrier telecommunications
regulation, large ILECs such as GTE and the RBOCs are currently considered
dominant carriers, while CLECs are considered nondominant carriers.
Tariffs. As a nondominant carrier, the Company may install and
operate facilities for the transmission of domestic interstate
communications without prior FCC authorization. Services of
nondominant carriers have been subject to relatively limited
regulation by the FCC, primarily consisting of the filing of tariffs
and periodic reports. However, nondominant carriers like the Company
must offer interstate services on a nondiscriminatory basis, at just
and reasonable rates, and remain subject to FCC complaint procedures.
With the exception of informational tariffs for operator-assisted
services and tariffs for interexchange casual calling services, the
FCC has ruled that IXCs must cancel their tariffs for domestic,
interstate interexchange services. Tariffs remain required for
international services. The effectiveness of those orders currently
is subject to a stay issued by the U.S. Court of Appeals for the
District of Columbia Circuit. On June 19, 1997, the FCC issued an
order granting petitions filed by Hyperion Telecommunications Inc.
and Time Warner Inc. to provide CLECs the option to cease filing
tariffs for interstate interexchange access services and has proposed
to make the withdrawal of CLEC access service tariffs mandatory.
Pursuant to these FCC requirements, the Company has filed and
maintains tariffs for its interstate services with the FCC. All of
the interstate access and retail "basic" services (as defined by the
FCC) provided by the Company are described therein. "Enhanced"
services (as defined by the FCC) need not be tariffed. The Company
believes that its proposed enhanced voice and Internet services are
<PAGE> 31
"enhanced" services that need not be tariffed. However, the FCC is
reexamining the "enhanced" definition as it relates to IP transport
and the Company cannot predict whether the FCC will change the
classification of such services.
International Services. Nondominant carriers such as the Company
also are required to obtain FCC authorization pursuant to Section 214
of the Communications Act and file tariffs before providing
international communications services. The Company has obtained
authority from the FCC to provide voice and data communications
services between the United States and all foreign authorized points.
ILEC Price Cap Regulation Reform. In 1991, the FCC replaced
traditional rate of return regulation for large ILECs with price cap
regulation. Under price caps, ILECs can raise prices for certain
services by only a small percentage each year. In addition, there
are constraints on the pricing of ILEC services that are competitive
with those of CLECs. On September 14, 1995, the FCC proposed a
three-stage plan that would substantially reduce ILEC price cap
regulation as local markets become increasingly competitive and
ultimately would result in granting ILECs nondominant status.
Adoption of the FCC's proposal to reduce significantly its regulation
of ILEC pricing would significantly enhance the ability of ILECs to
compete against the Company and could have a material adverse effect
on the Company. The FCC released an order on December 24, 1996 that
adopted certain of these proposals, including the elimination of the
lower service band index limits on price reductions within the access
service category. The FCC's December 1996 order also eased the
requirements necessary for the introduction of new services by ILECs.
On May 7, 1997, the FCC took further action in its CC Docket No. 94-1
updating and reforming its price cap plan for the ILECs. Among other
things, the changes require price cap LECs to reduce their price cap
indices by 6.5 percent annually, less an adjustment for inflation.
The FCC also eliminated rules that require ILECs earning more than
certain specified rates of return to "share" portions of the excess
with their access customers during the next year in the form of lower
access rates. These actions could have a significant impact on the
interstate access prices charged by the ILECs with whom the Company
expects to compete.
Access Charges. Over the past few years, the FCC has granted ILECs
significant flexibility in pricing their interstate special and
switched access services. Under this pricing scheme, ILECs may
establish pricing zones based on access traffic density and charge
different prices for each zone. The Company anticipates that this
pricing flexibility will result in ILECs lowering their prices in
high traffic density areas, the probable area of competition with the
Company. The Company also anticipates that the FCC will grant ILECs
increasing pricing flexibility as the number of interconnections and
competitors increases. On May 7, 1997, the FCC took action in its CC
Docket No. 96-262 to reform the current interstate access charge
system. The FCC adopted an order that makes various reforms to the
<PAGE> 32
existing rate structure for interstate access that are designed to
move access charges, over time, to more economically efficient rate
levels and structures. The following is a nonexclusive list of
actions announced by the FCC:
Subscriber Line Charge ("SLC"). The maximum permitted amount that
an ILEC may charge for SLCs on certain lines was increased.
Specifically, the ceiling was increased significantly for second and
additional residential lines, and for multi-line business customers.
SLC ceiling increases began in July 1997 and will be phased in over a
two-year period.
Presubscribed Interexchange Carrier Charge ("PICC"). The FCC
created a new PICC access charge rate element. The PICC is a flat-
rate, per-line charge that is recovered by LECs from IXCs. The
charge is designed to recover common line revenue not recovered
through SLCs. Effective January 1, 1998, the maximum permitted
interstate PICC charge is $0.53 per month for primary residential
lines and $1.50 per month for second and additional residential
lines. The initial maximum interstate PICC for multi-line businesses
are $2.75. The ceilings will be permitted to increase over time.
Carrier Common Line Charge ("CCL"). As the ceilings on the SLCs
and PICCs increase, the per-minute CCL charge will be eliminated.
Until then, the CCL will be assessed on originating minutes of use.
Thus, ILECs will charge lower rates for terminating than originating
access. In addition, Long-term Support ("LTS") payments for
universal service will be eliminated from the CCL charge.
Local Switching. Effective January 1, 1998, ILECs subject to price-
cap regulation were required to move non-traffic-sensitive ("NTS")
costs of local switching associated with line ports to common line
rate elements and recover them through the common line charge
discussed above. Local switching costs attributable to dedicated
trunk ports must be moved to the trunking basket and recovered
through flat-rate monthly charges.
Transport. The "unitary" rate structure option for tandem-
switched transport was eliminated effective July 1, 1998. For price
cap LECs, additional rate structure changes became effective on
January 1, 1998, which altered the recovery of certain NTS costs of
tandem- switching and multiplexing and the minutes-of-use assumption
employed to determine tandem-switched transport prices. Also
effective January 1, 1998, certain costs currently recovered through
the Transport Interconnection Charge ("TIC") were reassigned to
specified facilities charges. The reassignment of tandem costs
currently recovered through the TIC to the tandem switching charge
will be phased in evenly over a three-year period. Residual TIC
charges will be covered in part through the PICC, and price cap
reductions will be targeted at the per-minute residual TIC until it
is eliminated.
<PAGE> 33
In other actions, the FCC clarified that ILECs may not assess
interstate access charges on the purchasers of unbundled network
elements or information services providers (including ISPs). Further
regulatory actions affecting ISPs are being considered in a FCC
notice of inquiry released on December 24, 1996. The FCC also
decided not to adopt any regulations governing the provision of
terminating access by CLECs. ILECs also were ordered to adjust their
access charge rate levels to reflect contributions to and receipts
from the new universal service funding mechanisms.
The FCC also announced that it will, in a subsequent Report and
Order, provide detailed rules for implementing a market-based
approach to further access charge reform. On October 5, 1998, the
FCC asked interested parties to update and refresh its record on
pricing flexibility. That process will give ILECs progressively
greater flexibility in setting rates as competition develops,
gradually replacing regulation with competition as the primary means
of setting prices. The FCC also adopted a "prescriptive safeguard"
to bring access rates to competitive levels in the absence of
competition. For all services then still subject to price caps and
not deregulated in response to competition, the FCC required ILECs
subject to price caps to file Total Service Long-Run Incremental Cost
("TSLRIC") cost studies no later than February 8, 2001.
This series of decisions is likely to have a significant impact on
the operations, expenses, pricing and revenue of the Company and
costs vis-a-vis larger, more efficient carriers such as AT&T, MCI and
Sprint. Various parties have sought reconsideration or appeal of
various aspects of the FCC's access charge rulings and part of the
order ultimately could be set aside or revised. On August 19, 1998,
the Court of Appeals for the Eighth Circuit upheld the FCC's May 7,
1997 order in CC Docket No. 96-262. The Company cannot predict the
outcome of these proceedings.
Universal Service Reform. On May 8, 1997, the FCC released an order in
its CC Docket No. 96-45, which reforms the current system of interstate
universal service support and implements the universal service provisions
of the Telecommunications Act. The FCC established a set of policies and
rules that ensure low-income consumers and consumers that live in rural,
insular and high-cost areas receive a defined set of local
telecommunications services at affordable rates. This is accomplished in
part through expansion of direct consumer subsidy programs and in part by
ensuring that rural, small and high-cost LECs continue to receive
universal service subsidy support. The FCC also created new programs to
subsidize connection of eligible schools, libraries and rural health care
providers to telecommunications networks. These programs will be funded by
assessment of eligible revenue of nearly all providers of interstate
telecommunications carriers, including the Company.
The Company, like other telecommunications carriers that provide
interstate telecommunications services, will be required to contribute a
portion of its end-user telecommunications revenue to fund universal
<PAGE> 34
service programs. These contributions became due beginning in 1998 for
all providers of interstate telecommunications services. Such
contributions are assessed based on intrastate, interstate and
international end user telecommunications revenue. Contribution factors
vary quarterly, and carriers, including the Company, are billed each
month. Contribution factors for the first two quarters of 1999 have been
determined by the FCC as follows: first quarter and second quarter factors
are 3.18% and 3.05%, respectively, for the high cost and low income funds
(interstate and international end user telecommunications revenue) and
0.58% and 0.57%, respectively, for the schools, libraries and rural health
funds (intrastate, interstate and international end user communications
revenue). In addition, many state regulatory agencies have instituted
proceedings to revise state universal support mechanisms to make them
consistent with the requirements of the Telecommunications Act. As a
result, the Company will be subject to state, as well as federal,
universal service fund contribution requirements, which will vary from
state to state. Several parties have appealed the FCC's May 8th order,
and these appeals have been consolidated in the U.S. Court of Appeals for
the Fifth Circuit. In addition, a number of telecommunications companies
have filed a petition for a stay with the FCC, which is currently pending.
Pursuant to the Universal Service Order, all carriers were required to
submit a Universal Service Fund worksheet biannually on March 31 and
September 1. The Company has filed its required Universal Service Fund
worksheets. The amounts remitted to the Universal Service Fund may be
billed to the Company's customers. If the Company does not bill these
amounts to its customers, its profit margins may be less than if it had
elected to do so. However, if the Company elects to bill these amounts to
its customers, customers may reduce their use of the Company's services,
or elect to use the services provided by the Company's competitors, which
may have a material adverse effect upon the Company's business, financial
condition, or results of operation. The Company is eligible to qualify as
a recipient of universal service support if it elects to provide
facilities-based local service to areas designated for universal service
support and if it complies with federal and state regulatory requirements
to be an eligible telecommunications carrier. The Company may also
qualify to receive universal support if it provides eligible services to
schools and libraries at discounted rates. The FCC's decisions in CC
Docket No. 96-45 could have a significant impact on future operations of
the Company. Significant portions of the FCC's order have been appealed
and are under review by the U.S. Court of Appeals for the Fifth Circuit.
The Company cannot predict the outcome of these proceedings.
Current Company Certifications. The Company has received Section 214
authorization from the FCC allowing it to engage in business as a resale
and facilities-based international carrier.
State Regulation
Most states require a certification or other authorization to offer local
exchange and intrastate long distance services. These certifications
generally require a showing that the carrier has adequate financial,
<PAGE> 35
managerial and technical resources to offer the proposed services in a
manner consistent with the public interest. In addition to tariff
requirements, most states require that common carriers charge just and
reasonable rates and not discriminate among similarly situated customers.
Some states also require the filing of periodic reports, the payment of
various regulatory fees and surcharges, and compliance with service
standards and consumer protection rules. States generally retain the
right to sanction a carrier or to revoke certification if a carrier
violates relevant laws and/or regulations. If any state regulatory agency
were to conclude that the Company is or was providing intrastate services
without the appropriate authority, the agency could initiate enforcement
actions, which could include the imposition of fines, a requirement to
disgorge revenues, or the refusal to grant the regulatory authority
necessary for the future provision of intrastate telecommunications
services. The Company holds authority to provide intrastate interLATA
and, where authorized, intraLATA toll service in 49 states. The authority
in some states may be limited to resale of long distance service. The
Company is in the process of obtaining intrastate toll authority in
Alaska. The Company has authority to provide competitive local exchange
service in Connecticut, Florida, Georgia, Massachusetts, New Hampshire,
New Jersey, New York, Pennsylvania, Rhode Island and Tennessee. The
Company has applications pending to provide resold and facilities-based
competitive local exchange services in several other Northeastern and
Southeastern states. There can be no assurance that the Company will
receive the authorizations it seeks currently or in the future.
The Company believes that most, if not all, states in which it proposes to
operate as a local telecommunications provider will require certification
or other authorization to offer local intrastate services. Many of the
states in which the Company intends to operate are in the process of
addressing issues relating to the regulation of CLECs.
In some states, existing state statutes, regulations or regulatory policy
may preclude some or all forms of local service competition. However,
Section 253 of the Telecommunications Act prohibits states and localities
from adopting or imposing any legal requirement that may prohibit, or have
the effect of prohibiting, the ability of any entity to provide any
interstate or intrastate telecommunications service. The FCC has the
authority to preempt any such state or local requirements to the extent
necessary to enforce the Telecommunications Act's open market entry
requirements. States and localities may, however, continue to regulate
the provision of intrastate telecommunications services and require
carriers to obtain certificates or licenses before providing service if
such requirements do not constitute prohibited barriers to market entry.
Some states in which the Company operates are considering legislation that
could impede efforts by new entrants in the local services market to
compete effectively with ILECs.
The Company believes that, as the degree of intrastate competition
increases, the states will offer the ILECs increasing pricing flexibility.
This flexibility may present the ILECs with an opportunity to subsidize
<PAGE> 36
services that compete with the Company's services with revenue generated
from non-competitive services, thereby allowing ILECs to offer competitive
services at prices below the cost of providing the service. The Company
cannot predict the extent to which this may occur or its impact on the
Company's business.
Local Interconnection. The Telecommunications Act imposes a duty upon all
ILECs to negotiate in good faith with potential interconnectors to provide
interconnection to the ILEC networks, exchange local traffic, make
unbundled network elements available and permit resale of most local
services. In the event that negotiations do not succeed, the Company has
a right to seek state PUC arbitration of any unresolved issues.
Arbitration decisions involving interconnection arrangements in several
states have been challenged and appealed to U.S. Courts of appeal. The
Company may experience difficulty in obtaining timely ILEC implementation
of local interconnection agreements, and there can be no assurance the
Company will offer local services in these areas in accordance with its
projected schedule, if at all.
Local Government Authorizations. If the Company constructs local
networks, it will be required to obtain street use and construction
permits and licenses and/or franchises to install and expand its fiber
optic networks using municipal rights-of-way. In some municipalities, the
Company may be required to pay license or franchise fees based on a
percentage of gross revenue or on a per linear foot basis, as well as post
performance bonds or letters of credit. There can be no assurance that
the Company will not be required to post bonds in the future. In many
markets, the ILECs do not pay such franchise fees or pay fees that are
substantially less than those that will be required to be paid by the
Company. To the extent that competitors do not pay the same level of fees
as the Company, the Company could be at a competitive disadvantage.
However, the Telecommunications Act provides that any compensation
extracted by states and localities for use of public rights-of-way must be
"fair and reasonable", applied on a "competitively neutral and
nondiscriminatory basis" and be "publicly disclosed" by such government
entity.
<PAGE> 37
Executive Officers and Directors
The following table provides certain information regarding the executive
officers and directors of the Company, including their ages, as of
December 31, 1998:
NAME AGE POSITION
- ------------------------ --- ------------------------------------------
Robert T. Hale 60 Chairman of the Board of Directors
Robert T. Hale, Jr. 32 Chief Executive Officer, President and
Director
James J. Crowley 34 Executive Vice President, Chief Operating
Officer, Secretary and Director
David Martin 59 Director
Joseph C. McNay 64 Director
Michael F. Oyster 42 Executive Vice President of Networks and
Product Development
Joseph Haines 36 Vice President of Local Operations
Steven L. Shapiro 40 Vice President of Finance,
Chief Financial Officer and Treasurer
Steven J. Stanfill 45 Vice President of Network Services
Kevin B. McConnaughey 41 Vice President and General Manager of
International Services
<PAGE> 38
Robert T. Hale is a co-founder of the Company and has served as Chairman
of the Board since its inception in 1990. Mr. Hale is a founding member of
the Telecommunications Resellers Association and has served as chairman of
its Carrier Committee since 1993 and served as chairman of its board from
May 1995 to May 1997. Mr. Hale was president of Hampshire Imports, the
original importer of Laura Ashley Womenswear to the U.S. and a manufacturer
of exclusive women's apparel, from 1968 to 1992.
Robert T. Hale, Jr., is a co-founder of the Company and has served as
Chief Executive Officer, President and Director since its inception in
1990. He was employed by U.S. Telecenters, a sales agent for NYNEX
Corporation, from 1989 to 1990, and as a sales representative at MCI from
1988 to 1989.
James J. Crowley has served as Executive Vice President since 1994 and
became Chief Operating Officer and a Director in 1998. He was an attorney
at Hale and Dorr LLP, a Boston law firm, from 1992 to 1994.
David Martin has served as a Director of the Company since September
1998. Mr. Martin was employed by Texas Instruments Inc. from 1960 until
June 1998, most recently as Executive Vice President. Mr. Martin is a
member of the Board of Directors of Mathsoft Inc.
Joseph C. McNay has served as a Director of the Company since September
1998. Mr. McNay serves as Chairman and Chief Investment Officer of Essex
Investment Management Company, LLC, a private investment management company
founded by Mr. McNay in 1976. Previously he served as Executive Vice
President and Director of Endowment Management & Research Corp. Mr. McNay
serves as Trustee of University Hospital, Boston, Trustee of Simmons
College, Trustee of the Dana Farber Cancer Institute, and Chairman and
Trustee of Children's Hospital, Boston.
Michael F. Oyster was named Executive Vice President of Networks and
Product Development in July 1998. Mr. Oyster served as Regional Vice
President and General Manager, and in other capacities, at Teleport
Communications Group from August 1997 to July 1998. Mr. Oyster served in
various capacities at AT&T from 1977 to 1997.
Joseph Haines was named Vice President of Local Operations in July 1998.
From 1992 to 1998, Mr. Haines held various positions with Teleport
Communications Group, most recently as its Regional Vice President of
Operations.
Steven L. Shapiro has served as Vice President of Finance, Chief
Financial Officer and Treasurer since July 1997. He served as Vice
President and Controller of Grossman's Inc., a publicly held retailer of
building materials, from 1993 to 1997, and as its Assistant Controller from
1986 to 1993. Mr. Shapiro served as a certified public accountant with
Arthur Andersen & Co. from 1979 to 1986.
<PAGE> 39
Steven J. Stanfill has served as Vice President of Network Services since
1994. He served as Vice President of Network Operations at Ascom
Communications, a telecommunication services provider, from 1989 to 1994.
From 1983 to 1989, Mr. Stanfill served in various management capacities at
National Applied Computer Technologies, a telecommunications switching
equipment manufacturer.
Kevin B. McConnaughey has served as Vice President and General Manager of
International Services since March 1997. From 1995 to 1997, he was
Associate Vice President of Business Development for Teleglobe
International. From 1990 to 1995, Mr. McConnaughey was employed by Sprint
International, where he held a variety of product management, international
carrier relations and marketing positions.
Each director serves until his or her successor is duly elected and
qualified. Officers serve at the discretion of the Board of Directors.
Robert T. Hale, Jr. is the son of Robert T. Hale. There are no other
family relationships among the Company's executive officers and directors.
No executive officer of the Company is a party to an employment agreement
with the Company.
Item 2. PROPERTIES
The Company's corporate headquarters are located in a 39,500-square foot
facility in Quincy, Massachusetts. The Quincy facility also serves as a
sales office and includes the Company's customer service operations,
certain network facilities and its Network Operations Center. The Quincy
facility is leased from an affiliate of the Company. The Company currently
leases 11 additional facilities for current sales offices. The Company
also leases real estate to house its telemarketing center in Largo,
Florida, interexchange switching facilities in Los Angeles, Chicago and
Orlando, and local switching facilities in Cambridge, Massachusetts and New
York City. The Company has also recently entered into a lease to house a
network management facility on Long Island, New York.
Item 3. LEGAL PROCEEDINGS
From time to time the Company is party to routine litigation and
proceedings in the ordinary course of its business. The Company is not
aware of any current or pending litigation to which the Company is or may
be a party that the Company believes could have a material adverse effect
on the Company's results of operations or financial condition.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
<PAGE> 40
Part II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market for the Company's Common Stock
Network Plus Corp.'s Common Stock does not currently trade on any market.
There were 2 holders of the Company's Common Stock on March 26, 1999.
Dividend Policy
On September 2, 1998, the Company paid a dividend to Robert T. Hale and
Robert T. Hale, Jr. in the aggregate amount of $5.0 million, of which $1.9
million was reinvested by one of the stockholders in the form of a long-
term loan to the Company. For the foreseeable future the Company intends
to retain its earnings for its operations and expansion of its business and
it does not expect to pay dividends on its Common Stock (other than in
amounts necessary to enable the Company's stockholders to pay taxes and
related tax preparation expenses in respect of income allocated to such
stockholders through the date the Company's status as an S Corporation
ceased). The payment of any future dividends will be at the discretion of
the Board of Directors, except as required by the terms of the 13.5% Series
A Cumulative Preferred Stock, and will depend upon, among other factors,
the Company's earnings, financial condition, capital requirements and
general business outlook at the time payment is considered. In addition,
the Company's ability to pay dividends will depend upon the amount of
distributions, if any, received from Network Plus, Inc. or any future
operating subsidiaries of the Company. The Company intends to exercise its
option to make dividend payments on the Series A Preferred Stock prior to
September 1, 2003 by allowing such dividends to be added to the specified
amount of the 13.5% Series A Cumulative Preferred Stock. The New Revolving
Credit Facility, as defined herein, will, and any future indebtedness
incurred by the Company may, restrict the ability of the Company to pay
dividends.
Recent Sales of Unregistered Securities
Set forth below is certain information regarding securities issued by the
Registrant in 1998.
1. Upon its inception in July 1998, the Registrant issued 5,000,000 shares
of Common Stock to each of Robert T. Hale and Robert T. Hale, Jr., in
exchange for all of the issued and outstanding shares of common stock of
Network Plus, Inc.
2. In September 1998, the Registrant issued 40,000 Units, each consisting
of one share of 13.5% Series A Cumulative Preferred Stock due 2009 and 7.75
Initial Warrants and 15 Continent Warrants, each to purchase one share of
Common Stock, for an aggregate purchase price of $40,000,000. The initial
<PAGE> 41
purchasers were Goldman, Sachs & Co., Lehman Brothers Inc. and Merrill
Lynch, Pierce, Fenner & Smith Incorporated, who received a purchase price
discount of 3.25% for acting as underwriters in connection therewith.
3. The Registrant granted stock options to employees and a consultant to
purchase an aggregate of 741,140 shares of Common Stock with exercise
prices ranging from $15.00 to $50.00 per share.
The securities issued in the foregoing transactions were offered and sold
in reliance upon exemptions set forth in Sections 3(b) and 4(2) of the
Securities Act, or regulations promulgated thereunder, relating to sales by
an issuer not involving a public offering. In the case of certain options
to purchase shares of Common Stock, such offers and sales were made in
reliance upon an exemption from registration under Rule 701 of the
Securities Act. Except as noted above, no underwriters or placement agents
were involved in the foregoing sales of securities.
Preferred Stock Offering and Use of Proceeds
On February 16, 1999, the Securities and Exchange Commission issued an
order declaring the Company's registration statement on Form S-1 effective
pursuant to Section 8(a) of the Securities Act of 1933, as amended. The
registration statement (File No. 333-64663) registered for resale 58,276
shares of 13.5% Series A Cumulative Preferred Stock Due 2009 (41,350
outstanding shares and 16,926 shares that may be issued as dividends).
The Preferred Shares were originally issued and sold on September 3, 1998
in a transaction exempt from registration under the Securities Act. The
transaction was for the sale of 40,000 Units, consisting of $40,000,000 of
13.5% Series A Cumulative Preferred Stock due 2009, 310,000 initial
warrants to purchase 310,000 shares and 600,000 contingent warrants to
purchase 600,000 shares of common stock of the Company. The underwriters
in this transaction were Goldman, Sachs & Co., (24,000 units), Lehman
Brothers Inc. (8,000 units) and Merrill Lynch, Pierce, Fenner & Smith
Incorporated (8,000 units).
Net proceeds from the offering, after deducting discounts and offering
expenses totaling $2.5 million, were $37.5 million. The Company used $9.8
million of the net proceeds to pay down borrowings under its then
outstanding revolving credit agreement. The remainder of the net proceeds
were invested in cash equivalents and will be used to finance the Company's
anticipated expansion, including the expansion of its local
telecommunications infrastructure, information technology systems and sales
force; and for working capital. At December 31, 1998, the Company's cash
and cash equivalents totaled $12.2 million.
Item 6. SELECTED FINANCIAL DATA
The following table presents selected financial data for the years ended
December 31, 1994, 1995, 1996, 1997 and 1998. The financial and balance
sheet data for the years ending December 31, 1995, 1996, 1997 and 1998 have
been derived from financial statements that have been audited by
<PAGE> 42
PricewaterhouseCoopers LLP, independent accountants. The financial data
presented for the year ended December 31, 1994 are derived from the
unaudited financial statements of the Company and in the opinion of
management include all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the Company's results of
operations and financial condition for those periods. The selected
financial data should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
financial statements, including the notes thereto, of the Company appearing
in Item 8.
For periods prior to the formation of the Company on July 15, 1998, the
financial data reflect the financial statements of Network Plus, Inc., the
Company's wholly-owned subsidiary, as it was the sole operating entity.
<PAGE> 43
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenue $30,754 $49,024 $75,135 $98,209 $105,545
Costs of services 16,061 35,065 57,208 78,106 78,443
Selling, general
and administrative 11,631 17,697 19,230 25,704 29,426
Depreciation and
amortization 180 276 533 994 2,037
-------- -------- -------- -------- ---------
Operating income (loss) 2,882 (4,014) (1,836) (6,595) (4,361)
Interest income 37 202 95 86 395
Interest expense (2) (40) (313) (557) (1,474)
Other income, net 102 7,859 3,529 3,917 151
(Provision) credit for
income taxes (167) (312) (60) (42) 906
-------- -------- -------- -------- ---------
Net income (loss) 2,852 3,695 1,415 (3,191) (4,383)
Preferred stock
dividends and accretion - - - - (2,005)
-------- -------- -------- -------- ---------
Net income (loss)
applicable to common
stockholders $ 2,852 $ 3,695 $ 1,415 $(3,191) $ (6,388)
======== ======== ======== ======== =========
Net income (loss) per
share applicable common
stockholders -
basic and diluted $ 0.29 $ 0.37 $ 0.14 $ (0.32) $ (0.64)
======== ======== ======== ======== =========
Pro forma net income
(loss) per share
applicable to common
stockholders -
basic and diluted $ 0.18 $ 0.24 $ 0.09 $ (0.21) $ (0.54)
======== ======== ======== ======== =========
Weighted average shares
outstanding -
basic and diluted 10,000 10,000 10,000 10,000 10,000
======== ======== ======== ======== =========
</TABLE>
<PAGE> 44
<TABLE>
<CAPTION>
December 31,
---------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents $ 1,232 $ 1,673 $ 2,303 $ 1,567 $ 12,197
Current assets 9,264 16,441 19,771 28,521 31,050
Property and equipment, net 1,435 1,507 3,075 6,957 15,822
Working capital 4,388 2,369 1,621 (3,128) (16,168)
Total assets 11,264 18,005 22,915 35,581 48,868
Other long-term obligations 24 11 664 3,623 5,072
Redeemable Series A
Preferred Stock - - - - 35,146
Total stockholders' equity
(deficit) 2,117 3,922 4,101 309 (6,723)
Year Ended December 31,
---------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- ---------
(in thousands, except per share data)
OTHER FINANCIAL DATA:
Capital expenditures 813 860 2,135 3,363 10,919
EBITDA (1) 3,164 4,121 2,226 (1,684) (2,173)
Net cash provided by (used
for) operating activities 1,904 2,463 (322) 184 (10,768)
Net cash provided by (used
for) investing activities 368 (184) (644) (6,924) (1,402)
Net cash provided by (used
for) financing activities (1,255) (1,903) 1,596 6,004 22,800
Ratio of earnings to
combined fixed charges (2) 23.4x 20.4x 3.7x (2.9)x (0.5)x
<F1>
(1) EBITDA consists of net income (loss) before net interest, income
taxes, depreciation and amortization. Management believes that EBITDA is a
useful financial performance measure for comparing companies in the
telecommunications industry in terms of operating performance, leverage, and
ability to incur and service debt, because it provides an alternative
measure of cash flow from operations. EBITDA should not be considered in
isolation from, or as a substitute for, net income (loss), net cash provided
by (used for) operating activities or other consolidated income or cash flow
statement data presented in accordance with generally accepted accounting
principles ("GAAP") or as a measure of profitability or liquidity. EBITDA
does not reflect working capital changes and includes non-interest
components of other income (expense), most of which are non-recurring.
These items may be considered significant components in understanding and
assessing the Company's results of operations and cash flows. EBITDA may
not be comparable to similarly titled amounts reported by other companies.
<F2>
(2) For purposes of calculating the ratio of earnings to combined fixed
charges, "earnings" represent net income (loss) before income taxes plus
combined fixed charges, and combined fixed charges consist of interest
expense, preferred stock dividends and accretion of issuance costs and
discount, and the interest portion of operating lease rentals. For the
years ended December 31, 1997 and 1998, earnings were insufficient to
cover combined fixed charges by $3.1 million and $5.3 million, respectively.
</TABLE>
<PAGE> 45
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
The following discussion and analysis should be read in conjunction with
the financial statements and related notes and other detailed information
regarding the Company included elsewhere in this Annual Report. This
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" includes "forward-looking statements", including
statements containing the words "believes", "anticipates", "expects"
and words of similar import. All statements other than statements of
historical fact regarding the Company or any of the transactions described
herein, including the time, financing, strategies and effects of such
transactions and the Company's growth strategy and anticipated growth, are
forward-looking statements. Actual events or results may differ
materially from such statements, including as a result of the statements
set forth below under the heading "Certain Factors That May Affect Future
Operating Results".
For periods prior to the formation of the Company on July 15, 1998, the
financial data reflect the financial statements of Network Plus, Inc., the
Company's wholly-owned subsidiary, as it was the sole operating entity.
Overview
The Company was founded in 1990 as an aggregator of AT&T long distance
services, reselling AT&T branded products primarily to small and medium-
sized businesses. As an aggregator of AT&T services, customers were
billed and serviced by AT&T. The Company derived its profits through 1993
by obtaining volume discounts on bulk purchases of long distance services
from AT&T and passing along a portion of these discounts to its customers.
In 1993, the Company entered into an agreement with Sprint Communications
Company L.P. ("Sprint") and in 1994 began to resell Sprint
telecommunications services. As a reseller of Sprint, the Company began
provisioning, servicing and billing customers under the Network Plus name.
Volume discounts offered by Sprint enabled the Company to offer low-cost,
high quality, long distance services at favorable rates to its customers.
In addition, by servicing its own customers, the Company was better able
to meet customer needs and control costs.
In mid-1996, in addition to provisioning customer traffic onto Sprint's
network ("off-net" traffic) as a switchless reseller of Sprint long
distance services, the Company initiated the deployment of its own long
distance network and began operating as a switch-based provider in certain
states, switching customer traffic on its own facilities ("on-net"
traffic). The Company's decision to deploy switches was based on economic
efficiencies resulting from customer concentrations and traffic patterns.
Installation of telephony switches was completed in Quincy, Massachusetts
in June 1996, Orlando in November 1997 and Chicago and Los Angeles in
<PAGE> 46
March 1999. As a switch-based provider, the Company is able to lower its
direct transmission costs.
In mid-1998, the Company entered into two 20-year indefeasible right-of-
use ("IRU") agreements pursuant to which it acquired 625 route miles of
dark fiber (1,830 digital fiber miles). When the fiber is fully deployed
and activated, it will form a redundant fiber ring connecting major
markets throughout New England and the New York metropolitan area,
providing the Company with significant transmission capacity.
The Company has sold wholesale services for international traffic since
1997. In 1998, the Company began offering off-net local exchange services
in selected markets. The Company intends to continue to add services to
maintain and enhance its position as an integrated communications provider
("ICP"). The Company's strategic initiatives include expanding its
service offerings to include Internet, on-net local exchange, and enhanced
bandwidth services (e.g. xDSL services). By adding these services, the
Company will offer a single-source solution for all of the
telecommunication needs of its customers. The Company believes the
expansion of service offerings will improve customer retention and market
share, while simultaneously reducing overall transmission costs.
The Company sells its services through a direct retail sales force, an
international wholesale sales force and a reseller and independent agent
sales force. As the Company expands its network facilities, the Company
intends to increase its sales force to approximately 300 members by year
end 1999. The investment in the sales force, expansion of the existing
network and the addition of new and enhanced services will require
significant expenditures, a substantial portion of which will be incurred
before related revenue is realized. As these expansion plans are
undertaken and the revenue base grows, future periods of operating losses
and negative cash flows from operations are anticipated.
Results of Operations
<TABLE>
The following table sets forth for the periods indicated certain financial
data as a percentage of revenues:
<CAPTION>
Year Ended
December 31,
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Revenue 100.0 % 100.0 % 100.0 %
Cost of services 74.3 79.5 76.1
Selling, general and administrative 27.9 26.2 25.6
Depreciation and amortization 1.9 1.0 0.7
Operating loss (4.1) (6.7) (2.4)
Other income (expense) (0.1) 3.5 4.4
Income (loss) before income taxes (5.0)% (3.2)% (2.0) %
</TABLE>
<PAGE> 47
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Revenue increased 7.5% to $105.5 million for the year ended
December 31, 1998 from $98.2 million for the year ended December 31, 1997.
Revenue for the year ended December 31, 1997 included approximately $12.6
million from two customers with whom the Company did not do business in
1998. Exclusive of the revenue from these two former customers, revenue
increased by 23.2% from period to period. The components of revenue in
each year reflect the Company's initiative to become a facilities-based
services provider. In 1998, on-net revenue and on-net billed customer
minutes were 63.1% and 54.2%, respectively, of total revenue and minutes,
as compared to 40.2% and 21.2%, respectively, in 1997.
Costs of Services. Costs of services for the year ended December 31, 1998
totaled $78.4 million, an increase of 0.4% from the $78.1 million incurred
in the corresponding period in 1997. As a percentage of revenue, costs of
services decreased to 74.3% in 1998 from 79.5% in 1997, reflecting the
increase in on-net traffic, the reduced costs of carrying off-net traffic
and a reduction in costs of originating and terminating traffic. Costs of
originating and terminating traffic have declined in part as a result of
provisions mandated by the Telecommunications Act of 1996. Finally,
increased competition in the long distance telecommunications industry
resulted in slightly lower pricing and margins in 1998, as compared to
1997.
Selling, General and Administrative. Selling, general and administrative
expenses increased by 14.5% to $29.4 million for the year ended
December 31, 1998 from $25.7 million for the year ended December 31, 1997,
and increased as a percentage of revenue to 27.9% from 26.2% for the
corresponding periods. Within selling, general and administrative
expenses, the largest component is personnel and related expenses, which
combines all wages and salaries, along with commissions earned by the
Company's sales force. These expenses increased by 26.3% from 1997 to
1998, reflecting an increase in the number of employees. In April 1998,
the Company commenced its initiative to expand its 96-member sales force,
and as of December 31, 1998, the sales force had increased to 220 members.
Other expenses within selling, general and administrative expenses
increased as a result of the Company's ongoing growth.
Depreciation and Amortization. Depreciation and amortization increased to
$2.0 million for the year ended December 31, 1998 from $1.0 million for
the year ended December 31, 1997, reflecting the Company's network build
out and capital additions for the Company's internal computer systems.
Interest. Interest expense, net of interest income, increased to $1.1
million for the year ended December 31, 1998 from $471,000 for the year
ended December 31, 1997. This increase resulted from interest on capital
leases entered into in the latter half of 1997 to finance network
additions and internal computer systems, interest incurred related to
notes payable entered into in December 1997, and additional interest
related to higher levels of revolving credit borrowings in 1998, offset
somewhat by interest earned on investments during the fourth quarter of
1998.
<PAGE> 48
Other Income (Expense). Other income totaled $151,000 in the year ended
December 31, 1998 and $3.9 million in the year ended December 31, 1997.
The $3.9 million in 1997 principally related to warrants. In 1995, the
Company transferred (the "Transfer") certain customers to whom it
provided long distance and toll-free telecommunications services pursuant
to certain AT&T resale contracts (the "AT&T contracts") to Tel-Save
Holdings, Inc. ("Tel-Save"). Concurrent with the Transfer, the
Company's obligations to AT&T under the AT&T contracts were terminated
without obligation or liability on the part of the Company. Prior to the
time of this transaction, there was no value recorded in the financial
statements related to these customers. In consideration of the Transfer,
the Company received four separate warrants to purchase a total of
1,365,000 shares of Tel-Save common stock at an exercise price of $4.67
per share (after reflecting stock splits through December 31, 1997). Each
warrant vested separately based on the retail revenue generated by Tel-
Save with respect to the transferred customers, which had to exceed
specified levels for three consecutive months. The warrants expired at
various dates through 1997. In addition to the Warrant Agreements, the
Company was subject to a Voting Rights Agreement whereby Tel-Save retained
the right to hold and vote the stock until the Company informed Tel-Save
it wished to sell the stock. Upon receiving such notice from the Company,
Tel-Save was obligated either to purchase the stock at the price offered
by the Company or, alternatively, to deliver the common stock certificates
to the Company.
In 1996, the vesting requirements were met with respect to the first three
warrants. The vesting requirement for the first warrant was met at the
end of the third quarter of 1996, entitling the Company to purchase
600,000 shares of Tel-Save common stock. The Company exercised this
warrant and sold the related common stock, which had previously been
registered, resulting in net proceeds and other income of $1.4 million in
the third quarter of 1996.
The vesting requirements with respect to the second and third warrants
were met in November 1996. The second warrant entitled the Company to
purchase 300,000 shares of Tel-Save common stock prior to January 8, 1997.
The third warrant entitled the Company to purchase 150,000 shares of Tel-
Save Common stock prior to June 10, 1997. The warrants were valued upon
vesting at approximately $2.1 million using the Black-Scholes valuation
model. The significant assumptions in the valuation model were an
interest rate of 5.1%, warrant lives reflecting the respective expiration
periods, expected volatility of 50% and no dividend rate. At December 31,
1996, the warrants had not yet been exercised and were classified as
investments. The value of the warrants at December 31, 1996 was the fair
value recorded by the Company at the date of vesting. Other income of
$2.1 million related to the second and third warrants was recognized in
the fourth quarter of 1996. On January 6, 1997, the Company exercised the
second and third warrants and paid Tel-Save the total exercise price of
$2.1 million.
<PAGE> 49
The vesting requirement with respect to the fourth warrant was met in June
1997, entitling the Company to purchase 315,000 shares of Tel-Save common
stock. The fourth warrant was valued upon vesting at approximately $3.4
million using Black-Scholes valuation model. The significant assumptions
in the valuation model were an interest rate of 5.1%, a warrant life
reflecting the June 1997 expiration period, expected volatility of 50% and
no dividend rate. On June 4, 1997, the Company exercised the warrant,
paid Tel-Save the exercise price of $1.5 million and recorded other income
of approximately $3.4 million.
On November 7, 1997, Tel-Save filed a registration statement with the SEC,
listing the Company as a selling shareholder with respect to 765,000
shares (the total shares purchased by the Company, after reflecting stock
splits, under the second, third and fourth warrants). Following the
registration of the common stock, the Company intended to immediately sell
the shares of Tel-Save, which had a market value of approximately $16.6
million at that date, as it had done previously with respect to the shares
acquired upon exercise of the first warrant. Accordingly, all activities
necessary for the transfer of the certificates were completed and the
Company issued a demand to Tel-Save for the common stock certificates or,
alternatively, requested that Tel-Save purchase the shares. Throughout
the remainder of the fourth quarter, Tel-Save refused to deliver the
common stock certificates to the Company.
In order to take physical possession of the Tel-Save common stock
certificates, the Company filed a lawsuit against Tel-Save in January
1998. On June 24, 1998, a settlement agreement was signed between the
parties pursuant to which the Company received a total of $9.5 million
from Tel-Save. As part of the settlement, all 765,000 shares were either
returned to or repurchased by Tel-Save. Following the June 1998
settlement, there are no continuing obligations between the parties.
Accordingly, the Company's investment in Tel-Save at December 31, 1997 was
valued at the final negotiated payment. This settlement resulted in
approximately $422,000 other income, recorded in the fourth quarter of
1997.
Income Taxes. In the year ended December 31, 1998, net income tax credits
of $906,000 were recorded. In September 1998, the Company converted from
an S Corporation to a C Corporation, and a $480,000 provision for deferred
taxes was recorded to reflect the change in status. Offsetting this
provision were tax credits recorded at statutory rates for both Federal
and state taxes. Prior to conversion, income taxes were provided solely
for state tax purposes. State income taxes in 1997 totaled $42,000.
Net Income (Loss) and Net Income (Loss) Applicable to Common Stockholders.
As a result of the aforementioned increases in revenue, operating
expenses, depreciation and amortization, net interest expense, the Company
incurred a net loss of $4.4 million in 1998, compared to a net loss of
$3.2 million in 1997.
In 1998, the Company accrued dividends to be paid in the form of
additional shares of Series A Preferred Stock totaling $1,814,000 and
<PAGE> 50
recorded $191,000 of accretion of offering expenses and discount on this
preferred stock issued September 3, 1998. The resulting net loss
applicable to common stockholders in 1998 was $6.4 million, compared to a
net loss of $3.2 million in 1997.
EBITDA. EBITDA decreased to negative $2.2 million for the year ended
December 31, 1998 from negative $1.7 million for the year ended
December 31, 1997. This decline was due to income in 1997 related to the
Tel-Save warrants, offset by increases resulting from changes in revenues,
network development, operations and selling, general and administrative
expenses discussed above.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenue. Revenue increased by 30.7% to $98.2 million in 1997 from $75.1
million in 1996, primarily related to an increase in the Company's
customer base. The Company's customers totaled approximately 30,000 at
the end of 1997 and 19,000 at the end of 1996. Revenue in 1996 also
included approximately $1.8 million related to the amortization of credits
received through AT&T sales promotions on three-year contracts that were
fully amortized by year end 1996.
Costs of Services. Costs of services increased to $78.1 million in 1997
from $57.2 million in 1996, a 36.5% increase, and increased as a
percentage of revenue to 79.5% in 1997 from 76.1% in 1996. The increase
as a percentage of revenue resulted from several factors. Revenue in 1996
included $1.8 million of nonrecurring revenue derived from the
amortization of the AT&T credits described above. In mid-1996, the
Company began to operate its own network, incurring start up costs related
to investment in these facilities. The first network switch, deployed in
Quincy, Massachusetts in June 1996, did not begin to carry any significant
traffic until late 1996. A second switch, deployed in Orlando, Florida in
November 1997, did not carry any significant traffic in 1997. In 1997,
the Company began to transmit international wholesale traffic through the
Quincy switch. International wholesale traffic generates margins
significantly below domestic on-net traffic. In addition, initiatives
undertaken to provision existing customer traffic from off-net to on-net
generally did not commence until the latter part of 1997 and,
consequently, the improved percentages generated by on-net traffic did not
significantly impact the results for the year. Finally, increased
competition in the long distance telecommunications industry resulted in
slightly lower pricing and margins in 1997, as compared to 1996.
Selling, General and Administrative. Selling, general and administrative
expenses increased by 33.7% to $25.7 million in 1997 from $19.2 million in
1996, and increased as a percentage of revenue to 26.2% in 1997 from 25.6%
in 1996. Personnel and related expenses, the largest component of
selling, general and administrative expenses, decreased by 1.5% from 1996
to 1997. A decrease in the direct sales force was principally offset by
an expansion of administrative services, including customer service and
provisioning personnel, to support the revenue growth. Sales offices were
added in 1997 in conjunction with the November 1997 deployment of the
<PAGE> 51
Company's switch in Orlando, Florida. Other selling, general and
administrative expenses also increased as a result of the revenue and
personnel growth, including rent and utilities for additional offices and
commissions paid to independent marketing representatives. The provision
for doubtful accounts increased by $3.0 million in 1997 from 1996,
principally relating to two former customers and an increase in the
estimate of the bad debt reserve proportionate to the increase in revenue.
In November 1997, the Company fully provided for the receivables from
these two former customers. The Company ceased its relationship with one
of these customers based upon diminishing payment experience and the
customer's inability to provide worthy collateral. Subsequently, this
former customer ceased operations. The other customer's receivable was
fully reserved when a collection arrangement was not honored and
additional disputes arose.
Depreciation and Amortization. Depreciation and amortization expense
increased to $994,000 in 1997 from $533,000 in 1996 as a result of capital
additions for the Company's network build-out and internal computer
systems. The Company's internal computer hardware was significantly
upgraded in November 1997. Future depreciation expense will increase as
assets related to the Company's network expansion plans are placed into
service.
In August 1997, upon review of the Company's experience and expectations
for upgrades and replacement of equipment, including information gathered
during the process of financing such equipment, the Company changed its
estimate of the useful life of its switching equipment from 12 years to 5
years. The Company also reviewed publicly available industry data on
telecommunications equipment, which confirmed that the estimate of useful
lives of the Company's telecommunications equipment, which was entirely
switching equipment at that time, reasonably approximated 5 years. The
Company also assessed that there had been no significant decline in the
market value of its switching equipment since purchased and that the
market value exceeded the net book value of the equipment at the time of
the change in estimate. This was confirmed by the Company's ability to
enter into a sale and leaseback of the switches for the approximate book
value, completed at the same time as the change in estimate.
Depreciation expense in the year ended December 31, 1997 was approximately
$114,000 less than what would have otherwise been reported had the change
been previously made.
Interest. Interest expense, net of interest income, increased from
$218,000 in 1996 to $471,000 in 1997. This interest relates to a higher
level of revolving credit borrowings in 1997, interest on capital leases
entered into in the latter half of 1997 and interest incurred related to
notes payable entered into in December 1997.
In 1995, the Company transferred (the "Transfer") certain customers to
whom it provided long distance and toll free telecommunications services
pursuant to certain AT&T resale contracts (the "AT&T contracts") to Tel-
Save Holdings, Inc. ("Tel-Save"). Concurrent with the Transfer, the
<PAGE> 52
Company's obligations to AT&T under the AT&T contracts were terminated
without obligation or liability on the part of the Company. Prior to the
time of this transaction, there was no value recorded in the financial
statements related to these customers. In consideration of the Transfer,
the Company received four separate warrants to purchase a total of
1,365,000 shares of Tel-Save common stock at an exercise price of $4.67
per share (after reflecting stock splits through December 31, 1997). Each
warrant vested separately based on the retail revenue generated by Tel-
Save with respect to the transferred customers, which had to exceed
specified levels for three consecutive months. The warrants expired at
various dates through 1997. In addition to the Warrant Agreements, the
Company was subject to a Voting Rights Agreement whereby Tel-Save retained
the right to hold and vote the stock until the Company informed Tel-Save
it wished to sell the stock. Upon receiving such notice from the Company,
Tel-Save was obligated either to purchase the stock at the price offered
by the Company or, alternatively, to deliver the common stock certificates
to the Company.
In 1996, the vesting requirements were met with respect to the first three
warrants. The vesting requirement for the first warrant was met at the
end of the third quarter of 1996, entitling the Company to purchase
600,000 shares of Tel-Save common stock. The Company exercised this
warrant and sold the related common stock, which had previously been
registered, resulting in net proceeds and other income of $1.4 million in
the third quarter of 1996.
The vesting requirements with respect to the second and third warrants
were met in November 1996. The second warrant entitled the Company to
purchase 300,000 shares of Tel-Save common stock prior to January 8, 1997.
The third warrant entitled the Company to purchase 150,000 shares of Tel-
Save Common stock prior to June 10, 1997. The warrants were valued upon
vesting at approximately $2.1 million using the Black-Scholes valuation
model. The significant assumptions in the valuation model were an
interest rate of 5.1%, warrant lives reflecting the respective expiration
periods, expected volatility of 50% and no dividend rate. At December 31,
1996, the warrants had not yet been exercised and were classified as
investments. The value of the warrants at December 31, 1996 was the fair
value recorded by the Company at the date of vesting. Other income of
$2.1 million related to the second and third warrants was recognized in
the fourth quarter of 1996. On January 6, 1997, the Company exercised the
second and third warrants and paid Tel-Save the total exercise price of
$2.1 million.
The vesting requirement with respect to the fourth warrant was met in June
1997, entitling the Company to purchase 315,000 shares of Tel-Save common
stock. The fourth warrant was valued upon vesting at approximately $3.4
million using Black-Scholes valuation model. The significant assumptions
in the valuation model were an interest rate of 5.1%, a warrant life
reflecting the June 1997 expiration period, expected volatility of 50% and
no dividend rate. On June 4, 1997, the Company exercised the warrant,
paid Tel-Save the exercise price of $1.5 million and recorded other income
of approximately $3.4 million.
<PAGE> 53
On November 7, 1997, Tel-Save filed a registration statement with the SEC,
listing the Company as a selling shareholder with respect to 765,000
shares (the total shares purchased by the Company, after reflecting stock
splits, under the second, third and fourth warrants). Following the
registration of the common stock, the Company intended to immediately sell
the shares of Tel-Save, which had a market value of approximately $16.6
million at that date, as it had done previously with respect to the shares
acquired upon exercise of the first warrant. Accordingly, all activities
necessary for the transfer of the certificates were completed and the
Company issued a demand to Tel-Save for the common stock certificates or,
alternatively, requested that Tel-Save purchase the shares. Throughout
the remainder of the fourth quarter, Tel-Save refused to deliver the
common stock certificates to the Company.
In order to take physical possession of the Tel-Save common stock
certificates, the Company filed a lawsuit against Tel-Save in January
1998. On June 24, 1998, a settlement agreement was signed between the
parties pursuant to which the Company received a total of $9.5 million
from Tel-Save. As part of the settlement, all 765,000 shares were either
returned to or repurchased by Tel-Save. Following the June 1998
settlement, there are no continuing obligations between the parties.
Accordingly, the Company's investment in Tel-Save at December 31, 1997 was
valued at the final negotiated payment. This settlement resulted in
approximately $422,000 other income, recorded in the fourth quarter of
1997.
Net Loss. As a result of the aforementioned increases in revenue,
operating expenses, depreciation and amortization, interest income and
expense, the Company incurred a net loss of $3.2 million for the year
ended December 31, 1997, compared to net income of $1.4 million for the
year ended December 31, 1996.
EBITDA. EBITDA was negative $1.7 million for the year ended December 31,
1997 compared to positive $2.2 million for the year ended December 31,
1996. This decline was due to the changes in revenue, network
development, operations and selling, general and administrative expenses
and other income discussed above.
Liquidity and Capital Resources
Overview of Historical Cash Requirements
Since commencing operations in 1990, the Company has experienced
significant growth. Prior to 1994, the Company operated solely as an
aggregator of AT&T services and funded its growth principally with cash
provided from operating activities. In 1994, the Company became a
reseller of Sprint services, requiring additional funding to support the
development of an infrastructure to support provisioning, billing and
servicing of customers billed under the Network Plus name. Cash
requirements in 1994 and 1995 were financed primarily by cash credits
received in 1993 and 1994 under AT&T promotions and by transfers of AT&T
<PAGE> 54
contracts and customers to other telecommunications companies in 1995.
These transfers resulted in the receipt by the Company of a cash payment
of $8.4 million and warrants to purchase common stock of Tel-Save. In
1996, the Company further expanded its infrastructure and began to deploy
its own network. To support 1996 cash requirements, the Company entered
into a $7.0 million revolving credit agreement with Fleet National Bank
("Fleet") and a term loan for $1.0 million with Fleet to allow for its
initial purchase of network facilities, and entered into a financing
transaction involving the sale and lease back of the Quincy switch. Cash
flows in 1996 were supplemented by the exercise of Tel-Save warrants and
the subsequent sale of the underlying common stock, resulting in total net
proceeds of $1.4 million.
In 1997, the Company continued to expand its network and infrastructure.
In addition, $3.6 million was expended to exercise additional warrants for
common stock of Tel-Save. Cash needs in 1997 were met through the
addition of capital leases, including a financing transaction involving
the sale and lease back of the Company's two switches, utilization of a
revolving credit facility, refinancing of a portion of accounts payable to
Sprint into a short-term promissory note (the "Sprint Note") and receipt
of loans totaling $1.8 million from the Company's stockholders (the
"Stockholder Loans").
On May 1, 1998, the Company entered into a $23.0 million revolving credit
agreement with Fleet (the "Former Bank Credit Facility"). Borrowings
under this line were used to repay the Sprint Note and the Stockholder
Loans. On September 3, 1998, the Company issued 40,000 units consisting
of shares of 13.5% Series A Cumulative Preferred Stock Due 2009 and
warrants, resulting in net proceeds to the Company of $37.5 million. The
proceeds were used to repay all amounts owed under the Former Bank Credit
Facility and the excess funds were invested in cash equivalents. On
October 7, 1998, the Company entered into a loan agreement with Goldman
Sachs Credit Partners, L.P. and Fleet for a $60.0 million revolving credit
facility (the "New Revolving Credit Facility"). Other than draw downs
utilized to cover closing costs, which were immediately repaid, the
Company did not utilize this facility in 1998.
In December 1998, the Company received an $81.0 million commitment for
equipment lease financing for telecommunications equipment to be acquired
through December 31, 1999. Depending on the type of equipment, the lease
term will either be for three or five years. All of the leases to be
entered into will contain bargain purchase options upon conclusion of the
lease term. Leases were entered into as of January 1, 1999 totaling $22.9
million and included $4.0 million for refinancing of previously existing
leases. Also included in the new lease financing was an additional $3.5
million received by the Company from the lessor for the sale and leaseback
of equipment acquired by the Company in 1998.
Financial Condition
Total assets were $48.9 million at December 31, 1998 compared to $35.6
million at December 31, 1997. Cash and cash equivalents increased to
<PAGE> 55
$12.2 million at December 31, 1998 from $1.6 million at December 31, 1997
due to proceeds received from the preferred stock offering which are
invested in cash equivalents until such time as the funds are needed to
help finance the Company's expansion plans. Accounts receivable decreased
by $702,000 from 1997 to 1998, due to improved collections. Prepaid
expenses, other current assets, and accrued liabilities all increased in
relation to revenue growth. Accounts payable fluctuations were due to
timing of payments.
Investments represent the value ascribed to the exercised Tel-Save
warrants. As described above, the investment was liquidated for cash in
the amount of $9.5 million in June 1998 and was valued at December 31,
1997 at the amount of cash received.
Property and equipment totaled $15.8 million at December 31, 1998 and $7.0
million at December 31, 1997. Capital expenditures in 1998 totaled $10.9
million, principally related to payments made toward switches and network
equipment being installed in the fourth quarter. Property and equipment
is expected to grow through 1999 and beyond, as the Company adds
additional switches and other equipment to its existing network.
During 1997, additional capital was required to continue to expand the
Company's business. Additional liquidity was achieved by the issuance of
notes payable. In December 1997, the Company issued a promissory note to
Sprint for the repayment of $4.6 million previously classified as accounts
payable. The note's maturity was September 1998. The note's remaining
balance of $3.7 million was repaid on May 1, 1998 from borrowings under
the Former Bank Credit Facility in effect at that time, as described
below. In December 1997, the Company borrowed $1.8 million pursuant to
the Stockholder Loans. Interest was paid monthly at the prevailing prime
rate. The Stockholder Loans, including accrued interest, were also repaid
on May 1, 1998.
In January 1996, the Company entered into a revolving credit agreement
with Fleet, which provided for borrowings of up to $7.0 million, including
letters of credit. This agreement was due to expire on May 31, 1998 and
was refinanced in May 1998, as described below. Interest was payable
monthly at Fleet's prime rate or available LIBOR options. The maximum
borrowings under the agreement in 1998 and 1997 were $10.9 million and
$5.0 million, respectively. At December 31, 1997, the loan balance was
$4.5 million, with letters of credit of $120,000 outstanding.
Cash used by operating activities in 1998 totaled $10.8 million,
principally due to working capital changes. At December 31, 1998,
outstanding letters of credit totaled $1.1 million, secured by a
corresponding amount of cash equivalents.
On May 1, 1998, the Company entered into the Former Bank Credit Facility
with Fleet and terminated the previously existing agreement. This
agreement was in turn terminated on October 7, 1998 upon entering into the
New Revolving Credit Facility, described below. Proceeds from this
financing were used to repay the Sprint Note and the Stockholder Loans.
<PAGE> 56
In August 1998, the Company paid a dividend in the aggregate amount of
$5.0 million. As a result, $2.5 million was distributed to each of Robert
T. Hale and Robert T. Hale, Jr. Following receipt of the dividend, Robert
T. Hale, Jr. reinvested $1.9 million in the Company (representing
approximately the distribution to Robert T. Hale, Jr., net of his
estimated tax liability resulting from such distribution), in the form of
a long-term loan to the Company; such loan, including interest, will be
payable 10 days after the redemption of the Series A Preferred Stock. The
dividend distribution was funded out of existing cash resources and the
Former Bank Credit Facility.
The Company consummated the offering of Units including the Series A
Preferred Stock (the "Initial Offering") on September 3, 1998. The net
proceeds to the Company of the Initial Offering, after deducting
commissions and offering expenses, were approximately $37.5 million. The
Company used $9.8 million of the net proceeds of the Initial Offering to
pay down borrowings under the Former Bank Credit Facility. The Company
expects to use the remainder of the net proceeds to finance a portion of
the Company's anticipated expansion, including the expansion of its local
telecommunications infrastructure, information technology systems and
sales force; and for working capital.
Prior to the Initial Offering, the Company was an S Corporation and, as a
result, did not pay corporate Federal income taxes. Instead, the
Company's stockholders were liable for their share of taxes in respect of
the Company's taxable income. The Company had similar tax status in
certain states that recognize S Corporation status. Accordingly, in each
year prior to 1998 the Company distributed, and for the 1998 period prior
to September 1998 the Company will distribute, to its stockholders cash in
amounts sufficient to enable the Company's stockholders to pay Federal and
state taxes on income of the Company attributable to the stockholders and
related tax preparation expenses. The Company does not expect the
distribution for the 1998 period prior to September 1998 to be material.
During the years ended December 31, 1997, 1996 and 1995, the Company
distributed an aggregate of $601,000, $1.2 million and $1.9 million,
respectively, to its stockholders.
Dividends on the Series A Preferred Stock accruing on or before September
1, 2003 may be paid, at the Company's option, either in cash or by
allowing such dividends to be issued in the form of additional preferred
stock. It is not anticipated that the Company will pay any dividends in
cash for any period ending on or prior to September 1, 2003.
On October 7, 1998, the Company entered into the New Revolving Credit
Facility, concurrent with the closing of which the Company terminated the
Former Bank Credit Facility. The New Revolving Credit Facility has a term
of 18 months. Under the New Revolving Credit Facility, $30 million of the
$60 million is immediately available, while the additional $30 million is
available based upon a percentage of accounts receivable. Interest is
payable monthly at one percent above the prime rate. The New Revolving
Credit Facility requires the Company, among other things, to meet minimum
<PAGE> 57
levels of revenues and earnings before interest, taxes, depreciation and
amortization, and not to exceed certain customer turnover levels and debt
to revenue ratios. Other than draw downs utilized to cover closing costs,
which were immediately repaid, the Company did not utilize the New
Revolving Credit Facility in 1998.
The Company will seek to refinance the New Revolving Credit Facility
during the second quarter of 1999 with the objective of obtaining a
facility with a longer term and with covenants more closely aligned with
its current expansion plans.
In December 1998, the Company received an $81.0 million commitment for
equipment lease financing for telecommunications equipment to be acquired
through December 31, 1999. Depending on the type of equipment, lease
terms will either be for three or five years. All of the leases to be
entered into will contain bargain purchase options upon conclusion of the
lease term. Leases were entered into as of January 1, 1999 totaling
$22,904 and included $4.0 million for refinancing of previously existing
leases. Also included in the new lease financing was an additional $3.5
million received by the Company from the lessor for the sale and leaseback
of equipment acquired by the Company in 1998. The Company currently
expects to fully utilize the available leasing facility during 1999.
The Company's strategic initiatives include the deployment of additional
long distance and international switches, the deployment of local
switches, the offering of new services such as local exchange and Internet
access, the expansion of its sales force and other personnel, and
significant investment in its information technology systems. These
initiatives will require a substantial amount of capital for, but not
limited to, the installation of network switches and related equipment,
fiber, personnel additions and funding of operating losses and working
capital.
The Company's ability to meet its projected growth is dependent upon its
ability to secure substantial additional financing in the future. The
Company estimates that, for 1999, capital required for expansion of its
infrastructure and services and to fund negative cash flow will be
approximately $100.0 million. The Company believes that its current cash
resources, revolving credit availability and availability of lease
financing will be sufficient to fund the Company's operating losses and
planned capital expenditures for the next 12 months. To meet its
additional future financing requirements, sources of funding may include
public offerings or private placements of equity or debt securities, bank
loans, capital leases and additional capital contributions from new or
existing stockholders. The Company may be required to apply all or a
portion of any such financing to redeem all or a portion of the Series A
Preferred Stock. There can be no assurance that additional financing will
be available to the Company or, if available, that it can be obtained on a
timely basis, on terms acceptable to the Company, and within the
limitations contained in the Company's commercial lending agreements and
the terms of the Series A Preferred Stock. Failure to obtain such
financing could result in the delay or abandonment of certain of the
<PAGE> 58
Company's development and expansion plans and could have a material
adverse effect on the Company. Furthermore, there can be no assurance
that actual capital needs and expenditures will not be significantly
higher than the Company's current estimates.
In March 1999, the Company entered into a strategic partnership with
NorthPoint Communications, Inc. ("NorthPoint"), which included an equity
investment of $2.5 million by the Company in NorthPoint, to provide xDSL
services to businesses currently reach by NorthPoint's infrastructure.
The Company expects to begin offering such services during mid-1999.
Recently Issued Accounting Standards
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The Company will adopt
the provisions of this statement effective January 1, 1999 and does not
believe that it will have a material impact on its business or results of
operations.
In June 1998, Statement of Financial Accounting Standards No. 133 ("SFAS
133"), "Accounting for Derivative Instruments and Hedging Activities",
was issued, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts, and for hedging activities. This statement is
effective for the quarters in the Company's fiscal year 2000. Had the
Company implemented SFAS 133 in the current period, financial position and
results of operations would not have been affected.
Impact of Year 2000
Many computer systems experience problems handling dates beyond the year
1999. Therefore, some computer hardware and software will need to be
modified prior to the year 2000 in order to remain functional. The
Company is currently accessing the implication of Year 2000 issues on
operations, in order to determine the extent to which the Company may be
adversely affected. Based on the internal assessment, which is
substantially complete, the Company believes that the majority of its
software applications will be Year 2000 compliant by June 30, 1999.
However, there can be no assurance that all systems will function
adequately beginning in the year 2000. There can also be no assurance
that the Company will not incur significant unanticipated costs in
achieving Year 2000 compliance. Though limited testing of systems has
been performed to date, the Company had developed its systems with Year
2000 in mind, thus minimizing its impact. The Company may conduct further
testing and/or an external audit following the conclusion of its internal
assessment. To date there have been a limited number of hours devoted to
Year 2000 issues, with no additional cost expended in systems upgrades
directly relating to Year 2000 issues. Present estimates for further
expenditures of both employee time and expenses to address Year 2000
issues are not expected to have a material impact on the operations and
cash flows of the Company. All expenditures will be expensed as incurred
<PAGE> 59
and they are not expected to have a significant impact on the Company's
ongoing results of operations.
If the hardware or software comprising the Company's network elements
acquired from third-party vendors, the software applications of the long
distance carriers, local exchange carriers or others on whose services the
Company depends or with whom the Company's systems interface, or the
software applications of other suppliers, are not Year 2000 compliant, it
could affect the Company's systems, which could have a material adverse
effect on the Company. The Company is undertaking a formal survey of the
Year 2000 compliance status of its suppliers, with responses indicating
Year 2000 compliance at this time.
Based on its assessments to date, the Company believes that it will not
experience any material disruption as a result of Year 2000 issues in
internal processes, information processing or interface with key
customers, or with processing orders and billing. The Company has
developed contingency plans which management believes can be successfully
implemented, if required, to address potential Year 2000 issues in the
Company's internal processes. There can be no assurance; however, that
Year 2000 issues will not have a material adverse effect on the Company's
business, results of operations and financial condition.
Certain Factors That May Affect Future Operating Results
The Company had operating losses in each of the years ending December 31,
1998, 1997, 1996 and 1995 and negative cash flow in the years ended
December 31, 1998 and 1997, and there can be no assurance that the Company
will achieve or sustain profitability or generate positive cash flow in
the future. The Company expects to incur significant expenditures in the
future in connection with the acquisition, development and expansion of
its network, information technology systems, employee base, services and
customer base. To the extent the Company's cash needs exceed the
Company's available cash and existing borrowing availability, the funding
of these expenditures will be dependent upon the Company's ability to
raise substantial financing.
The Company's ability to meet its projected growth is dependent upon its
ability to secure substantial additional financing in the future. There
can be no assurance that additional financing will be available to the
Company or, if available, that it can be obtained on a timely basis, on
terms acceptable to the Company, and within the limitations contained in
the Company's commercial lending agreements and the Certificate of
Designation. Failure to obtain such financing could result in the delay
or abandonment of the Company's development and expansion plans and could
have a material adverse effect on the Company.
The Company will have a significant amount of indebtedness outstanding
and, as a result of its growth strategy, expects to incur additional
indebtedness in the future. The Company's ability to make cash payments
with respect to its outstanding indebtedness and the Series A Preferred
Stock, and to repay its obligations on such indebtedness and preferred
<PAGE> 60
stock at maturity, will depend on its future operating performance, which
will be affected by prevailing economic conditions and financial, business
and other factors, certain of which are beyond the Company's control.
The Company's future performance will depend, in large part, upon its
ability to implement and manage its growth effectively. The Company's
rapid growth has placed, and in the future will continue to place, a
significant strain on its administrative, operational and financial
resources. Failure to retain and attract additional qualified sales and
other personnel, including management personnel who can manage the
Company's growth effectively, and failure to successfully integrate such
personnel, could have a material adverse effect on the Company. To manage
its growth successfully, the Company will also have to continue to improve
and upgrade operational, financial, accounting and information systems,
controls and infrastructure as well as expand, train and manage its
employee base. In the event the Company is unable to upgrade its
financial controls and systems adequately to support its anticipated
growth, the Company could be materially adversely affected.
The Company's strategy includes offering additional telecommunications
services, including local service and Internet access. The Company has
limited experience providing local services on its own network and
Internet access. There can be no assurance that the Company's future
services will receive market acceptance in a timely manner, if at all, or
that prices and demand for these services will be sufficient to provide
profitable operations.
The Company's success will depend upon its ability to develop and expand
its network infrastructure and support services in order to offer local
telecommunication services, Internet access and other services. Executing
the Company's business strategy will require that the Company enter into
agreements, on acceptable terms and conditions, with various providers of
infrastructure capacity, in particular, interconnection agreements with
ILECs and peering agreements with internet service providers ("ISPs").
No assurance can be given that all of the requisite agreements can be
obtained on satisfactory terms and conditions.
The Company relies on other companies to supply certain key components of
its network infrastructure, including telecommunications services, network
capacity and switching and networking equipment, which, in the quantities
and quality demanded by the Company, are available only from sole or
limited sources. The Company is also dependent upon ILECs and other
carriers to provide telecommunications services and facilities to the
Company and its customers. There can be no assurance that the Company
will be able to obtain such services or facilities on the scale and within
the time frames required by the Company at an affordable cost, or at all.
In 1998, approximately 37% of the Company's revenue was attributable to
the resale of long distance service provided by Sprint. The current
agreement with Sprint was renegotiated, effective March 1999, and
terminates in February 2000, and there can be no assurance that this
agreement will be extended on terms acceptable to the Company, if at all.
<PAGE> 61
Early termination of the Company's relationship with Sprint could have a
material adverse effect on the Company.
The Company operates in a highly competitive environment and currently
does not have a significant market share in any of its markets. Most of
its actual and potential competitors have substantially greater financial,
technical, marketing and other resources (including brand or corporate
name recognition) than the Company. Also, the continuing trend toward
business alliances in the telecommunications industry and the absence of
substantial barriers to entry in the data and Internet services markets
could give rise to significant new competition. The Company's success
will depend upon its ability to provide high-quality services at prices
competitive with those charged by its competitors.
Telecommunications services are subject to significant regulation at the
Federal, state, local and international levels, affecting the Company and
its existing and potential competitors. Delays in receiving required
regulatory approvals or the enactment of new and adverse legislation,
regulations or regulatory requirements may have a material adverse effect
on the Company's financial condition, results of operations and cash flow.
In addition, future legislative, judicial and regulatory agency actions
could alter competitive conditions in the markets in which the Company is
operating or intends to operate in ways that are materially adverse to the
Company.
The telecommunications industry has been, and is likely to continue to be,
characterized by rapid technological change, frequent new service
introductions and evolving industry standards. Increases or changes in
technological capabilities or efficiencies could create an incentive for
more competitors to enter the facilities-based local exchange business in
which the Company intends to compete. Similarly, such changes could
result in lower retail rates for telecommunications services, which could
have a material adverse effect on the Company's ability to price its
services competitively or profitably.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not believe that it faces any material risk exposure with
respect to derivative or other financial instruments that would require
disclosure under this item.
<PAGE> 62
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Network Plus Corp.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity
(deficit) and cash flows present fairly, in all material respects, the
financial position of Network Plus Corp. and its subsidiary at December
31, 1998 and 1997 and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards, which 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, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 17, 1999,
except for the information
in Note 21, for which the
date is March 23, 1999
<PAGE> 63
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
<CAPTION>
December 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $12,197 $ 1,567
Accounts receivable, net of allowance for
doubtful accounts of $513 and $926, respectively 16,225 16,927
Investments - 9,500
Prepaid expenses 760 415
Deferred taxes 277 -
Other current assets 1,591 112
-------- --------
Total current assets 31,050 28,521
PROPERTY AND EQUIPMENT, NET 15,822 6,957
OTHER ASSETS 821 103
DEFERRED TAXES 1,175 -
-------- --------
TOTAL ASSETS $48,868 $35,581
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Revolving line of credit - 4,510
Accounts payable $11,402 $17,445
Accrued liabilities 2,617 2,245
Notes payable to stockholders - 1,755
Current portion of debt and capital lease
obligations 863 5,694
-------- --------
Total current liabilities 14,882 31,649
(continued)
</TABLE>
<PAGE> 64
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(continued)
<CAPTION>
December 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS 3,147 3,623
LONG-TERM NOTE PAYABLE TO STOCKHOLDER 1,875 -
DEFERRED TAXES 491 -
OTHER LONG-TERM LIABILITIES 50 -
COMMITMENTS AND CONTINGENCIES
REDEEMABLE PREFERRED STOCK
13.5% Series A cumulative due 2009, $.01 par
value, 50 shares authorized, 40 shares
issued and outstanding (aggregate liquidation
preference of $41,814) 35,146 -
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.01 par value, 20,000 shares
authorized, 10,000 shares issued and outstanding 100 100
Additional paid-in capital - 183
Warrants 4,359 -
Retained earnings (accumulated deficit) (11,182) 26
-------- --------
Total stockholders' equity (deficit) (6,723) 309
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT) $48,868 $35,581
======== ========
<F1>
The accompanying notes are an integral part of the consolidated financial
statements.
</TABLE>
<PAGE> 65
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenue $ 105,545 $ 98,209 $ 75,135
Operating expenses
Costs of services 78,443 78,106 57,208
Selling, general and
administrative expenses 29,426 25,704 19,230
Depreciation and amortization 2,037 994 533
------------ ------------ ------------
109,906 104,804 76,971
------------ ------------ ------------
Operating loss (4,361) (6,595) (1,836)
Other income (expense)
Interest and dividend income 395 86 95
Interest expense (1,474) (557) (313)
Other income, net 151 3,917 3,529
------------ ------------ ------------
(928) 3,446 3,311
------------ ------------ ------------
Net income (loss) before income
taxes (5,289) (3,149) 1,475
Provision (credit) for income taxes (906) 42 60
------------ ------------ ------------
Net income (loss) (4,383) (3,191) 1,415
Preferred stock dividends and
accretion of offering expenses
and discount (2,005) - -
------------ ------------ ------------
Net income (loss) applicable to
common stockholders $ (6,388) $ (3,191) $ 1,415
============ ============ ============
Net income (loss) per share
applicable to common stockholders -
basic and diluted $ (0.64) $ (0.32) $ 0.14
============ ============ ============
Weighted average shares
outstanding - basic and diluted 10,000 10,000 10,000
============ ============ ============
(continued)
</TABLE>
<PAGE> 66
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(continued)
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Pro forma data:
Historical income (loss) before
Income taxes $ (5,289) $ (3,149) $ 1,475
Pro forma provision (credit)
for income taxes (1,904) (1,094) 607
------------ ------------ ------------
Pro forma net income (loss) (3,385) (2,055) 868
Historical preferred stock dividends
and accretion of offering expenses
and discount (2,005) - -
------------ ------------ ------------
Pro forma net income (loss)
applicable to common stockholders $ (5,390) $ (2,055) $ 868
============ ============ ============
Pro forma net income (loss)
per share applicable to common
stockholders - basic and diluted $ (0.54) $ (0.21) $ 0.09
============ ============ ============
<F1>
The accompanying notes are an integral part of the consolidated financial
statements.
</TABLE>
<PAGE> 67
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<CAPTION>
Year Ended December 31,
--------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (4,383) $(3,191) $ 1,415
Adjustments to reconcile net income to net
cash provided by (used for) operating
activities:
Depreciation and amortization 2,037 994 533
Provision for losses on accounts receivable 1,931 4,104 1,102
Amortization of AT&T credits - - (1,810)
Valuation of Tel-Save common stock warrants - (3,837) (2,093)
Gain on sale of Tel-Save common stock - - (1,367)
(Increase) decrease in assets:
Accounts receivable (1,229) (6,059) (1,584)
Prepaid expenses (345) (107) (218)
Deferred taxes (1,452) - -
Other current assets (1,479) (19) 5
Other long-term assets (718) (34) (13)
(Decrease) increase in liabilities:
Accounts payable (6,043) 8,022 4,146
Accrued liabilities 422 311 (438)
Deferred taxes 491 - -
--------- -------- --------
Net cash provided by (used for)
operating activities (10,768) 184 (322)
Cash flows from investing activities:
Capital expenditures (10,919) (3,363) (2,135)
Proceeds from sale of Tel-Save common stock 9,500 - 4,167
Exercise of Tel-Save common stock warrants - (3,570) (2,800)
Other 17 9 124
--------- -------- --------
Net cash provided by (used for)
investing activities (1,402) (6,924) (644)
(continued)
</TABLE>
<PAGE> 68
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(continued)
<CAPTION>
Year Ended December 31,
--------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Cash flows from financing activities:
Net proceeds from (payments on) from line
of credit (4,510) 2,510 2,000
Net proceeds from issuance of preferred
stock and warrants 37,500 - -
Proceeds from note payable - - 1,000
Proceeds from (payments on) notes payable
to stockholders (1,755) 1,755 -
Proceeds from note payable to stockholder 1,875 - -
Proceeds from sale and leaseback of fixed
assets - 3,450 -
Payments on debt and capital lease
obligations (5,307) (1,110) (167)
Distribution to stockholders (5,003) (601) (1,237)
--------- -------- --------
Net cash provided by financing activities 22,800 6,004 1,596
--------- -------- --------
Net increase (decrease) in cash 10,630 (736) 630
Cash at beginning of year 1,567 2,303 1,673
--------- -------- --------
Cash at end of year $ 12,197 $ 1,567 $ 2,303
========= ======== ========
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest $ 1,114 $ 498 $ 298
========= ======== ========
Income taxes $ 111 $ 15 $ 243
========= ======== ========
Noncash Investing and Financing Activities:
Fixed assets acquired under capital leases $ 28 $ 1,521 $ -
========= ======== ========
Preferred stock dividends paid-in-kind $ 1,814 $ - $ -
========= ======== ========
<F1>
The accompanying notes are an integral part of the consolidated financial
statements.
</TABLE>
<PAGE> 69
<TABLE>
NETWORK PLUS CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except per share data)
<CAPTION>
Common
Stock, Retained Total
$0.01 Additional Earnings Stockholders'
Par Paid-in (Accumulated Equity
Value Capital Warrants Deficit) (Deficit)
------ ---------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at
December 31, 1995 $100 $ 183 $ - $ 3,639 $ 3,922
Net income 1,415 1,415
Distributions to
stockholders (1,236) (1,236)
---- ------ ------- --------- --------
Balance at
December 31, 1996 100 183 - 3,818 4,101
Net loss (3,191) (3,191)
Distributions to
stockholders (601) (601)
---- ------ ------- --------- --------
Balance at
December 31, 1997 100 183 - 26 309
Net loss (4,383) (4,383)
Distributions to
stockholders (3) (3)
Common stock
dividends (5,000) (5,000)
Issuance of
310,000 warrants 4,359 4,359
Dividends on
preferred stock (183) (1,631) (1,814)
Accretion of
preferred stock
offering expenses
and discount (191) (191)
---- ------- ------- --------- --------
Balance at
December 31, 1998 $100 $ - $4,359 $(11,182) $(6,723)
==== ======= ======= ========= ========
<F1>
The accompanying notes are an integral part of the consolidated financial
statements.
</TABLE>
<PAGE> 70
NETWORK PLUS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Activity
Network Plus Corp. (the "Company") is a facilities-based integrated
communications provider offering switched long distance, data and enhanced
telecommunications services. The Company's customers consist primarily of
small and medium-sized businesses located in major markets in the
Northeastern and Southeastern regions of the United States. The Company
also provides international wholesale transport and termination services
to major domestic and international telecommunication carriers. In
addition, the Company presently offers local services through resale
agreements with local exchange carriers. Revenues are derived from the
sale of domestic and international telephone services, calling cards,
debit cards and paging services. All revenues are billed and collected in
U.S. dollars. In addition to switching customer traffic on its own
facilities, the Company contracts with Sprint Communications Company, L.P.
("Sprint") to provide switching and dedicated voice and data services
for a portion of the Company's telecommunications traffic.
Basis of Presentation
On July 15, 1998, Network Plus Corp. was incorporated in the state of
Delaware. The stockholders of Network Plus, Inc. contributed 100% of
their shares to the Company, in return for an aggregate of 10,000,000
shares of the common stock. Accordingly, Network Plus, Inc. became a
wholly-owned subsidiary of the Company.
The Company's consolidated financial statements reflect the financial
position and results of operations of its wholly-owned subsidiary, Network
Plus, Inc. All intercompany transactions are eliminated in consolidation.
For periods prior to the formation of the Company on July 15, 1998, the
financial statements reflect the activities of Network Plus, Inc., as it
was the sole operating entity.
Cash Equivalents
All highly liquid cash investments with maturities of three months or less
at date of purchase are considered to be cash equivalents. At December
31, 1998, $1,063 of cash equivalents are restricted for use as collateral
for outstanding letters of credit.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets.
<PAGE> 71
Leasehold improvements are amortized over the shorter of the lease term or
the estimated useful life of the improvements. Upon retirement or other
disposition of property and equipment, the cost and related depreciation
are removed from the accounts and the resulting gain or loss is reflected
in earnings.
Long-lived assets and identifiable intangibles held and used are reviewed
for impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets or intangibles may exceed the
undiscounted future net cash flow expected to be generated by such assets.
If it is determined that impairment has occurred, the asset is written
down to fair value as determined by market value or discounted cash flow.
Capital Leases
Capital leases, those leases which transfer substantially all benefits and
risks of ownership, are accounted for as acquisitions of assets and
incurrences of obligations. Capital lease amortization is included in
depreciation and amortization expense, with the amortization period equal
to the estimated useful life of the assets. Interest on the related
obligation is recognized over the lease term at a constant periodic rate.
Revenue Recognition and Accounts Receivable
Telecommunication revenues and accounts receivable are recognized when
calls are completed or when services are provided. Accounts receivable
include both billed and unbilled amounts, and are reduced by an estimate
for uncollectible amounts. Unbilled amounts result from the Company's
monthly billing cycles and reflect telecommunications services provided in
the 30 days prior to the reporting date. These amounts are billed within
30 days subsequent to the reporting date and are expected to be collected
under standard terms offered to customers.
Unbilled amounts were $8,563 and $7,594 at December 31, 1998 and 1997,
respectively.
Costs of Services
Costs of services include costs of origination, transport and termination
of traffic, exclusive of depreciation and amortization.
Income Taxes
Effective March 1, 1992, the Company elected by the consent of its
stockholders to be taxed under the provisions of Subchapter S of the
Internal Revenue Code. Under those provisions, the Company did not pay
corporate Federal income taxes on its taxable income. Instead, the
stockholders were liable for individual income taxes on their share of the
Company's taxable income.
The issuance of preferred stock on September 3, 1998 terminated the
Company's election to be taxed under the provisions of Subchapter S of the
<PAGE> 72
Internal Revenue Code. Accordingly, subsequent to September 3, 1998, the
Company provides for and reports statutory Federal and state income taxes,
as necessary. These financial statements also present, on a pro forma
basis, Federal and state income taxes assuming the Company had been a C
Corporation for all periods presented.
The Company accounts for income taxes under Statement of Financial
Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income
Taxes". SFAS 109 is an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future
tax consequences of events that have been recognized in the Company's
financial statements or tax returns. In estimating future tax
consequences, SFAS 109 generally considers all expected future events
other than enactment of changes in the tax law or rates.
Earnings (Loss) Per Share
The Company computes and reports earnings per share in accordance with the
provisions of SFAS No. 128, "Earnings Per Share". The computations of
basic and diluted earnings (loss) per common share are based upon the
weighted average number of common shares outstanding and potentially
dilutive securities. Potentially dilutive securities include convertible
preferred stock, stock options and warrants. There were no potentially
dilutive securities outstanding during 1998, 1997 or 1996.
Pro forma net loss per share reflecting the Company's conversion from an S
Corporation to a C Corporation is presented using an estimated effective
income tax rate of approximately 35% to 41%.
Concentration of Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts
receivable. In addition, risk exists in cash deposited in banks that may,
at times, be in excess of FDIC insurance limits. The trade accounts
receivable risk is limited due to the breadth of entities comprising the
Company's customer base and their dispersion across different industries
and geographical regions. The Company evaluates the credit worthiness of
customers, as appropriate, and maintains an adequate allowance for
potential uncollectible accounts.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain amounts in the financial statements for prior years have been
reclassified to conform with the current year presentation. Such
<PAGE> 73
reclassifications had no effect on previously reported results of
operations.
2. RELATED PARTY TRANSACTIONS
In September 1998, one of the Company's stockholders made a loan to the
Company for $1,875. Interest on the loan accrues at the prime rate (7.75%
at December 31, 1998). Accrued interest on this loan, included in other
long-term assets, totaled $50 at December 31, 1998. Principal and
interest will be payable 10 days after redemption of the Series A
Preferred Stock (see Note 10).
On December 31, 1997, the Company's stockholders made loans to the Company
totaling $1,755. Interest on the loans accrued at the prevailing prime
rate and was payable monthly. Interest expense related to these loans
totaled $49 in 1998. There was no required period for principal
repayment. The loans were repaid in May 1998.
Office space, located in Quincy, Massachusetts, is leased from a trust,
the beneficiaries of which are the stockholders of the Company. The
Company makes monthly rental payments of $50. In 1998, the amount paid to
the trust was $544. In each of the years ending December 31, 1997 and
1996, the amount paid to the trust was $431.
3. INVESTMENTS AND TRANSFER OF CUSTOMERS
In 1995, the Company transferred (the "Transfer") certain customers to
whom it provided long distance and toll free telecommunications services
pursuant to certain AT&T resale contracts (the "AT&T contracts") to Tel-
Save Holdings, Inc. ("Tel-Save"). Concurrent with the Transfer, the
Company's obligations to AT&T under the AT&T contracts were terminated
without obligation or liability on behalf of the Company. Prior to the
time of this transaction, there was no value recorded in the financial
statements related to these customers. In exchange for the Transfer, the
Company received four separate warrants to purchase a total of 1,365,000
shares of Tel-Save common stock at an exercise price of $4.67 per share
(after reflecting stock splits through December 31, 1997). Each warrant
vested to the Company separately based on the retail revenue generated by
Tel-Save with respect to the transferred customers, which had to exceed
specified levels for three consecutive months. The warrants expired at
various dates through 1997. In addition to the Warrant Agreements, the
Company was subject to a Voting Rights Agreement whereby Tel-Save retained
the right to hold and vote the stock until the point in time when the
Company informed Tel-Save it wished to sell the stock. Upon receiving
such notice from the Company, Tel-Save was obligated to either purchase
the stock at the price offered by the Company or, alternatively, was to
deliver the common stock certificates to the Company.
In 1996, the vesting requirements were met to exercise the first three
warrants. The vesting requirement for the first warrant was met at the
end of the third quarter of 1996, entitling the Company to purchase
600,000 shares of Tel-Save common stock. The Company exercised this
<PAGE> 74
warrant and sold the related common stock, which had previously been
registered, resulting in net proceeds and other income of $1,370 in the
third quarter of 1996.
The vesting requirements with respect to the second and third warrants
were met in November 1996. The second warrant entitled the Company to
purchase 300,000 shares of Tel-Save common stock prior to January 8, 1997.
The third warrant entitled the Company to purchase 150,000 shares of Tel-
Save Common stock prior to June 10, 1997. The warrants were valued upon
vesting at approximately $2,093 using the Black-Scholes valuation model.
The significant assumptions in the valuation model were an interest rate
of 5.1%, warrant lives reflecting the respective expiration periods,
expected volatility of 50% and no dividend rate. At December 31, 1996,
the warrants had not yet been exercised and were classified as
investments. The value of the warrants at December 31, 1996 was the fair
value recorded by the Company at the date of vesting. Other income of
$2,093 related to the second and third warrants was recognized in the
fourth quarter of 1996. On January 6, 1997, the Company exercised the
second and third warrants and paid Tel-Save the total exercise price of
$2,100.
The vesting requirement with respect to the fourth warrant was met in June
1997, entitling the Company to purchase 315,000 shares of Tel-Save common
stock. The fourth warrant was valued upon vesting at approximately $3,415
using Black-Scholes valuation model. The significant assumptions in the
valuation model were an interest rate of 5.1%, a warrant life reflecting
the June 1997 expiration period, expected volatility of 50% and no
dividend rate. On June 4, 1997, the Company exercised the warrant, paid
Tel-Save the exercise price of $1,470 and recorded other income of
approximately $3,415.
On November 7, 1997, Tel-Save filed a registration statement with the SEC,
listing the Company as a selling shareholder with respect to 765,000
shares (the total shares purchased by the Company, after reflecting stock
splits, under the second, third and fourth warrants). Following the
registration of the common stock, the Company intended to immediately sell
the shares of Tel-Save, which had a market value of approximately $16,600
at that date, as it had done previously with the first warrant.
Accordingly, all activities necessary for the transfer of the certificates
were completed and the Company issued a demand to Tel-Save for the common
stock certificates or, alternatively, requested that Tel-Save purchase the
shares. Throughout the remainder of the fourth quarter, Tel-Save refused
to deliver the common stock certificates to the Company.
In order to take physical possession of the Tel-Save common stock
certificates, the Company filed a lawsuit against Tel-Save in January
1998. On June 24, 1998, a settlement agreement was signed between the
parties pursuant to which the Company received a total of $9,500 from Tel-
Save. As part of the settlement, all 765,000 shares were either returned
to or repurchased by Tel-Save. Following the June 1998 settlement, there
are no continuing obligations between the parties. Accordingly, the
Company's investment in Tel-Save at December 31, 1997 was valued at the
<PAGE> 75
final negotiated payment. This settlement resulted in approximately $422
of other income, recorded in the fourth quarter of 1997.
<TABLE>
4. PROPERTY AND EQUIPMENT
<CAPTION>
December 31,
Estimated -----------------------
Useful Life 1998 1997
------------- ---------- ----------
<S> <C> <C> <C>
Telecommunications equipment 5 years $ 13,247 $ 4,004
Computer equipment 3-5 years 3,145 2,756
Office furniture and equipment 7 years 1,393 1,272
Purchased software 3 years 1,245 694
Motor vehicles 5 years 201 174
Leasehold improvements Term of Lease 689 130
-------- --------
19,920 9,030
Less accumulated depreciation
and amortization (4,098) (2,073)
--------- --------
$ 15,822 $ 6,957
========= ========
</TABLE>
In August 1997, upon review of the Company's experience and expectations
for upgrades and replacement of equipment, including information gathered
during the process of financing such equipment, the Company changed its
estimate of the useful life of its switching equipment from 12 years to 5
years. The Company also reviewed publicly available industry data on
telecommunications equipment, which confirmed that the estimate of useful
lives of the Company's telecommunications equipment, which was entirely
switching equipment at that time, reasonably approximated 5 years. The
Company also assessed that there had been no significant decline in the
market value of its switching equipment since purchased and that the
market value exceeded the net book value of the equipment at the time of
the change in estimate. This was confirmed by the Company's ability to
enter into a sale and leaseback of the switches for the approximate book
value, completed at the same time as the change in estimate.
Depreciation expense in 1997 was approximately $136 more than what would
have otherwise been reported had the change in estimate not been made.
Annual depreciation expense related to these assets will be approximately
$407 more through 2002 than what would have otherwise been reported had
the change not been made.
In November 1997, the Company entered into a sale and leaseback of its
switching equipment. The equipment was sold at book value, which
approximates market value, and, consequently, no gain or loss was recorded
on the sale. This lease was refinanced, effective January 1, 1999. See
Note 8.
<PAGE> 76
5. ACCRUED LIABILITIES
<TABLE>
Accrued liabilities consist of the following:
<CAPTION>
December 31,
----------------
1998 1997
------- -------
<S> <C> <C>
Accrued interest $ 46 $ 60
Accrued salaries, wages, commissions and related taxes 821 297
Customer deposits 142 361
Accrued income and franchise taxes 462 766
Accrued taxes other than income and franchise 170 238
Accrued agency commissions 285 183
Other accrued liabilities 691 340
------ ------
$2,617 $2,245
====== ======
</TABLE>
6. REVOLVING CREDIT AGREEMENTS AND LETTERS OF CREDIT
The Company had a revolving line of credit with Fleet National Bank
("Fleet") for borrowings up to $7,000, including letters of credit,
which was refinanced on May 1, 1998, as described below. At December 31,
1997, cash borrowings under the line of credit totaled $4,510 and letters
of credit issued in the ordinary course of business totaled $120. The
interest rate on such borrowings was 8.5% at December 31, 1997. The
maximum borrowings under the agreement in 1997 was $5,000.
On May 1, 1998, the Company entered into a revolving credit agreement with
Fleet, which allowed for up to $23,000 of borrowings, based upon a
percentage of accounts receivable. This agreement had a term of three
years, but was terminated on October 7, 1998, upon entering into the New
Revolving Credit Facility, described below. Interest was payable monthly
at Fleet's prime rate or available LIBOR options. All outstanding notes
payable were paid in full in May 1998 with proceeds from the $23 million
facility.
On October 7, 1998, the Company entered into a loan agreement with Goldman
Sachs Credit Partners, L.P. and Fleet for a $60,000 revolving credit
facility (the "New Revolving Credit Facility"), and concurrently
terminated the $23 million facility. The New Revolving Credit Facility
has a term of 18 months. Under the New Revolving Credit Facility, $30,000
of the $60,000 is immediately available, while the additional $30 million
is available based upon a percentage of accounts receivable. Interest is
payable monthly at one percent above the prime rate. The New Revolving
Credit Facility requires the Company, among other things, to meet minimum
levels of revenues and earnings before interest, taxes, depreciation and
amortization, and not to exceed certain customer turnover levels and debt
to revenue ratios. At December 31, 1998, there were no borrowings
outstanding under the New Revolving Credit Facility. The maximum
borrowings under the agreement in 1998 were $3,210.
<PAGE> 77
Letters of credit issued in the ordinary course of business totaled $1,063
as of December 31, 1998 and were collateralized by a corresponding amount
of cash equivalents.
7. DEBT AND CAPITAL LEASE OBLIGATIONS
<TABLE>
Debt and capital lease obligations consist of the following:
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Notes payable $ - $ 4,600
Capital lease obligations 4,010 4,717
-------- --------
4,010 9,317
Less current portion (863) (5,694)
-------- --------
$ 3,147 $ 3,623
======== ========
</TABLE>
The Company issued a promissory note, dated December 1, 1997, to Sprint
for repayment of $4,600 previously classified as accounts payable.
Monthly principal payments are required from February 1998 through the
note's maturity on September 1, 1998. Interest accrued at a fixed rate of
9.75% per annum on the unpaid principal balance and was payable monthly.
The promissory note and accrued interest were paid in full on May 1, 1998.
The Company's capital leases as of December 31, 1998 were refinanced
effective January 1, 1999 and the current and long-term portions of such
leases have been classified in accordance with the new lease terms. See
Note 8.
8. LEASE COMMITMENTS
The Company has entered into noncancellable operating leases for office
space in several locations in the United States. The leases have
termination dates through 2014 and require the payment of various
operating costs including condominium fees. Rental expense related to the
leases for the years ended December 31, 1998, 1997 and 1996 were $1,263,
$733 and $688, respectively.
<PAGE> 78
<TABLE>
Minimum lease payments for the next five years and thereafter are as
follows:
<CAPTION>
Capital Operating
Year Ended December 31, Leases Leases
- --------------------------------------- -------- ---------
<S> <C> <C>
1999 $ 1,046 $ 2,680
2000 1,046 2,531
2001 1,042 2,344
2002 691 2,352
2003 691 2,347
Thereafter - 24,456
-------- -------
Total minimum lease payments $ 4,516 $36,710
Less imputed interest (506) =======
--------
Present value of minimum lease payments 4,010
Less current portion (863)
--------
Long-term capital lease obligations $ 3,147
========
</TABLE>
<TABLE>
Property and equipment under capital leases are as follows:
<CAPTION>
December 31,
--------------------
1998 1997
------- -------
<S> <C> <C>
Telecommunications equipment $ 3,837 $ 3,837
Computer equipment 1,527 1,527
Motor vehicles 55 -
-------- --------
5,419 5,364
Less accumulated amortization (1,701) (515)
-------- --------
$ 3,718 $ 4,849
======== ========
</TABLE>
In December 1998, the Company received an $81,000 commitment for equipment
lease financing for telecommunications equipment to be acquired through
December 31, 1999. Depending on the type of equipment, the lease term
will either be for three or five years. All of the leases to be entered
into will contain bargain purchase options upon conclusion of the lease
term. Leases were entered into as of January 1, 1999 totaling $22,904 and
included $3,986 for refinancing of previously existing leases. Also
included in the new lease financing was an additional $3,462 received by
the Company from the lessor for the sale and leaseback of equipment
acquired by the Company in 1998.
<PAGE> 79
9. STOCKHOLDERS' EQUITY
Common Stock
The certificate of incorporation of the Company authorizes the issuance of
up to 20,000,000 shares of $.01 par value common stock. There are
10,000,000 shares of common stock issued and outstanding and held of
record by two stockholders as of March 26, 1999. The holders of common
stock are entitled to receive dividends when and as dividends are declared
by the Board of Directors of NP Corp. out of funds legally available
therefor, provided that if any shares of preferred stock are at the time
outstanding, the payment of dividends on the common stock or other
distributions may be subject to the declaration and payment of dividends
on outstanding shares of preferred stock. Holders of common stock are
entitled to one vote per share on all matters submitted to a vote of the
stockholders, including the election of directors. Upon any liquidation,
dissolution or winding up of the affairs of the Company, whether voluntary
or involuntary, any assets remaining after the satisfaction in full of the
prior rights of creditors and the aggregate liquidation preference of any
preferred stock then outstanding will be distributed to the holders of
common stock ratably in proportion to the number of shares held by them.
The common stock is not publicly traded.
Preferred Stock
Under the certificate of incorporation of the Company, the Board of
Directors has the authority to issue up to 1,000,000 shares of $.01 par
value preferred stock from time to time in one or more series with such
preferences, terms and rights as the Board of Directors may determine
without further action by the stockholders of the Company. Accordingly,
the Board of Directors has the power to establish the provisions, if any,
relating to dividends, voting rights, redemption rates, sinking funds,
liquidation preferences and conversion rights for any series of preferred
stock issued in the future. At December 31, 1998, there were 40,000
shares of 13.5% Series A Cumulative Preferred Stock outstanding, plus
1,814 shares to be issued for paid-in-kind dividends.
Common Stock Dividends
On September 2, 1998, the Board of Directors of the Company issued a
$5,000 dividend to its stockholders. Following receipt of the dividend,
one stockholder loaned the Company $1,875 (representing the distribution
to that stockholder, net of the estimated tax liability resulting from
such distribution). Interest accrues at prime rate, and interest and
principal will be payable 10 days after redemption of the Series A
Preferred Stock.
10. PREFERRED STOCK ISSUANCE
On September 3, 1998, the Company issued 40,000 shares of 13.5% Series A
Cumulative Preferred Stock Due 2009, warrants to purchase, for $.01 per
share, 310,000 shares of the Company's common stock ("Initial Warrants")
<PAGE> 80
and rights to receive warrants to purchase 600,000 shares of the Company
common stock at an exercise price of $.01 per share ("Contingent
Warrants"), resulting in proceeds to the Company of $37,500, net of
issuance costs of $2,500. The Contingent Warrants entitle the holders of
the preferred stock to receive annually, beginning on September 1, 1999,
warrants to purchase approximately 1.36 shares of the Company's common
stock for each share of preferred stock. The Warrants vest on
September 1, 2000, subject to acceleration upon the occurrence of certain
events. A total value of $4,359 was ascribed to the Initial Warrants, net
of issuance costs of $290, and was accounted for as a separate component
of stockholders' equity. The value ascribed to the Initial Warrants was
recorded as a discount to the preferred stock, which will be accreted to
the preferred stock balance over the period from date of issuance through
the date of mandatory redemption (September 1, 2009). The value
ascribed to the Contingent Warrants was de minimis. The Company will
record a dividend for an amount equal to the fair value of the warrants
based upon future vesting.
11. STOCK OPTION PLANS
Stock-based Compensation Plans
On July 15, 1998, the Company adopted the 1998 Stock Incentive Plan (the
"1998 Incentive Plan"). The 1998 Incentive Plan provides for the grant
of stock-based awards to employees, officers and directors of, and
consultants or advisors to, the Company. Under the 1998 Incentive Plan,
the Company may grant options that are intended to qualify as incentive
stock options ("incentive stock options") within the meaning of Section
422 of the Internal Revenue Code of 1986, as amended (the "Code"),
options not intended to qualify as incentive stock options ("non-
statutory options"), restricted stock and other stock-based awards.
Incentive stock options may be granted only to employees of the Company or
its subsidiaries. A total of 1,400,000 shares of common stock may be
issued upon the exercise of options or other awards granted under the 1998
Incentive Plan. The number of shares with respect to which awards may be
granted to any employee under the 1998 Incentive Plan may not exceed
700,000 during any calendar year. The exercisability of options or other
awards granted under the 1998 Incentive Plan may, in certain
circumstances, be accelerated in connection with an Acquisition Event (as
defined in the 1998 Incentive Plan). Options and other awards may be
granted under the 1998 Incentive Plan at exercise prices that are equal
to, less than or greater than the fair market value of NP Corp.'s common
stock, and the Board generally retains the authority to reprice
outstanding options. The 1998 Incentive Plan expires in July 2008, unless
sooner terminated by the Board.
On July 15, 1998, the Company authorized the grant of a total of 741,140
options to purchase the Company common stock at exercise prices at or
above the fair market value of the Company's common stock, as determined
by its Board of Directors. The options, when issued, will generally vest
ratably over a period of four years.
<PAGE> 81
On July 15, 1998, the Company adopted the 1998 Director Stock Option Plan
(the "Director Plan"). Under the terms of the Director Plan, 5,000
shares of common stock will be granted to each non-employee director upon
his or her initial election to the Board of Directors. Annual options to
purchase 2,500 shares of common stock will also be granted to each non-
employee director on the date of each annual meeting of stockholders, or
on August 1 of each year if no annual meeting is held by such date.
Options granted under the Director Plan will vest in four equal annual
installments beginning on the first anniversary of the date of grant. The
exercisability of these options will be accelerated upon the occurrence of
an Acquisition Event (as defined in the Director Plan). The exercise
price of options granted under the Director Plan is equal to the fair
market value of the common stock on the date of grant. A total of 100,000
shares of common stock may be issued upon the exercise of stock options
granted under the Director Plan. Pursuant to the Director Plan, on
September 3, 1998, the two non-employee directors each received an option
to purchase 5,000 shares of common stock at an exercise price of $15.00
per share.
The Company elected to adopt the disclosure only provision of Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for
Stock Based Compensation", for stock based compensation issued to
employees. The Company accounts for its stock based compensation issued
to employees under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees" and, in accordance with the
recognition requirements set forth under this pronouncement, no
compensation expense was recognized in 1998.
<TABLE>
Stock option activity for the year ended December 31, 1998 is as follows:
<CAPTION>
Number Weighted-Average
of Shares Exercise Price
--------- ----------------
<S> <C> <C>
Shares under option, December 31, 1997 - -
Options granted 751,140 $32.87
Options cancelled 5,840 $38.29
------- ------
Shares under option, December 31, 1998 745,300 $32.82
======= ======
</TABLE>
<PAGE> 82
<TABLE>
The following table summarizes information about the stock options
outstanding at December 31, 1998.
<CAPTION>
Weighted-
Average Weighted-
Remaining Average Weighted-Average
Number Contractual Exercise Fair Value at
Exercise Price Outstanding Life (Years) Price Grant Date
- -------------- ----------- ------------- --------- ----------------
<S> <C> <C> <C> <C>
$15.00 204,449 9.5 $15.00 $6.99
30.00 282,220 9.5 30.00 -
50.00 258,631 9.5 50.00 -
------- --- ------ -----
745,300 9.5 $33.07 $1.92
======= === ====== =====
</TABLE>
At December 31, 1998, no options were exercisable and the Company had an
aggregate of 754,700 shares available for future grant under its Stock
Incentive Plan and Director Stock Option Plan.
For disclosure purposes, the fair value of each stock option grant is
estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions used for stock
options granted in 1998: no dividends or volatility, risk-free interest
rate of 6.3% and expected life of ten years for all grants. The weighted-
average fair value of the stock options granted in 1998 was $1.92.
Under the above model, the total value of stock options granted in 1998
was $1,436, which would be amortized ratably on a pro forma basis over the
four-year option vesting period. Had the company determined compensation
expense for the stock-based compensation plans in accordance with the fair
value methodology prescribed by SFAS 123, the Company's pro forma net loss
and loss per share would have been:
<TABLE>
<CAPTION>
Year Ended
December 31, 1998
-----------------
<S> <C>
Pro forma net loss applicable to common
stockholders $(6,556)
========
Pro forma net loss per share - basic and
diluted $ (0.66)
========
</TABLE>
12. UNEARNED CREDITS
In 1993 and 1994, the Company, through special sales promotions offered
through AT&T on three-year service contracts, received cash based on
maintaining annual sales commitment levels over a specific dollar amount.
The total amounts received from the AT&T promotions were initially
amortized over the three-year length of each contract, which approximated
the achievement of required sales commitment levels. During 1996, all
<PAGE> 83
contracts concluded or were terminated without continuing liability to the
Company. Upon termination, any remaining unearned credits were recorded
in income. Accordingly, all amounts were amortized prior to 1997.
Amortization of these credits included in revenue in 1996 was $1,810.
13. INCOME TAXES
<TABLE>
The provision (credit) for income taxes consists of the following:
<CAPTION>
Year Ended December 31, 1998
----------------------------
<S> <C>
Current taxes:
Federal $ -
State 55
--------
Total $ 55
========
Deferred taxes:
Federal $ (880)
State (81)
--------
Total $ (961)
--------
Provision (credit) for income taxes $ (906)
=======
</TABLE>
<TABLE>
Deferred tax (assets) liabilities consist of the following:
<CAPTION>
December 31, 1998
----------------------------
<S> <C>
Accrued expenses $ 83
Allowance for doubtful accounts 195
Net operating loss carryforwards 1,175
--------
Deferred tax assets $ 1,452
========
Depreciation $ 491
--------
Deferred tax liabilities $ 491
========
</TABLE>
<PAGE> 84
<TABLE>
The provision (credit) for income taxes differs from the amount computed
by applying the U.S. Federal income tax rate due to the following items:
<CAPTION>
Year Ended December 31, 1998
----------------------------
<S> <C>
Tax at U.S. Federal income tax rate $(1,798)
State income taxes, net of U.S.
Federal income tax benefit 41
Recognition of deferred taxes
upon conversion from S Corp.
to C Corp. 349
Permanent timing differences 42
S Corp. loss 470
--------
$ (906)
========
</TABLE>
14. NET INCOME (LOSS) PER SHARE
The computations of basic and diluted earnings per common share are based
upon the weighted average number of common shares outstanding and
potentially dilutive securities. Potentially dilutive securities for the
Company include stock options and warrants.
Pro forma net loss per share reflecting the Company's conversion from an S
Corporation to a C Corporation is presented using estimated effective
income tax rates and excludes a $480 tax provision for deferred payable
recorded in the third quarter of 1998 resulting from the conversion.
<TABLE>
The following table sets forth the computation of basic and diluted income
(loss) per share:
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income (loss) applicable to
Network Plus Corp. common
stock - basic and diluted $(6,388) $(3,191) $1,415
Shares used in net income (loss)
per share - basic and diluted 10,000,000 10,000,000 10,000,000
============ ============ ============
Net income (loss) per share
applicable to common
stockholders - basic and
diluted $(0.64) $(0.32) $0.14
============ ============ ============
</TABLE>
<PAGE> 85
Warrants for the purchase of 310,000 shares of common stock were not
included in the 1998 computations of diluted net income (loss) per share
because inclusion of such shares would have an anti-dilutive effect on net
loss per share, as the Company reported net losses in the respective 1998
periods.
Stock options for the purchase of 745,300 shares of common stock were not
included in the 1998 computation of diluted net loss per share because the
exercise prices of those stock options are assumed to be at or above the
average fair value of the Company's common stock for 1998, and inclusion
of such shares would have an anti-dilutive effect on net loss per share.
15. COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income". This
Statement establishes new rules for the statement had no impact on the
Company's net income or stockholders' equity. There were no adjustments
required to calculate comprehensive income for either 1998 or 1997.
16. SEGMENT INFORMATION
In July 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS 131"), which is effective for
fiscal years beginning after December 15, 1997. The Company adopted SFAS
131 in 1998 and believes that it operates in one segment.
17. SIGNIFICANT CUSTOMER
During the year ended December 31, 1998, the Company had one wholesale
customer that accounted for approximately 13% of the Company's revenue;
during each of 1997 and 1996, the Company had one retail customer that
accounted for approximately 10% of the Company's revenue. No other
customer comprised greater than 10% of total revenue in these periods.
18. MAJOR SUPPLIER
The Company has an agreement with Sprint to provide switching and
dedicated voice and data services. At expiration or any time prior, the
Company can seek to renew all material aspects of the agreement with
Sprint. In the event that renewal does not occur, the Company may be able
to negotiate equally beneficial terms with other major telecommunications
companies. Should neither of these alternatives be possible, there could
be material adverse implications for the Company's financial position and
operations. Management's experience has been to renegotiate agreements
annually to ensure receiving competitive pricing, and management believes
the Company will be able to continue to renegotiate the agreements. The
current agreement was renegotiated, effective March 1999, and will expire
in February 2000.
<PAGE> 86
19. EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) and profit sharing plan (the "Plan") which
is open to all eligible employees under the Plan's provisions. The terms
of the Plan allow the Company to determine its annual profit sharing
contribution. There were no Company contributions to the Plan in 1998,
1997 or 1996.
20. NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The Company will adopt
the provisions of this statement effective January 1, 1999 and does not
believe that it will have a material impact on its business or results of
operations.
In June 1998, Statement of Financial Accounting Standards No. 133 ("SFAS
133"), "Accounting for Derivative Instruments and Hedging Activities",
was issued, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts, and for hedging activities. This statement is
effective for the quarters in the Company's fiscal year 2000. Had the
Company implemented SFAS 133 in the current period, financial position and
results of operations would not have been affected.
21. SUBSEQUENT EVENT
On March 23, 1999, the Company entered into a strategic partnership with
NorthPoint Communications, Inc. ("NorthPoint"), which included an equity
investment of $2.5 million by the Company in NorthPoint, to provide xDSL
services to businesses currently reached by NorthPoint's infrastructure.
The Company will account for this investment on the cost basis.
<PAGE> 87
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following selected quarterly financial data should be read in
conjunction with the consolidated financial statements, related notes and
Management's Discussion and Analysis of Financial Condition and Results of
Operations. This information has been derived from unaudited financial
statements that, in the opinion of management, reflect all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of such quarterly information. For periods prior to the
formation of the company on July 15, 1998, the financial data reflect the
financial statements of Network Plus, Inc., the Company's wholly-owned
subsidiary, as it was the sole operating entity. The operating results
for any quarter are not necessarily indicative of results to be expected
for any future period. Certain amounts in individual quarters have been
reclassified to conform with year end presentation.
<PAGE> 88
<TABLE>
<CAPTION>
1997
-------------------------------------------------
Three Months Ended
---------------------------------------
March 31, June 30, Sept. 30, Dec. 31, Full Year
--------- --------- --------- --------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenue $ 24,740 $ 24,641 $ 24,540 $ 24,288 $ 98,209
Operating Expenses
Costs of services 19,110 19,330 19,753 19,913 78,106
Selling, general
and administrative
expenses 5,127 5,440 5,803 9,334 25,704
Depreciation and
amortization 156 168 257 413 994
--------- --------- --------- --------- ---------
24,393 24,938 25,813 29,660 104,804
--------- --------- --------- --------- ---------
Operating income (loss) 347 (297) (1,273) (5,372) (6,595)
Other income (expense)
Interest and dividend
income 22 38 17 9 86
Interest expense (83) (94) (153) (227) (557)
Other income, net 16 3,436 35 430 3,917
--------- --------- --------- --------- ---------
(45) 3,380 (101) 212 3,446
Net income (loss) before
income taxes 302 3,083 (1,374) (5,160) (3,149)
Provision (credit) for
income taxes 25 - 17 - 42
--------- --------- --------- --------- ---------
Net income (loss) 277 3,083 (1,391) (5,160) (3,191)
Preferred stock
dividends and accretion
of offering expenses
and discount - - - - -
--------- --------- --------- --------- ---------
Net income (loss)
applicable to common
stockholders $ 277 $ 3,083 $ (1,391) $ (5,160) $ (3,191)
========= ========= ========= ========= =========
Net income (loss) per
share applicable to
common stockholders -
basic and diluted $ 0.03 $ 0.31 $ (0.14) $ (0.52) $ (0.32)
========= ========= ========= ========= =========
Weighted average shares
outstanding - basic
and diluted 10,000 10,000 10,000 10,000 10,000
========= ========= ========= ========= =========
</TABLE>
<PAGE> 89
<TABLE>
<CAPTION>
1998
-------------------------------------------------
Three Months Ended
---------------------------------------
March 31, June 30, Sept. 30, Dec. 31, Full Year
--------- --------- --------- --------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenue $ 25,202 $ 27,103 $ 27,283 $ 25,957 $105,545
Operating Expenses
Costs of services 18,836 19,992 20,406 19,209 78,443
Selling, general
and administrative
expenses 5,544 6,391 8,164 9,327 29,426
Depreciation and
amortization 468 483 498 588 2,037
--------- --------- --------- --------- ---------
24,848 26,866 29,068 29,124 109,906
--------- --------- --------- --------- ---------
Operating income (loss) 354 237 (1,785) (3,167) (4,361)
Other income (expense)
Interest and dividend
income 3 9 50 333 395
Interest expense (285) (293) (203) (693) (1,474)
Other income, net 21 16 32 82 151
--------- --------- --------- --------- ---------
(261) (268) (121) (278) (928)
Net income (loss) before
income taxes 93 (31) (1,906) (3,445) (5,289)
Provision (credit) for
income taxes 9 125 296 (1,336) (906)
--------- --------- --------- --------- ---------
Net income (loss) 84 (156) (2,202) (2,109) (4,383)
Preferred stock
dividends and accretion
of offering expenses
and discount - - - (2,005) (2,005)
--------- --------- --------- --------- ---------
Net income (loss)
applicable to common
stockholders $ 84 $ (156) $ (2,202) $ (4,114) $ (6,388)
========= ========= ========= ========= =========
Net income (loss) per
share applicable to
common stockholders -
basic and diluted $ 0.01 $ (0.02) $ (0.22) $ (0.43) $ (0.64)
========= ========= ========= ========= =========
Weighted average shares
outstanding - basic
and diluted 10,000 10,000 10,000 10,000 10,000
========= ========= ========= ========= =========
</TABLE>
<PAGE> 90
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's Directors and Executive Officers is
set forth above in Item 1 of this Annual Report.
<PAGE> 91
<TABLE>
Item 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information concerning the cash and
non-cash compensation during fiscal year 1998 earned by or awarded to the
Chief Executive Officer and the five other most highly compensated executive
officers of the Company whose combined salary and bonus exceeded $100,000
during the fiscal year ended December 31, 1998 (the "Named Executive
Officers").
ANNUAL COMPENSATION
<CAPTION>
Long-Term
Compensation
Annual Compensation ------------
----------------------- Option All Other
Name and Title Year Salary Bonus(1)(2) Awards (#) Compensation
- -------------------- ---- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Robert T. Hale, Jr. 1998 $246,163(3) $2,671 - $ -
Chief Executive
Officer and
President
Robert T. Hale 1998 187,708 1,484 - -
Chairman of the
Board of Directors
James J. Crowley 1998 156,500 - 120,000 -
Executive Vice
President and Chief
Operating Officer
Michael F. Oyster (4) 1998 80,208 64,500 40,000 -
Executive Vice
President of
Networks and
Product Development
Joseph Haines (4) 1998 91,667 80,000 40,000 -
Vice President
of Local Operations
Kevin B. McConnaughey 1998 138,487 14,755 14,620 13,487(5)
Vice President and
General Manager
Of International
Services
<F1>
(1) Includes the cash value of travel awarded as bonuses.
<F2>
(2) Includes amounts paid subsequent to December 31, 1998 related to 1998
performance.
<F3>
(3) Includes sales commissions of $20,538.
<F4>
(4) Commenced employment with the Company on July 16, 1998.
<F5>
(5) Compensable reimbursement for moving expenses.
</TABLE>
<PAGE> 92
<TABLE>
OPTION GRANTS IN LAST FISCAL YEAR
<CAPTION>
Potential Realizable
% of Value at Assumed
Total Annual Rates of Stock
Options Price Appreciation
Granted Exercise for Option Term
Options to Price Expiration ---------------------
Granted Employees ($/Share) Date 5% 10%
------- --------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Robert T. Hale, Jr. - - - - - -
Robert T. Hale - - - - - -
James J. Crowley 66,667 9.0% $15.00 7/15/08 $628,898 $1,593,750
33,333 4.5 30.00 7/15/08 0 296,868
20,000 2.7 50.00 7/15/08 0 0
------- ----- ------- ----------
120,000 16.2% 628,898 1,890,618
Michael F. Oyster 10,000 1.3% 15.00 7/15/08 13,395 33,947
20,000 2.7 30.00 7/15/08 0 53,437
10,000 1.3 50.00 7/15/08 0 0
------- ----- ------- ----------
40,000 5.4% 13,395 87,384
Joseph Haines 0 0.0% 15.00 7/15/08 4,990 12,646
40,000 5.4 30.00 7/15/08 0 35,313
0 0.0 50.00 7/15/08 0 0
------- ----- ------- ----------
40,000 5.4% 4,990 47,959
Kevin B. McConnaughey 1,420 0.2% 15.00 7/15/08 41,932 106,263
6,000 0.8 30.00 7/15/08 0 79,167
7,200 1.0 50.00 7/15/08 0 0
------- ----- ------- ----------
14,620 2.0% 41,932 185,430
</TABLE>
<PAGE> 93
<TABLE>
YEAR-END OPTION VALUES
<CAPTION>
Number of Value of Unexercised
Unexercised Options In-the-Money Options
at December 31, 1998 at December 31, 1998(1)
------------------------- -------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Robert T. Hale, Jr. - - $ - $ -
Robert T. Hale - - - -
James J. Crowley - 120,000 - -
Michael F. Oyster - 40,000 - -
Joseph Haines - 40,000 - -
Kevin B. McConnaughey - 14,620 - -
<F1>
(1) Based on the difference between the fair market value of the common
stock at fiscal year end, as most recently determined by the Board
of Directors ($15.00) and the option exercise price.
</TABLE>
Compensation of Directors
In July 1998, the Company adopted the 1998 Director Stock Option Plan (the
"Director Plan"). Under the terms of the Director Plan, options to
purchase 5,000 shares of Common Stock will be granted to each new non-
employee director upon his or her initial election to the Board of
Directors. Annual options to purchase 2,500 shares of Common Stock will
also be granted to each non-employee director on the date of each annual
meeting of stockholders, or on August 1 of each year if no annual meeting
is held by such date. Options granted under the Director Plan will vest
in four equal annual installments beginning on the first anniversary of
the date of grant. The exercisability of these options will be
accelerated upon the occurrence of an Acquisition Event (as defined in the
Director Plan). The exercise price of options granted under the Director
Plan is equal to the fair market value of the Common Stock on the date of
grant. A total of 100,000 shares of Common Stock may be issued upon the
exercise of stock options granted under the Director Plan. In addition,
Directors are reimbursed for out-of-pocket expenses incurred as a result
of their service as Directors. Pursuant to the Director Plan, on
September 3, 1998, Messrs. Martin and McNay each received an option to
purchase 5,000 shares of Common Stock at an exercise price of $15.00 per
share.
<PAGE> 94
Employee Benefit Plans
1998 Stock Incentive Plan
The Company's 1998 Stock Incentive Plan (the "1998 Incentive Plan") was
adopted by the Company in July 1998. The 1998 Incentive Plan provides for
the grant of stock-based awards to employees, officers and directors of,
and consultants or advisors to, the Company. Under the 1998 Incentive
Plan, the Company may grant options that are intended to qualify as
incentive stock options ("incentive stock options") within the meaning
of Section 422 of the Internal Revenue Code of 1986, as amended (the
"Code"), options not intended to qualify as incentive stock options
("nonqualified options"), restricted stock and other stock-based awards.
Incentive stock options may be granted only to employees of the Company. A
total of 1,400,000 shares of common stock may be issued upon the exercise
of options or other awards granted under the 1998 Incentive Plan. The
number of shares with respect to which awards may be granted to any
employee under the 1998 Incentive Plan may not exceed 700,000 during any
calendar year. The exercisability of options or other awards granted
under the 1998 Incentive Plan may in certain circumstances be accelerated
in connection with an Acquisition Event (as defined in the 1998 Incentive
Plan). Options and other awards may be granted under the 1998 Incentive
Plan at exercise prices that are equal to, less than or greater than the
fair market value of the Company's common stock, and the Board generally
retains the right to reprice outstanding options. The 1998 Incentive Plan
expires in June 2008, unless sooner terminated by the Board. As of
December 31, 1998, there were options outstanding to purchase an aggregate
of 745,300 shares of Common Stock under the 1998 Incentive Plan. These
options generally become exercisable in four equal annual installments
beginning on the first anniversary of the date of grant, subject in
certain cases to accelerated vesting in connection with an Acquisition
Event.
401(k) Plan
Effective January 1, 1995, the Company adopted the Employee 401(k) and
Profit Sharing Plan (the "401(k) Plan") covering the Company's eligible
employees. Pursuant to the 401(k) Plan, employees may elect to reduce
their current compensation by up to the lesser of 15% of eligible
compensation or the statutorily prescribed annual limit ($10,000 in 1998)
and have the amount of such reduction contributed to the 401(k) Plan. The
401(k) Plan permits, but does not require, additional contributions to the
401(k) Plan by the Company on behalf of all participants. The Company
contributed $175,000 to the 401(k) Plan in 1995. No additional
contributions have been made by the Company. The 401(k) Plan is intended
to qualify under Section 401 of the Code, so that contributions by
employees or by the Company to the 401(k) Plan, and income earned on plan
contributions, are not taxable to employees until withdrawn, and
contributions by the Company, if any, are deductible by the Company when
made.
<PAGE> 95
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
<TABLE>
The following table sets forth, as of March 26, 1999, the number of shares
of Common Stock and the percentage of the outstanding shares of Common
Stock that are beneficially owned by (i) each person that is the
beneficial owner of more than 5% of the outstanding shares of Common
Stock, (ii) each of the directors and Names Executive Officers of the
Company and (iii) all of the current directors and executive officers of
the Company as a group.
<CAPTION>
Amount and Nature
of Beneficial Ownership (1)
--------------------------------
Number of
Shares of Percent
Name and Address of Beneficial Owner Common Stock of Class
- ------------------------------------ --------------- ---------------
<S> <C> <C>
5% STOCKHOLDERS
Robert T. Hale 5,000,000 50%
c/o Network Plus Corp.
234 Copeland Street
Quincy, Massachusetts 02169
Robert T. Hale, Jr. 5,000,000 50%
c/o Network Plus Corp.
234 Copeland Street
Quincy, Massachusetts 02169
OTHER DIRECTORS
James J. Crowley 0 -
David Martin 0 -
Joseph C. McNay 0 -
OTHER NAMED EXECUTIVE OFFICERS
Michael F. Oyster 0 -
Joseph Haines 0 -
Kevin B. McConnaughey 0 -
All directors and executive officers
as a group (10 persons) 10,000,000 100%
______________
<F1>
(1) Each stockholder possesses sole voting and investment power with
respect to the shares listed. Excludes options that vest subsequent to
May 28, 1999. None of the named stockholders holds shares of any other
class of the Company's securities.
</TABLE>
<PAGE> 96
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company's office space in Quincy, Massachusetts is leased from a
trust, the beneficiaries of which are the common stockholders of the
Company. The Company makes monthly rental payments to the trust of
$50,000. In 1998, the amount paid to the trust was $544,000. In each of
the years ending December 31, 1998, 1997 and 1996, the amount paid to the
trust was $431,000.
On September 2, 1998, the Company paid a dividend in the aggregate amount
of $5.0 million. As a result, $2.5 million was distributed to each of
Robert T. Hale and Robert T. Hale, Jr. Robert T. Hale, Jr., reinvested
$1.9 million in the Company (representing approximately the distribution
to him, net of his estimated tax liability resulting from such dividend)
in the form of a long-term loan to the Company. Interest on such loan
will accrue at Fleet Bank's prime rate. Principal and interest on such
loan will be payable 10 days after the redemption of the Series A
Preferred Stock.
In December 1997, the Company's stockholders issued the Company loans
totaling $1.8 million. Interest on the loans accrued at the bank's prime
rate (8.5% at December 31, 1997) and was payable monthly. There was no
required period for principal repayment. The loans, including $12,017 of
accrued interest, were repaid in May 1998.
<PAGE> 97
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 - Financial Statements
Consolidated Balance Sheets
December 31, 1998 and 1997
Consolidated Statements of Operations
Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows
Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
Years Ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a) 2 - Financial Statement Schedules
The following consolidated financial statement schedules
of Network Plus Corp. are included in Item 14(d) and filed
herewith (page numbers refer to page numbers in this Form
10-K):
Schedule II - Valuation and Qualifying Accounts................ 101
Report of Independent Accountants on Financial Statement
Schedules..................................................... 102
All other schedules for which provision is made in the
applicable accounting regulations of the Securities and
Exchange Commission are not required under the related
instructions, or are inapplicable and, therefore, have
been omitted.
(b) Reports on Form 8-K
None.
<PAGE> 98
(a) 3. and (c) - Exhibits
Exhibit
Number Description
- ------- ------------------------------------------------------------
3.1* Certificate of Incorporation of the Company.
3.2* Certificate of Designation of the Series A Preferred Stock.
3.3* By-laws of the Company.
4.1* Exchange and Registration Rights Agreement dated as of
September 1, 1998 between the Company and the Purchasers.
4.2* Purchase Agreement dated as of September 1, 1998 between the
Company and the Purchasers.
10.1* 1998 Stock Incentive Plan.
10.2* 1998 Director Stock Option Plan.
10.3+* Resale Solutions Switched Services Agreement dated as of June
21, 1998 between the Company and Sprint Communications Company
L.P.
10.4+* Agreement for the Provision of Fiber Optic Facilities and
Services dated as of July 17, 1998 between the Company and
Northeast Optic Network, Inc.
10.5+* IRU Agreement dated as of July 17, 1998 between the Company
and Qwest Communications Corporation.
10.6* Net Lease by and between Network Plus Realty Trust, Landlord,
and Network Plus, Inc., Tenant, dated July 1, 1993.
10.7* Interconnection Agreement Under Sections 251 and 252 of the
Telecommunications Act of 1996, dated September 4, 1998, by
and between New England Telephone and Telegraph Company d/b/a
Bell Atlantic-Massachusetts and Network Plus, Inc.
10.8* Loan and Security Agreement dated October 7, 1998 by and
between Network Plus, Inc., as Borrower, Goldman Sachs Credit
Partners L.P. and Fleet National Bank as Lenders, Fleet
National Bank as Agent and Goldman Sachs Credit Partners L.P.
as Syndication and Arrangement Agent.
10.9+* Master Lease Agreement, dated as of August 8, 1997, by and
between Chase Equipment Leasing, Inc. and Network Plus, Inc.,
as amended.
<PAGE> 99
Exhibit
Number Description
- ------- ------------------------------------------------------------
10.10 Master Lease Agreement, dated as of December 30, 1998, by and
between Comdisco, Inc. and Network Plus, Inc.
12 Ratio of Earnings to Combined Fixed Charges.
21* Subsidiaries of the Registrant.
27 Financial Data Schedules.
* Incorporated herein by reference to the Company's Registration
Statement on Form S-1, as amended (File No. 333-64663).
+ Confidential treatment granted as to certain portio
<PAGE> 100
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
NETWORK PLUS CORP.
------------------
Company
Date: March 30, 1999 By /s/ Steven L. Shapiro
--------------------------
Steven L. Shapiro,
Vice President of Finance,
Chief Financial Officer
and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Company and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ----------------------------- --------------------------- --------------
/s/ Robert T. Hale, Chairman of the Board March 30, 1999
- -----------------------------
Robert T. Hale, Sr.
/s/ Robert T. Hale, Jr. President, Chief Executive March 30, 1999
- ----------------------------- Officer and Director
Robert T. Hale, Jr. (Principal Executive Officer)
/s/ James J. Crowley Executive Vice President, March 30, 1999
- ----------------------------- Chief Operating Officer and
James J. Crowley Director
/s/ Steven L. Shapiro Vice President of Finance, March 30, 1999
- ----------------------------- Chief Financial Officer
Steven L. Shapiro and Treasurer (Principal
Financial and Accounting
Officer)
/s/ David Martin Director March 30, 1999
- -----------------------------
David Martin
/s/ Joseph C. McNay Director March 30, 1999
- -----------------------------
Joseph C. McNay
<PAGE> 101
<TABLE>
NETWORK PLUS CORP.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<CAPTION>
Additions
Balance at Charged to Balance
Beginning Costs and At End
Description of Year Expenses Deductions (1) of Year
- ------------------ ------------- ----------- -------------- ---------
<S> <C> <C> <C> <C>
Allowance for
doubtful accounts
Year Ended
December 31, 1998 $926 1,931 2,344 $513
Year Ended
December 31, 1997 $850 4,104 4,028 $926
Year Ended
December 31, 1996 $500 1,102 752 $850
<F1>
(1) Write-off of bad debts less recoveries.
</TABLE>
<PAGE> 102
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and
Stockholders of Network Plus Corp.
Our report on the consolidated financial statements of Network Plus
Corp. is included in this Form 10-K in Item 8. In connection with our
audits of such financial statements, we have also audited the related
financial statement schedule listed in Item 14(b) of this Form 10-K.
In our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements as a whole,
presents fairly, in all material respects, the information required to be
included therein.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 17, 1999
<PAGE> 1
MASTER AGREEMENT
This Master Agreement dated December 30, 1998 is made by and between
Comdisco, Inc. ("Comdisco") with offices at 6111 North River Road,
Rosemont, Illinois 60018 and Network Plus, Inc. ("Customer") with offices
at 234 Copeland Street, Quincy, MA 02169.
SECTION 1. SCOPE
1.1 Schedules. Comdisco will provide Services and Products under the
terms and conditions of this Master Agreement and as more particularly
defined in each Schedule. Each Schedule will constitute a separate
agreement with respect to the Services and Products provided. Schedules
may be entered into by Customer or any of its domestic subsidiaries and
affiliates and such entity will be deemed to be Customer for that
Schedule. However, Customer, as set forth above, will remain jointly and
severally liable for the performance of all obligations under each
Schedule.
1.2 Supplements. In connection with certain Services and Products,
terms and conditions in addition to those specified in this Master
Agreement may apply. Where such additional terms and conditions apply,
the Services and Products will be provided under this Master Agreement,
related Schedules and Supplements. If there is a conflict among the
documents, the order of precedence will be the (i) Schedule, (ii)
Supplement, and (iii) Master Agreement.
1.3 Changes. Any change to this Agreement, which will include the terms
and conditions of this Master Agreement together with related Schedules
and Supplements, must be documented in writing. Comdisco will have no
obligation to commence work in connection with a change request until the
change has been approved in writing by Comdisco and Customer.
SECTION 2. FEES
2.1 Fees. Customer will pay the fees for the Services and the Products
in the amounts and in accordance with the payment terms set forth in each
Schedule.
2.2 Late Fee. Whenever any payment is not made within thirty (30) days
of invoice date, or as otherwise specified in this Agreement, Customer
will pay interest at the lesser of one and one-half percent (1.5%) per
month or the maximum amount permitted by law.
2.3 Expenses. Unless otherwise specified in a Schedule or Supplement,
Customer will reimburse Comdisco for all reasonable expenses incurred in
connection with Comdisco's performance under this Agreement.
<PAGE> 2
2.4 Taxes. Customer will pay or reimburse Comdisco for any taxes, fees
or other charges imposed by any local, state or federal authority
(together with any related interest or penalties not due to the fault of
Comdisco) resulting from this Agreement, or from any activities hereunder,
except for taxes based on Comdisco's net income.
SECTION 3. TERM
Each Schedule will take effect upon the signature of both parties and
continue through the term as specified therein. The Services to be
provided under each Schedule will begin on the date set forth in the
Schedule.
SECTION 4. WARRANTIES AND LIABILITY
4.1 Services. Comdisco warrants that the Services will be performed in
a professional manner.
4.2 Products. EXCEPT AS SPECIFICALLY STATED IN A SCHEDULE, THE
PRODUCTS, INCLUDING THIRD PARTY SOFTWARE, ARE PROVIDED ON AN "AS IS" BASIS
FROM THE MANUFACTURER AND COMDISCO SHALL HAVE NO LIABILITY IN CONNECTION
WITH SUCH PRODUCTS OR ANY PORTION THEREOF, INCLUDING, BUT NOT LIMITED TO,
INFRINGEMENT OF ANY PATENTS, COPYRIGHTS, TRADE SECRETS OR ANY OTHER
PROPRIETARY RIGHT.
4.3 Exclusive Warranty. EXCEPT AS EXPRESSLY SET FORTH IN THIS
AGREEMENT, COMDISCO MAKES NO REPRESENTATIONS OR WARRANTIES WHATSOEVER,
EXPRESS OR IMPLIED, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF
MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE.
4.4 Liability. Comdisco's liability to Customer from any cause
whatsoever arising out of this Agreement will not, in any event, exceed
the aggregate of the fees paid by Customer for the Services giving rise to
the claim during the twelve (12) month period immediately prior to the
occurrence of the claim. UNDER NO CIRCUMSTANCES, WILL EITHER PARTY BE
LIABLE FOR INDIRECT, SPECIAL, CONSEQUENTIAL OR PUNITIVE DAMAGES EVEN IF
SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
SECTION 5. MUTUAL INDEMNIFICATION
Each party will indemnify and hold the other party and its employees and
agents, harmless against any and all third party claims, liabilities,
losses, damages and causes of action relating to bodily injury, including
death, or damage to real or tangible personal property arising out of the
intentional or negligent acts or omissions of the indemnifying party which
occurred during the performance of a Schedule. The indemnifying party,
however, will not be responsible for injury or damage attributed to the
intentional or negligent acts or omissions of the indemnified party, its
employees or agents.
<PAGE> 3
SECTION 6. OWNERSHIP AND CONFIDENTIALITY
6.1 Ownership. Comdisco retains all rights in Comdisco Proprietary
Materials. For purposes of this Agreement, Comdisco Proprietary Materials
will mean all materials, information and other deliverable items
originally developed by Comdisco under a Schedule as well as Comdisco's
proprietary tools, methodologies, documentation and methods of analysis.
Comdisco grants to Customer the right to use Comdisco Proprietary
Materials delivered to Customer under a Schedule. Customer may use
Comdisco Proprietary Materials for Customer's internal business use only
and not for the benefit of a third party. Any proprietary software
product of Comdisco will be licensed to Customer under a separate license
agreement.
6.2 Confidentiality. Each party (including its employees and agents)
will use the same standard of care to protect any confidential information
of the other disclosed during negotiation or performance of this Agreement
that it uses to protect its own confidential information. Comdisco's
confidential information includes this Master Agreement, each Schedule and
Supplement, Comdisco Proprietary Materials and Comdisco's security systems
and procedures. Confidential information will not include information
which (i) is or becomes publicly available through no wrongful act of the
receiving party; (ii) was known by the receiving party at the time of
disclosure without any obligation of confidentiality; (iii) was acquired
by the receiving party from a third party that was not under an obligation
of confidence; or (iv) was developed independently by the receiving party.
SECTION 7. PROPRIETARY RIGHTS PROTECTION
Comdisco will defend at its expense any third party claim brought against
Customer alleging that the Comdisco Proprietary Materials infringe a
copyright, trade secret or presently existing United States patent and
will pay any damages finally awarded against Customer. Comdisco will not
be obligated to defend Customer unless Customer notifies Comdisco promptly
in writing of the claim and provides reasonable cooperation and full
authority for Comdisco to defend or settle the claim. Comdisco will not
be liable for any claim of infringement based on any information, data, or
materials provided by Customer.
<PAGE> 4
SECTION 8. TERMINATION
Either party may, by written notice, terminate a Schedule for cause if the
other party fails to cure a material default under the Schedule. Any
material default must be specifically identified in the notice of
termination. After written notice, the notified party will have ten (10)
days to remedy any monetary default and thirty (30) days to remedy any
other default. Failure to remedy the material default within the time
period provided for herein will give cause for immediate termination. If
termination is due to Customer's material default, Customer will
immediately pay to Comdisco the amounts then owing under the relevant
Schedule up to the date of termination. The foregoing payments will be in
addition to all other legal and equitable rights of Comdisco and any
remedies set forth in a Schedule or Supplement
SECTION 9. MISCELLANEOUS
9.1 Each party is an independent contractor and, except as expressly set
forth herein will have no authority to bind or commit the other party.
Nothing herein shall be deemed or construed to create a joint venture,
partnership or agency relationship between the parties.
9.2 Customer may not assign this Agreement or any of its rights or
obligations therein (except to its successor pursuant to a merger,
consolidation or sale of all or substantially all of its assets) without
obtaining the prior written consent of Comdisco.
9.3 The waiver by either party of a breach of any provision of this
Agreement will not be construed as a waiver of any subsequent breach. The
invalidity, in whole or in part, of any provision of this Agreement will
not affect the validity of the remaining provisions.
9.4 This Master Agreement and each Schedule and Supplement represents
the entire agreement between the parties and supersedes all oral or other
written agreements or understandings between the parties concerning the
Services and Products. This Agreement may not be modified unless in
writing and signed by the party against whom enforcement of the
modification is sought.
9.5 Any notice, request or other communication under this Agreement will
be given in writing and deemed received upon the earlier of actual receipt
or three (3) days after mailing if mailed postage prepaid by regular or
airmail to the address set forth above or, one day after such notice is
sent by courier or facsimile transmission.
9.6 No third party is intended to be, or will be construed to be, a
beneficiary of any provision of this Agreement nor have any right to
enforce any of its provisions or to pursue any remedy for its breach.
9.7 Those terms and conditions which would, by their meaning or intent,
survive the expiration or termination of any Schedule will so survive.
<PAGE> 5
9.8 THIS MASTER AGREEMENT AND EACH SCHEDULE AND SUPPLEMENT IS GOVERNED
BY THE LAWS OF THE STATE OF ILLINOIS WITHOUT REGARD TO ITS CONFLICT OF
LAWS PROVISIONS. If there is any dispute or litigation as a result of
this Agreement, the prevailing party will be entitled to reasonable
attorney's fees. Any action by either party must be brought within two
(2) years after the cause of action arose.
9.9 During the term of each Schedule and for a period of one (1) year
from the completion of the Services thereunder, Customer agrees not to
knowingly employ or solicit for employment any Comdisco employee who was
involved in the furnishing of the Services under the relevant Schedule.
9.10 Preprinted terms on Customer's purchase order or other
acknowledgment form will be of no force or effect.
9.11 Comdisco will not be considered in default under this Agreement due
to any failure in its performance due to causes beyond its control.
IN WITNESS WHEREOF, the parties have caused this Master Agreement to be
executed by their duly authorized officers as of the day and year first
set forth above.
Network Plus, Inc. Comdisco, Inc.
- ----------------------------
Customer
By: Steven Shapiro By: Rosemary P. Geisler
Title: Vice President, CFO Title: Senior Vice President
and Treasurer
<PAGE> 6
PRODUCT SUPPLEMENT DATED December 30, 1998
TO THE MASTER AGREEMENT DATED December 30, 1998
BETWEEN COMDISCO, INC ("COMDISCO") AND
Network Plus, Inc. ("CUSTOMER")
SECTION 1. PROPERTY LEASED
Comdisco leases to Customer all of the Products described on any Schedule
entered into pursuant to the terms of this Product Supplement.
SECTION 2. TERM
On the Commencement Date Customer will be deemed to accept the Products,
will be bound to its rental obligations for the Products and the term of a
Schedule will begin and continue through the Initial Term and thereafter
until terminated by either party upon prior written notice received during
the Notice Period. No termination may be effective prior to the
expiration of the Initial Term.
SECTION 3. RENT AND PAYMENT
Rent is due and payable in advance, in immediately available funds, on the
first day of each Rent Interval to the payee and at the location specified
in Comdisco's invoice. Interim Rent is due and payable when invoiced. If
any payment is not made when due, Customer will pay interest at the
Overdue Rate.
SECTION 4. SELECTION AND WARRANTY AND DISCLAIMER OF WARRANTIES
4.1 Selection. Customer acknowledges that it has selected the Products
and disclaims any reliance upon statements made by Comdisco.
4.2 Warranty and Disclaimer of Warranties. Comdisco warrants to
Customer that, so long as Customer is not in default, Comdisco will not
disturb Customer's quiet and peaceful possession, and unrestricted use of
the Products. To the extent permitted by the manufacturer, Comdisco
assigns to Customer during the term of the Schedule any manufacturer's
warranties for the Products. Comdisco is not responsible for any
liability, claim, loss, damage or expense of any kind (including strict
liability in tort) caused by the Products except for any loss or damage
caused by the negligent acts of Comdisco.
<PAGE> 7
SECTION 5. TITLE AND ASSIGNMENT
5.1 Title. Customer holds the Products subject and subordinate to the
rights of the Owner, Comdisco, any Assignee and any Secured Party.
Customer authorizes Comdisco, as Customer's agent, to prepare, execute and
file in Customer's name precautionary Uniform Commercial Code financing
statements showing the interest of the Owner, Comdisco, and any Assignee
or Secured Party in the Products and to insert serial numbers in Schedules
as appropriate. Except as provided in Sections 5.2 and 7.2, Customer
will, at its expense, keep the Products free and clear from any liens or
encumbrances of any kind (except any caused by Comdisco) and will
indemnify and hold Comdisco, Owner, any Assignee and Secured Party
harmless from and against any loss caused by Customer's failure to do so.
5.2 Relocation or Sublease. Upon prior written notice, Customer may
relocate Products to any location within the continental United States
provided (i) the Products will not be used by an entity exempt from
federal income tax and (ii) all additional costs (including any
administrative fees, additional taxes and insurance coverage) are
reconciled and promptly paid by Customer.
5.3 Customer may sublease the Products upon the reasonable consent of
Comdisco and the Secured Party. Such consent to sublease will be granted
if: (i) Customer meets the relocation requirements set out above, (ii)
the sublease is expressly subject and subordinate to the terms of the
Schedule, (iii) Customer assigns its rights in the sublease to Comdisco
and the Secured Party as additional collateral and security, (iv)
Customer's obligation to maintain and insure the Products is not altered,
(v) all financing statements required to continue the Secured Party's
prior perfected security interest are filed, and (vi) the sublease is not
to a leasing entity affiliated with the manufacturer of the Products
described on the Schedule. Comdisco acknowledges Customer's right to
sublease for a term which extends beyond the expiration of the Initial
Term. If Customer subleases the Products for a term extending beyond the
expiration of such Initial Term of the applicable Schedule, Customer shall
remain obligated upon the expiration of the Initial Term to return such
Products, or, at Comdisco's sole discretion to (i) return Like Products or
(ii) negotiate a mutually acceptable lease extension or purchase. If the
parties cannot mutually agree upon the terms of an extension or purchase,
the term of the Schedule will extend upon the original terms and
conditions until terminated pursuant to Section 2.
No relocation or sublease will relieve Customer from any of its
obligations under this Product Supplement and the applicable Schedule.
5.3 Assignment by Comdisco. The terms and conditions of each Schedule
have been fixed by Comdisco in order to permit Comdisco to sell and/or
assign or transfer its interest or grant a security interest in each
Schedule and/or the Products to a Secured Party or Assignee. In that
event the term Comdisco will mean the Assignee and any Secured Party.
However, any assignment, sale, or other transfer by Comdisco will not
relieve Comdisco of its obligations to Customer and will not materially
change Customer's duties or materially increase the burdens or risks
<PAGE> 8
imposed on Customer. The Customer consents to and will acknowledge such
assignments in a written notice given to Customer. Customer also agrees
that:
(a) The Secured Party will be entitled to exercise all of Comdisco's
rights, but will not be obligated to perform any of the obligations of
Comdisco. The Secured Party will not disturb Customer's quiet and
peaceful possession and unrestricted use of the Products so long as
Customer is not in default and the Secured Party continues to receive all
Rent payable under the Schedule;
(b) Customer will pay all Rent and all other amounts payable to the
Secured Party, despite any defense or claim which it has against Comdisco.
Customer reserves its right to have recourse directly against Comdisco for
any defense or claim; and
(c) Subject to and without impairment of Customer's leasehold rights in
the Products, Customer holds the Products for the Secured Party to the
extent of the Secured Party's rights in the Products.
SECTION 6. NET LEASE AND TAXES
6.1 Net Lease. Each Schedule constitutes a net lease. Customer's
obligation to pay Rent and all other amounts is absolute and unconditional
and is not subject to any abatement, reduction, set-off, defense,
counterclaim, interruption, deferment or recoupment for any reason
whatsoever.
6.2 Taxes. Comdisco will file all personal property tax returns for the
Products and pay all property taxes due. Customer will reimburse Comdisco
for property taxes within thirty (30) days of receipt of an invoice.
SECTION 7. CARE, USE AND MAINTENANCE, ATTACHMENTS AND RECONFIGURATIONS
AND INSPECTION BY COMDISCO
7.1 Care, Use and Maintenance. Customer will maintain the Products in
good operating order and appearance, protect the Products from
deterioration, other than normal wear and tear, and will not use the
Products for any purpose other than that for which it was designed. If
commercially available, Customer will maintain in force a standard
maintenance contract with the manufacturer of the Products, or another
party acceptable to Comdisco, and upon request will provide Comdisco with
a complete copy of that contract. If Customer has the Products maintained
by a party other then the manufacturer, Customer agrees to pay any costs
necessary for the manufacturer to bring the Products to then current
release, revision and engineering change levels, and to re-certify the
Products as eligible for manufacturer's maintenance at the expiration of
the lease term. The lease term will continue upon the same terms and
conditions until recertification has been obtained.
<PAGE> 9
7.2 Attachments and Reconfigurations. Upon prior written notice to
Comdisco, Customer may reconfigure and install Attachments on the
Products. In the event of such a Reconfiguration or Attachment, Customer
shall, upon return of the Products, at its expense, restore the Products
to the original configuration specified on the Schedule in accordance with
the manufacturer's specifications and in the same operating order, repair
and appearance as when installed (normal wear and tear excluded). If any
parts are removed from the Products during the Reconfiguration or
Attachment, the restoration will include, at Customer's option, the
installation of either the original removed parts or Like Parts.
Alternatively, with Comdisco's prior written consent which will not be
unreasonably withheld, Customer may return the Products with any
Attachment or upgrade. If any parts of the Products are removed during a
Reconfiguration or Attachment, Comdisco may require Customer to provide
additional security, satisfactory to the Comdisco, in order to ensure
performance of Customer's obligations set forth in this subsection.
Neither Attachments nor parts installed on Products in the course of
Reconfiguration shall be accessions to the Products.
However, if the Reconfiguration or Attachment (i) adversely affects
Comdisco's tax benefits relating to the Products; (ii) is not capable of
being removed without causing material damage to the Products; or (iii) if
at the time of the Reconfiguration or Attachment the manufacturer does not
offer on a commercial basis a means for the removal of the additional
items; then such Reconfiguration or Attachment is subject to the prior
written consent of Comdisco.
7.3 Inspection by Comdisco. Upon request, Customer, during reasonable
business hours and subject to Customer's security requirements, will make
the Products and its related log and maintenance records available to
Comdisco for inspection.
SECTION 8. REPRESENTATIONS AND WARRANTIES OF CUSTOMER
Customer represents and warrants that for each Schedule entered into under
this Product Supplement:
(a) The execution, delivery and performance of the Customer have been
duly authorized by all necessary corporate action;
(b) The individual executing was duly authorized to do so;
(c) The Master Agreement, Product Supplement and each Schedule
constitute legal, valid and binding agreements of the Customer enforceable
in accordance with their terms; and
(d) The Products are personal property and when subjected to use by the
Customer will not be or become fixtures under applicable law.
<PAGE> 10
SECTION 9. DELIVERY AND RETURN OF PRODUCTS
Customer assumes the full expense of transportation and in-transit
insurance to Customer's premises and for installation of the Products.
Upon expiration or termination of each Schedule, Customer will, at
Comdisco's instructions and at Customer's expense (including
transportation and in-transit insurance), have the Products deinstalled,
audited by the manufacturer, packed and shipped in accordance with the
manufacturer's specifications and returned to Comdisco in the same
operating order, repair and appearance as when installed (ordinary wear
and tear excluded), to a location within the continental United States as
directed by Comdisco. All items returned to Comdisco in addition to the
Products become property of Comdisco.
SECTION 10. LABELING
Upon request, Customer will mark the Products indicating Comdisco's
interest. Customer will keep all Products free from any other marking or
labeling which might be interpreted as a claim of ownership.
SECTION 11. INDEMNITY
Customer will indemnify and hold Comdisco, any Assignee and any Secured
Party harmless from and against any and all claims, costs, expenses,
damages and liabilities, including reasonable attorney's fees, arising out
of the ownership (for strict liability in tort only), selection,
possession, leasing, operation, control, use, maintenance, delivery,
return or other disposition of the Products. However, Customer is not
responsible to a party indemnified hereunder for any claims, costs,
expenses, damages and liabilities occasion by the negligent acts of such
indemnified party. Customer agrees to carry bodily injury and property
damage liability insurance during the term of the Schedule in amounts and
against risks customarily insured against by the Customer on Products
owned by it. Any amounts received by Comdisco under that insurance will
be credited against Customer's obligations under this Section.
<PAGE> 11
SECTION 12. RISK OF LOSS
12.1 Customer's Risk of Loss. If the Schedule indicates that the
Customer has responsibility for the risk of loss of the Products, then the
following terms will apply:
Effective upon delivery and until the Products are returned, Customer
relieves Comdisco of responsibility for all risks of physical damage to or
loss or destruction of the Products. Customer will carry casualty
insurance for the Products in an amount not less than the Casualty Value.
All policies for such insurance will name Comdisco and any Secured Party
as additional insured and as loss payee, and will provide for at least
thirty (30) days prior written notice to Comdisco of cancellation or
expiration. The Customer will furnish appropriate evidence of such
insurance.
Customer shall promptly repair any damaged Product unless such Product has
suffered a Casualty Loss. Within fifteen (15) days of a Casualty Loss,
Customer will provide written notice of that loss to Comdisco and Customer
will, at Comdisco's option, either (a) replace the damaged Product with
Like Products and marketable title to the Like Products will automatically
vest in Comdisco or (b) pay the Casualty Value and after that payment and
the payment of all other amounts due and owing, Customer's obligation to
pay further Rent for the damaged Product will cease.
12.2 Comdisco's Risk of Loss. If the Schedule indicates that Comdisco
has responsibility for the risk of loss of the Products, then the
following terms will apply:
Effective upon delivery and throughout the Initial Term of a Schedule and
any extension, Comdisco agrees to insure the Products against physical
damage to or loss or destruction due to external cause as specified by the
terms of Comdisco's then current insurance policy. Comdisco relieves
Customer of responsibility for physical damage to or loss or destruction
of Products reimbursed by that insurance. Customer will give Comdisco
prompt notice of any damage, loss or destruction to any Product and
Comdisco will determine within fifteen (15) days of its receipt of that
notice whether the item has suffered a Casualty Loss. If any Product
suffers damage or a Casualty Loss which is reimbursable under Comdisco's
insurance, upon payment by Customer of Comdisco's deductible, Comdisco
will: (i) (for damaged Products) arrange and pay for the repair of any
damaged Product; or (ii) (for any Casualty Loss) at Comdisco's option
either replace the damaged Product with Like Products, or upon payment of
all other amounts due by Customer terminate the relevant Schedule as it
relates to the damaged Product.
If any Product suffers damage or a Casualty Loss which is not reimbursable
under Comdisco's insurance, then Customer will comply with the provisions
of the last paragraph of Section 12.1 regarding repair, replacement or
payment of Casualty Value.
If Comdisco fails to maintain insurance coverage as required by this
subsection 12.2, Customer will assume such risk of loss and, at the
<PAGE> 12
request of any Assignee or Secured Party, will promptly provide insurance
coverage. This paragraph does not relieve Comdisco of its obligations to
maintain coverage of the Products.
SECTION 13. DEFAULT, REMEDIES AND MITIGATION
13.1 Default. The occurrence of any one or more of the following Events
of Default constitutes a default under a Schedule:
(a) Customer's failure to pay Rent or other amounts payable by Customer
when due if that failure continues for ten (10) days after written notice;
or
(b) Customer's failure to perform any other term or condition of the
Schedule or the material inaccuracy of any representation or warranty made
by the Customer in the Schedule or in any document or certificate
furnished to the Comdisco hereunder if that failure or inaccuracy
continues for fifteen (15) days after written notice; or
(c) An assignment by Customer for the benefit of its creditors, the
failure by Customer to pay its debts when due, the insolvency of Customer,
the filing by Customer or the filing against Customer of any petition
under any bankruptcy or insolvency law or for the appointment of a trustee
or other officer with similar powers, the adjudication of Customer as
insolvent, the liquidation of Customer, or the following of any action for
the purpose of the foregoing; or
(d) The occurrence of an Event of Default under any Schedule or other
agreement between Customer and Comdisco or its Assignee or Secured Party.
13.2 Remedies. Upon the occurrence of any of the above Events of
Default, Comdisco, at its option, may:
(a) enforce Customer's performance of the provisions of the applicable
Schedule by appropriate court action in law or in equity;
(b) recover from Customer any damages and or expenses, including Default
Costs;
(c) with notice and demand, recover all sums due and accelerate and
recover the present value of the remaining payment stream of all Rent due
under the defaulted Schedule (discounted at the same rate of interest at
which such defaulted Schedule was discounted with a Secured Party plus any
prepayment fees charged to Comdisco by the Secured Party or, if there is
no Secured Party, then discounted at 6%) together with all Rent and other
amounts currently due as liquidated damages and not as a penalty;
(d) with notice and process of law and in compliance with Customer's
security requirements, Comdisco may enter Customer's premises to remove
and repossess the Products without being liable to Customer for damages
due to the repossession, except these resulting from Comdisco's, its
assignees', agents' or representatives' negligence; and
<PAGE> 13
(e) pursue any other remedy permitted by law or equity.
The above remedies, in Comdisco's discretion and to the extent permitted
by law, are cumulative and may be exercised successively or concurrently.
13.3 Mitigation. Upon return of the Products pursuant to the terms of
Section 13.2, Comdisco will use its best efforts in accordance with its
normal business procedures (and without obligation to give any priority to
such Products) to mitigate Comdisco's damages as described below. EXCEPT
AS SET FORTH IN THIS SECTION, CUSTOMER HEREBY WAIVES ANY RIGHTS NOW OR
HEREAFTER CONFERRED BY STATUTE OR OTHERWISE WHICH MAY REQUIRE COMDISCO TO
MITIGATE ITS DAMAGES OR MODIFY ANY OF COMDISCO'S RIGHTS OR REMEDIES STATED
HEREIN. Comdisco may sell, lease or otherwise dispose of all or any part
of the Products at a public or private sale for cash or credit with the
privilege of purchasing the Products. The proceeds from any sale, lease
or other disposition of the Products are defined as either:
(a) if sold or otherwise disposed of, the cash proceeds less the Fair
Market Value of the Products at the expiration of the Initial Term less
the Default Costs; or
(b) if leased, the present value (discounted at three points over the
prime rate as referenced in the Wall Street Journal at the time of the
mitigation) of the rentals for a term not to exceed the Initial Term, less
the Default Cost.
Any proceeds will be applied against liquidated damages and any other sums
due to Comdisco from Customer. However, Customer is liable to Comdisco
for, and Comdisco may recover, the amount by which the proceeds are less
than the liquidated damages and other sums due to Comdisco from Customer.
SECTION 14. ADDITIONAL PROVISIONS
14.1 Binding Nature. Each Schedule is binding upon, and inures to the
benefit of Comdisco and its assigns. CUSTOMER MAY NOT ASSIGN ITS RIGHTS
OR OBLIGATIONS.
14.2 Counterparts. Any Schedule may be executed in any number of
counterparts, each of which will be deemed an original but all such
counterparts together constitute one and the same instrument. If Comdisco
grants a security interest in all or any part of a Schedule, the Products
or sums payable thereunder, only that counterpart Schedule marked "Secured
Party's Original" can transfer Comdisco's rights and all other
counterparts will be marked "Duplicate".
14.3 Nonspecific Features and Licensed Products. If the Products are
supplied from Comdisco's inventory and contains any features not specified
in the Schedule, Customer grants Comdisco the right to remove any such
features. Any removal will be performed by the manufacturer or another
party acceptable to Customer, upon the request of Comdisco, at a time
<PAGE> 14
convenient to Customer, provided that Customer will not unreasonably delay
the removal of such features.
Customer acknowledges that the Products may contain or include software or
other licensed products of a third party. Customer will obtain no title
to the software or licensed products which at all times remains the
property of the owner of the software or licensed products. A license
from the owner may be required and it is Customer's responsibility to
obtain any required license before the use of the software or licensed
product.
14.4 Additional Documents. Customer will, upon execution of this
Supplement and as may be requested thereafter, provide Comdisco with a
secretary's certificate of incumbency and authority and any other
documents reasonably requested by Comdisco. Upon the execution of each
Schedule with an aggregate Rent in excess of $2,000,000, Customer will
provide Comdisco with an opinion from Customer's counsel regarding the
representations and warranties in Section 8. Customer will furnish, upon
request, audited financial statements for the most recent period.
14.5 Comdisco's Right to Match. Customer's rights under Section 5.2 and
7.2 are subject to Comdisco's right to match any sublease or upgrade
proposed by a third party. Customer will provide Comdisco with the terms
of the third party offer and Comdisco will have three (3) business days to
match the offer. Customer shall obtain such upgrade from or sublease the
Products to Comdisco if Comdisco has timely matched the third party offer.
SECTION 15. DEFINITIONS
Assignee - means an entity to whom Comdisco has sold or assigned its
rights as owner and lessor of the Products.
Attachment - means any accessory, equipment or device and the installation
thereof that does not impair the original function or use of the Products
and is capable of being removed without causing material damage to the
Products and is not an accession to the Products.
Casualty Loss - means the irreparable loss or destruction of Products.
Casualty Value - means the greater of the aggregate Rent remaining to be
paid for the balance of the lease term or the Fair Market Value of the
Products immediately prior to the Casualty Loss. However, if a Casualty
Value Table is attached to the relevant Schedule its terms will control.
Commencement Certificate - means the Comdisco provided certificate which
must be signed by Customer within ten (10) days of the Commencement Date
as requested by Comdisco.
Commencement Date - is defined in each Schedule.
<PAGE> 15
Default Costs - means reasonable attorney's fees and remarking costs
resulting from a Customer default or Comdisco's enforcement of its
remedies.
Event of Default - means the events described in Subsection 13.1.
Fair Market Value - means the aggregate amount which would be obtainable
in an arm's-length transaction between an informed and willing buyer/user
and an informed and willing seller under no compulsion to sell.
Initial Term - means the period of time beginning on the first day of the
first full Rent Interval following the Commencement Date for all Products
and continuing for the number of Rent Intervals indicated on a Schedule.
Installation Date - means the day on which Products are installed and
qualified for a commercially available manufacturer's standard maintenance
contract or warranty coverage, if available.
Interim Rent - means the pro-rata portion of Rent due for the period from
the Commencement Date through but not including the first day of the first
full Rent Interval included in the Initial Term.
Licensed Products - means any software or other licensed products attached
to the Products.
Like Part - means a substituted part which is lien free and of the same
manufacturer and part number as the removed part, and which when installed
on the Products will be eligible for maintenance coverage with the
manufacturer of the Products.
Like Products - means replacement Products which are lien free and of the
same modal, type, configuration and manufacture as Products.
Notice Period - means the time period described in a Schedule during which
Customer may give Comdisco notice of the termination of the term of that
Schedule.
Overdue Rate - means the lesser of 18% per year or the maximum rate
permitted by the law of the state where the Products are located.
Owner - means the owner of the Products.
Products - means the property described on a Schedule and any replacement
for that property required or permitted by this Product Supplement or a
Schedule but not including any Attachment.
Reconfiguration - means any change to Products that would upgrade or
downgrade the performance capabilities of the Products in any way.
Rent - means the rent, including Interim Rent, Customer will pay for the
Products expressed in a Schedule either as a specific amount or an amount
equal to the amount which Comdisco pays for the Products multiplied by a
<PAGE> 16
lease rate factor plus all other amounts due to Comdisco under this
Product Supplement or a Schedule.
Rent Interval - means a full calendar month or quarter as indicated on a
Schedule.
Schedule - means a Schedule which incorporates all of the terms and
conditions of this Product Supplement and the Master Agreement and, for
purposes of Section 14.2, its associated Commencement Certificate(s).
Secured Party - means an entity to whom Comdisco has granted a security
interest in a Schedule and related Products for the purpose of securing a
loan.
The Product Supplement is issued pursuant to the Master Agreement
identified above. All of the terms and conditions of the Master Agreement
are incorporated herein and made a part hereof.
Network Plus, Inc. COMDISCO, INC.,
- ---------------------------
Customer
By: Steven Shapiro By: Rosemary P. Geisler
Title: Vice President, CFO Title: Senior Vice President
and Treasurer
<PAGE> 17
Addendum dated December 30, 1998
to the Master Agreement dated as of December 30, 1998
and the Product Supplement dated as of December 30, 1998
between Network Plus, Inc. ("Customer")
and Comdisco, Inc. ("Comdisco")
I. The terms and conditions of the above-referenced Master Agreement
are amended and modified as follows:
1. Section 1.3, "Changes"
At the end of the first sentence, insert the words "and signed by
Comdisco and Customer".
2. Section 2.3, "Expenses"
At the end of this Section, insert the words "only with respect to a
Schedule for Services".
3. Section 4.4, "Liability"
Add the following after the first sentence: "The foregoing provision
will not apply in connection with any Schedules under a Product
Supplement"
4. Section 6.2, "Confidentiality"
Add the following at the end of the Section: "Notwithstanding the
foregoing, either party may disclose such confidential information
to the extent it is required to do so by applicable law (including
SEC rules and regulations) or by court order."
5. Section 7, "Proprietary Rights Protection"
Add the following at the beginning of the Section: "Notwithstanding
the limitations in Section 4.4 hereof,".
6. Section 8, "Termination"
In line 4, before the word "written" insert the words "receipt by
addressee of". In line 5, after the number "(10)", insert the word
"business". In line 10, after the word "will" insert the words
"upon demand".
<PAGE> 18
7. Section 9, "Miscellaneous"
a. In paragraph 9.2, add the following at the end: ", which shall
not be unreasonably withheld".
b. In paragraph 9.5, in line 3, after the number "(3)", insert
the word "business".
c. In paragraph 9.8, in line 7, after the word "after" insert the
words "the affected party knew or had reason to know of".
Delete the word "arose" in the last line.
d. In paragraph 9.10, in line 2 after the word "form" insert the
words" or on any invoice or other form provided by Comdisco
(other than the Master Agreement, Supplements, or Schedules)
which purport to modify, delete or add to any agreement
executed by both parties". Add the following at the end: ",
unless such pre-printed terms have been agreed to in writing
by the parties with the parties intending to be bound by such
pre-printed terms."
e. Delete paragraph 9.11 in its entirety and replace with the
following: "Comdisco will not be considered in default under
this Agreement due to any failure in its performance as a
consequence of any fire, flood, natural disaster, labor
dispute, public disturbance, declared or undeclared war, or
similar occurrence, or as a consequence of any other similar
occurrence entirely beyond the reasonable control of
Comdisco."
II. The terms and conditions of the above-referenced Product Supplement
are amended and modified as follows:
1. Section 4.1, "Selection"
Add the following at the end of the Section: "with respect to the
selection thereof."
2. Section 4.2, "Warranty and Disclaimer of Warranties"
Add the following after the second sentence: "Comdisco appoints
Customer as Comdisco's agent to assert, during the term of the
applicable Schedule, any right Comdisco may have to enforce the
manufacturer's warranties, if any, provided, however, that Customer
will indemnify and hold Comdisco or its assignee harmless from and
against any and all claims, costs, expenses, damages, losses and
liabilities incurred or suffered by Comdisco as a result of or
incident to any action by Customer in connection therewith, except
any claims, costs, expenses damages, losses and liabilities
resulting from the gross negligence of Comdisco."
<PAGE> 19
3. Section 5.2, "Relocation or Sublease"
In line 4 of the first paragraph, after the word "costs" insert the
words "to Comdisco caused solely by such relocations".
4. Section 5.3, "Assignment by Comdisco"
a. In the last line of the first paragraph, after the words
"written notice given to Customer" insert the words "provided
that the assignee is a financial institution with a net worth
of at least $250,000,000.00."
b. Add the following at the end of paragraph (c): ", and will not
result in any additional obligations on the part of Customer".
5. Section 6.1, "Net Lease"
Add the following at the end of the Section: "Notwithstanding the
foregoing, nothing herein shall be deemed to limit Customer's rights
and remedies as against Comdisco or Assignee in any independent
action or proceeding, such rights and remedies being expressly
reserved by Customer."
6. Section 6.2, "Taxes"
In line 3 before the word "within" insert the words "for the
Products".
7. Section 7.2, "Attachments and Reconfigurations"
In the second paragraph, line 2 after the word "Products" insert the
words "in any material respect".
8. Section 8, "Representations and Warranties of Customer"
Paragraph (d) is deleted in its entirety.
9. Section 9, "Delivery and Return of Products"
a. Add the following at the beginning of the Section: "Unless
otherwise specified in the purchase agreement between Customer
and the Product supplier,".
b. In line 4, after the word "transportation" insert the words
"by a reputable carrier".
c. In line 9, after the word "Comdisco" insert the words "to the
Chicago metropolitan area".
d. The last sentence is deleted in its entirety.
<PAGE> 20
10. Section 12.2, "Comdisco's Risk of Loss"
In the second paragraph, line 10 after the word "will" insert the
words "as soon as practicable".
11. Section 13.1, "Default"
a. In paragraph (a) after the number "(10)" insert the word
"business" and after the word "notice" insert the words "is
received".
b. In paragraph (b), line 1, after the word "other" insert the
word "material"; in line 4 after the number "(15)" insert the
word "business".
c. In paragraph (c), line 2, after the word "to" insert the word
"generally"; in line 4 after the word "law" and in line 5
after the word "powers", insert the words "(with respect to
any filing against Customer which continues for sixty (60)
days)"; in line 6 after the word "action" insert the words "by
the Customer".
12. Section 13.2, "Remedies"
a. In the first sentence after the word "occurrence" insert the
words "and the continuance".
b. In paragraph (a), add the following at the end: "to preserve
and protect Comdisco's rights in the Products".
c. In paragraph (b), line 1, delete the words "accelerate and
recover"; in line 6 delete from the word "together" through
the end of the paragraph.
13. Section 13.3, "Mitigation"
In paragraph (b), line 1, delete the word "three" and insert the
words "one and one-half".
14. Section 14.1, "Binding Nature"
Add the following at the end of the Section: "(except to its
successor pursuant to a merger, consolidation or sale of all or
substantially all of its assets with equal or better
creditworthiness of Customer at the time of the assignment) without
obtaining the prior written consent of Comdisco, which shall not be
unreasonably withheld."
15. Section 14.3, "Nonspecific Features and Licensed Products"
In the first paragraph, line 2, delete the word "contains" and
replace with the word "contain"; in line 3 after the word "features"
insert the words "at Comdisco's cost".
<PAGE> 21
16. Section 15, "Definitions"
a. In the definition of "Default Costs" delete the words "a
Customer default or".
b. Delete the definition of "Installation Date" in its entirety.
Network Plus, Inc. Comdisco, Inc.
By: Steven Shapiro By: Rosemary P. Geisler
Title: Vice President, CFO Title: Senior Vice President
and Treasurer
Date: 1/6/99 Date: 1/26/99
<PAGE> 22
GUARANTY
In consideration for COMDISCO, INC. ("COMDISCO") entering into the
Master Agreement and Product Supplement dated
December 30, 1998 and all of its related Equipment Schedules (the "Lease")
with Network Plus, Inc. (as "LESSEE"), a wholly-owned subsidiary of the
undersigned, the undersigned hereby guarantees the prompt and complete
performance by LESSEE of all the terms and conditions of the Lease to be
performed by it, including but not limited to, the prompt payment of all
rentals and other sums payable.
This is a continuing, absolute and unconditional guaranty of
performance and payment and not of collection. The undersigned
specifically waives any right to setoff or counterclaim, and any defense
for changes in applicable law or any other circumstances which might
constitute a legal or equitable defense or discharge of a guarantor or
surety. Notwithstanding the foregoing, the undersigned retains the right
to maintain an independent cause of action against COMDISCO. The
undersigned waives any right to require a proceeding first against LESSEE
or to exhaust any security for the performance of the obligations of
LESSEE, and waives notice of acceptance and of defaults. The undersigned
agrees that the liability of the undersigned shall not be affected or
decreased by any amendment, termination, extension, renewal, waiver or
modification of the Lease or the rejection or disaffirmance of the Lease
in bankruptcy or like proceedings and that certain obligations under the
Lease may be accelerated upon any nonpayment by LESSEE. This Guaranty
shall be specifically assignable to and inure to the benefit of Lessor's
Assignee and Secured Party as set forth in the Lease and is irrevocable so
long as there are any obligations of LESSEE remaining under the Lease
unless otherwise agreed in writing by the parties.
This guaranty shall be governed by and construed in accordance with
the laws of the State of Illinois.
Dated: December 30, 1998
Network Plus Corp.
(Guarantor)
By: Steven Shapiro
Title: Vice President, CFO
and Treasurer
EXHIBIT 12
<TABLE>
NETWORK PLUS CORP.
COMPUTATION OF RATIOS
RATIO OF EARNINGS TO COMBINED FIXED CHARGES
<CAPTION>
Year Ended December 31,
---------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
EARNINGS
Net income (loss) before
income taxes $3,019 $4,007 $1,475 $(3,149) $(5,289)
Combined fixed charges 135 207 542 801 3,527
------- ------- ------- -------- --------
Total Earnings $3,154 $4,214 $2,014 $(2,348) $(1,762)
COMBINED FIXED CHARGES
Interest expense 2 40 313 557 1,101
Preferred stock dividends
and accretion of issuance
costs and discounts - - - - 2,005
Interest portion of
operating lease rentals 133 167 229 244 421
------- ------- ------- -------- --------
Total Combined Fixed $ 135 $ 207 $ 542 $ 801 $ 3,527
Charges
RATIO OF EARNINGS TO
COMBINED FIXED CHARGES 23.4x 20.4x 3.7x (2.9)x (0.5)x
</TABLE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration
Statement of Network Plus Corp. on Form S-1 (File No. 333-64663) of our
report dated March 17, 1999, on our audits of the consolidated
financial statements and the financial statements schedule of Network
Plus Corp., as of December 31, 1998 and 1997, and for each of the three
years in the period ended December 31, 1998, which reports are included
in this Annual Report on Form 10-K.
PriceWaterhouseCoopers LLP
Boston, Massachusetts
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001065633
<NAME> NETWORK PLUS CORP.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 12,197
<SECURITIES> 0
<RECEIVABLES> 16,738
<ALLOWANCES> 513
<INVENTORY> 0
<CURRENT-ASSETS> 31,050
<PP&E> 19,920
<DEPRECIATION> 4,098
<TOTAL-ASSETS> 48,868
<CURRENT-LIABILITIES> 14,882
<BONDS> 5,022
35,146
0
<COMMON> 100
<OTHER-SE> (6,823)
<TOTAL-LIABILITY-AND-EQUITY> 48,868
<SALES> 105,545
<TOTAL-REVENUES> 105,545
<CGS> 0
<TOTAL-COSTS> 109,906
<OTHER-EXPENSES> 928
<LOSS-PROVISION> 1,931
<INTEREST-EXPENSE> 1,474
<INCOME-PRETAX> (5,289)
<INCOME-TAX> (906)
<INCOME-CONTINUING> (4,383)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,383)
<EPS-PRIMARY> (0.64)
<EPS-DILUTED> (0.64)
</TABLE>
