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PROSPECTUS Registration No. 333-64717
Filed pursuant to Rule 424(b)(3)
[USXCHANGE LOGO]
OFFER TO EXCHANGE
15% SENIOR NOTES DUE JULY 1, 2008
FOR ALL OUTSTANDING 15% SENIOR NOTES DUE JULY 1, 2008
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THE EXCHANGE OFFER WILL EXPIRE AT 12:00 MIDNIGHT NEW YORK CITY TIME ON
DECEMBER 23, 1998, UNLESS EXTENDED.
US Xchange, L.L.C., a Michigan limited liability company (the "Company"),
is hereby offering (the "Exchange Offer"), upon the terms and subject to the
conditions set forth in this Prospectus and the accompanying Letter of
Transmittal (the "Letter of Transmittal"), to exchange $1,000 principal amount
of its 15% Senior Notes due July 1, 2008 (the "Exchange Notes"), which exchange
has been registered under the Securities Act of 1933, as amended (the
"Securities Act"), pursuant to a registration statement of which this Prospectus
is a part, for each $1,000 principal amount of its outstanding 15% Senior Notes
due July 1, 2008 (the "Private Notes"), of which $200,000,000 in aggregate
principal amount was issued on June 25, 1998 and is outstanding as of the date
hereof. The form and terms of the Exchange Notes are identical in all material
respects to those of the Private Notes, except for certain transfer restrictions
and exchange and registration rights relating to the Private Notes and except
for certain interest provisions related to such registration rights. The
Exchange Notes will evidence the same indebtedness as the Private Notes (which
they replace) and will be entitled to the benefits of an Indenture dated as of
June 25, 1998 governing the Private Notes and the Exchange Notes (the
"Indenture"). The Private Notes and the Exchange Notes are sometimes referred to
herein collectively as the "Notes." See "The Exchange Offer" and "Description of
the Notes."
The Notes are non-callable. However, at any time prior to July 1, 2001, the
Company may redeem up to 35% of the aggregate principal amount of the Notes with
the proceeds of one or more Public Equity Offerings at 115% of their principal
amount, plus accrued interest; provided, however, that (i) after any such
redemption, Notes representing at least 65% of the aggregate principal amount of
the Notes originally issued remain outstanding and (ii) notice of any such
redemption is mailed within 60 days of such Public Equity Offering.
The Company has pledged a portfolio of Pledged Securities, consisting of
U.S. government securities, as security for the first six scheduled interest
payments on the Notes.
The Notes are unsubordinated, unsecured (except as described above)
indebtedness of the Company, rank pari passu in right of payment with all other
unsubordinated, unsecured indebtedness of the Company, rank senior in right of
payment to all subordinated indebtedness of the Company and are subordinated to
the claims of holders of any secured indebtedness of the Company with respect to
the assets securing such secured indebtedness. Moreover, the Company is a
holding company, and the Notes are effectively subordinated to all existing and
future liabilities (including trade payables) of the Company's subsidiaries. As
of September 30, 1998, the total amount of indebtedness of the Company (parent
only) was $203.6 million, of which $200.0 million represented the Notes and $3.6
million was secured indebtedness, to which the Notes are subordinated to the
extent of the value of the assets securing such indebtedness. As of September
30, 1998, the Company's subsidiaries had approximately $9.1 million in the
aggregate of liabilities (excluding intercompany payables), to which the Notes
are effectively subordinated.
The Company will accept for exchange any and all validly tendered Private
Notes not withdrawn prior to 12:00 midnight, New York City time, on December 23,
1998 unless the Exchange Offer is extended by the Company in its sole discretion
(the "Expiration Date"). Tenders of Private Notes may be withdrawn at any time
prior to the Expiration Date. Private Notes may be tendered only in integral
multiples of $1,000. The Exchange Offer is subject to certain customary
conditions. See "The Exchange Offer."
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FOR A DISCUSSION OF CERTAIN FACTORS RELATING TO THE EXCHANGE OFFER AND AN
INVESTMENT IN THE NOTES, SEE "RISK FACTORS" BEGINNING ON PAGE 14.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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THE DATE OF THIS PROSPECTUS IS NOVEMBER 24, 1998.
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[MAP DEPICTING EXISTING AND PLANNED US XCHANGE NETWORKS OMITTED]
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NOTICE TO INVESTORS
The Exchange Notes are being offered hereunder in order to satisfy certain
obligations of the Company undertaken in connection with the issuance of the
Private Notes. Based on interpretations by the staff of the Securities and
Exchange Commission (the "Commission") set forth in no-action letters issued to
third parties, the Company believes that the Exchange Notes issued pursuant to
the Exchange Offer in exchange for Private Notes may be offered for resale,
resold and otherwise transferred by a holder thereof ("Holder") without
compliance with the registration and prospectus delivery provisions of the
Securities Act, provided that the holder is acquiring the Exchange Notes in the
ordinary course of its business, is not participating and has no arrangement or
understanding with any person to participate in the distribution of the Exchange
Notes and is not an "affiliate" of the Company within the meaning of Rule 405 of
the Securities Act. Holders of Private Notes wishing to accept the Exchange
Offer must represent to the Company that such conditions have been met. The
Company believes that none of the registered Holders of the Private Notes is an
"affiliate" of the Company as such term is defined in Rule 405 under the
Securities Act.
Each broker-dealer who holds Private Notes acquired for its own account as
a result of market-making or other trading activities and who receives Exchange
Notes for its own account in exchange for such Private Notes pursuant to the
Exchange Offer must acknowledge that it will deliver a prospectus in connection
with any resale of such Exchange Notes. This Prospectus, as it may be amended or
supplemented from time to time, may be used by any such broker-dealer in
connection with resales of such Exchange Notes. The Letter of Transmittal states
that, by acknowledging that it will deliver a prospectus in connection with any
resale of such Exchange Notes, and by delivering a prospectus, any such
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. The Company has agreed to make this Prospectus
(as it may be amended or supplemented) available to any such broker-dealer that
requests copies of such Prospectus in the Letter of Transmittal for use in
connection with any such resale for a period of up to 90 days after the
Expiration Date. See "Plan of Distribution."
Prior to the Exchange Offer, there has been no public market for the
Exchange Notes. There can be no assurance as to the liquidity of any market that
may develop for the Exchange Notes, the ability of Holders to sell Exchange
Notes, or the price at which Holders would be able to sell Exchange Notes. The
Company does not intend to apply for listing of the Exchange Notes for trading
on any securities exchange or for inclusion of the Exchange Notes in any
automated quotation system. The National Association of Securities Dealers, Inc.
("NASD") has designated the Private Notes as securities eligible for trading in
the Private Offerings, Resales and Trading through Automatic Linkages ("PORTAL")
market of the NASD and the Company has been advised that Morgan Stanley & Co.
Incorporated has heretofore acted as market maker for the Private Notes. The
Company has been advised by Morgan Stanley & Co. Incorporated that it currently
intends to make a market in the Exchange Notes. Future trading prices of the
Exchange Notes will depend on many factors, including, among other things,
prevailing interest rates, the Company's operating results and the market for
similar securities. Historically, the market for securities similar to the
Exchange Notes, including non-investment grade debt, has been subject to
disruptions that have caused substantial volatility in the prices of such
securities. There can be no assurance that any market for the Exchange Notes, if
such market develops, will not be subject to similar disruptions. See "Risk
Factors--No Prior Public Market for Exchange Notes; Possible Volatility of
Market Price of Exchange Notes."
The Company will not receive any proceeds from, and has agreed to bear the
expenses of, the Exchange Offer. No underwriter is being used in connection with
the Exchange Offer.
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF PRIVATE NOTES IN ANY JURISDICTION IN
WHICH THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE
WITH THE SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
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AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (the "Exchange Offer Registration Statement") under the Securities Act with
respect to the Exchange Notes offered hereby. As permitted by the rules and
regulations of the Commission, this Prospectus omits certain information,
exhibits and undertakings contained in the Exchange Offer Registration
Statement. Statements contained in this Prospectus as to the contents of any
contract or other document are not necessarily complete, and in each instance
reference is made to the copy of such contract or document filed or incorporated
by reference as an exhibit to the Exchange Offer Registration Statement, each
such statement being qualified in all respects by such reference. For further
information with respect to the Company and the Exchange Notes offered hereby,
reference is made to the Exchange Offer Registration Statement, including the
exhibits thereto.
Upon effectiveness of the Exchange Offer Registration Statement, the
Company will be subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith will file reports and other information with
the Commission. The Exchange Offer Registration Statement and reports and other
information filed by the Company with the Commission may be inspected and copied
at the public reference facilities maintained by the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and will also be
available for inspection and copying at the regional offices of the Commission
located at Suite 1400, 500 West Madison Street, Chicago, Illinois 60661-2511 and
Suite 1300, 7 World Trade Center, New York, New York 10048. Copies of such
material can be obtained by mail from the Public Reference Section of the
Commission at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549,
at prescribed rates. The Commission maintains a website (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission. Under the
terms of the Indenture pursuant to which the Private Notes were, and the
Exchange Notes will be, issued, the Company will be required to file with the
Commission, and to furnish Holders of the Notes with, the information, documents
and other reports specified in Sections 13 and 15(d) of the Exchange Act,
including reports on Forms 10-K, 10-Q and 8-K.
INCORPORATION BY REFERENCE
All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Prospectus and prior to the
termination of the Exchange Offer shall be deemed to be incorporated in this
Prospectus by reference and to be a part hereof from the date of the filing of
such documents.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein
or in any subsequently filed document which also is or is deemed to be
incorporated by reference herein modifies or supersedes such statement. Any
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person, including any
beneficial owner of Notes, to whom a copy of this Prospectus is delivered, upon
written or oral request of such person, a copy of any documents incorporated
herein by reference (other than exhibits to such documents unless such exhibits
are specifically incorporated by reference in such documents). Such a request
may be directed in writing to Donald Offringa, Vice President of Finance, US
Xchange, L.L.C., 20 Monroe Avenue NW, Suite 450, Grand Rapids, Michigan 49503,
telephone (616) 493-7000.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
THE STATEMENTS CONTAINED IN THIS PROSPECTUS WHICH ARE NOT HISTORICAL FACTS
ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THESE
FORWARD-LOOKING STATEMENTS GENERALLY CAN BE IDENTIFIED BY THE USE OF
FORWARD-LOOKING TERMINOLOGY SUCH AS "WILL," "MAY," "SHOULD," "BELIEVES,"
"EXPECTS" OR "ANTICIPATES" OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON
OR COMPARABLE TERMINOLOGY, OR BY DISCUSSION OF CERTAIN STRATEGIES THAT INVOLVE
RISKS AND UNCERTAINTIES. MANAGEMENT WISHES TO CAUTION INVESTORS THAT THESE
FORWARD-LOOKING STATEMENTS, SUCH AS THE COMPANY'S PLANS AND STRATEGIES, ITS
ANTICIPATION OF REVENUES FROM DESIGNATED MARKETS, AND STATEMENTS REGARDING THE
DEVELOPMENT OF THE COMPANY'S BUSINESSES, THE MARKETS FOR THE COMPANY'S SERVICES
AND PRODUCTS, THE COMPANY'S ANTICIPATED CAPITAL EXPENDITURES, POSSIBLE CHANGES
IN REGULATORY REQUIREMENTS AND OTHER STATEMENTS CONTAINED HEREIN REGARDING
MATTERS THAT ARE NOT HISTORICAL FACTS, ARE ONLY PREDICTIONS, ASSUMPTIONS AND
ESTIMATES REGARDING FUTURE EVENTS AND CIRCUMSTANCES. NO ASSURANCE CAN BE GIVEN
THAT SUCH PREDICTIONS, ASSUMPTIONS OR ESTIMATES WILL BE ACHIEVED; ACTUAL EVENTS
OR RESULTS MAY DIFFER MATERIALLY AS A RESULT OF RISKS FACING THE COMPANY. SUCH
RISKS INCLUDE, BUT ARE NOT LIMITED TO, THE COMPANY'S LIMITED OPERATING HISTORY
AND ANTICIPATED SIGNIFICANT NEGATIVE CASH FLOWS AND OPERATING LOSSES AND ITS
ABILITY TO MEET ITS ADDITIONAL CAPITAL REQUIREMENTS, GENERATE POSITIVE OPERATING
CASH FLOW, COMPETE IN ITS TARGETED MARKETS, SUCCESSFULLY MANAGE THE DEVELOPMENT
AND GROWTH OF ITS BUSINESS AND OPERATIONS, ATTRACT AND RETAIN KEY PERSONNEL,
DEVELOP, IMPLEMENT AND INTEGRATE NECESSARY OSS AND OTHER INFORMATION AND
PROCESSING SYSTEMS, SUCCESSFULLY MARKET ITS SERVICES TO CURRENT AND NEW
CUSTOMERS, INTERCONNECT WITH ILECS, PROVISION AND SERVICE ITS CUSTOMERS, ASSESS
MARKETS, INSTALL FACILITIES, INCLUDING SWITCHING ELECTRONICS, AND OBTAIN
RIGHTS-OF-WAY AND ANY REQUIRED GOVERNMENTAL AUTHORIZATIONS, FRANCHISES AND
PERMITS, ALL IN A TIMELY MANNER, AT REASONABLE COSTS AND ON SATISFACTORY TERMS
AND CONDITIONS. REGULATORY, LEGISLATIVE AND JUDICIAL DEVELOPMENTS COULD ALSO
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE FUTURE RESULTS INDICATED,
EXPRESSED OR IMPLIED IN SUCH FORWARD-LOOKING STATEMENTS. ALL SUBSEQUENT WRITTEN
AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS
ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE FOREGOING
CAUTIONARY STATEMENTS. INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THEIR DATES. THE
COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-
LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR
OTHERWISE.
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SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information, including the consolidated
financial statements of the Company and the notes thereto, appearing elsewhere
in this Prospectus. Unless the context otherwise requires, the term "Company,"
as used in this Prospectus, means US Xchange, L.L.C., a Michigan limited
liability company, and, where appropriate, its subsidiaries. See "Glossary of
Selected Terms" beginning at page G-1 for the definitions of certain technical
terms used in this Prospectus. Certain other capitalized terms used herein have
the meanings ascribed to them in "Description of the Notes--Certain
Definitions."
THE COMPANY
The Company is a facilities-based competitive local exchange carrier
("CLEC") that commenced commercial operations in July 1997. The Company offers
telecommunications services primarily in metropolitan markets with populations
of 100,000 to 750,000 ("Tier III Markets") in the midwestern United States. The
Company's target customers include small and medium-sized businesses, Internet
Service Providers ("ISPs") and government and other institutional end users, as
well as residential end users. As a result of the Company's limited operating
history, the Company has to date generated only nominal revenues from
facilities-based operations, and its operations to date have resulted in
significant operating and net losses and negative cash flow and a substantial
accumulated deficit. See "Risk Factors--Limited History of Operations;
Historical and Anticipated Future Negative Cash Flow and Operating Losses" and
"Selected Consolidated Financial Data."
Upon entering a targeted market, the Company resells the services of the
incumbent local exchange carrier ("ILEC"). As each of the Company's networks and
switching systems becomes commercially operational in that market, the Company
transitions its resale customers to its own facilities-based services. As of the
date of this Prospectus, the Company was providing services primarily on a
resale basis in Wisconsin, Indiana and Illinois and had six switches and six
local fiber optic networks that were commercially operational. The Company is
currently deploying or plans to deploy an additional seven switches and 12 local
networks in Wisconsin, Indiana, Illinois and Michigan.
In addition to deploying its own local networks in targeted commercial
regions, the Company plans to (i) construct, lease or acquire long haul fiber
that will interconnect its owned local networks and host switches and (ii) lease
feature group access to ILEC tandem switches to originate and terminate calls in
regions bordering its owned facilities, as well as certain other regions where
cost and demand justify. See "Business--Markets." The Company also is
considering opportunities to expand its operations into additional commercial
regions in the Midwest, which would require additional financing. See "Risk
Factors--Additional Capital Requirements."
The principal elements of the Company's business strategy include: (i) a
focus on Tier III Markets in the Midwest; (ii) efforts to achieve
early-to-market competitive and marketing advantages in each of its targeted
markets; (iii) the deployment of networks and switching facilities designed to
address customers in an entire commercial region; (iv) the establishment of a
fully integrated system of networks throughout its targeted commercial regions;
(v) an emphasis on its local presence to gain market share; (iv) the
installation of high quality, flexible networks at a low cost; and (vii) the
implementation of innovative, integrated operations support, customer care and
billing systems. See "Business--US Xchange Strategy."
The Company is a Michigan limited liability company with its principal
executive offices located at 20 Monroe Avenue NW, Suite 450, Grand Rapids,
Michigan 49503, and its telephone number is (616) 493-7000.
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RISK FACTORS
An investment in the Exchange Notes involves a high degree of risk. See
"Risk Factors" for a description of various risk factors relating to the Company
and an investment in the Exchange Notes, including but not limited to the
following:
- the Company's limited operating history and anticipated significant
negative cash flows and operating losses;
- the Company's ability to meet its additional capital requirements and
generate operating cash flow;
- the Company's indebtedness and its effect on the Company's ability to
meet its debt service requirements and its operational flexibility;
- the effect of the priority of claims of holders of secured indebtedness
and the Company's holding company structure on the Company's ability to
meet its obligations on the Notes;
- the Company's ability to compete in its targeted markets;
- the Company's ability to successfully manage the continued development
and expansion of its business;
- the Company's ability to successfully market its services to current and
new customers;
- the Company's ability to obtain needed interconnections with ILECs on
acceptable terms;
- the Company's ability to provision and service its customers; and
- the possible lack of liquidity in any trading market for the Exchange
Notes.
Prospective investors should carefully consider these and other risk
factors and information contained in the Prospectus.
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THE EXCHANGE OFFER
The Exchange Offer............ The Company is hereby offering to exchange
$1,000 principal amount of Exchange Notes for
each $1,000 principal amount of Private Notes
that are properly tendered and accepted. The
Company will issue Exchange Notes on or as
promptly as practicable after the Expiration
Date. As of the date hereof, there is
$200,000,000 aggregate principal amount of
Private Notes outstanding. See "The Exchange
Offer."
Based on interpretations by the staff of the
Commission set forth in no-action letters
issued to third parties, the Company believes
that the Exchange Notes issued pursuant to the
Exchange Offer in exchange for Private Notes
may be offered for resale, resold and otherwise
transferred by a Holder thereof without
compliance with the registration and prospectus
delivery provisions of the Securities Act,
provided that the Holder is acquiring Exchange
Notes in the ordinary course of its business,
is not participating and has no arrangement or
understanding with any person to participate in
the distribution of the Exchange Notes and is
not an "affiliate" of the Company within the
meaning of Rule 405 under the Securities Act.
Any Holder of Private Notes who tenders in the
Exchange Offer with the intention to
participate, or for the purpose of
participating, in a distribution of the
Exchange Notes could not rely on the
above-referenced position of the staff of the
Commission and, in the absence of an exemption
therefrom, would have to comply with the
registration and prospectus delivery
requirements of the Securities Act in
connection with any resale transaction. Failure
to comply with such requirements in such
instance could result in such Holder incurring
liability under the Securities Act for which
the Holder is not indemnified by the Company.
See "The Exchange Offer--Resale of the Exchange
Notes."
Each broker-dealer who holds Private Notes
acquired for its own account as a result of
market-making or other trading activities and
who receives Exchange Notes pursuant to the
Exchange Offer for its own account in exchange
therefor must acknowledge that it will deliver
a copy of this Prospectus, as it may be amended
or supplemented from time to time, in
connection with any resale of such Exchange
Notes. The Letter of Transmittal that
accompanies this Prospectus states that by so
acknowledging and by delivering a prospectus, a
broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of
the Securities Act.
Registration Rights
Agreement..................... The Private Notes were sold by the Company on
June 25, 1998 to Morgan Stanley & Co.
Incorporated (the "Placement Agent") pursuant
to a Placement Agreement, dated June 22, 1998,
by and among the Company and the Placement
Agent (the "Placement Agreement"). Pursuant to
the Placement Agreement, the Company and the
Placement Agent entered into a Registration
Rights Agreement, dated as of June 25, 1998
(the "Registration Rights Agreement"), which
grants the Holders of the Private Notes certain
exchange and registration rights. The Exchange
Offer is intended to satisfy such rights, which
will terminate upon the consummation of the
Exchange Offer. The Holders of the
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Exchange Notes will not be entitled to any
exchange or registration rights with respect to
the Exchange Notes. See "The Exchange
Offer--Termination of Certain Rights." The
Company will not receive any proceeds from, and
has agreed to bear the expenses of, the
Exchange Offer. See "Use of Proceeds."
Expiration Date............... The Exchange Offer will expire at 12:00
midnight, New York City time, on December 23,
1998, unless the Exchange Offer is extended by
the Company in its sole discretion, in which
case the term "Expiration Date" shall mean the
latest date and time to which the Exchange
Offer is extended. See "The Exchange
Offer--Expiration Date; Extensions;
Amendments."
Procedures for Tendering
Private Notes................. Each Holder of Private Notes wishing to accept
the Exchange Offer must complete, sign and date
the Letter of Transmittal, or a facsimile
thereof, in accordance with the instructions
contained herein and therein, and mail or
otherwise deliver such Letter of Transmittal,
or such facsimile, together with such Private
Notes and any other required documentation to
The Bank of New York, as exchange agent (the
"Exchange Agent"), at the address set forth
herein. By executing the Letter of Transmittal,
the Holder will represent to and agree with the
Company that, among other things, (i) the
Exchange Notes to be acquired by such Holder of
Private Notes in connection with the Exchange
Offer are being acquired by such Holder in the
ordinary course of its business, (ii) such
Holder has no arrangement or understanding with
any person to participate in a distribution of
the Exchange Notes and (iii) such Holder is not
an "affiliate" of the Company within the
meaning of Rule 405 under the Securities Act.
If the Holder is a broker-dealer that will
receive Exchange Notes for its own account in
exchange for Private Notes that were acquired
for its own account as a result of
market-making or other trading activities, such
Holder will be required to acknowledge in the
Letter of Transmittal that such Holder will
deliver a prospectus in connection with any
resale of such Exchange Notes; however, by so
acknowledging and by delivering a prospectus,
such Holder will not be deemed to admit that it
is an "underwriter" within the meaning of the
Securities Act. See "The Exchange
Offer--Procedures for Tendering."
Special Procedures for
Beneficial Owners............. Any beneficial owner whose Private Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
and who wishes to tender such Private Notes in
the Exchange Offer should contact such
registered Holder promptly and instruct such
registered Holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes
to tender on its own behalf, such owner must,
prior to completing and executing the Letter of
Transmittal and delivering such owner's Private
Notes, either make appropriate arrangements to
register ownership of the Private Notes in such
owner's name or obtain a properly completed
bond power from the registered Holder. The
transfer of registered ownership may take
considerable time and may not be able to be
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completed prior to the Expiration Date. See
"The Exchange Offer--Procedures for Tendering."
Guaranteed Delivery
Procedures.................... Holders of Private Notes who wish to tender
their Private Notes and whose Private Notes are
not immediately available or who cannot deliver
their Private Notes, the Letter of Transmittal
or any other documentation required by the
Letter of Transmittal to the Exchange Agent
prior to the Expiration Date, must tender their
Private Notes in accordance with the guaranteed
delivery procedures set forth under "The
Exchange Offer--Guaranteed Delivery
Procedures."
Acceptance of the Private
Notes and Delivery of the
Exchange Notes.............. Subject to the satisfaction or waiver of the
conditions to the Exchange Offer, the Company
will accept for exchange any and all Private
Notes that are properly tendered in the
Exchange Offer prior to the Expiration Date. NO
VOTE OF THE COMPANY'S SECURITY HOLDERS IS
REQUIRED TO EFFECT THE EXCHANGE OFFER AND NO
SUCH VOTE (OR PROXY THEREFOR) IS BEING SOUGHT
HEREBY. The Exchange Notes issued pursuant to
the Exchange Offer will be delivered on or as
promptly as practicable after the Expiration
Date. See "The Exchange Offer--Terms of the
Exchange Offer."
Withdrawal Rights............. Tenders of Private Notes may be withdrawn at
any time prior to the Expiration Date. See "The
Exchange Offer--Withdrawal of Tenders."
United States Federal Income
Tax Considerations............ For a discussion of United States federal
income tax considerations relating to the
exchange of Exchange Notes for Private Notes,
see "United States Federal Income Tax
Considerations."
Exchange Agent................ The Bank of New York is serving as the Exchange
Agent in connection with the Exchange Offer.
The Bank of New York also serves as trustee
under the Indenture and as collateral agent
under the Pledge Agreement.
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THE NOTES
The Exchange Offer applies to $200,000,000 aggregate principal amount of
Private Notes. The form and terms of the Exchange Notes are identical in all
material respects to the form and terms of the Private Notes, except that the
exchange will have been registered under the Securities Act, and, therefore, the
Exchange Notes will not bear legends restricting the transfer thereof, and
Holders of the Exchange Notes will not be entitled to any of the exchange and
registration rights of Holders of the Private Notes under the Registration
Rights Agreement, which rights will terminate upon consummation of the Exchange
Offer. The Exchange Notes will evidence the same indebtedness as the Private
Notes (which they replace) and will be issued under, and be entitled to the
benefits of, the Indenture and the Pledge Agreement. For further information and
for definitions of certain capitalized terms used herein, see "Description of
the Notes."
Issuer........................ US Xchange, L.L.C.
Securities Offered............ $200,000,000 principal amount of 15% Senior
Notes due 2008.
Maturity...................... July 1, 2008.
Interest...................... Interest on the Notes is payable semi-annually
in cash on July 1 and January 1 of each year,
beginning on January 1, 1999. Interest on each
Exchange Note will accrue at the rate of 15%
per annum from the last payment date on which
interest was paid on the Private Note
surrendered in exchange therefor or, if no
interest has been paid on the Private Note,
from June 25, 1998, the date of original
issuance of the Private Notes.
Non-callable.................. The Notes are non-callable.
Redemption Upon Receipt of
Public Equity Offering
Proceeds.................... At any time prior to July 1, 2001, the Company
may redeem up to 35% of the aggregate principal
amount of the Notes with the proceeds of one or
more Public Equity Offerings at 115% of their
principal amount, plus accrued interest;
provided, however, that (i) after any such
redemption, Notes representing at least 65% of
the aggregate principal amount of the Notes
originally issued remains outstanding and (ii)
notice of any such redemption is mailed within
60 days of such Public Equity Offering. See
"Description of the Notes--Redemption Upon
Receipt of Public Equity Offering Proceeds."
Change of Control............. Upon a Change of Control, the Company will be
required to make an offer to purchase all of
the outstanding Notes at a purchase price equal
to 101% of their principal amount, plus accrued
interest. There can be no assurance that the
Company will have sufficient funds available at
the time of any Change of Control to make any
required debt repayment (including repurchases
of the Notes). See "Description of the
Notes--Repurchase of Notes Upon a Change of
Control."
Security...................... Pursuant to the Indenture, the Company has
purchased and pledged to the Trustee under the
Indenture, as security for the benefit of the
Holders of the Notes, approximately $79.6
million of Pledged Securities consisting of
U.S. government securities, which the Company
believes will be sufficient, upon receipt of
scheduled principal and interest payments
thereon to provide for the payment
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in full of the first six scheduled interest
payments due on the Notes. See "Description of
the Notes--Security."
Ranking....................... The Notes are unsubordinated, unsecured (except
as described above under "--Security")
indebtedness of the Company, rank pari passu in
right of payment with all other unsubordinated,
unsecured indebtedness of the Company, rank
senior in right of payment to all subordinated
indebtedness of the Company and are
subordinated to the claims of holders of any
secured indebtedness of the Company with
respect to the assets securing such secured
indebtedness. Moreover, the Company is a
holding company, and the Notes will be
effectively are subordinated to all existing
and future liabilities (including trade
payables) of the Company's subsidiaries. As of
September 30, 1998, the total amount of
indebtedness of the Company (parent only) was
$203.6 million, of which $200.0 million
represented the Notes and $3.6 million was
secured indebtedness, to which the Notes are
subordinated to the extent of the value of the
assets securing such indebtedness. As of
September 30, 1998, the Company's subsidiaries
had approximately $9.1 million in the aggregate
of liabilities (excluding intercompany
payables), to which the Notes are effectively
subordinated. See "Risk Factors--Priority of
Holders of Secured Indebtedness" and "--Holding
Company Structure; Structural Subordination of
the Notes," "Description of Existing
Indebtedness," "Description of the
Notes--Ranking."
Certain Covenants............. The Indenture contains certain covenants that,
among other things, restrict the ability of the
Company and its Restricted Subsidiaries to
incur additional indebtedness, create liens,
engage in sale-leaseback transactions, pay
dividends or make distributions in respect of
their membership interests, redeem membership
interests, make investments or certain other
restricted payments, sell assets, issue or sell
membership interests of Restricted
Subsidiaries, enter into transactions with
members or affiliates or effect a consolidation
or merger. However, these limitations are
subject to a number of important qualifications
and exceptions. See "Description of the
Notes--Covenants."
Book-Entry; Delivery and
Form.......................... It is expected that delivery of the Exchange
Notes will be made in book-entry form as
described below. The Notes will be issued only
in registered form without coupons and in
minimum denominations of $1,000 and any
integral multiples of $1,000 in excess thereof.
Exchange Notes issued in exchange for Private
Notes sold in reliance on Rule 144A under the
Securities Act will be evidenced by one or more
Notes in global form (each a "Global Note"),
which will be deposited with the Trustee as
custodian for, and registered in the name of, a
nominee of The Depository Trust Company ("DTC")
in New York, New York. Exchange Notes issued in
exchange for Private Notes sold in offshore
transactions pursuant to Regulation S under the
Securities Act will be evidenced by one or more
Global Notes which will be deposited with the
Trustee as custodian for, and registered in the
name of, a nominee of DTC for the accounts of
Morgan Guaranty Trust Company of New York,
Brussels office, as operator of the
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Euroclear System ("Euroclear"), and Cedel
Banks, societe anonyme ("Cedel Bank").
Beneficial interests in such Global Notes will
be shown on, and transfers thereof will be
effected only through, records maintained by
DTC and its participants. Such interests will
trade in DTC's Same-Day Funds Settlement
System, and secondary market trading activity
in such interests will therefore settle in
immediately available funds, subject in all
cases to the rules and procedures of DTC and
its participants. Beneficial interests in a
Global Note may not be exchanged for Notes
issued in certificated form except in the
limited circumstances described herein. See
"Description of the Notes--Book Entry; Delivery
and Form."
For additional information regarding the Notes, see "Notice to Investors,"
"Description of the Notes" and "United States Tax Federal Income Tax
Considerations."
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RISK FACTORS
An investment in the Exchange Notes involves a high degree of risk. The
following risk factors, together with the other information set forth in this
Prospectus, should be considered carefully when evaluating an investment in the
Exchange Notes.
LIMITED HISTORY OF OPERATIONS; HISTORICAL AND ANTICIPATED FUTURE NEGATIVE CASH
FLOW AND OPERATING LOSSES
The Company commenced commercial operations in July 1997 and, as a result,
prospective investors have limited operating and financial data about the
Company upon which to base an evaluation of the Company's performance and an
investment in the Notes.
As a result of the Company's limited operating history, the Company has
generated only nominal revenues from operations resulting in significant
operating losses and negative cash flows to date. For the year ended December
31, 1997 and the nine months ended September 30, 1998, the Company had total
revenues of $207,000 and $4.1 million, losses from operations of $5.8 million
and $26.5 million, earnings before net interest, income taxes, depreciation and
amortization ("EBITDA") of negative $5.6 million and negative $24.2 million,
cash flows from operating activities of negative $396,000 and negative $15.3
million, cash flows from investing activities of negative $28.2 million and
negative $140.8 million, cash flows from financing activities of $28.7 million
and $227.8 million, net loss of $5.8 million and $31.0 million, and a deficiency
of earnings to cover fixed charges of $5.8 million and $32.3 million ($32.4
million and $43.9 million after giving pro forma effect to the increase in net
interest expense resulting from the issuance of the Notes), respectively. The
Company expects that planned capital expenditures, together with the associated
operating expenses in each of its target markets, will result in negative cash
flows operating and investing activities and negative EBITDA for approximately
24 to 36 months after facilities-based switched operations commence in each of
such markets, and, accordingly, the Company expects to experience increasing
consolidated operating losses as it expands its operations, builds its network
and switching facilities and develops its customer base. None of the Company's
markets currently generates positive operating cash flows or EBITDA. The Company
must significantly increase its revenues and cash flows to meet its obligations
on the Notes. There can be no assurance that the Company will sufficiently
increase its revenues, achieve or sustain positive EBITDA or profitability or
generate sufficient positive consolidated cash flow to meet its working capital
and debt service requirements. The Company's failure to accomplish any of the
foregoing would have a material adverse effect on the Company and its ability to
meet its obligations on the Notes. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation--Liquidity and Capital Resources."
ADDITIONAL CAPITAL REQUIREMENTS
The Company's current plans for the development and expansion of its
networks, services and customer base, and the continued funding of its operating
losses, will require significant capital. The Company estimates that, as of
September 30, 1998, its future capital requirements (including requirements for
capital expenditures, working capital, debt service and operating losses) to
fund the installation, deployment and operating losses of the networks in its
current development plans and the interconnection of certain of such networks
through the construction or acquisition of long haul fiber routes will total
approximately $115 million. The Company believes that its existing equity and
debt capital will provide the Company with sufficient capital to fund the
installation and deployment of networks in its current development plans and
estimated operating losses of such networks through December 31, 1998. The
Company plans to seek additional financing to fund the balance of the capital
requirements for its current development plans, although the Company currently
has no commitments for such additional capital.
The Company's expectations of its capital requirements are based on the
Company's current estimates. However, the Company is in the early stages of the
implementation of its network buildout plans, and actual capital requirements
may vary based upon the timing and success of the Company's implementation of
its development plans. There can be no assurance that actual expenditures will
not be significantly higher or lower. Factors which could affect the amount and
timing of the Company's capital requirements include, among other things, the
demand for the Company's services and regulatory, technological and competitive
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developments. The Company is considering opportunities to expand its operations
into additional commercial regions in the Midwest which would require additional
financing. The Company may commence these activities before obtaining such
additional financing. The Company may also require additional financing (or
require additional financing sooner than anticipated) if: (i) the Company's
current development plans or projections change or prove to be inaccurate or
attractive additional opportunities are identified; (ii) the Company effects any
acquisitions or joint ventures; (iii) the Company's cost projections prove to be
underestimated; or (iv) the Company accelerates or otherwise alters the schedule
or target markets of its roll-out plans. If available, sources of additional
financing may include commercial bank borrowings, vendor financing, the private
or public sale of additional equity or debt securities and joint ventures.
There can be no assurance that the additional capital that the Company will
require to fully implement its current development plans and to fund any
expansion beyond the Company's current development plans will be available to
the Company, that the Company will be successful in raising any additional
capital on terms that it will consider acceptable or that the Company's
operations will produce positive consolidated cash flow in amounts sufficient to
meet its additional capital requirements. If the Company is unable to raise and
generate sufficient funds, it may be required to modify, delay or abandon some
of its planned expansion or expenditures or to forego the installation and
deployment of networks in additional commercial regions. Any of the foregoing
factors would have a material adverse effect on the Company and its ability to
meet its obligations on the Notes. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
SUBSTANTIAL INDEBTEDNESS; POSSIBLE SUBSTANTIAL ADDITIONAL INDEBTEDNESS;
FINANCING RISKS
At September 30, 1998, the Company had $203.6 million of indebtedness, of
which the Notes represented $200.0 million, and $60.0 million of contributed
equity. To fully implement the Company's current development plans and to fund
any future expansion beyond the Company's current development plans, the Company
will be required to raise additional financing. See "--Additional Capital
Requirements" above. The Indenture limits, but does not prohibit, the incurrence
of additional indebtedness by the Company. In particular, the Indenture permits
the Company and its subsidiaries to incur an unlimited amount of indebtedness
(including secured indebtedness) to finance the cost of equipment, inventory and
network assets (including the cost of the design, development, acquisition,
construction, installation, improvement, transportation and integration
thereof).
A relatively high level of indebtedness could have important consequences
to the Company's future prospects, including the following: (i) limiting the
ability of the Company to obtain any necessary financing in the future for
working capital, capital expenditures, debt service requirements or other
purposes; (ii) requiring that a substantial portion of the Company's cash flow
from operations, if any, be dedicated to the payment of principal of and
interest on its indebtedness; (iii) limiting its flexibility in planning for, or
reacting to changes in, its business; (iv) making the Company more highly
leveraged than some of its competitors, which may place it at a competitive
disadvantage; (v) making it more difficult for the Company to meet its
obligations on the Notes; and (vi) increasing the Company's vulnerability in the
event of a downturn in its business. The debt service requirements of any
additional indebtedness of the Company and its subsidiaries would also make it
more difficult for the Company to meet its obligations on the Notes. There can
be no assurance that the Company's consolidated cash flow and capital resources
will be sufficient for payment of the principal of, premium, if any, and
interest on, its indebtedness (including the Notes).
Cash flow from operations may be insufficient to repay the Company's
indebtedness, including the Notes, in full, and, accordingly, a substantial
portion of the Company's indebtedness may need to be refinanced. Any additional
indebtedness incurred in the future may mature prior to the Notes and may also
need to be refinanced. There can be no assurance that the Company will be able
to effect such refinancings. The ability of the Company to meet its debt service
requirements and to effect any needed refinancings will be dependent upon, among
other things, the future performance of the Company, which will be subject to
prevailing economic conditions and to financial, business, regulatory and other
factors, including factors beyond the Company's control. Further, there can be
no assurance that the Company will have sufficient funds available
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<PAGE> 16
at the time of any Change of Control to make any required debt repayment
(including repurchases of the Notes). See "Description of the Notes--Repurchase
of Notes Upon a Change of Control."
INDENTURE COVENANTS
The Indenture imposes certain financial and operating restrictions on the
Company and its subsidiaries. These restrictions limit, among other things, the
ability of the Company and its Restricted Subsidiaries to incur additional
indebtedness, create liens, engage in sale-leaseback transactions, pay dividends
or make distributions in respect of their membership interests, redeem
membership interests, make investments or certain other restricted payments,
sell assets, issue or sell membership interests of its Restricted Subsidiaries,
enter into transactions with members or affiliates, and effect consolidations or
mergers. While these limitations are subject to a number of important
qualifications and exceptions, any failure to comply with these restrictions
could result in a default thereunder. See "Description of the Notes." In
addition, the terms of any additional debt or equity financings undertaken by
the Company to meet its future cash requirements could further restrict the
Company's operational flexibility and thereby adversely affect the Company and
its ability to meet its obligations on the Notes.
PRIORITY OF HOLDERS OF SECURED INDEBTEDNESS
The Indenture permits the Company to incur an unlimited amount of
indebtedness for capital expenditures and to secure such indebtedness. At
September 30, 1998, the Company had $3.6 million of outstanding secured
indebtedness. See "Description of Existing Indebtedness." Holders of secured
indebtedness of the Company will have claims that are prior to the claims of the
holders of the Company's unsecured indebtedness (including the Notes) with
respect to the assets securing such secured indebtedness. In addition, to the
extent the value of such assets is insufficient to satisfy such secured
indebtedness of the Company, the holders of such secured indebtedness would be
entitled to share pari passu with the holders of the Company's unsecured
indebtedness (including the Notes) to the extent of the remaining unpaid amounts
thereunder. The priority claims of the holders of secured indebtedness of the
Company could have a material adverse effect on the ability of the Company to
meet its obligations on the Notes.
HOLDING COMPANY STRUCTURE; STRUCTURAL SUBORDINATION OF THE NOTES
The Company is a holding company, and its principal assets consist of its
equity interests in its operating subsidiaries. The Company will rely upon
payments from its subsidiaries to generate the funds necessary to meet its
obligations, including the payment of the principal of, premium, if any, and
interest on, the Notes. The Company's subsidiaries, however, are legally
distinct from the Company, and such subsidiaries have no obligation, contingent
or otherwise, to pay amounts due pursuant to the Notes or to make funds
available for such payment. The Company's subsidiaries have not guaranteed the
Notes. The ability of the Company's subsidiaries to make such payments to the
Company will be subject to, among other things, the availability of funds and
the terms of any indebtedness of such subsidiaries. The Indenture permits
subsidiaries of the Company to incur substantial amounts of indebtedness. Claims
of such subsidiaries' creditors, including trade creditors, will generally have
priority as to the assets of such subsidiaries over the claims of the holders of
the Company's indebtedness, including the Notes. Accordingly, the Notes are
effectively subordinated to the liabilities (including trade payables) of the
subsidiaries of the Company. As of September 30, 1998, the subsidiaries of the
Company had approximately $9.1 million of liabilities (excluding intercompany
payables). The Company's holding company structure could have a material adverse
effect on the Company's ability to meet its obligations on the Notes.
COMPETITION
The telecommunications industry is highly competitive, and one of the
primary purposes of the Telecommunications Act of 1996 (the "Telecommunications
Act") is to foster additional competition. In each of its markets, the Company
competes principally with the ILEC serving such market, which is generally one
of the Regional Bell Operating Companies (the "RBOCs") or GTE Corporation
("GTE") or one of its affiliated companies (the "GTE Companies"). The ILECs have
long-standing relationships with their
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<PAGE> 17
customers, have financial, technical and marketing resources substantially
greater than those of the Company and have the potential to fund competitive
services with cash flows from a variety of businesses. ILECs presently have a
near 100% market share in each of the Company's target markets. The Company
expects to face significant competitive product and pricing pressure in each of
its markets.
It is likely that the Company will also face competition from other
facilities-based CLECs in certain of its markets. After the investment and
expense of establishing a network and support services in a given market, the
marginal cost of carrying an additional call is negligible. Accordingly, in Tier
III Markets where there are other facilities-based CLECs, the Company expects
substantial price competition. The Company believes that Tier III Markets will
support only a limited number of competitors and that operations in Tier III
Markets with multiple competitive providers are likely to be unprofitable for
one or more of such providers.
CLEC competitors that provide local services or have started or announced
plans for either construction or solicitation activities in the Company's
current markets include: Telephone and Data Systems, Inc. ("TDS") and McLeod USA
Incorporated ("McLeod") in Green Bay/Appleton, Wisconsin; Teleport
Communications Group Inc. ("TCG"), TWI Cable Inc. (a wholly owned subsidiary of
Time Warner Companies, Inc.) ("TWI"), McLeod and Ovation Communications, Inc.
("OCI") in Milwaukee, Wisconsin; KMC Telecom Holdings, Inc. ("KMC Telecom"), TDS
and McLeod in Madison, Wisconsin; KMC Telecom in Ft. Wayne, Indiana; McLeod in
Rockford, Illinois; Climax Telephone Company in Kalamazoo, Michigan; and Brooks
Fiber Properties, Inc. ("Brooks Fiber"), a wholly owned subsidiary of MCI
WorldCom Inc. ("MCI WorldCom"), in Grand Rapids, Michigan. The Company believes
that there may be additional competitors that have formulated plans to enter its
target markets, including the additional markets in its current development
plans.
The Company has acquired from another carrier an IRU for dark fibers along
long haul routes that interconnect certain of the Company's networks in
Wisconsin and Illinois and, in exchange, the Company has granted such carrier an
IRU for dark fibers in and between certain of the Company's networks in
Wisconsin and Illinois. While this and any other similar swap of excess fiber
capacity which the Company may enter into with other carriers reduces the cable
investments of both parties, it also facilitates the market entry of the carrier
acquiring the right to use the Company's fiber.
Other potential competitors in the Company's markets include resellers,
microwave, satellite and other wireless telecommunications providers, cable
television companies, electric utilities and RBOCs seeking to operate outside
their current local service areas. In particular, electric utilities and cable
companies are likely competitors given their existing rights of way. Electric
utilities using Digital Line Power ("DLP") technologies can transmit Internet
and data services over their power lines at speeds faster than those achievable
by telephone companies on their asymmetric digital subscriber lines ("ADSL") or
ISDN lines. The development of networks utilizing new technologies such as
Internet telephony, cable modem service and wireless networks utilizing Local
Multi-Point Distribution Services ("LMDS") and satellite transmission, which can
be used to provide high capacity wireless local loop, LAN, Internet access and
interactive services, might also create significant new competitors that may
have a lower cost basis than the Company. The Company believes that there may
also be an increasing level of agent and distributor resale initiatives in Tier
III Markets.
Prices in both the long distance business and the data transmission
business have declined significantly in recent years and are expected to
continue to decline. The Company will face competition from large carriers such
as AT&T Corp. ("AT&T"), MCI WorldCom and Sprint Corporation ("Sprint"), as well
as from other resellers and companies offering Internet telephony services,
which could create additional pricing pressures. In addition, long distance
carriers, including AT&T, MCI WorldCom and Sprint, as well as smaller carriers,
have begun to offer integrated local, long distance and data telecommunications
services. MCI WorldCom was recently formed by the merger of WorldCom, Inc. and
MCI Communications Corporation, and AT&T has recently acquired TCG and announced
a proposed combination with Tele-Communications, Inc. ("TCI"). Combinations such
as these should enhance carriers' ability to offer bundled local and long
distance telecommunications services. The RBOCs are also making concerted
efforts to gain regulatory permission
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under the Telecommunications Act to offer their own bundled local and long
distance telecommunications services.
Increasing competition has led to consolidations among the original seven
RBOCs, including the recently announced agreement of SBC Communications, Inc.
("SBC") to acquire Ameritech Corp. ("Ameritech") and SBC's recent acquisition of
Southern New England Telecommunications Corp. ("SNET"). Following these
combinations, SBC would be a coast-to-coast local telephone company with an
estimated 30% of all United States local access lines. SBC has also announced
plans to enter an additional 30 markets outside the territories of the combined
entity. In addition, Bell Atlantic Corporation ("Bell Atlantic") has reached an
agreement for the acquisition of GTE. Further consolidation of
telecommunications companies and the formation of additional strategic alliances
within the telecommunications industry could give rise to significant new
competitors.
While recent regulatory initiatives, which allow CLECs such as the Company
to interconnect with ILEC facilities and to obtain unbundled network elements
from the ILECs, provide increased business opportunities for the Company, such
regulatory initiatives have been accompanied by increased pricing flexibility
for, and relaxation of regulatory oversight of, the ILECs. This may present
ILECs with an opportunity to subsidize services that compete with the Company's
services with revenues generated from non-competitive services, thereby allowing
ILECs to offer competitive services at lower prices. There can be no assurance
that the Company will be able to obtain the interconnections and unbundled
network elements it requires at rates, and on terms and conditions, that will
permit the Company to offer switched and advanced, high speed digital services
at rates that are both competitive and profitable. See "--Implementation Risks"
below. If the ILECs engage in increased volume and discount pricing practices or
charge CLECs increased fees for interconnection or unbundled network elements,
or if the ILECs delay implementation of interconnection or the provision of
unbundled network elements, the Company would be adversely affected.
The Company expects to experience declining prices and increasing price
competition. There can be no assurance that the Company will be able to achieve
or maintain adequate market share or margins, or compete effectively, in any of
its markets. Moreover, substantially all of the Company's current and potential
competitors have financial, technical, marketing, personnel and other resources,
including brand name recognition, substantially greater than those of the
Company, as well as other competitive advantages over the Company.
Any of the foregoing factors could have a material adverse effect on the
Company and its ability to meet its obligations on the Notes. See
"Business--Competition."
BUSINESS DEVELOPMENT AND EXPANSION RISKS; POSSIBLE INABILITY TO MANAGE GROWTH
The Company must achieve substantial growth in order to meet its payment
obligations on the Notes and its other indebtedness. The Company began providing
switched local, long distance and Centrex services on a resale basis to its
customers in July 1997, and its first network became commercially operational in
March 1998. The continued development and expansion of the Company's operations
will depend, among other things, upon the Company's ability to install cable and
establish facilities, including switches and electronics, obtain needed OSS
interfaces and unbundled network elements from the ILECs, obtain required rights
of way and governmental authorizations, franchises and permits, provision and
service customers, implement interconnection and collocation with ILEC
facilities, implement efficient operations support and other back office,
customer care and billing systems, and develop and retain a sufficient customer
base, all in a timely manner, at reasonable costs and on satisfactory terms and
conditions. The Company's business success will also depend upon the Company's
ability to control costs, maintain regulatory compliance, maintain effective
quality controls and attract, assimilate and retain sufficient qualified
management, technical and sales personnel. See "--Dependence on Key Personnel"
below. To the extent the Company may determine to pursue acquisitions or joint
ventures, its ability to do so will depend on, among other things, the Company's
ability to successfully identify, finance, complete and assimilate such
acquisitions or joint ventures. See "--Risks Related to Potential Acquisitions
and Joint Ventures" below.
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The failure of the Company to successfully manage the continued development
and expansion of its operations could adversely affect the expansion of the
Company's customer base and service offerings. There can be no assurance that
the Company will successfully implement and maintain the needed operational,
information, customer care and billing systems, procedures and controls and
successfully obtain, integrate and utilize the employees and management,
operational, technical and financial resources necessary to manage a developing
and expanding business in an evolving, highly regulated and increasingly
competitive industry. Any significant failure by the Company to meet the demands
of its customers and to manage the expansion of its business and operations
would have a material adverse effect on the Company and its ability to meet its
obligations on the Notes.
DEPENDENCE ON KEY PERSONNEL
The Company is managed by a small number of key executive officers, most
notably Mr. Ronald H. VanderPol, the Company's Co-Chairman and co-founder, and
Mr. Richard Postma, its Co-Chairman, Chief Executive Officer and co-founder. The
loss of services of one or more of these key executive officers, particularly
Mr. VanderPol or Mr. Postma, could have a material adverse effect on the
business of the Company, its prospects and its ability to meet its obligations
on the Notes. The Company believes that its success will depend in large part on
its ability to develop a large and effective sales force and its ability to
attract and retain highly skilled and qualified management, technical and sales
personnel. Only three of the executive officers of the Company have employment
agreements, and the Company does not maintain key person life insurance for any
of its executive officers (See "Management--Executive Officers" and
"--Employment Agreements"). Although the Company has been successful to date in
attracting and retaining a sufficient number of qualified management, technical
and sales personnel, the competition for qualified personnel in the
telecommunications industry is intense, and, accordingly, there can be no
assurance that the Company will be able to continue to attract and retain the
qualified management, technical and sales personnel necessary to achieve its
business objectives. The Company's failure to attract and retain such key
personnel could have a material adverse effect on the Company and its ability to
meet its obligations on the Notes.
DEPENDENCE ON INFORMATION AND PROCESSING SYSTEMS
Sophisticated back office information and processing systems are vital to
the Company's growth and its ability to monitor costs, bill customers, provision
customer orders and achieve operating efficiencies. The Company's OSS systems
have either been acquired from or developed with third-party vendors and are
designed to be scalable, to be employed either centrally or in more than one
location and to automate many of the functions which previously have required
multiple manual entries of customer information to accomplish order management,
provisioning, switch administration and billing. The Company has recently
implemented new provisioning and order entry systems acquired from a third party
vendor and is in the process of integrating these new systems with its other
information and processing systems. However, there can be no assurance that the
Company will be successful in integrating such systems in-house to produce the
anticipated operational solutions or that the Company's information or
processing systems will perform as expected. As the Company expands its customer
base, deploys its networks and provides its own switch-based services, the
failure of these systems to perform as expected or interface with ILEC legacy
systems or the failure of the Company to adequately identify all of its
information and processing needs or to upgrade systems as necessary could have a
material adverse effect on the Company and its ability to meet its obligations
on the Notes. In addition, the Company's right to use certain of these systems
is dependent upon license agreements with third party vendors. Certain of such
agreements may be cancelable by the vendor, and the cancellation or nonrenewal
of these agreements may have an adverse effect on the Company and its ability to
meet its obligations on the Notes.
YEAR 2000 COMPLIANCE
The year 2000 issue is a matter of particular worldwide concern for
telecommunications carriers because it affects many aspects of
telecommunications technology, including the computer systems and software
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applications that are essential for network administration and operations. A
significant portion of telecommunications voice and data networking and network
management devices have date-sensitive processing in them which affect network
administration and operations functions such as service activation, service
assurance and billing processes. However, because the Company has only recently
commenced operations and its key processing systems have recently been acquired,
costs related to year 2000 issues historically have not been material. Lucent
and the other vendors of such systems have represented to the Company that such
systems are year 2000 compliant without any required modification, and the
Company will require confirmation of year 2000 compliance in its future requests
for proposals from Lucent and any other equipment and software vendors. The
Company has developed and begun to implement a strategic year 2000 compliance
plan to address year 2000 issues. The Company has completed the inventory of its
mission-critical systems and is in various stages of modification and testing of
these systems. The Company plans to have all of its systems fully compliant by
early 1999.
The failure of the Company's computer systems and software applications to
accommodate the year 2000 could have a material adverse effect on the Company
and its ability to meet its obligations on the Notes. Further, if the networks
and systems of the ILECs, IXCs and others on whose services the Company depends
and with whom the Company's networks and systems must interface are not year
2000 functional, it could have a material adverse effect on the operation of the
Company's networks and, as a result, have a material adverse effect on the
Company and its customers. Most major domestic carriers have announced that they
expect all of their network and support systems to be year 2000 functional by
mid-1999. However, other domestic and international carriers may not be year
2000 functional. The Company has not yet established a contingency plan that
addresses its response to any potential failure of its systems, or those of
other entities on whose services it depends or with whom its networks and
systems must interface, to accommodate year 2000 issues. However, the Company
plans to participate in the interoperability testing processes and to implement
the contingency plans being put in place by industry organizations, and the
Company intends to continue to monitor the performance of its accounting,
information and processing systems and software applications and those of its
third-party constituents to identify and resolve any year 2000 issues.
To the extent necessary, the Company may need to replace, upgrade or
reprogram certain existing systems and software applications to ensure that all
of the Company's computer systems and software applications and all of its
interoperability applications are year 2000 functional. However, based on
current information, the Company does not believe that it will incur costs for
any replacement, upgrade or reprogramming of its computer systems and software
applications to resolve any year 2000 issues that will be material to its
business, financial condition or results of operations.
IMPLEMENTATION RISKS
The Company is a recent entrant into the CLEC industry. The local dial tone
services market was not fully opened to competition by CLECs until the passage
of the Telecommunications Act and related regulatory rulings in 1996. There are
numerous operating complexities associated with providing facilities-based local
exchange services. The Company will be required to develop and enhance new
services, products and systems and will need to develop new marketing
initiatives to sell these services. The Company will also need to identify,
procure and install the equipment that is capable of providing such services and
products in a timely and cost-efficient manner and that will perform as expected
by the Company.
The Company's services may not be profitable due to, among other factors,
lack of customer demand, inability to secure access to the ILECs' facilities on
acceptable terms, competition and pricing pressure from the ILECs, other CLECs
and other competitive providers, and cost overruns in connection with network
build-outs. The Company expects to face significant competitive product and
pricing pressure in each of its markets. The Company has very limited experience
providing any telecommunications services, and there can be no assurance that
the Company will be able to successfully implement its business strategy.
Implementation of the Company's own switched services is also subject to the
ability of Lucent and the Company's other suppliers to meet the Company's
network deployment schedules. See "--Reliance on Lucent for Supply, Installation
and Monitoring of Equipment" below. There can be no assurance that the Company's
networks will be deployed on the schedules contemplated by the Company or that,
if deployed, such networks will generate the revenues, operating cash flows and
EBITDA contemplated by the Company.
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The Company's business is highly dependent on its ability to interconnect
with and obtain unbundled network elements from the ILECs in its markets. In
each of its markets, the Company relies on ILECs to permit the Company to
collocate its equipment in the ILEC's central offices as a means of connecting
to its customers. Although, under the Telecommunications Act, the ILECs are
required to permit the Company to effect such collocations and interconnections
and to purchase only the origination and termination services and network
elements that the Company needs, thereby decreasing the Company's operating
expenses, there can be no assurance that the ILECs will effect such collocations
and interconnections and such unbundling of network elements in a timely manner
or at rates, and on terms and conditions, that will permit the Company to offer
switched services that are profitable.
In August 1996, the FCC issued an order which established national rules
for negotiating interconnection agreements and guidelines for review of such
agreements by state public utilities commissions, which rules, in general, are
favorable to new competitive entrants such as the Company. In July 1997, the
United States Court of Appeals for the Eighth Circuit (the "Eighth Circuit")
found significant portions of the FCC's rules to be beyond the scope of the
FCC's legal authority. The court ruled that the state public service
commissions, not the FCC, have jurisdiction over the pricing of interconnection,
unbundled network elements and resale services. State PSCs may favor ILECs, with
whom they have long-standing relationships in these matters. The Eighth Circuit
also ruled that the FCC's interpretation of the so-called "pick and choose"
provisions of the Telecommunications Act was incorrect. The Eighth Circuit held
that the Telecommunications Act allows CLECs to adopt an entire interconnection
agreement negotiated with an ILEC by another provider, but does not allow CLECs
to "pick and choose" from among pieces of existing agreements. In October 1997,
the Eighth Circuit issued a decision vacating additional FCC rules. This
decision will likely have the effect of increasing the costs of obtaining the
use of ILEC unbundled network elements. These Eighth Circuit decisions create
uncertainty about the rules governing the pricing, terms and conditions of
agreements to obtain needed interconnections and unbundled network elements,
could make negotiating and enforcing such agreements more difficult and
protracted and could require renegotiation of existing agreements. The United
States Supreme Court has heard oral arguments on the appeals of the Eighth
Circuit decisions and a decision is expected before July 1999. Any significant
increase in the cost of interconnection or unbundled network elements would have
a material adverse effect on the Company and its ability to meet its obligations
on the Notes.
To the extent the Company interconnects with and uses an ILEC's network to
service its customers, the Company will be dependent upon the technology and
capabilities of the ILEC, and the Company will be required to interface with the
ILEC's legacy systems in order to properly provision and service the Company's
customers. Many CLECs such as the Company have experienced difficulties in
working with the ILECs with respect to provisioning, interconnection,
collocation and implementation of the systems used by CLECs to order and receive
unbundled network elements and wholesale services from the ILECs. Coordination
with ILECs to gain access to network elements, complete the necessary OSS
interfaces and secure reasonable and affordable collocation is necessary for
CLECs such as the Company to provide integrated local services to customers on a
timely and competitive basis. In the event that the Company experiences
difficulties in obtaining high quality, reliable and reasonably priced services
from the ILECs, the attractiveness of the Company's services to its customers
could be impaired. The FCC has created a task force that is examining the
problems that have slowed the development of local telephone competition.
Sections 271 through 275 of the Telecommunications Act contain incentives
for the RBOCs to cooperate with their competitors and permit access to the
RBOCs' facilities by denying the RBOCs the ability to provide in-region long
distance services until there is adequate in-region local competition. On
December 31, 1997, the U.S. District Court for the Northern District of Texas
issued a decision finding that such sections of the Telecommunications Act are
unconstitutional since they impose restrictions on the RBOCs but do not impose
comparable restrictions on other ILECs such as the GTE Companies. On September
4, 1998, the United States Court of Appeals for the Fifth Circuit, in a 2-to-1
ruling, reversed the Texas District Court's decision. SBC has asked the United
States Supreme Court to review the Fifth Circuit's September 4 ruling. If the
ruling is not upheld on appeal, it would likely have an unfavorable effect on
the Company's business for at least two reasons. First, RBOCs currently have an
incentive under the challenged provisions of the
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Telecommunications Act to open their local markets to competition so that they
can qualify to offer in-region long distance services. Second, the Company is
legally able to offer its customers bundled long distance and local exchange
services, which the RBOCs currently may not do in their regions. The Company
believes that this ability to offer "one-stop shopping" gives the Company a
marketing advantage over the ILECs that it would no longer enjoy if the Fifth
Circuit's September 4 ruling is not upheld on appeal.
ILECs around the country have been contesting whether the obligation to pay
reciprocal compensation to CLECs should apply to local telephone calls from ILEC
customers to ISPs served by CLECs. The ILECs claim that this traffic is
interstate in nature and therefore should be exempt from compensation
arrangements applicable to local, intrastate calls. CLECs have contended that
the interconnection agreements provide no exception for local calls to ISPs and
reciprocal compensation is therefore applicable. The FCC recently held that
GTE's ADSL service, which provides a dedicated connection (rather than
circuit-switched dial up) that permits an ISP to provide its end user with
high-speed access to the Internet, is a special access service with more than a
de minimis amount of interstate traffic. This Order (GTE ADSL Order) determined
that GTE's ADSL service is properly tariffed at the federal level but if GTE or
any other ILECs were to offer an xDSL service that is intrastate in nature, that
service should be tariffed at the state level.
Under the Eighth Circuit decisions, the states have primary jurisdiction
over the determination of reciprocal compensation arrangements and as a result,
the treatment of this issue can vary from state to state. Currently, 23 state
commissions (including Illinois, Michigan and Wisconsin), three federal courts
and one state court have ruled that reciprocal compensation arrangements do
apply to calls to ISPs. Certain of these rulings are subject to appeal.
Additional disputes over the appropriate treatment of ISP traffic are pending in
other states. The National Association of Regulatory Utility Commissioners
("NARUC") adopted a resolution in favor of applying reciprocal compensation to
calls to IPSs. The FCC made clear that its GTE ADSL Order did not determine
whether reciprocal compensation is owed pursuant to existing interconnection
agreements, state arbitration decisions and federal court decisions. The FCC
indicated that it intends to issue a separate order specifically addressing
reciprocal compensation issues. The Company anticipates that ISPs will be among
its target customers, and adverse decisions in these proceedings could limit the
Company's ability to service this group of customers profitably.
The profitability of the Company's Internet access services, and related
services such as Web site hosting, may also be affected by its ability to obtain
"peering" arrangements with ISPs. In recent years, major ISPs routinely
exchanged traffic with other ISPs that met certain technical criteria on a
"peering" basis, meaning that each ISP accepted traffic routed to Internet
addresses on its system from its "peers" on a reciprocal basis, without payment
of compensation. Since late 1997, however, several of the largest ISPs have
publicly announced they will not accept peering arrangements with other ISPs
that do not meet certain size criteria and that smaller carriers will have to
negotiate arrangements for the exchange of traffic with such ISPs that have
usually imposed charges for accepting their traffic. There can be no assurance
that the Company will be able to negotiate "peer" status with any of the major
nationwide ISPs, or that it will be able to terminate traffic on ISPs' networks
at favorable prices. See "--Competition."
On August 7, 1998, the FCC released a Memorandum Opinion and Order ("MO&O")
and Notice of Proposed Rule Making ("NPRM") proposing to ease regulations on the
deployment of advanced data services such as high-speed internet access and
video telephony by ILECs. In its MO&O, the FCC clarified that advanced
telecommunications facilities and services offered by ILECs are subject to
Sections 251 and 252 of the Telecommunications Act (regarding terms of and
procedures for interconnection with local exchange carriers), and that the
facilities and equipment used to provide advanced services are network elements
that must be provided to new entrants on an unbundled basis. The FCC also held
that ILECs must offer for resale, at wholesale rates, any advanced services that
they offer to subscribers that are not telecommunications carriers.
In its NPRM, however, the FCC proposed to permit ILECs to form separate
affiliates that could offer advanced services without giving competitors access
to network elements at discounted prices. Thus, the separate affiliates could
install new data equipment to upgrade the ILEC networks to Digital Subscriber
Line standards without having to share the new networks with competitors. To the
extent that the affiliates provided
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interstate exchange access service, they would be presumed to be nondominant and
therefore not subject to price cap or rate of return regulation for advanced
services, and would not be required to file tariffs for such services. The
ILECs, however, would be required to give their competitors and the new
affiliates access on an equitable basis to the ILEC's central offices to install
data equipment, and would also have to provide access on an equitable basis to
local loops conditioned for data use. The FCC's proposal would not change the
existing prohibition on the provision of services by ILECs across LATA
boundaries, although the FCC stated that it would take comments on easing LATA
restrictions in special cases. At least one ILEC is expected to seek
reconsideration of the FCC's NPRM. It is unclear at this time whether the FCC's
proposal will ultimately be adopted in its present form or what effect such
adoption may have, and the NPRM's impact on the Company is therefore uncertain.
Any of the foregoing factors could have a material adverse effect on the
Company and its ability to meet its obligations on the Notes.
RISKS RELATED TO LONG DISTANCE BUSINESS
The Company offers long distance services to its customers as part of its
"one-stop shopping" offering of bundled telecommunications services. The long
distance business is extremely competitive, and prices have declined
substantially in recent years and are expected to continue to decline. In
addition, the long distance industry has a high average churn rate, as customers
frequently change long distance providers in response to the offering of lower
rates or promotional incentives by competitors. The Company relies on other
carriers to provide it with a major portion of its long distance transmission
services. Such agreements typically provide for the resale of long distance
services on a per-minute basis and contain minimum volume commitments. The
negotiation of these agreements involves estimates of future supply and demand
for transmission capacity as well as estimates of the calling patterns and
traffic levels of the Company's future customers. In the event the Company fails
to meet such minimum volume commitments, it may be obligated to pay
underutilization charges, and, in the event it underestimates its need for
transmission capacity, the Company may be required to obtain capacity through
more expensive means. The Company's failure to achieve acceptable profits on its
long distance business could have a material adverse effect on the Company and
its ability to meet its obligations on the Notes.
RISKS RELATED TO RESIDENTIAL BUSINESS
The Company offers telecommunications services to residential customers in
each of its target markets. Factors that could affect the profitability of the
Company's residential business include, among other things, the demand for such
services, the number of lines required per residential customer, the amount of
usage on each residential line and the number of value-added services subscribed
to by each residential customer. The Company's success in providing services to
residential customers will depend, among other things, upon the Company's
ability to attract residential customers, to maintain competitive prices and
thus minimize the churn rate of its residential customers, and to provide high
quality customer care services without incurring significant additional costs.
The Company's success in providing residential services will also depend upon
its ability to evaluate the creditworthiness of prospective residential
customers, to collect amounts owed by such customers in a timely, cost-effective
manner and to limit the amount of uncollectible bad debt from such customers.
There can be no assurance that the Company will be able to achieve acceptable
profit margins on its residential business. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors Affecting
Results of Operations." The Company's failure to achieve acceptable profits on
its residential business could have a material adverse effect on the Company and
its ability to meet its obligations on the Notes.
RISKS RELATED TO DATA TRANSMISSION BUSINESS
As part of its complete range of telecommunications services offerings, the
Company plans to offer data transmission services in markets where its network
and switches have become commercially operational. These services, which include
ISDN and frame relay services, are targeted at large and medium-sized businesses
with substantial data communications requirements. As a new entrant in the data
transmission
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business, the Company expects to generate low or negative gross margins and
substantial start-up expenses as it begins to offer data transmission services.
The Company does not expect such services to generate a material portion of its
revenues over the near term. The success of the Company's entry into the data
transmission business will be dependent upon, among other things, the
effectiveness of the Company's sales personnel in the promotion and sale of the
Company's data transmission services, the acceptance of such services by
potential customers, and the Company's ability to hire and train qualified
personnel and further enhance its services in response to future technological
changes. No assurance can be given that the Company will be successful with
respect to these matters. If the Company is not successful with respect to these
matters, it could have a material adverse effect on the Company and its ability
to meet its obligations on the Notes.
NEED TO ADAPT TO TECHNOLOGICAL DEVELOPMENTS
The telecommunications industry is subject to rapid and significant changes
in technology, with the Company relying on third parties for the development of
and access to new technologies. The Company believes its future success will
depend, in part, on its ability to anticipate or adapt to technological
developments and to offer, on a timely basis and at competitive prices, services
that meet customer demands for lower costs and better-integrated voice and data
services. There can be no assurance that the Company will obtain access to new
technologies on a timely basis or on satisfactory terms. While the Company
believes that, for the foreseeable future, technological changes will neither
materially affect the continued use of fiber optic cable and circuit-switched
transmission, nor materially hinder the Company's ability to acquire necessary
technologies, the effect of technological changes on the Company's operations
cannot be predicted. For example, Qwest Communications International Inc. and
Level 3 Communications Inc. are building global fiber optic communications
networks that are based on Internet Protocol ("IP") packet-switched technologies
and are designed to be cheaper and faster systems than networks using circuit
switching technologies such as those used by the Company. In May 1998, AT&T
announced that it also intends, over the long term, to transition its entire
network infrastructure, including its long distance voice network, to an IP
platform. In addition, Sprint recently has announced that it plans to carry
integrated voice and data traffic on ATM networks. These IP-based and ATM
networks are designed with capabilities to transmit voice, data, fax and video
communications simultaneously over the same lines. Additionally, LMDS wireless
service has bandwidth characteristics that are well suited for voice, data and
video transmission, and ADSL technology could increase the carrying capacity of
the ILEC's copper wire networks. These new technologies could provide
competitive alternatives to the fiber optic circuit-switched transmission
technologies being deployed by the Company. Any of the foregoing factors could
have a material adverse effect on the Company and its ability to meet its
obligations on the Notes.
GOVERNMENT REGULATION
The Company's networks and the provision of its telecommunications services
are subject to significant regulation at the federal, state and local levels.
Delays in receiving required regulatory approvals, or new adverse regulations or
regulatory or judicial requirements, may have a material adverse effect upon the
Company and its ability to meet its obligations on the Notes.
The FCC exercises jurisdiction over the Company with respect to interstate
and international services. Additionally, the Company files tariffs with the
FCC. On October 29, 1996, the FCC approved an order that eliminates the tariff
filing requirements for interstate domestic long distance service provided by
non-dominant carriers such as the Company (the "Detariffing Order"). On February
13, 1997, the United States Court of Appeals for the District of Columbia
Circuit (the "District of Columbia Circuit") stayed the FCC order, and the
Company is required to continue filing tariffs while this stay remains in
effect. If the stay is lifted and the Detariffing Order becomes effective,
telecommunications carriers such as the Company will no longer be able to rely
on the filing of tariffs with the FCC as a means of providing notice to
customers of the prices, terms and conditions on which they offer interstate
services. If the Company cancels its FCC tariffs as a result of the Detariffing
Order, it will need to implement replacement contracts, which could result in
substantial legal and administrative expenses.
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On August 6, 1998, the FCC released a proposal to make significant changes
to the application of its International Settlements Policy. That policy was
designed to protect U.S. carriers from discriminatory treatment in their
dealings with foreign correspondents, and places restrictions on the nature of
the arrangements into which U.S. and foreign carriers may enter with one
another. If adopted, the FCC's proposed changes would eliminate those
restrictions in many cases and enhance the Company's ability to compete in the
U.S. market for international services. The changes would also, however,
intensify competition in that market. See "Business--Regulation."
State regulatory commissions exercise jurisdiction over the Company to the
extent it provides intrastate services. As such a provider, the Company is
required to obtain regulatory authorizations and/or file tariffs with state
agencies in each of the states in which it operates. Local authorities regulate
the Company's access to municipal rights-of-way. Network buildouts are also
subject to numerous local regulations such as building codes and licensing
requirements. Such regulations vary on a city-by-city and county-by-county
basis. See "Business--Regulation."
There can be no assurance that the FCC or state or local authorities will
grant required authorizations or refrain from taking action against the Company
if it is found to have provided services without obtaining the necessary
authorizations or without complying with other regulatory obligations. If
authority is not obtained or if tariffs are not filed, or are not updated, or
otherwise do not fully comply with the tariff filing rules of the FCC or state
regulatory agencies, or if other regulatory obligations are not met, third
parties or regulators could challenge these actions. Such challenges could cause
the Company to incur substantial legal and administrative expenses and
sanctions.
The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry. The Telecommunications Act remains subject
to judicial review and additional FCC rulemaking, and thus it is difficult to
predict what effect the legislation will have on the Company and its operations.
There are currently many regulatory actions underway and being contemplated by
federal and state authorities regarding interconnection, pricing and other
issues that could result in significant changes to the business conditions in
the telecommunications industry. There can be no assurance that these changes
will not have a material adverse effect upon the Company and its ability to meet
its obligations on the Notes. See "--Implementation Risks" above and
"Business--Regulation."
The Telecommunications Act subjects CLECs such as the Company to certain
federal regulatory requirements relating to the provision of local exchange
service. Both ILECs and CLECs are obligated to interconnect with other carriers,
offer reciprocal compensation for termination of traffic and provide dialing
parity and telephone number portability. The Telecommunications Act also
requires all telecommunications carriers to ensure that their services are
accessible to and usable by persons with disabilities.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new subsidies of up to $2.7 billion for telecommunications and
information services provided to qualifying schools and libraries and for
services provided to rural heath care providers. The FCC also expanded the
federal subsidies for local exchange telephone service provided to low-income
consumers. Providers of interstate telecommunications service, such as the
Company, as well as certain other entities, must pay for these programs. The
Company's share of these federal subsidy funds will be based on its share of
certain defined telecommunications end-user revenues. Currently, the FCC is
assessing such payments on the basis of a provider's revenue for the previous
year. Since the Company had no significant revenue in 1997, it will not be
liable for subsidy payments in any material amount during 1998. With respect to
subsequent years, however, the Company is currently unable to quantify the
amount of subsidy payments that it will be required to make and the effect that
these required payments will have on its financial condition and results of
operation. In addition, many state PSCs have instituted proceedings to revise
state universal service fund contribution requirements to make them consistent
with the requirements of the Telecommunications Act. The Company will be subject
to state, as well as federal, universal service fund contribution requirements,
which will vary from state to state. In the May 8th order, the FCC also
announced that it will soon revise its rules for subsidizing service provided to
consumers in high cost areas, which may result in further substantial increases
in the overall cost of the subsidy programs. Several parties have appealed
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the May 8th order. Such appeals have been consolidated and transferred to the
United States Court of Appeals for the Fifth Circuit where they are currently
pending. In addition, on July 3, 1997, several ILECs filed a petition for stay
of the May 8th order with the FCC. That petition is pending, as well as several
petitions for administrative reconsideration of the order.
The Company is required to pay access charges to ILECs when it uses the
facilities of those companies to originate or terminate interexchange calls.
Also, as a CLEC, the Company provides access services to other interexchange
service providers. The interstate access charges of ILECs are subject to
extensive regulation by the FCC, while those of CLECs are subject to a lesser
degree of FCC regulation but remain subject to the requirement that all charges
be just, reasonable and not unreasonably discriminatory. In two orders released
on December 24, 1996 and May 16, 1997, the FCC made major changes in the
interstate access charge structure. In the December 24th order, the FCC removed
restrictions on ILECs' ability to lower access prices and relaxed the regulation
of new switched access services in those markets where there are other providers
of access services. The May 16th order substantially increased the costs that
ILECs subject to the FCC's price cap rules may recover through monthly,
non-traffic-sensitive access charges and substantially decreased the costs that
ILECs may recover through traffic-sensitive access charges based on minutes of
use. In the May 16th order, the FCC also announced its plan to bring interstate
access rate levels more in line with costs. The plan will include rules that are
expected to be established sometime in 1998 that may grant ILECs increased
pricing flexibility upon demonstration of increased competition (or potential
competition) in relevant markets. The manner in which the FCC implements this
approach to lowering access charge levels could have a material effect on the
Company's ability to compete in providing interstate access services. Several
parties have appealed the May 16th order. Those appeals have been consolidated
and have been transferred to the Eighth Circuit where they are currently
pending.
RELIANCE ON LUCENT FOR SUPPLY, INSTALLATION AND MONITORING OF EQUIPMENT
The Company has contracted with Lucent to supply its host and remote
switches and transmission and related electronic equipment, to install and turn
up its network systems and to monitor and maintain its networks and switching
and transmission equipment until the Company's Network Operations Control Center
(the "NOC Center") is constructed and becomes fully operational. There can be no
assurance that Lucent will be able to continue to meet the Company's
requirements on a timely basis or that the Company will have its NOC Center
available to transition from Lucent's provision of monitoring and maintenance
services as currently scheduled during the second quarter of 1999. Further,
Lucent may terminate its agreement with the Company at any time and for any
reason with 60 days' prior written notice to the Company. There can be no
assurance that Lucent will not terminate such agreement. While the Company
believes that its Lucent-based switching systems are compatible with alternative
suppliers' equipment and platforms, any extended interruption in the supply of
switches or other network equipment, disturbance in the pricing arrangements
with Lucent, extended interruption of the installation, turn-up, monitoring and
maintenance of the Company's networks, or delay in transitioning an alternative
supplier's products or services into the Company's networks could disrupt the
Company's operations. Any of the foregoing factors could have a material adverse
effect on the Company and its ability to meet its obligations on the Notes.
RISKS RELATED TO POTENTIAL ACQUISITIONS AND JOINT VENTURES
The Company may, as part of its business strategy, acquire other businesses
that complement its existing businesses. Management is unable to predict whether
or when any prospective acquisitions will occur or the likelihood of a material
transaction being completed on favorable terms and conditions. Acquisitions
commonly involve certain risks, including, among others: the difficulty in
assimilating the acquired operations and personnel; the potential disruption of
the Company's ongoing business and diversion of resources and management time;
the possible inability of management to maintain uniform standards, controls,
procedures and policies; the risks of entering markets in which the Company has
little or no direct prior experience; and the potential impairment of
relationships with employees, suppliers or customers as a result of changes in
management. There can be no assurance that any acquisition will be made, that
the Company will be able to finance or obtain financing needed to complete any
such acquisition and, if any acquisition is so made, that the
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acquired business will be successfully integrated into the Company's operations
or that the acquired business will perform as expected.
The Company may also enter into joint venture transactions. These
transactions present many of the same risks involved in acquisitions, and many
also involve the risk that the Company will not have control over the venture
and that a joint venture partner may have economic, business or legal interests
or objectives that are inconsistent with those of the Company. Joint venture
partners may also be unable to meet their economic or other obligations, thereby
forcing the Company to fulfill these obligations or abandon or curtail the
venture.
The Company has no definitive agreement with respect to any material
acquisition or joint venture, although from time to time it has discussions with
other companies and assesses opportunities on an ongoing basis. To the extent
the Company may determine to pursue acquisitions or joint ventures, it could
have a material adverse effect on the Company and its ability to meet its
obligations on the Notes.
NO PRIOR PUBLIC MARKET FOR THE EXCHANGE NOTES; POSSIBLE VOLATILITY OF MARKET
PRICE OF EXCHANGE NOTES
The NASD has designated the Private Notes as securities eligible for
trading in the PORTAL market of the NASD. However, the Exchange Notes are new
securities for which there is currently no market. The Company does not intend
to apply for listing of the Exchange Notes on any securities exchange or for
inclusion of the Exchange Notes in any automated quotation system. Although the
Company has been advised by the Placement Agent that it currently intends to
make a market in the Exchange Notes following completion of the Exchange Offer,
the Placement Agent is not obligated to do so, and any such market making
activities may be discontinued at any time without notice. Accordingly, there
can be no assurance as to the development or liquidity of any market for the
Exchange Notes. If a market for the Exchange Notes were to develop, the Exchange
Notes could trade at prices that may be higher or lower than their principal
amount depending upon many factors, including prevailing interest rates, the
Company's operating results and the markets for similar securities.
Historically, the market for non-investment grade debt such as the Notes has
been subject to disruptions that have caused substantial volatility in the
prices of securities similar to the Notes. There can be no assurance that, if a
market for the Exchange Notes were to develop, such a market would not be
subject to similar disruptions.
FAILURE TO EXCHANGE PRIVATE NOTES
The Exchange Notes will be issued in exchange for Private Notes only after
timely receipt by the Exchange Agent of such Private Notes, a properly completed
and duly executed Letter of Transmittal and all other required documentation.
Therefore, Holders of Private Notes desiring to tender such Private Notes in
exchange for Exchange Notes should allow sufficient time to ensure timely
delivery. Neither the Exchange Agent nor the Company is under any duty to give
notification of defects or irregularities with respect to tenders of Private
Notes for exchange. Private Notes that are not tendered or are tendered but not
accepted will, following consummation of the Exchange Offer, continue to be
subject to the existing restrictions upon transfer thereof. To the extent that
Private Notes are tendered and accepted in the Exchange Offer, the trading
market for untendered and tendered but unaccepted Private Notes could be
adversely affected due to the limited amount, or "float," of the Private Notes
that are expected to remain outstanding following the Exchange Offer. Generally,
a lower "float" of a security could result in less demand to purchase such
security and could, therefore, result in lower prices for such security. For the
same reason, to the extent that a large amount of Private Notes are not tendered
or are tendered and not accepted in the Exchange Offer, the trading market for
the Exchange Notes could be adversely affected. See "The Exchange Offer" and
"Plan of Distribution."
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USE OF PROCEEDS
Of the $193.1 million of net proceeds to the Company from the sale of the
Private Notes, approximately $82.5 million was used to purchase the Pledged
Securities, consisting of U.S. government securities and including accrued
interest, to secure and fund the first six scheduled semi-annual payments of
interest on the Notes. The Pledged Securities have been pledged to the Trustee
as security for the benefit of the Holders. The Trustee is holding and will
continue to hold the Pledged Securities pursuant to the Pledge Agreement,
pending disbursement. See "Description of the Notes--Security." As of September
30, 1998, the Company had applied $24.2 million of such net proceeds toward
capital expenditures required for the development and deployment of its
networks. The Company currently intends to use the remaining net proceeds to
fund the installation and deployment of networks in its current development
plans and operating losses of such networks. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
The Exchange Offer is intended to satisfy certain obligations of the
Company under the Registration Rights Agreement. The Company will not receive
any proceeds from the issuance of the Exchange Notes offered hereby and has
agreed to pay the expenses of the Exchange Offer. In consideration for issuing
the Exchange Notes as contemplated in this Prospectus, the Company will receive,
in exchange, Private Notes in like principal amount. The form and terms of the
Exchange Notes are identical in all material respects to the form and terms of
the Private Notes, except as otherwise described herein under "The Exchange
Offer--Terms of the Exchange Offer." The Private Notes surrendered in exchange
for the Exchange Notes will be retired and cancelled and cannot be reissued.
Accordingly, issuance of the Exchange Notes will not result in any increase in
the outstanding debt of the Company.
CAPITALIZATION
The following table sets forth the cash and capitalization of the Company
as of September 30, 1998. This table should be read in conjunction with
"Selected Consolidated Financial Data," "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and the Company's consolidated
financial statements, including the notes thereto, contained elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, 1998
------------------
(IN THOUSANDS)
<S> <C>
Cash and cash equivalents................................... $ 71,837
========
Restricted investments for payment of interest(1)........... 83,713
========
Long-term debt:
15% Senior Notes.......................................... $200,000
Note payable, less current maturities(2).................. 2,800
--------
Total long-term debt................................... 202,800
Member's capital:
Capital contributions..................................... 60,000
Accumulated deficit....................................... (36,998)
--------
Total members' capital................................. 23,002
--------
Total capitalization................................... $225,802
========
</TABLE>
- ---------------
(1) Represents Pledged Securities which the Company has purchased to secure the
first six scheduled interest payments on the Notes. See "Description of the
Notes--Security."
(2) See "Description of Existing Indebtedness."
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<PAGE> 29
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below for the period
from August 5, 1996 (date of inception) to December 31, 1996 and for the year
ended December 31, 1997 were derived from the audited consolidated financial
statements of the Company contained elsewhere in this Prospectus, which have
been audited by BDO Seidman, LLP, independent certified public accountants. The
selected consolidated financial data set forth below as of the end of and for
the nine months ended September 30, 1998 were derived from the unaudited
consolidated financial statements of the Company contained elsewhere in this
Prospectus, which have been prepared on the same basis as the audited
consolidated financial statements of the Company and, in the opinion of
management, reflect all normal recurring adjustments necessary for a fair
presentation of the Company's consolidated financial position and results of
operations as of the end of and for such period. The results for the nine months
ended September 30, 1998 are not necessarily indicative of the operating results
to be expected for the entire year. All of the selected consolidated financial
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Company's consolidated
financial statements and notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
PERIOD FROM SEPTEMBER 30,
AUGUST 5, 1996(1) YEAR ENDED --------------------------
TO DECEMBER 31, 1996 DECEMBER 31, 1997 1998 1997
-------------------- ----------------- ------------ -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................ $ -- $ 206,682 $ 4,128,955 $ 28,308
--------- ----------- ------------ -----------
Cost and expenses:
Cost of communication services.... -- 749,662 9,455,274 153,926
Selling, general and
administrative................. 137,810 5,065,589 18,901,677 2,171,674
Depreciation and amortization..... -- 189,347 2,290,778 67,649
--------- ----------- ------------ -----------
Total costs and expenses....... 137,810 6,004,598 30,647,729 2,393,249
--------- ----------- ------------ -----------
Loss from operations................ (137,810) (5,797,916) (26,518,774) (2,364,941)
Interest expense, net(2)............ -- 30,452 (7,178,744) --
Interest income..................... -- -- 2,665,715 --
--------- ----------- ------------ -----------
Net loss............................ $(137,810) $(5,828,368) $(31,031,803) $(2,364,941)
========= =========== ============ ===========
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF AS OF
DECEMBER 31, 1996 DECEMBER 31, 1997 SEPTEMBER 30, 1998
----------------- ----------------- ------------------
(UNAUDITED)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents...................... $ -- $ 100,590 $ 71,837,287
Restricted investments(3)...................... -- -- 83,713,272
Networks and equipment, net.................... -- 27,967,741 83,929,342
Total assets................................... 25,675 28,385,270 248,782,685
Advances from affiliate........................ 163,485 21,038,789 --
Long-term debt, less current maturities........ -- 2,189,000 202,800,000
Capital contributions.......................... -- 5,000,000 60,000,000
Members' capital (deficit)..................... (137,810) (966,178) 23,002,019
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
PERIOD FROM SEPTEMBER 30,
AUGUST 5, 1996(1) YEAR ENDED ----------------------------
TO DECEMBER 31, 1996 DECEMBER 31, 1997 1998 1997
-------------------- ----------------- ------------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OTHER DATA:
Capital expenditures.............. $ -- $28,157,088 $ 58,252,380 $ 11,752,005
EBITDA(4)......................... (137,810) (5,608,569) (24,227,996) (2,297,293)
Cash flows from operating
activities...................... (163,485) (395,530) (15,345,739) (1,882,339)
Cash flows from investing
activities...................... -- (28,168,184) (140,760,422) (11,863,036)
Cash flows from financing
activities...................... 163,485 28,664,304 227,842,857 13,839,346
Ratio of earnings to fixed
charges(5)...................... -- -- -- --
Deficiency of earnings to cover
fixed charges(5)................ 137,810 5,830,471 32,313,632 2,364,942
</TABLE>
29
<PAGE> 30
- ---------------
(1) The Company was organized on August 5, 1996.
(2) Excludes capitalized interest of $2,103 for 1997 and $10,300 for the nine
months ended September 30, 1998. During the construction of the Company's
networks, interest expense related to construction expenditures is
capitalized.
(3) Represents Pledged Securities which the Company has purchased to secure the
first six scheduled interest payments on the Notes. See "Description of the
Notes--Security."
(4) EBITDA consists of earnings (loss) before net interest, income taxes,
depreciation and amortization. EBITDA is provided because the Company
believes it is a measure commonly used in the telecommunications industry.
It is presented to enhance an understanding of the Company's operating
results and is not intended to represent cash flow or results of operations
in accordance with generally accepted accounting principles ("GAAP"). The
Indenture contains (and the Company expects that agreements governing any
additional future indebtedness may contain) covenants based on EBITDA that,
among other things, may limit the Company's ability to incur additional
indebtedness. EBITDA is not a measure of financial performance under GAAP
and should not be considered an alternative to earnings (loss) from
operations and net income (loss) as a measure of performance or to cash flow
as a measure of liquidity. EBITDA is not necessarily comparable to similarly
titled measures of other companies. For a presentation of cash flows used in
and provided by operating, investing and financing activities as calculated
under GAAP, see the Company's consolidated financial statements contained
elsewhere in this Prospectus.
(5) For purposes of calculating the ratio of earnings to fixed charges, earnings
are defined as net loss plus fixed charges (other than capitalized
interest). Fixed charges consist of interest expense and amortization of
debt issuance costs, whether expensed or capitalized, and that portion of
rental expense (one-third) estimated to represent interest expense. After
giving pro forma effect to the increase in interest expense resulting from
the issuance of the Notes, as of the beginning of each such period, net
interest expense would have been $10.6 million, $25.9 million and $19.5
million, and earnings would have been insufficient to cover fixed charges by
approximately $11.0 million, $32.4 million and $43.9 million for the period
from inception (August 5, 1996) through December 31, 1996, for the year
ended December 31, 1997 and for the nine months ended September 30, 1998,
respectively.
30
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a facilities-based CLEC offering telecommunications services
primarily in Tier III Markets in the midwestern United States. The Company
currently provides switched local, long distance, Internet and Centrex services
primarily on a resale basis and is deploying and plans to deploy high-capacity
digital switches and fiber optic networks in each of its target markets. The
Company's target customers include small and medium-sized businesses, ISPs and
government and other institutional end users, as well as residential end users.
The Company's objective is to become the leading competitor to the ILEC in each
of its target markets by offering complete, cost-effective telecommunications
solutions.
The Company was formed in August 1996 and was a development stage
enterprise until July 1, 1997, when it first began providing services on a
resale basis. As of the date of this Prospectus, the Company was providing
services primarily on a resale basis in eight commercial regions in Wisconsin,
Indiana and Illinois and had six switches and six local fiber optic networks
that were commercially operational. The Company is currently deploying or plans
to deploy an additional seven switches and 12 local networks. As of September
30, 1998, the Company had invested an aggregate of approximately $86.4 million
in networks and equipment, and had approximately 500 route miles of local and
long haul optical fiber deployed, 15,418 access lines in service, 10 local sales
offices and approximately 460 full-time employees, including approximately 200
employees engaged full time in its sales and marketing efforts. The Company has
entered into interconnection agreements with ILECs for, and is certified as a
CLEC in, each of its current and target markets. The Company's interconnection
agreements with Ameritech in Wisconsin, Illinois and Indiana markets do not
provide for termination except upon expiration of the term of the particular
agreement. The Company's interconnection agreements with GTE in Wisconsin and
Indiana markets provide for termination only upon default, which is defined
generally as a party's refusal or failure in any material respect to perform its
obligations under the agreement, the violation of any material terms or
conditions of the agreement and certain events of insolvency or bankruptcy. The
defaulting party has 60 days from the receipt of any notice of default to cure
the default before any such agreement may be terminated.
Resale revenues from July 1997 (when the Company commenced commercial
operations) through December 31, 1997 totaled approximately $207,000. Revenues
for the nine months ended September 30, 1998, substantially all of which were
resale revenues, totaled approximately $4.1 million, of which approximately
$565,000, $1.4 million and $2.1 million was generated in the first, second and
third quarters of 1998, respectively.
As a result of the Company's limited operating history, the Company has
generated only nominal revenues from operations resulting in significant
operating losses and negative cash flows from operating and investing activities
to date. The Company expects that planned capital expenditures, together with
the associated operating expenses in each of its target markets, will result in
negative cash flows from operating and investing activities and negative EBITDA
for approximately 24 to 36 months after facilities-based switched operations
commence in each of such markets, and, accordingly, the Company expects to
experience increasing consolidated operating losses as it expands its
operations, builds its network and switching facilities and develops its
customer base.
FACTORS AFFECTING RESULTS OF OPERATIONS
REVENUES
The Company directs its sales and marketing efforts primarily towards small
to medium-sized business customers, ISPs and governmental and other
institutional end users in its target markets. After identifying a target
market, the Company initially resells ILEC services to establish a market
presence and enhance its market penetration efforts. As each of its network
switching systems becomes commercially operational, the Company transitions its
resale customers to its own switch-based networks. The Company believes that its
strategy of being an early CLEC entrant in selected underserved Tier III Markets
will result in faster
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<PAGE> 32
penetration of the available customer base and will discourage market entry by
additional CLECs. The Company competes primarily on the basis of competitive
pricing, superior service and products and innovative service and product
offerings. By using its own switched-based facilities, the Company believes it
will be able to achieve higher gross margins on the telecommunications services
it offers than can currently be obtained by reselling ILEC services.
The Company also expects to generate revenues from the sale of its services
to residential customers. The Company believes that its bundled service
offerings, high degree of front office and back office automation and customer
care, billing and automated credit-checking systems and procedures enhance its
ability to offer services to residential customers in its target markets. In
addition, the Company believes it has significant operating leverage and a
relatively low marginal cost of providing service to residential customers. The
Company targets creditworthy residential customers who the Company believes are
likely to have needs for multiple services with various affinity and other
cost-effective marketing programs and service packages designed to appeal to
such customers.
To further leverage its fixed costs, the Company intends to establish
strategic alliances with and supply wholesale services to electric utilities and
other selected telecommunications providers for the bundling of services and
billing to such entities' own customers. The Company has also recently begun
offering its local and Internet access services on a wholesale basis to ISPs in
certain of its target markets.
OPERATING EXPENSES
The Company's primary operating expenses consist of the cost of
communication services, selling, general and administrative expenses and
depreciation and amortization charges.
Cost of Communication Services. Cost of communication services consists of
the fixed costs of leased facilities, minutes-of-use charges for origination and
termination services and access line charges for local and long distance
services, including the costs to use ILEC unbundled network elements, costs for
installation and initial service turn-up and support services outsourced to
Lucent, and costs of network personnel. As network installation progresses, the
Company incurs rights-of-way costs and, in certain markets, franchise fees and
taxes paid to local governments based on revenue. After the network
infrastructure is established and the switched system is activated, the Company
expects it will be able to add customers and associated revenues with nominal
additional expense, providing significant contributions to operating cash flows
and EBITDA. While the Company primarily targets business, ISP, governmental and
other institutional customers, it believes that, once a network is operational,
the marginal cost of providing its services to residential customers is low
enough to allow the Company to economically address such customers because they
generally require less complex services than the Company's other customers. Cost
of communication services does not include depreciation and amortization.
Selling, General and Administrative. The Company's selling, general and
administrative expenses include sales and marketing costs (including print and
radio advertisements), customer service and technical support, billing and
collection, and general management and overhead expenses. The Company expects
that these costs will grow significantly as it expands its operations and that
administrative overhead will be a large portion of these expenses during the
deployment of the Company's networks in its target markets. However, the Company
expects that, as it expands its customer base, these expenses will eventually
become a smaller percentage of the Company's revenues.
Depreciation and Amortization. The Company depreciates and amortizes its
property and equipment using the straight-line method over the estimated useful
life of the assets, ranging from five to eight years for equipment, 20 years for
fiber and the lesser of 10 years or the lease term for leasehold improvements.
The Company also depreciates and amortizes its third-party software costs using
the straight-line method over three to five years.
32
<PAGE> 33
INTEREST EXPENSE
Prior to the Company's issuance of the Notes in June 1998, the Company did
not incur material interest expense. However, as a result of the issuance of the
Notes, the Company will incur substantial interest expense in future periods.
RESULTS OF OPERATIONS
From its inception on August 5, 1996 through June 30, 1997, the Company was
in the development stage of operations. During that time, the Company's
principal activities included developing business plans, hiring management and
other key personnel, designing the architecture for its network systems and
negotiating an interconnection agreement with an ILEC.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
Revenues for the nine months ended September 30, 1998, totaled
approximately $4.1 million, of which $169,000 were derived from facilities-based
switched operations and $4.0 million were from resale services. Revenues
increased from $28,000 for the nine months ended September 30, 1997 as a result
of the Company's aggressive sales and marketing efforts in its markets, as well
as the offering of services in additional markets.
Cost of communication services increased to $9.5 million for the nine
months ended September 30, 1998, from $154,000 for the same period in 1997. A
substantial portion of the increase, approximately $6.6 million, relates to the
costs of leased telecommunications facilities and services in connection with
the Company's resale services. In addition, approximately $1.0 million resulted
from increased network personnel related costs as the Company has expanded its
network operations.
Selling, general and administrative expenses increased $16.7 million to
$18.9 million for the nine months ended September 30, 1998 compared to $2.2
million for the same period in 1997. The increase was due primarily to hiring
additional personnel in the areas of sales and marketing, customer service and
technical support services as a result of the Company's continued growth.
Depreciation and amortization expenses increased to $2.3 million for the
nine months ended September 30, 1998, from $68,000 for the same period in 1997.
The increase reflected the six switches and networks that became commercially
operational during the nine months ended September 30, 1998 and the overall
growth in capital assets through September 30, 1998.
Interest expense of $7.2 million for the nine months ended September 30,
1998 included approximately $7.0 million related to the accrual of interest on
the Notes with the remainder associated with the borrowings under the Company's
$4.0 million Loan Agreement dated August 28, 1997 (the "Bank Credit Facility").
See "Description of Existing Indebtedness." Interest costs of $1.3 million were
capitalized during the nine months ended September 30, 1998 related to network
construction projects.
Interest income of approximately $2.7 million for the nine months ended
September 30, 1998, resulted primarily from interest earnings on the short-term
investment of the cash proceeds from the issuance of the Notes.
For the reasons stated above, net loss increased to $31.0 million for the
nine months ended September 30, 1998, compared to $2.4 million for the same
period in 1997.
1997 Compared to 1996
Following the completion of its development stage activities, the Company
began its sales efforts in July 1997 and generated resale revenues of
approximately $207,000 for 1997, of which approximately $85,000 was generated in
December 1997.
Total operating expenses (other than interest expense) for 1997
approximated $6.0 million, including approximately $750,000 related to cost of
communication services, approximately $5.1 million of selling, general and
administrative expenses, which primarily consisted of payroll and legal and
professional costs
33
<PAGE> 34
related to the commencement of the Company's operations, and depreciation and
amortization on office equipment and leaseholds of approximately $189,000.
During the period from inception through December 31, 1996, the Company incurred
general and administrative expenses of approximately $138,000, primarily due to
payroll and professional costs related to the commencement of the Company's
operations. Interest expense for 1997 of approximately $30,000 was due to the
borrowings under the Company's Bank Credit Facility.
LIQUIDITY AND CAPITAL RESOURCES
The Company experienced a deficiency in net cash from operations of $15.3
million and $1.9 million for the nine months ended September 30, 1998 and 1997,
respectively, and $396,000 for the year ended December 31, 1997. Because the
Company is in the early stages of its development, significant cash outlays are
necessary to develop and operate its networks and back office systems
infrastructure prior to the generation of customer revenues. The increase in the
deficiency for the nine months ended September 30, 1998 from that reported for
the same period of 1997 is primarily the result of increased operating losses in
connection with the Company's continued expansion into additional markets during
1998. The Company's deficiency in net cash from operating activities for the
year ended December 31, 1997 was lower than such deficiency for the first three
quarters of 1997 primarily as a result of an increase in accounts payable during
the fourth quarter of 1997, consistent with the expansion of the Company's
operations and increase in capital expenditures. The Company expects to
experience continuing negative operating cash flows as it expands into
additional targeted markets and transitions its customers from resale services
to the Company's facilities-based services.
Net cash used in investing activities increased to $140.8 million for the
nine months ended September 30, 1998 from $11.9 million for the same period of
1997, and was $28.2 million for the year ended December 31, 1997. Such increase
resulted primarily from the Company's significant capital expenditures to
acquire network-related equipment, information systems software and office
furniture to support its growth. Capital expenditures totaled $58.3 million and
$11.8 million during the nine months ended September 30, 1998 and 1997,
respectively, and $28.2 million for the year ended December 31, 1997. In
addition, during the second quarter of 1998, the Company was required to set
aside $82.5 million of the proceeds from the sale of the Notes to purchase U.S.
government securities and accrued interest thereon to secure and fund payment of
the first six interest payments on the Notes.
During the nine months ended September 30, 1998, net cash provided by
financing activities was $227.8 million, compared to $13.8 million during the
same period of 1997, and was $28.7 million for the year ended December 31, 1997.
The increase during the first nine months of 1998 primarily reflected the
receipt during 1998 of $193.1 million in proceeds from the sale of the Notes and
an additional $33.9 million in member capital contributions. During the nine
months ended September 30, 1997 and the year ended December 31, 1997, the
Company received $13.8 million and $20.9 million, respectively, from an
affiliated company to fund capital expenditures and operating losses. During the
fourth quarter of 1997, the Company received $2.8 million in proceeds from the
Bank Credit Facility and $5.0 million of members' capital contributions to fund
capital expenditures.
The Company's operations have required a substantial capital investment for
the purchase of telecommunications equipment and the construction and
development of its networks. Since the beginning of fiscal 1997 and through
September 30, 1998, the Company has spent approximately $86.4 million on capital
expenditures. The Company has funded these expenditures through its existing
equity capital, proceeds from the sale of the Notes and the Bank Credit
Facility.
The costs associated with the initial installation and expansion of each
network, including development, installation, certain organizational costs and
early operating expenses, and the construction of its planned long haul routes
interconnecting its commercial regions are significant and will result in
negative cash flow for each market until an adequate customer base and revenue
stream have been established. The Company estimates that, as of September 30,
1998, its future capital requirements (including requirements for capital
expenditures, working capital, debt service and operating losses) to fund the
installation, deployment and operating losses of the networks in its current
development plans will total approximately $115 million. The Company expects
that the remaining net proceeds from the issuance of the Notes, approximating
$71.8 million as of
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<PAGE> 35
September 30, 1998, will be available to fund the further installation and
deployment of networks in its current development plans and the estimated
operating losses of such networks through December 31, 1998. The Company plans
to seek additional debt financing to fund the balance of the capital
requirements for its current development plans, although the Company currently
has no commitments for such additional capital funding.
The Company will require additional financing to fully fund its current
development plans and to fund any expansion beyond the Company's current
development plans. The actual amount and timing of future capital requirements
may differ significantly from the Company's estimates as a result of, among
other things, the demand for the Company's services and regulatory,
technological and competitive developments. The Company may also require
additional financing (or require additional financing sooner than anticipated)
if (i) the Company's current development plans or projections change or prove to
be inaccurate or attractive additional opportunities are identified, (ii) the
Company effects any acquisitions or joint ventures, (iii) the Company's cost
projections prove to be underestimated or (iv) the Company accelerates or
otherwise alters the schedule or target markets of its roll-out plans. As of
September 30, 1998, the Company had existing capital expenditure commitments in
the aggregate amount of approximately $10.8 million payable over the next 12
months, including expenditures for the acquisition of host and remote switches,
transmission, Advanced Intelligent Network ("AIN") and other equipment from
Lucent, and voice mail systems and OSS and billing software from third-party
vendors.
A variety of factors, including the ability of the Company to deploy its
network systems in a timely manner in accordance with its cost projections and
to negotiate favorable prices for purchases of equipment, as well as the
customer penetration achieved, the extent and pricing of subscriber services
offered by the Company and regulatory, technological and competitive
developments, will affect the Company's cost of operating its business and
success in implementing its business plan. Actual revenues and costs may vary
materially from expected amounts, and such variations will likely affect the
Company's future cash flow requirements. Accordingly, there can be no assurance
that the Company's actual capital requirements will not exceed the anticipated
amounts described above.
YEAR 2000 COMPLIANCE
The year 2000 issue is a matter of particular worldwide concern for
telecommunications carriers because it affects many aspects of
telecommunications technology, including the computer systems and software
applications that are essential for network administration and operations. A
significant portion of telecommunications voice and data networking and network
management devices have date-sensitive processing in them which affect network
administration and operations functions such as service activation, service
assurance and billing processes. However, because the Company has only recently
commenced operations and its key processing systems have recently been acquired,
costs relating to year 2000 issues historically have not been material. Lucent
and the other vendors of such systems have represented to the Company that such
systems are year 2000 compliant without any required modification, and the
Company will require confirmation of year 2000 compliance in its future requests
for proposals from Lucent and its other equipment and software vendors. The
Company has developed and begun to implement a strategic year 2000 compliance
plan to address year 2000 issues. The Company has completed the inventory of its
mission-critical systems and is in various stages of modification and testing of
these systems. The Company plans to have all of its systems fully compliant by
early 1999.
The failure of the Company's computer systems and software applications to
accommodate the year 2000 could have a material adverse effect on the Company
and its ability to meet its obligations on the Notes. Further, if the networks
and systems of the ILECs, IXCs and others on whose services the Company depends
and with whom the Company's networks and systems must interface are not year
2000 functional, it could have a material adverse effect on the operation of the
Company's networks and, as a result, have a material adverse effect on the
Company and its customers. Most major domestic carriers have announced that they
expect all of their network and support systems to be year 2000 functional by
mid-1999. However, other domestic and international carriers may not be year
2000 functional. The Company has not yet established a contingency plan that
addresses its response to any potential failure of its systems, or those of
other entities on whose services it depends or with whom its networks and
systems must interface, to accommodate year 2000
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<PAGE> 36
issues. However, the Company plans to participate in the interoperability
testing processes and to implement the contingency plans being put in place by
industry organizations, and the Company intends to continue to monitor the
performance of its accounting, information and processing systems and software
applications and those of its third-party constituents to identify and resolve
any year 2000 issues.
To the extent necessary, the Company may need to replace, upgrade or
reprogram certain existing systems and software applications to ensure that all
of the Company's computer systems and software applications and all of its
interoperability applications are year 2000 functional. However, based on
current information, the Company does not believe that it will incur costs for
any replacement, upgrade or reprogramming of its computer systems and software
applications to resolve any year 2000 issues that will be material to its
business, financial condition or results of operations.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130 "Reporting Comprehensive Income," which became effective for the
Company's current fiscal year and establishes standards for reporting and
display of comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. Among other
disclosures, SFAS No. 130 requires that all items that are required to be
recognized under current accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. The Company had no items of
comprehensive income for the year and period ended December 31, 1997 and 1996,
respectively.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which became effective for
the Company's current fiscal year and supersedes SFAS No. 14. SFAS No. 131
establishes standards for the way that public enterprises report information
about operating segments in annual financial statements and requires reporting
of selected information about operating segments in interim financial statements
issued to the public. It also establishes standards for disclosures regarding
products and services, geographic areas and major customers. SFAS No. 131
defines operating segments as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. Management believes that SFAS No. 131 will not have a significant
impact on its financial position, operations or cash flows when adopted.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." Among other
provisions, this standard requires that entities recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. Gains and losses resulting from changes in the fair values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. This standard is effective for
fiscal years beginning after June 15, 1999, though earlier adoption is
encouraged and retroactive application is prohibited. The Company believes that
this standard will not have a material impact on the Company's consolidated
financial position, results of operations or cash flows.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position (SOP) 98-1, "Accounting for Costs of
Computer Software Developed or Obtained for Internal Use." Among other
provisions, SOP 98-1 requires that entities capitalize certain internal-use
software costs once certain criteria are met. In April 1998, the AICPA issued
SOP 98-5, "Reporting on the Costs of Start-Up Activities," which, among other
provisions, requires costs of start-up activities and organization costs to be
expensed as incurred. Both SOP 98-1 and 98-5 are effective for fiscal years
beginning after December 15, 1998, though earlier adoption is encouraged. The
Company believes that the adoption of SOP 98-1 and 98-5 will not have a material
impact on the Company's consolidated financial position, results of operations
or cash flows.
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THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
The Private Notes were sold by the Company on June 25, 1998 to the
Placement Agent pursuant to the Placement Agreement. The Placement Agent
subsequently sold the Private Notes (i) to "qualified institutional buyers"
("QIBs"), as defined in Rule 144A under the Securities Act, in reliance on Rule
144A under the Securities Act and (ii) in "Offshore Transactions" to persons
other than "U.S. Persons" as defined in Rule 902 of Regulation S under the
Securities Act. As a condition to the sale of the Private Notes, the Company and
the Placement Agent entered into the Registration Rights Agreement. Pursuant to
the Registration Rights Agreement, the Company agreed that it would use its
reasonable best efforts to file and cause to become effective a registration
statement under the Securities Act with respect to the Exchange Notes, and to
issue and exchange Exchange Notes for all Private Notes validly tendered and not
withdrawn before the Expiration Date. A copy of the Registration Rights
Agreement has been filed as an exhibit to the Exchange Offer Registration
Statement of which this Prospectus is a part. The Exchange Offer Registration
Statement is intended to satisfy certain of the Company's obligations under the
Registration Rights Agreement and the Placement Agreement.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Private
Notes validly tendered and not withdrawn prior to the Expiration Date.
The Company will issue $1,000 principal amount of Exchange Notes in
exchange for each $1,000 principal amount of outstanding Private Notes validly
tendered pursuant to the Exchange Offer and not withdrawn prior to the
Expiration Date. Private Notes may be tendered only in integral multiples of
$1,000.
The form and terms of the Exchange Notes are the same as the form and terms
of the Private Notes except that (i) the Exchange Notes will not bear legends
restricting the transfer thereof and (ii) Holders of the Exchange Notes will not
be entitled to any of the exchange and registration rights of Holders of Private
Notes under the Registration Rights Agreement, which rights will terminate upon
the consummation of the Exchange Offer. The Exchange Notes will evidence the
same indebtedness as the Private Notes which they replace and will be issued
under, and be entitled to the benefits of, the Indenture, which also authorized
the issuance of the Private Notes, such that both series of Notes will be
treated as a single class of debt securities under the Indenture.
As of the date of this Prospectus, $200,000,000 in aggregate principal
amount of the Private Notes is outstanding, all of which is registered in the
name of Cede & Co., as nominee for DTC (the "Depositary"). Only a registered
Holder of the Private Notes (or such Holder's legal representative or
attorney-in-fact) as reflected on the records of the Trustee under the Indenture
may participate in the Exchange Offer. Solely for reasons of administration, the
Company has fixed the close of business on November 23, 1998 as the record date
for the Exchange Offer for purposes of determining the persons to whom this
Prospectus and the Letter of Transmittal will be mailed initially. There will be
no fixed record date for determining registered Holders of the Private Notes
entitled to participate in the Exchange Offer.
No vote of the Company's security holders is required to effect the
Exchange Offer and no such vote (or proxy therefor) is being sought hereby.
Holders of the Private Notes do not have any appraisal or dissenters' rights
under the Michigan Limited Liability Company Act or the Indenture in connection
with the Exchange Offer. The Company intends to conduct the Exchange Offer in
accordance with the provisions of the Registration Rights Agreement and the
applicable requirements of the Securities Act and the rules and regulations of
the Commission thereunder.
The Company shall be deemed to have accepted validly tendered Private Notes
when, and if, the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as
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agent for the tendering Holders of Private Notes for the purposes of receiving
the Exchange Notes from the Company.
Holders who tender Private Notes in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Private
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than certain applicable taxes described below, in connection
with the Exchange Offer. See "--Fees and Expenses" below.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 12:00 midnight, New York City time,
on December 23, 1998, unless the Company, in its sole discretion, extends the
Exchange Offer, in which case the term "Expiration Date" shall mean the latest
date and time to which the Exchange Offer is extended.
In order to extend the Exchange Offer, the Company will (i) notify the
Exchange Agent of any extension by oral or written notice, (ii) mail to the
registered Holders of Private Notes an announcement thereof and (iii) issue a
press release or other public announcement which shall include disclosure of the
approximate amount of Private Notes deposited to the date of such announcement,
in each case prior to 9:00 a.m., New York City time, on the next business day
after the previously scheduled Expiration Date.
The Company reserves the right, in its reasonable discretion, (i) to delay
accepting any Private Notes, (ii) to extend the Exchange Offer or (iii) if, in
the opinion of counsel, for the Company, the consummation of the Exchange Offer
would violate any applicable law, rule or regulation or any applicable
interpretation of the staff of the Commission, to terminate or amend the
Exchange Offer by giving oral or written notice of such delay, extension,
termination or amendment to the Exchange Agent. Any such delay in acceptance,
extension, termination or amendment will be followed as promptly as practicable
by oral or written notice thereof to the registered Holders of Private Notes. If
the Exchange Offer is amended in a manner determined by the Company to
constitute a material change, the Company will promptly disclose such amendment
by means of a prospectus supplement that will be distributed to the registered
Holders of Private Notes, and the Company will extend the Exchange Offer for a
period of five to ten business days, depending upon the significance of the
amendment and the manner of disclosure to the registered Holders of Private
Notes, if the Exchange Offer would otherwise expire during such five to ten
business day period.
Without limiting the manner in which the Company may choose to make a
public announcement of any delay, extension, amendment or termination of the
Exchange Offer, the Company shall have no obligation to publish, advertise, or
otherwise communicate any such public announcement, other than by making a
timely release to an appropriate news agency.
INTEREST ON THE NOTES
The Private Notes and the Exchange Notes bear interest from June 25, 1998
at the rate of 15% per annum, payable semi-annually in arrears on July 1 and
January 1 of each year, commencing January 1, 1999.
RESALE OF THE EXCHANGE NOTES
Based upon interpretations by the staff of the Commission set forth in
certain no-action letters issued to third parties, the Company believes that a
Holder who exchanges Private Notes for Exchange Notes in the ordinary course of
business, who is not participating, does not intend to participate, and has no
arrangement with any person to participate in a distribution of the Exchange
Notes, and who is not an "affiliate" of the Company within the meaning of Rule
405 of the Securities Act, will be allowed to resell Exchange Notes to the
public without further registration under the Securities Act and without
delivering to the purchasers of the Exchange Notes a prospectus that satisfies
the requirements of Section 10 of the Securities Act. However, if any Holder
acquires Exchange Notes in the Exchange Offer for the purpose of distributing or
participating in the distribution of the Exchange Notes, such Holder cannot rely
on the position of the staff of the Commission enumerated in those no-action
letters and must comply with the registration and prospectus delivery
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requirements of the Securities Act in connection with any resale transaction,
unless an exemption from registration is otherwise available. Each broker-dealer
that receives Exchange Notes for its own account in exchange for Private Notes
acquired by such broker-dealer for its own account as a result of market-making
or other trading activities must acknowledge that it will deliver a prospectus
in connection with any resale of such Exchange Notes. The Letter of Transmittal
states that, by so acknowledging and by delivering a prospectus, any such
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. This Prospectus, as it may be amended or
supplemented from time to time, may be used by any such broker-dealer in
connection with resales of any Exchange Notes received in exchange for Private
Notes acquired by such broker-dealer for its own account as a result of
market-making or other trading activities. Pursuant to the Registration Rights
Agreement, the Company has agreed to make this Prospectus, as it may be amended
or supplemented from time to time, available to any such broker-dealer that
requests copies of such Prospectus in the Letter of Transmittal for use in
connection with any such resale for a period of up to 90 days after the
Expiration Date. See "Plan of Distribution."
PROCEDURES FOR TENDERING
Only a registered Holder of Private Notes may tender such Private Notes in
the Exchange Offer. To tender in the Exchange Offer, a Holder of Private Notes
must complete, sign and date the Letter of Transmittal, or a facsimile thereof,
have the signatures thereon guaranteed if required by the Letter of Transmittal,
and mail or otherwise deliver such Letter of Transmittal or such facsimile to
the Exchange Agent at the address set forth below under "--Exchange Agent" for
receipt prior to the Expiration Date. In addition, either (i) certificates for
such Private Notes must be received by the Exchange Agent along with the Letter
of Transmittal, (ii) a timely confirmation of a book-entry transfer (a
"Book-Entry Confirmation") of such Private Notes, if such procedure is
available, into the Exchange Agent's account at the Depositary pursuant to the
procedure for book-entry transfer described below under "--Book-Entry Transfer",
must be received by the Exchange Agent prior to the Expiration Date or (iii) the
Holder must comply with the guaranteed delivery procedures described below under
"--Guaranteed Delivery Procedures".
The tender by a Holder of Private Notes that is not withdrawn prior to the
Expiration Date will constitute an agreement between such Holder and the Company
in accordance with the terms and subject to the conditions set forth herein and
in the Letter of Transmittal.
THE METHOD OF DELIVERY OF PRIVATE NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT
BEFORE THE EXPIRATION DATE. DO NOT SEND THE PRIVATE NOTES, THE LETTER OF
TRANSMITTAL OR ANY OTHER REQUIRED DOCUMENTS TO THE COMPANY. HOLDERS MAY REQUEST
THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES
TO EFFECT THE ABOVE TRANSACTIONS FOR SUCH HOLDERS.
Any beneficial owner(s) of the Private Notes whose Private Notes are
registered in the name of a broker, dealer, commercial bank, trust company or
other nominee and who wishes to tender should contact the registered Holder
promptly and instruct such registered Holder to tender such Private Notes on
such beneficial owner's behalf. If such beneficial owner wishes to tender on its
own behalf, such beneficial owner must, prior to completing and executing the
Letter of Transmittal and delivering such beneficial owner's Private Notes,
either make appropriate arrangements to register ownership of the Private Notes
in its name or obtain a properly completed bond power from the registered
Holder. The transfer of registered ownership may take considerable time and may
not be able to be completed prior to the Expiration Date.
Signatures on a Letter of Transmittal or a notice of withdrawal described
below under "--Withdrawal of Tenders", as the case may be, must be guaranteed by
an Eligible Institution (as defined below) unless the Private Notes tendered
pursuant thereto are tendered (i) by a registered Holder thereof who has not
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completed the box titled "Special Delivery Instructions" on the Letter of
Transmittal or (ii) for the account of an Eligible Institution. In the event
that signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, are required to be guaranteed, such guarantee must be made by a
member firm of a registered national securities exchange or of the NASD, a
commercial bank or trust company having an office or correspondent in the United
States (each an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the
registered Holder of any Private Notes listed therein, such Private Notes must
be endorsed or accompanied by a properly completed bond power, signed by such
registered Holder exactly as such registered Holder's name appears on such
Private Notes.
If the Letter of Transmittal or any Private Notes or bond powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and, unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
The Exchange Agent and the Depositary have confirmed that any financial
institution that is a participant in the Depositary's system may utilize the
Depositary's Automated Tender Offer Program to tender Private Notes.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Private Notes will be determined
by the Company in its reasonable discretion, which determination will be final
and binding. The Company reserves the right to reject any and all Private Notes
not properly tendered or any Private Notes the Company's acceptance of which
would, in the opinion of counsel for the Company, be unlawful. The Company also
reserves the right to waive any defects, irregularities or conditions of tender
as to particular Private Notes. The Company's interpretation of the terms and
conditions of the Exchange Offer (including the instructions in the Letter of
Transmittal) will be final and binding on all parties. Unless waived, any
defects or irregularities in connection with tenders of Private Notes must be
cured within such time as the Company shall determine. Although the Company
intends to notify Holders of any defects or irregularities with respect to
tenders of Private Notes, neither the Company, the Exchange Agent nor any other
person shall incur any liability for failure to give such notification. Tenders
of Private Notes will not be deemed to have been made until such defects or
irregularities have been cured or waived.
While the Company has no present plan to acquire any Private Notes that are
not tendered in the Exchange Offer or to file a registration statement to permit
resales of any Private Notes that are not tendered pursuant to the Exchange
Offer, the Company reserves the right in its sole discretion to purchase or make
offers for any Private Notes that remain outstanding subsequent to the
Expiration Date and, to the extent permitted by applicable law, purchase Private
Notes in the open market, in privately negotiated transactions or otherwise. The
terms of any such purchases or offers could differ from the terms of the
Exchange Offer.
By tendering Private Notes pursuant to the Exchange Offer, each Holder of
Private Notes will represent to the Company that, among other things, (i) the
Exchange Notes to be acquired by such Holder of Private Notes in connection with
the Exchange Offer are being acquired by such Holder in the ordinary course of
business of such Holder, (ii) such Holder has no arrangement or understanding
with any person to participate in the distribution of the Exchange Notes, (iii)
such Holder acknowledges and agrees that any person who is a broker-dealer
registered under the Exchange Act or is participating in the Exchange Offer for
the purposes of distributing the Exchange Notes must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with a secondary resale transaction of the Exchange Notes acquired by
such person and cannot rely on the position of the staff of the Commission
enumerated in certain no-action letters issued to third parties, (iv) such
Holder understands that a secondary resale transaction described in clause (iii)
above and any resales of Exchange Notes obtained by such Holder in exchange for
Private Notes acquired by such Holder directly from the Company should be
covered by an effective registration statement containing the selling
securityholder information required by Item 507 or Item 508, as applicable, of
Regulation S-K of the Commission and (v) such Holder is not an "affiliate" of
the Company within the meaning of Rule 405 under the Securities Act. If a Holder
of Private Notes is a broker-dealer that will receive Exchange Notes for such
Holder's own account in exchange for Private Notes that were acquired as a
result of
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<PAGE> 41
market-making activities or other trading activities, such Holder will be
required to acknowledge in the Letter of Transmittal that such Holder will
deliver a prospectus in connection with any resale of such Exchange Notes;
however, by so acknowledging and by delivering a prospectus, such Holder will
not be deemed to admit that it is an "underwriter" within the meaning of the
Securities Act.
RETURN OF PRIVATE NOTES
If any tendered Private Notes are not accepted for any reason set forth in
the terms and conditions of the Exchange Offer or if Private Notes are withdrawn
or are submitted for a greater principal amount than the Holder thereof desires
to exchange, such unaccepted, withdrawn or non-exchanged Private Notes will be
returned without expense to the tendering Holder thereof (or, in the case of
Private Notes tendered by book-entry transfer into the Exchange Agent's account
at the Depositary pursuant to the book-entry transfer procedures described below
under "--Book-Entry Transfer," such Private Notes will be credited to an account
maintained by such Holder with the Depositary) as promptly as practicable.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect
to the Private Notes at the Depositary for purposes of the Exchange Offer within
two business days after the date of this Prospectus, and any financial
institution that is a participant in any of the Depositary's book-entry systems
may make book-entry delivery of Private Notes by causing the Depositary to
transfer such Private Notes into the Exchange Agent's account at the Depositary
in accordance with the Depositary's procedures for book-entry transfer. However,
although delivery of Private Notes may be effected through book-entry transfer
at the Depositary, the Letter of Transmittal or facsimile thereof, with any
required signature guarantees and any other required documents, must, in any
case, be transmitted to and received by the Exchange Agent at the address set
forth below under "-- Exchange Agent" on or prior to the Expiration Date or
pursuant to the guaranteed delivery procedures described below under
"--Guaranteed Delivery Procedures".
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Private Notes and (i) whose Private Notes
are not immediately available or (ii) who cannot deliver their Private Notes,
the Letter of Transmittal or any other required documents to the Exchange Agent
prior to the Expiration Date, may effect a tender if:
(a) The tender is made through an Eligible Institution;
(b) Prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery substantially in the form provided by the Company (by
facsimile transmission, mail or hand delivery) setting forth the name and
address of the Holder, the certificate number(s) of such Private Notes and
the principal amount of Private Notes tendered, stating that the tender is
being made thereby and guaranteeing that, within three New York Stock
Exchange trading days after the Expiration Date, the Letter of Transmittal
(or a facsimile thereof), together with the certificate(s) representing the
Private Notes in proper form for transfer or a Book-Entry Confirmation, as
the case may be, and any other documents required by the Letter of
Transmittal, will be deposited by the Eligible Institution with the
Exchange Agent; and
(c) Such properly executed Letter of Transmittal (or facsimile
thereof), as well as the certificate(s) representing all tendered Private
Notes in proper form for transfer and all other documents required by the
Letter of Transmittal are received by the Exchange Agent within three New
York Stock Exchange trading days after the Expiration Date.
Upon request to the Exchange Agent, a form of Notice of Guaranteed Delivery
will be sent to Holders of Private Notes who wish to tender their Private Notes
in accordance with the guaranteed delivery procedures set forth above.
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WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Private Notes may be
withdrawn at any time prior to the Expiration Date.
To withdraw a tender of Private Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to the Expiration Date. Any such
notice of withdrawal must (i) specify the name of the person having deposited
the Private Notes to be withdrawn (the "Depositor"), (ii) identify the Private
Notes to be withdrawn (including the certificate number or numbers and principal
amount of such Private Notes) and (iii) be signed by the Holder in the same
manner as the original signature on the Letter of Transmittal with which such
Private Notes were tendered (including any required signature guarantees). All
questions as to the validity, form and eligibility (including time of receipt)
of any such notice of withdrawal will be determined by the Company, in its
reasonable discretion, whose determination shall be final and binding on all
parties. Any Private Notes so withdrawn will be deemed not to have been validly
tendered for purposes of the Exchange Offer, and no Exchange Notes will be
issued with respect thereto unless the Private Notes so withdrawn are validly
retendered prior to the Expiration Date. Properly withdrawn Private Notes may be
retendered by following one of the procedures described above under "Procedures
for Tendering" at any time prior to the Expiration Date.
TERMINATION OF CERTAIN RIGHTS
All exchange and registration rights under the Registration Rights
Agreement accorded to Holders of the Private Notes (and all rights to receive
additional interest in the event of a Registration Default as defined therein)
will terminate upon consummation of the Exchange Offer except with respect to
the Company's continuing obligation for a period of up to 90 days after the
Expiration Date to keep the Registration Statement effective and to provide
copies of the latest version of the Prospectus to any broker-dealer that
requests copies of such Prospectus in the Letter of Transmittal for use in
connection with any resale by such broker-dealer of Exchange Notes received for
its own account pursuant to the Exchange Offer in exchange for Private Notes
acquired for its own account as a result of market-making or other trading
activities.
EXCHANGE AGENT
The Bank of New York has been appointed as Exchange Agent for the Exchange
Offer. Tenders of Private Notes in the Exchange Offer and any questions and
requests for assistance, requests for additional copies of this Prospectus or of
the Letter of Transmittal and requests for a form of Notice of Guaranteed
Delivery should be directed to the Exchange Agent addressed as follows:
<TABLE>
<CAPTION>
By Registered or Certified Mail: By Hand/Overnight Delivery: By Facsimile:
<S> <C> <C>
The Bank of New York The Bank of New York (Eligible Institutions Only)
101 Barclay Street 101 Barclay Street (212) 815-6339
Floor 7 East Corporate Trust Services Window
New York, New York 10286 Ground Level Confirm by Telephone:
Attn.: Noriko Miyazaki, New York, New York 10286 (212) 815-6333
Reorganization Section Attn.: Noriko Miyazaki,
Reorganization Section
</TABLE>
The Bank of New York also serves as Trustee under the Indenture and as
collateral agent under the Pledge Agreement.
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
solicitation of tenders is being made primarily by mail; however, additional
solicitations may be made by telegraph, facsimile transmission, telephone or in
person by officers and regular employees of the Company and its affiliates.
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<PAGE> 43
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
it for its reasonable, out-of-pocket expenses in connection therewith.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company and are estimated in the aggregate to be approximately
$200,000. Such expenses include registration fees, fees and expenses of the
Exchange Agent and the Trustee, accounting and legal fees, and printing costs,
among others.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Private Notes for Exchange Notes pursuant to the Exchange Offer. If, however,
a transfer tax is imposed for any reason other than the exchange of Private
Notes for Exchange Notes pursuant to the Exchange Offer, then the amount of any
such transfer taxes (whether imposed on the registered Holder or any other
person) will be payable by the tendering Holder. If satisfactory evidence of
payment of such taxes or exemption therefrom is not submitted with the Letter of
Transmittal, the amount of such transfer taxes will be billed directly to such
tendering Holder.
CONSEQUENCE OF FAILURE TO EXCHANGE
Participation in the Exchange Offer is voluntary. Holders of the Private
Notes are urged to consult their financial and tax advisors in making their own
decisions on what action to take.
Private Notes that are not exchanged for Exchange Notes pursuant to the
Exchange Offer will remain "restricted securities" within the meaning of Rule
144(a)(3) under the Securities Act. Accordingly, such Private Notes may not be
offered, sold, pledged or otherwise transferred except (i) to a person whom the
seller reasonably believes is a "qualified institutional buyer" within the
meaning of Rule 144A under the Securities Act purchasing for its own account or
for the account of a qualified institutional buyer in a transaction meeting the
requirements of Rule 144A, (ii) in an offshore transaction complying with Rule
903 or Rule 904 of Regulation S under the Securities Act, (iii) pursuant to an
exemption from registration under the Securities Act provided by Rule 144
thereunder (if available), (iv) pursuant to an effective registration statement
under the Securities Act or (v) to institutional accredited investors in a
transaction exempt from the registration requirements of the Securities Act,
and, in each case, in accordance with all other applicable securities laws.
ACCOUNTING TREATMENT
For accounting purposes, the Company will recognize no gain or loss as a
result of the Exchange Offer. The expenses of the Exchange Offer and the
unamortized expenses related to the issuance of the Private Notes will be
amortized over the remaining term of the Notes.
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<PAGE> 44
BUSINESS
The Company is a facilities-based CLEC offering telecommunications services
primarily in Tier III Markets in the midwestern United States. The Company's
target customers include small and medium-sized businesses, ISPs and government
and other institutional end users, as well as residential end users. The
Company's objective is to become the leading competitor to the ILEC in each of
its target markets by offering complete, cost-effective telecommunications
solutions.
The Company commenced commercial operations in July 1997. It was founded by
Ronald H. VanderPol and Richard Postma, experienced operators of competitive
telecommunications companies, including (i) City Signal, Inc., one of the
country's first CLECs, which sold its Michigan operations to Brooks Fiber
Properties, Inc. in 1996 and sold certain other fiber properties to Teleport
Communications Group Inc. and a predecessor of Nextlink Communications Inc.,
(ii) Teledial America, Inc., a switch-based long distance reseller that was sold
to LCI International, Inc. in 1996, and (iii) Digital Signal, Inc., a carrier's
carrier that was sold to a predecessor of Qwest Communications International
Inc. in 1990. Mr. VanderPol has made an equity investment of $60 million in the
Company. The Company's senior management team includes individuals with over 100
years of collective experience in the telecommunications industry, including key
executives with significant experience in telecommunications marketing, network
design, deployment and operation, OSS and other back office systems, finance and
regulatory affairs.
As of the date of this Prospectus, the Company was providing services
primarily on a resale basis in eight commercial regions in Wisconsin, Indiana
and Illinois and had switches and local fiber optic networks that were
commercially operational in Appleton, Green Bay, Milwaukee, Madison and Oshkosh,
Wisconsin and in South Bend, Indiana. The Company owns all of these switches and
local fiber networks except for the network in Milwaukee, where it leases from a
third party transmission capacity and related electronic equipment connected to
the Company's host switch. The Company is currently deploying or plans to deploy
an additional seven switches and 12 local networks in targeted markets in
Illinois, Indiana, Michigan and Wisconsin. Upon entering a market, the Company
resells the services of the ILEC. As each of the Company's networks and
switching systems becomes commercially operational in that market, the Company
will transition its resale customers to its own facilities-based services.
The Company interconnects its networks with all or substantially all of the
ILEC central offices and IXC POPs in each of its markets and obtains "last mile"
connections to its customers primarily through unbundled network elements leased
from the ILEC (principally Ameritech or GTE). Unbundled network elements are any
of a number of facilities and equipment that an ILEC may lease to another
telecommunications provider for use in the provision of telecommunications
services and include features, functions and capabilities that are provided by
means of such facilities or equipment. Such features, functions and capabilities
include subscriber numbers, databases, signaling systems and information
sufficient for billing and collection or used in the transmission, routing or
other provision of telecommunications services.
The Company installs a Lucent Series 5ESS(TM)-2000 host switch,
transmission equipment and a SONET fiber optic ring network in each of its
commercial regions. The markets within a commercial region are served either by
the host switch or by a remote switch or other transmission equipment linked to
the host switch. The Company believes that a remote switch, which is linked with
the requisite transmission capacity to a host switch, can provide substantially
all of the same telecommunications services as a host switch, even if the link
connecting the two switches is temporarily interrupted, for approximately 33% to
50% of the installation and operational costs of a host switch. The Company
believes its host/remote network architecture will allow the Company to
cost-effectively provide its services in smaller markets and over a broader
geographic area.
As of September 30, 1998, the Company had invested approximately $86.4
million in networks and equipment, and had approximately 500 route miles of
local and long haul optical fiber deployed, 15,418 access lines in service, 10
local sales offices and approximately 460 full-time employees, including
approximately 200 employees engaged full time in its sales and marketing
efforts. The Company has entered into interconnection agreements with ILECs for,
and is certified as a CLEC in, each of its current and target markets.
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US XCHANGE STRATEGY
The principal elements of the Company's business strategy include:
Focus on Tier III Markets. The Company primarily targets Tier III Markets
with attractive demographic, economic, competitive and telecommunications demand
characteristics. The Company evaluates each of its potential markets on the
basis of (i) the Company's "bottom up" analyses of the potential demand for its
telecommunications services, (ii) the level of actual and potential CLEC
competition and (iii) the disparity between ILEC local service pricing and the
Company's anticipated cost of providing comparable service. The Company believes
that, in Tier III Markets, network construction is generally less expensive,
labor costs and the costs of obtaining rights-of-way are generally lower, aerial
deployment of fiber optic cable (which is less expensive than underground
deployment) is generally permitted to a greater extent, and there are fewer ILEC
central offices and IXC POP connections required for comprehensive market
coverage than in Tier I and Tier II Markets.
Achieve Early-to-Market Advantage. The Company strives to be the first CLEC
in a commercial region to actively market and provide services. The Company
believes that, by effecting early entry into selected Tier III Markets, it can
gain a competitive advantage over other potential CLEC competitors. To gain
early entry into each target market, the Company establishes a local sales force
offering switched local, long distance and Centrex services on a resale basis
until its network switching system becomes commercially operational, which the
Company believes will be approximately six to nine months after beginning
network construction. Entering a market by reselling services enables the
Company to build brand name recognition and develop a customer base that it can
transition to its own networks as they become commercially operational. To
accelerate the deployment of its networks, the Company outsources the
installation and initial service turn-up of its network systems to Lucent.
Gain Broad, Regional Market Coverage. The Company believes that Tier III
Markets are most effectively penetrated by installing networks and switching
facilities designed to address customers in an entire commercial region. The
Company believes that this regional focus enables it to (i) take advantage of
economies of scale in network architecture, management and operation, (ii)
cost-effectively address the available customer base in each of its markets and
(iii) leverage the US Xchange brand name across the markets within a commercial
region.
Establish Fully Integrated Networks. The Company intends to develop the
capability to provide facilities-based telecommunications services over a fully
integrated system of networks throughout its targeted commercial regions in the
Midwest. The Company plans to (i) construct, lease or acquire long haul fiber
that will interconnect its owned local networks and host switches and (ii) lease
feature group access to ILEC tandem switches to originate and terminate calls in
regions bordering its owned facilities, as well as certain other regions where
cost and demand justify, which will allow the Company to transmit such traffic
at an attractive cost. Through this integrated design, the Company believes it
can reduce its use of the facilities of other providers and more economically
provide long distance services.
Emphasize Local Presence to Gain Market Share. The Company staffs each of
its markets with experienced, local direct sales and technical personnel who
provide personalized customer service. The Company believes its local presence
and responsive customer service will give it a competitive advantage over the
ILECs in Tier III Markets, where the Company believes the ILECs generally do not
have significant local sales and technical support presence. The Company also
tailors its US Xchange brand advertising campaigns and marketing programs in
each of its selected markets to establish its brand identity as a provider that
is interested in and responsive to the particular telecommunications needs of
its local customers.
Install High Quality Flexible Networks at a Low Cost. The Company believes
its network design and technology and its use of ILEC unbundled network elements
to obtain "last mile" connections to its customers allow it to (i) reduce
investments in property and equipment needed to provide services, (ii) enter
markets quickly, (iii) reduce underutilized and/or stranded investments in
connections to customer premises, (iv) provide the broad market coverage needed
to address business and residential end users simultaneously and (v) if and when
supported by market demand, cost-effectively construct "last mile" transport to
selected
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customers. The Company's systems are designed to support a full complement of
services, including local dial tone and advanced local features, long distance,
Centrex, ISDN and frame relay data transmission, Internet access and wireless
services.
Maintain Innovative, Integrated Operations Support, Customer Care and
Billing Systems. The Company has recently implemented scalable, automated
provisioning and order entry systems that automate many of the functions that
have traditionally been performed manually to support the ILEC's "legacy"
systems. In addition to cost advantages, the Company believes that its automated
operations support, customer care and billing systems provide it with a
marketing advantage by allowing it more quickly and efficiently to activate and
change services for its customers and to provide more responsive customer
support and service. All of the services offered by the Company, including
bundled third party services, are billed to the customer on a single,
easy-to-read billing statement, which the Company believes provides it with a
competitive advantage.
INDUSTRY OVERVIEW
According to the FCC's Statistics of Communications Common Carriers, ILECs
in the United States generated approximately $103.1 billion in total revenue in
1997. Local exchange services consist of a number of service components and are
defined by specific regulatory classifications. For 1997, total revenue by
service was: (i) interstate dedicated access service (i.e.,connecting a customer
with a long distance carrier's facilities) revenues of approximately $4.6
billion; (ii) interstate switched access service (i.e.,originating and
terminating calls from a long distance carrier) revenues of approximately $11.8
billion; (iii) end-user fees (i.e., access charges paid by the consumer for the
use of the ILEC's networks) of approximately $7.7 billion; (iv) local network
service (including dial tone, local area charges, dedicated point-to-point
intra-LATA service and enhanced calling features) revenues of approximately
$52.0 billion; (v) toll call revenues of approximately $9.2 billion; (vi)
intrastate access (i.e., local origination and termination for long distance
carriers for calls within a state) revenues of approximately $8.0 billion; and
(vii) miscellaneous (including provision of directories, billing and collection
services, corporate operations, non-regulated revenues and accounting for
uncollectables) revenues of approximately $9.9 billion.
Until recently, the competitive local telecommunications industry had
generally been limited to providing private line, dedicated access and switched
access transport services. The Telecommunications Act opened local services
markets to full competition by preempting state and local laws, to the extent
that they prevented competitive entry with respect to the provision of any
telecommunications service, and imposed a variety of new duties on ILECs in
order to promote competition in local exchange and access services. See
"--Regulation" below.
SERVICES
Since July 1997, the Company has provided switched local and long distance
primarily on a resale basis in selected Wisconsin and Indiana markets. In March
1998, the Company began providing its own facilities-based switched services to
customers in the Green Bay/Appleton, Wisconsin commercial region, and, as of the
date of this Prospectus, was also providing such facilities-based services in
the Milwaukee and Madison, Wisconsin commercial regions. The Company expects to
begin providing facilities-based switched services in South Bend, Indiana
following approval of its tariff filing in Indiana, which it expects to receive
by the end of 1998. The Company is continuing to develop and deploy its networks
to allow it to provide its own switched local exchange services in its other
target markets. See "--Markets" below.
The Company provides switched services primarily on a retail basis but will
also provide certain of its services to other carriers and ISPs on a wholesale
basis as its networks become commercially operational. The Company believes that
its investment in SONET fiber optic ring networks, advanced switching,
transmission and related electronic equipment, coupled with its emphasis on
personalized sales and customer care, will allow it cost-effectively to tailor
its service offerings to meet the diverse voice and data transmission needs of
its customers, as well as provide its customers with the convenience of
"one-stop shopping" for telecommunications services.
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The Company is offering or plans to offer the following services in each of
its target markets:
Local Switched Services. The Company offers a full complement of local
switched services, including local dial tone, 911, directory assistance and
operator-assisted calling. As its networks become operational, the Company also
offers expanded area calling plans that are generally unavailable from the
ILECs.
Advanced Local Features. To supplement its line of local switched services,
the Company deploys advanced software and equipment on its networks to offer
advanced local features, including conference calling, speed dialing, call
waiting, voice mail, call forwarding, caller ID, last number redial and return
calling. The Company also offers a full range of AIN services, such as end-user
time-of-day routing and local number portability, which it believes will enhance
its market penetration.
Centrex. The Company's switches are equipped with the software and
equipment needed to provide Centrex services, including digital Centrex, to
business customers seeking a less costly alternative to a PBX to direct their
telecommunications traffic.
Advanced Data Services. The Company offers high speed, digital packet
switched data transmission services, such as ISDN, and, in January 1999, will
begin offering frame relay services.
Long Distance Services. The Company provides a full range of inter-LATA,
international and toll-free 800/888 long distance services. The Company
purchases these services wholesale from IXCs and resells them to the Company's
customers. The Company intends to provide its own facilities-based long distance
services by constructing, leasing or acquiring long haul fiber interconnecting
its owned local networks and host switches and by leasing feature group access
to ILEC access tandems in regions which are contiguous to its owned facilities,
as well as certain other regions when cost and demand justify.
Dedicated Access. The Company offers private line, dedicated access
services to its customers, typically larger business and governmental and other
institutional end users, who desire high capacity transmission connections to
IXC POPs and to interconnect their own internal networks.
Internet Services. The Company offers a variety of Internet services for
both retail customers and ISPs. The Company offers dedicated and dial-up high
speed Internet access services via conventional modem connections, ISDN and
frame relay, and markets its retail Internet services under the US Xchange brand
name. The Company incorporates Netscape Communications Corporation's high-end
commercial Internet software products into its Internet services and receives
technical support for such products from Netscape. The Company offers
individualized, comprehensive turn-key Internet services to its business
customers, including Web page hosting and design. The Company recently began
offering a full range of local and Internet access services on a wholesale basis
to ISPs, including local telephone numbers and switched and dedicated access to
the Internet.
Paging and Cellular/PCS Services. The Company intends to offer paging and
cellular/PCS services on a resale basis by bundling such services with its other
service offerings.
MARKETS
The Company evaluates each of its potential markets on the basis of (i) the
Company's "bottom up" analyses of the potential demand for its
telecommunications services, which includes analyses of certain publicly
available, third-party economic and demographic data and management's experience
in similar markets, (ii) the level of actual and potential CLEC competition and
(iii) the disparity between ILEC local service pricing and the Company's
anticipated cost of providing comparable service. The Company believes it can
distinguish itself from larger regional or national telecommunications providers
by rapidly establishing a strong local market presence and brand name
recognition in each of its markets. The Company believes that, by effecting
early entry into selected Tier III Markets, it can discourage market entry by
other CLECs. To gain early entry into each selected market, the Company
establishes a local sales force offering switched local, long distance and
Centrex services on a resale basis until its network switching system becomes
commercially operational, which the Company believes will require approximately
six to nine months from the beginning of network construction in a market to the
provision of facilities-based switched services. This enables the
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<PAGE> 48
Company to build brand name recognition in each of its markets as well as a
customer base that it can transition to its own networks as they become
operational. To accelerate the deployment of its networks, the Company
outsources the installation and initial service turn-up of its network systems
to Lucent.
As of the date of this Prospectus, the Company was providing service
primarily on a resale basis in eight commercial regions in Wisconsin, Indiana
and Illinois and had six switches and six local fiber optic networks that were
commercially operational. The Company is currently deploying or plans to deploy
an additional seven switches and 12 local networks in Illinois, Indiana,
Michigan and Wisconsin. The Company believes that Tier III Markets are most
effectively penetrated by installing networks and switching facilities designed
to address customers in an entire commercial region. The Company believes that
this regional focus enables it to (i) take advantage of economies of scale in
network marketing, management and operation, (ii) cost-effectively address the
available customer base in each of its markets and (iii) leverage the US Xchange
brand name across the markets within a commercial region.
The following table presents information concerning the networks in the
Company's current development plans:
<TABLE>
<CAPTION>
OTHER LOCATIONS SWITCH AND PLANNED TARGETED
COMMERCIAL SUPPORTED BY RESALE NETWORK ROUTE TARGETED ADDRESSABLE
REGION(1) HOST SWITCH(1) COMMENCEMENT(2) OPERATIONAL(2) MILES(3) COLLOCATIONS ACCESS LINES
- ------------------------------ ---------------- --------------- -------------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
GREEN BAY/ APPLETON, WI 3Q/97 1Q/98 1 2 97,660
Oshkosh, WI 3Q/97 2Q/98 4 1 42,711
Green Bay, WI 3Q/97 2Q/98 23 4 114,196
MILWAUKEE, WI 3Q/97 3Q/98 70 7 260,876
Kenosha, WI 3Q/97 2Q/99 6 2 50,065
Racine, WI 3Q/97 2Q/99 4 2 61,085
MADISON, WI 3Q/97 3Q/98 28 5 156,984
Beloit, WI 3Q/97 2Q/99 12 1 25,031
Janesville, WI 3Q/97 2Q/99 1 1 41,808
SOUTH BEND, IN 1Q/98 4Q/98(5) 20 4 137,580
Elkhart, IN 2Q/98 1Q/99 25 3 74,888
BLOOMINGTON, IN 2Q/98 4Q/98 15 2 75,193
FT. WAYNE, IN 2Q/98 4Q/98 50 8 183,900
EVANSVILLE, IN 3Q/98 1Q/99 30 3 74,888
ROCKFORD, IL 4Q/98 1Q/99 22 3 126,878
KALAMAZOO, MI 4Q/98 2Q/99 30 2 84,213
Battle Creek, MI 4Q/98 2Q/99 20 2 58,111
Grand Rapids, MI 1Q/99 2Q/99 25 5 234,386
<CAPTION>
OTHER LOCATIONS
COMMERCIAL SUPPORTED BY APPROXIMATE
REGION(1) HOST SWITCH(1) POPULATION(4)
- ------------------------------ ---------------- -------------
<S> <C> <C>
GREEN BAY/ APPLETON, WI 433,000
Oshkosh, WI --
Green Bay, WI 337,000
MILWAUKEE, WI 1,799,000
Kenosha, WI --
Racine, WI --
MADISON, WI 649,000
Beloit, WI --
Janesville, WI 234,000
SOUTH BEND, IN 349,000
Elkhart, IN 252,000
BLOOMINGTON, IN 235,000
FT. WAYNE, IN 680,000
EVANSVILLE, IN 518,000
ROCKFORD, IL 439,000
KALAMAZOO, MI 377,000
Battle Creek, MI 233,000
Grand Rapids, MI 1,009,000
</TABLE>
- ---------------
(1) Host switch locations are indicated in bold type; remote switch locations
are indicated in standard type; and locations with other transmission
equipment are italicized.
(2) Quarter during which the Company began or plans to begin offering services
on a resale basis or the network or switch became or is planned to become
commercially operational, as the case may be.
(3) Does not include long haul fiber that interconnects networks. As of
September 30, 1998, the Company had approximately 500 route miles of local
and long haul fiber deployed in its Green Bay/Appleton, Milwaukee and
Madison, Wisconsin and South Bend and Ft. Wayne, Indiana commercial regions.
(4) Cities whose populations are not included in this table are included with
other cities in the same commercial region. Populations are based on 1996
figures contained in the 1998 Rand McNally Commercial Atlas and Marketing
Guide.
(5) The Company's switch and network have been installed and are operational.
Commencement of facilities-based services, however, is subject to approval
of the Company's tariff filing in Indiana, which it expects to receive by
the end of 1998.
The Company intends to develop the capability to provide facilities-based
telecommunications services over a fully integrated system of networks
throughout its targeted commercial regions in the Midwest. The Company plans to
construct, lease or acquire long haul fiber that will interconnect its local
networks and host switches. The Company intends to construct its own long haul
routes connecting certain of its networks in Wisconsin, Illinois, Indiana and
Michigan. The Company has acquired from another carrier an IRU for dark fibers
along certain of that carrier's long haul routes interconnecting certain of the
Company's networks in Wisconsin and Illinois and, in exchange, has granted that
carrier an IRU for dark fibers in and between certain of the Company's networks
in Wisconsin and in Illinois. The Company may also acquire other IRUs for dark
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<PAGE> 49
fiber from IXCs, ILECs, CLECs and other carriers that have overbuilt their fiber
optic networks along long haul routes connecting the Company's targeted markets,
primarily for its long distance transmission requirements. In addition to
constructing, leasing and acquiring network facilities, the Company plans to
lease feature group access to ILEC tandem switches to originate and terminate
calls in regions bordering its owned facilities, as well as certain other
regions where cost and demand justify, which will allow the Company to transmit
such traffic at an attractive cost. Expansion into additional regions in the
Midwest would require additional financing. See "Risk Factors--Additional
Capital Requirements."
NETWORK DEVELOPMENT
The Company's strategy for simultaneously pursuing business and residential
market segments requires broad market coverage and a favorable cost position. As
a result of recent developments in switching technologies, the Company can
cost-effectively bundle its own switched local services with long distance and
other services offered by third-party providers within the same switching
platform. The Company believes that by utilizing newer technologies and by
strategically deploying fully redundant fiber optic networks and switching
systems within a commercial region and not solely in a specific city or
metropolitan area, it can provide a full line of services at a lower cost than
the ILECs.
The Company interconnects its networks with all or substantially all of the
ILEC central offices and IXC POPs in each of its markets and obtains "last mile"
connections to its customers primarily through unbundled network elements leased
from the ILEC. The Company has chosen Lucent Series 5ESS(TM)-2000 switching
systems, transmission equipment, AIN equipment and related electronics for use
throughout its networks. All systems are equipped with advanced software and are
designed to offer a full complement of features and have the flexibility to add
new services, including broadband and wireless communications, without
significant incremental cost. The Company installs a Lucent Series 5ESS(TM)-2000
host switch and transmission equipment connected to a SONET fiber optic ring
network in each of its commercial regions. Certain markets within a commercial
region are served only by a host switch, while others are served by a Lucent
Series 5ESS(TM)-2000 EXM remote switch or Lucent FAST(TM)-equipment. A remote
switch is linked to a host switch through high capacity transmission lines for
administrative functions. The Company believes such remote switching equipment
can provide substantially all of the same telecommunications services as a host
switch, even if the link connecting them is temporarily interrupted, for
approximately 33% to 50% of the installation and operational costs of a host
switch. Lucent's FAST(R) equipment can be used in markets with only one ILEC
central office to carry traffic from such central office location to the
Company's host switch and, by accommodating up to 3,500 access lines, serves as
a cost-effective alternative to standard subscriber loop carrier transmission
equipment, which can only accommodate up to 672 access lines. The Company
believes its network architecture will allow it to cost-effectively provide its
services in smaller markets and over a broader geographic area.
The Company's owned networks consist of digital fiber optic cable
backbones, typically containing 72 fiber strands, which have significantly
greater bandwidth carrying capacity than traditional analog copper cables. A
single pair of glass fibers on the Company's networks can carry up to 32,256
simultaneous voice or data transmissions, whereas a typical pair of wires in a
standard analog copper cable can currently carry only a maximum of 24
simultaneous voice conversations. However, the use of dense wavelength division
multiplexing ("DWDM") equipment can increase the carrying capacity of optical
fiber, and the use of ADSL can increase the carrying capacity of copper wire
networks. The SONET ring architecture of the Company's local networks allows for
the routing of traffic simultaneously in both directions around the ring, which
provides protection against fiber cuts in the network. Back-up electronics
become operational in the event of the failure of the primary network
components, which adds further redundancy to the Company's systems.
In each of its targeted markets, the Company has constructed or is
constructing its own local fiber optic network facilities, except in Milwaukee,
where the Company leases local network transmission facilities from another
telecommunications carrier. Pursuant to three-year service agreements that
expire in December 2000 and January 2001, the Company leases transmission
capacity and related electronic equipment connected to its owned host switch in
Milwaukee for monthly fees in the aggregate of approximately $50,000. These
agreements may be terminated by the other carrier in the event of a material
breach that the Company does not correct within 30 days of the receipt of notice
of such breach. The Company expects to replace this leased
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capacity in the future with its own fiber if and when it experiences sufficient
traffic volume growth between its host switch and its targeted central office
collocations. See "--Markets."
The Company believes that its network design and technology will produce a
significant cost advantage compared to the ILECs. The Company's networks are
designed to allow the Company to serve the customers of multiple ILEC central
offices with a single switching system, which the Company believes will
substantially reduce the investment and ongoing operational expense of the
Company as compared to the ILECs. The Company's SONET fiber optic ring networks
interconnect its strategically located switching systems with all or
substantially all of the ILEC central offices and IXC POPs located in each of
its target markets. The Company collocates transmission equipment in the ILEC
central office in order to interconnect to available local loop facilities
provided by the ILEC. The Company leases unbundled loops from the ILECs in order
to complete the "last mile" connection to its customers. In specific cases if
customer demand justifies the cost, the Company will physically connect
customers to its networks or link customers to its network through the use of
wireless technologies leased from other carriers. The Company plans to compare
and evaluate, on an ongoing basis, the cost of leasing local loop facilities
from the ILEC versus constructing "last mile" transport to selected customers.
The Company also reviews the cost and quality implications of using alternative
local loop providers or deploying other transmission technologies (such as
wireless).
The Company will monitor its fiber optic networks and switching and
transmission equipment seven days per week, 24 hours per day, using its planned
NOC Center in Grand Rapids, Michigan. The Company has contracted with Lucent to
provide monitoring and maintenance services for the Company through an
electronic interface with Lucent's own facilities until the Company's NOC Center
becomes fully operational, which is currently scheduled to occur in the second
quarter of 1999. See "Risk Factors--Reliance on Lucent for Supply, Installation
and Monitoring of Equipment."
SALES AND MARKETING
The Company's customer base includes both business and residential end
users, and the Company also intends to offer certain of its services on a
wholesale basis to ISPs, utilities and other telecommunications providers. The
Company believes that Tier III markets will support only a limited number of
competitors and that operations in Tier III Markets with multiple competitive
providers are likely to be unprofitable for one or more of such providers (see
"Risk Factors--Competition"). Accordingly, the Company believes its planned
early establishment of a broad, local market presence and brand name recognition
across both business and residential customer bases are important for its
success in its target markets. The Company expects that its locally oriented,
personalized sales and marketing organization and programs will provide the
Company competitive advantages over less focused ILECs in terms of image,
service and customer loyalty.
The Company maintains market-wide US Xchange brand name advertising
campaigns from the start of its market entry, which support both business and
residential marketing efforts. The Company implements inbound and outbound
telemarketing programs immediately upon entry into each market as local sales
persons are hired and begin their direct sales activities. The Company also
participates in affinity programs and marketing partnerships with local and
regional businesses, including utilities. These programs have a local market
emphasis tailored to the particular market.
The Company's direct sales and customer care programs focus on providing
responsive, personalized service to its customers on a local market and regional
basis. The Company establishes sales offices in each of its local markets and
recruits City Managers from each local market to manage its sales office in such
market. The Company also has inside sales staff located in Green Bay, Wisconsin
and at the Company's headquarters in Grand Rapids, Michigan. As of September 30,
1998, the Company had approximately 200 employees engaged full time in its sales
and marketing efforts, including 115 persons staffing sales offices located in
Wisconsin and another 44 sales personnel located in Indiana. The Company plans
that its sales force will grow to approximately 260 persons by the end of 1998
and also plans to launch an agency program to supplement its internal marketing
efforts.
In addition to their direct sales activities, the Company's sales personnel
provide customer care services to the Company's customers on both a local and
regional basis. The Company's support staffs in Green Bay
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and Grand Rapids provide customer care to customers in other markets who require
support or service during non-business hours.
BUSINESS CUSTOMER STRATEGY
The Company's local sales forces primarily target small to medium-sized
businesses and institutions in their respective markets because the Company
believes that a significant portion of these customers prefer a single source
telecommunications provider that can deliver a full range of sophisticated and
cost-effective solutions to their telecommunications needs with excellent,
personalized customer service. Further, the Company believes that the ILECs
typically do not have effective "face-to-face" marketing and customer service
programs designed to specifically address the needs of these customers. The
Company is employing strategies designed specifically to address these small and
medium-sized businesses, including: (i) hiring and training specialized account
executives dedicated to developing this customer segment; (ii) increasing
marketing efforts to shared tenant office buildings; (iii) developing special
services and service packages that are attractive to this market segment; and
(iv) developing US Xchange brand name recognition.
Although the primary focus of the Company's outside sales force is on small
and medium-sized businesses, the Company also intends to provide services to
larger businesses and governmental and other institutional end users. These
customers require maximum reliability, high quality solutions and the timely
introduction of new and innovative services. The Company addresses the
requirements of these customers by providing (i) a specialized sales and service
approach employing engineering and sales professionals who design and implement
cost-effective telecommunications solutions, (ii) strong, regional presence,
(iii) ongoing development and integration of new telecommunications services and
(iv) sophisticated telecommunications and transmission networks.
RESIDENTIAL CUSTOMER STRATEGY
The Company believes that Tier III Markets present attractive opportunities
for the economical offering of telecommunications services to residential
customers. The Company believes that its bundled service offerings, high degree
of front office and back office automation and customer care, billing and
automated credit-checking systems and procedures enhance its ability to offer
services to residential customers in its target markets. The Company also
believes that, because it collocates its networks in all or substantially all of
the ILEC central offices, sales to residential end users can be pursued
economically. The Company targets creditworthy residential customers who the
Company believes are likely to have needs for multiple services with various
affinity and other cost-effective marketing programs and service packages
designed to appeal to such customers. The Company has developed affinity
programs with certain utilities in its markets, including programs in which
Company marketing materials are to be included with the utility's bills to its
own customers. The Company also participates in marketing partnerships with
minor league baseball teams and church groups. The Company believes that such
programs can be cost-effectively implemented in tandem with its other marketing
programs directed primarily toward business customers, including marketing its
residential services to employees of its business customers. See "Risk
Factors--Risks Related to Residential Business."
WHOLESALE STRATEGY
To further leverage its fixed costs, the Company intends to establish and
maintain selective channels for the sale of its services on a wholesale basis.
For example, the Company has begun offering its local and Internet access
services on a wholesale basis to ISPs in certain of its targeted markets. The
Company also intends to establish strategic alliances with and supply wholesale
services to electric utility companies and other selected telecommunications
providers for the bundling of services and billing to such entities' own
customers.
INFORMATION SYSTEMS
The Company's operations support, customer care and billing systems have
either been acquired from or developed with third party vendors with proven
software and extensive knowledge of such systems. The
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Company has recently implemented a new provisioning and order entry system
acquired from a third party vendor and is in the process of integrating this new
system with its other information and processing systems. The Company believes
that its automated information systems and procedures for operations support and
customer care will provide a significant cost advantage for the processing of
large order volumes and customer service. Unlike the legacy systems currently
used by certain of the ILECs, the Company's systems are designed to be scalable,
to be employed either centrally or in more than one location and to automate
many of the functions which previously have required multiple manual entries of
customer information to accomplish order management, provisioning, switch
administration and billing. The ILEC legacy systems are not only
labor-intensive, but create numerous opportunities for errors in provisioning
services and billing, delays in installation, service interruptions, poor
customer service, increased customer churn and significant added expenses due to
duplicated efforts and the need to correct service and billing problems. The
Company's automated systems enter, schedule, provision and track a customer's
order from the point of sale to the installation and testing of service and
include automated interfaces with trouble management, inventory, billing,
collection and customer service systems. In addition to cost advantages, the
Company believes its automated system approach will result in improved customer
service relative to an ILEC that does not have comparable systems. Specifically,
the customer will benefit from more rapid service activation and service
changes, faster repairs and fewer errors.
To initiate service for a customer either on a resale basis or using
unbundled network elements, the Company must interface with the systems of the
ILECs and IXCs. The Company has established arrangements for "electronic
bonding" with approximately 85% to 90% of the ILEC central offices and certain
of the IXC POPs in its target markets. Electronic bonding with an ILEC permits
the Company to provision customer service electronically on an "assume as is" or
"assume as specified" basis. Provisioning for the remaining ILEC central offices
and IXC POPs in the Company's target markets is currently accomplished via fax
or e-mail order entry. The Company plans to work actively to establish
electronic bonding between its automated operations support and customer care
systems and those of the remaining ILECs and IXCs to the fullest extent
possible.
The Company has developed a convergent billing system that interfaces with
its operations support systems and accommodates billing for local, long distance
and Internet services offered by the Company, as well as paging, cellular and
other services available from third party providers. Among other benefits, this
system generates a single billing statement that is designed to be "user
friendly" by providing the Company's customers with more enhanced billing detail
while being easier to read and understand. The Company's billing system has the
ability to provide multiple summary methodologies, handle multiple hierarchies
for commercial accounts and accommodate a variety of output media, including
paper, EDI datafile, Internet or diskette.
The Company believes that its automated, integrated operations support and
back office systems will allow the Company to provide faster customer service
initiation and changes, greater billing accuracy and customization, and a
superior level of customer service. See "Risk Factors--Dependence on Information
and Processing Systems."
COMPETITION
The telecommunications industry is highly competitive, and one of the
primary purposes of the Telecommunications Act is to foster additional
competition. In each of its markets, the Company competes principally with the
ILEC serving such market, which is generally one of the RBOCs or one of the GTE
Companies. The ILECs have long-standing relationships with their customers, have
financial, technical and marketing resources substantially greater than those of
the Company and have the potential to fund competitive services with cash flows
from a variety of businesses. ILECs presently have a near 100% market share in
each of the Company's target markets. The Company expects to face significant
competitive product and pricing pressure in each of its markets.
It is likely that the Company will also face competition from other
facilities-based CLECs in certain of its markets. After the investment and
expense of establishing a network and support services in a given market, the
marginal cost of carrying an additional call is negligible. Accordingly, in Tier
III Markets where there are
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other facilities-based CLECs, the Company expects substantial price competition.
The Company believes that Tier III Markets will only support a limited number of
competitors and that operations in Tier III Markets with multiple competitive
providers are likely to be unprofitable for one or more of such providers.
CLEC competitors that provide local services or have started or announced
plans for either construction or solicitation activities in the Company's
current markets include: TDS and McLeod in Green Bay/Appleton, Wisconsin; TCG,
TWI, McLeod and OCI in Milwaukee, Wisconsin; KMC Telecom, TDS and McLeod in
Madison, Wisconsin; KMC Telecom in Ft. Wayne, Indiana; McLeod in Rockford,
Illinois; Climax Telephone Company in Kalamazoo, Michigan; and Brooks Fiber in
Grand Rapids, Michigan. The Company believes that there may be additional
competitors that have formulated plans to enter its target markets, including
the additional markets in its current development plans.
Other potential competitors in the Company's markets include resellers,
microwave, satellite and other wireless telecommunications providers, cable
television companies, electric utilities and RBOCs seeking to operate outside
their current local service areas. In particular, electric utilities and cable
companies are likely competitors given their existing rights of way. Electric
utilities using DLP technologies can transmit Internet and data services over
their power lines at speeds faster than those achievable by telephone companies
on their ADSL or ISDN lines. The development of networks utilizing new
technologies such as Internet telephony, cable modem service and wireless
networks utilizing LMDS and satellite transmission, which can be used to provide
high capacity wireless local loop, LAN, Internet access and interactive
services, might also create significant new competitors that may have a lower
cost basis than the Company. The Company believes that there may also be an
increasing level of agent and distributor resale initiatives in Tier III
Markets.
Prices in both the long distance business and the data transmission
business have declined significantly in recent years and are expected to
continue to decline. The Company will face competition from large carriers such
as AT&T, MCI WorldCom and Sprint, as well as from other resellers and companies
offering Internet telephony services, which could create additional pricing
pressures. In addition, long distance carriers, including AT&T, MCI WorldCom and
Sprint, as well as smaller carriers, have begun to offer integrated local and
long distance telecommunications services. MCI WorldCom was recently formed by
the merger of WorldCom, Inc. and MCI Communications Corporation, and AT&T has
recently acquired TCG and announced a proposed combination with TCI.
Combinations such as these should enhance carriers' ability to offer bundled
local and long distance telecommunications services. The RBOCs are also making
concerted efforts to gain regulatory permission under the Telecommunications Act
to offer their own bundled local and long distance telecommunications services.
Increasing competition has led to consolidations among the original seven
RBOCs, including the recently announced agreement of SBC to acquire Ameritech
and SBC's recent acquisition of SNET. Following these combinations, SBC would be
a coast-to-coast local telephone company with an estimated 30% of all United
States local access lines. SBC has also announced plans to enter an additional
30 markets outside the territories of the combined entity. In addition, Bell
Atlantic has reached an agreement for the acquisition of GTE. Further
consolidation of telecommunications companies and the formation of additional
strategic alliances within the telecommunications industry could give rise to
significant new competitors.
While recent regulatory initiatives, which allow CLECs such as the Company
to interconnect with ILEC facilities and to obtain unbundled network elements
from the ILECs, provide increased business opportunities for the Company, such
regulatory initiatives have been accompanied by increased pricing flexibility
for, and relaxation of regulatory oversight of, the ILECs. This may present
ILECs with an opportunity to subsidize services that compete with the Company's
services with revenues generated from non-competitive services, thereby allowing
ILECs to offer competitive services at lower prices. There can be no assurance
that the Company will be able to obtain the interconnections and unbundled
network elements it requires at rates, and on terms and conditions, that will
permit the Company to offer switched and advanced, high speed digital services
at rates that are both competitive and profitable. See "Risk
Factors--Implementation Risks." If the ILECs engage in increased volume and
discount pricing practices or charge CLECs increased fees for interconnection or
unbundled network elements, or if the ILECs delay implementation of
interconnection or the provision of unbundled network elements, the Company
would be adversely affected.
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The World Trade Organization ("WTO") agreement on basic telecommunications
could further increase the level of competition faced by the Company. Under this
agreement, the United States and 68 other WTO members committed themselves to
opening their respective telecommunications markets to foreign ownership and/or
to adopting regulatory measures to protect foreign competitors against
anticompetitive behavior by dominant telecommunications companies, effective in
some cases as early as January 1998.
Substantially all of the Company's current and potential competitors have
financial, technical, marketing, personnel and other resources, including brand
name recognition, substantially greater than those of the Company, as well as
other competitive advantages over the Company. The Company believes that the
principal competitive factors affecting its business operations are competitive
pricing, quality of services and products and innovative service and product
offerings. The Company expects to experience declining prices and increasing
price competition. The ability of the Company to compete effectively will depend
upon its ability to provide high quality, market-driven products and services
with excellent personalized customer service at prices generally below those
charged by its competitors. There can be no assurance that the Company will be
able to achieve or maintain adequate market share or margins, or compete
effectively, in any of its markets. See "Risk Factors--Competition."
REGULATION
The Company's services are subject to varying degrees of federal, state and
local regulation. The FCC exercises jurisdiction over all facilities of, and
services offered by, telecommunications common carriers to the extent those
facilities are used to provide, originate or terminate interstate or
international communications. The state regulatory commissions retain
jurisdiction over the same facilities and services to the extent they are used
to originate or terminate intrastate communications. Local governments also
sometimes impose franchise or licensing requirements on CLECs.
FEDERAL REGULATION
The Company is regulated at the federal level as a nondominant common
carrier subject to minimal regulation under Title II of the Communications Act
of 1934. The Communications Act of 1934 was substantially amended by the
Telecommunications Act, which was signed into law on February 8, 1996. This
legislation provides for comprehensive reform of the nation's telecommunications
laws and is designed to enhance competition in the local telecommunications
marketplace by: (i) removing state and local entry barriers, (ii) requiring
ILECs to provide interconnection to their facilities, (iii) facilitating end
users' choices to switch service providers from ILECs to competitive providers
such as the Company and (iv) requiring access to rights-of-way. Under the
Telecommunications Act, RBOCs have the opportunity to provide in-region long
distance services if they meet certain conditions, and they are no longer
prohibited from providing certain cable TV services. In addition, the
Telecommunications Act eliminates certain restrictions on utility holding
companies, thus clearing the way for them to diversify into telecommunications
services. See "Risk Factors--Competition."
The Telecommunications Act specifically requires all telecommunications
carriers (including ILECs and CLECs such as the Company): (i) not to prohibit or
unduly restrict resale of their services; (ii) to provide dialing parity and
nondiscriminatory access to telephone numbers, operator services, directory
assistance and directory listings; (iii) to afford access to poles, ducts,
conduits and rights-of-way; and (iv) to establish reciprocal compensation
arrangements for the transport and termination of telecommunications. It also
requires ILECs to provide interconnection for the transmission and routing of
local exchange services (a) at any technically feasible point within the ILEC's
network, (b) 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 (c) at rates and on 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 for resale at
wholesale rates their telecommunications services offered at retail to
subscribers who are not telecommunications carriers and to facilitate the
collocation of equipment necessary for competitors to interconnect with or
access the unbundled network elements. The term "network element" means a
facility or equipment used in the provision of telecommunications services
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and includes features, functions and capabilities that are provided by means of
such facility or equipment (including subscriber numbers, databases, signaling
systems, and information sufficient for billing and collection or used in the
transmission, routing or other provision of telecommunications services). The
Telecommunications Act delegated authority to the FCC to determine which network
elements should be made available to competitive providers on an unbundled
basis, taking into consideration, at a minimum, whether competitive access to
proprietary elements is necessary and whether the failure to provide such access
would impair the ability of the competitive provider to provide the services it
seeks to offer. However, certain aspects of the FCC regulations designed to
implement these provisions are subject to litigation as discussed below.
The Telecommunications Act also removed on a prospective basis most
restrictions on the RBOCs resulting from the consent decree which provided for
divestiture of the RBOCs from AT&T in 1984. The Telecommunications Act
establishes procedures under which an RBOC can enter the market for inter-LATA
(i.e., long distance) services within the area where it provides local exchange
service (the Telecommunications Act permitted the RBOCs to enter the out-of
region long distance market immediately upon enactment). Before the RBOC can
provide in-region inter-LATA services, it must obtain FCC approval upon a
showing that facilities-based competition is present in its local market, that
the RBOC has entered into interconnection agreements in the states where it
seeks authority, that the interconnection agreements satisfy a 14-point
"checklist" of competitive requirements and that such entry is in the public
interest. To date, such authority has not been granted to any RBOC, but requests
by RBOCs are the subject of various pending petitions and appeals. The provision
of in-region inter-LATA services by RBOCs in the Company's target markets would
permit them to offer bundled local and long distance services, thereby
eliminating the marketing advantage currently enjoyed by the Company.
FCC Rules Implementing the Local Competition Provisions of the
Telecommunications Act. On August 8, 1996, the FCC issued an order which
established a framework of minimum, national rules enabling state public utility
commissions and the FCC to begin implementing many of the local competition
provisions of the Telecommunications Act. The order promulgated rules to
implement Congress' statutory directive concerning the interconnection
obligations of the ILECs. 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
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.
On July 18, 1997, the Eighth Circuit vacated certain portions of the FCC's
rules, holding that, among other things:
- The FCC's pricing rules should be vacated because the FCC had exceeded
its jurisdiction in establishing rules governing the prices that ILECs
may charge competitors for interconnection, unbundled access and resale.
- The FCC's "pick and choose" rule, which allows competitors to select
terms of previously approved interconnection agreements for their own
use, conflicts with the purposes of the Telecommunications Act and should
be vacated.
- The FCC lacks authority to hear formal complaints which involve the
review and/or enforcement of certain terms of local interconnection
agreements approved by State commissions.
- The FCC may not adopt a blanket requirement that State interconnection
rules must be consistent with the FCC's regulations.
- The FCC correctly concluded that ILEC operations support systems,
operator services and signaling systems and various other facilities,
such as interoffice transmission facilities, qualify as network elements
that are subject to the unbundling requirements of the Telecommunications
Act.
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- The FCC erred in deciding that ILECs could be required by competitors to
provide interconnection and unbundled network elements at levels of
quality which exceed those levels at which ILECs provide such services to
themselves.
- The FCC cannot require ILECs to recombine network elements for
competitors, but competitors may recombine such network elements
themselves as necessary to provide telecommunications services.
- FCC rules and policies regarding the ILECs' duty to provide for physical
collocation of equipment were upheld.
A companion appeal was decided on June 27, 1997 in which the court upheld
the FCC's decision that the term "interconnection" as used in the
Telecommunications Act relates to physical access and does not include
transmission and routing services as well. On October 13, 1998, the United
States Supreme Court heard oral arguments on the appeals of the Eighth Circuit
decisions and a decision is expected before July 1999. The Company cannot
predict whether these Eighth Circuit decisions will stand or what further
actions the FCC may or may not take in response to these appellate decisions.
However, in its decision denying Ameritech's application to provide in-region
inter-LATA services, the FCC indicated that it would not grant such requests
unless its pricing rules vacated by the Eighth Circuit are followed.
On October 14, 1997, the Eighth Circuit issued a decision vacating
additional FCC rules that will likely have the effect of increasing the costs of
obtaining the use of combinations of an ILEC's unbundled network elements. The
Court ruled that ILECs need not provide combinations of network elements to
CLECs, even when the ILEC has already combined such elements within its network.
The Court's decision does not undermine the ILEC's obligation to provide
unbundled network elements but clarifies that the ILECs are not obligated to
offer bundled elements.
More recently, an Eighth Circuit panel denied an attempt by the FCC to make
an ILEC's compliance with the FCC's forward-looking pricing methodology--known
as total element long-run incremental cost, or TELRIC--a condition of FCC
approval of the ILEC's application under Section 271 of the Telecommunications
Act to provide in-region long distance service. The Court's February 1998 ruling
was issued with respect to Ameritech Michigan, which had applied to the FCC for
authority to provide in-region interLATA services in Michigan. The FCC denied
the application based on a determination that Ameritech Michigan had failed to
satisfy several of Section 271's checklist requirements. The FCC added,
however--in a statement that was not essential to the resolution of the case
before it--that it would require RBOCs to employ TELRIC in order to satisfy
Section 271's requirements in the future. Ameritech Michigan appealed the FCC's
decision to the Eighth Circuit. The Court held that the statement regarding
TELRIC violated the Court's July 1997 decision; that it appeared to be
calculated to avoid ordinary appellate review and to intimidate state PSCs; and
that, unless and until the Supreme Court reverses the Eight Circuit's July 1997
decision, the FCC simply may not reassert authority to mandate TELRIC pricing
under any of the local competition provisions of the Telecommunications Act. The
Court's decision renders unpredictable the pricing structure that the Company
will be able to obtain in its interconnection agreements with ILECs in any given
state.
On August 10, 1998, however, the Eighth Circuit upheld an FCC ruling of
August 18, 1997 that ILECs must treat shared transport as a network element and
must provide competitors access to unbundled transport facilities on a shared
basis between ILEC switches. The FCC had held, among other things, that ILECs
are required to provide competing carriers with access to the same transport
facilities that ILECs use to carry their own traffic for transport between an
end office switch and a tandem switch. The Court held that shared transport is
like any other feature, function or capability such as Caller ID, call
forwarding or operator service, and that the FCC therefore had the authority to
require ILECs to offer it to their competitors on an unbundled basis.
Nevertheless, the Court supported the arguments of ILECs that the FCC has no
authority to establish pricing for shared transport or any other network
element. While enabling the Company to make use of ILEC transport facilities on
a shared basis, the Court's decision once again will result in pricing
structures for such access that vary from state to state. On September 24, 1998,
the ILECs who were parties to this appeal asked the Eighth Circuit to reconsider
its decision.
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Taken as a whole, the Eighth Circuit decisions create uncertainty about the
rules governing pricing, terms and conditions of agreements to obtain needed
interconnections and unbundled network elements and could make negotiating and
enforcing such agreements more difficult and protracted and may require
renegotiation of existing agreements, to the extent that existing agreements
include provisions requiring ILECs to bundle elements. There can be no assurance
that the Company will be able to obtain or enforce interconnection agreements on
terms acceptable to the Company.
On December 31, 1997, the U.S. District Court for the Northern District of
Texas (the "Texas District Court") issued a decision finding that Sections 271
through 275 of the Telecommunications Act are unconstitutional since they impose
restrictions on the RBOCs but do not impose comparable restrictions on other
ILECs such as the GTE Companies. These sections of the Telecommunications Act
impose restrictions on the lines of business in which the RBOCs may engage,
including establishing the conditions that the RBOCs must satisfy before they
may provide in region inter-LATA long distance telecommunications services. On
September 4, 1998, the United States Court of Appeals for the Fifth Circuit (the
"Fifth Circuit"), in a 2-to-1 ruling, reversed the Texas District Court's
decision, finding that these sections are constitutional. Southwestern Bell has
sought review in the United States Supreme Court. If the Fifth Circuit's
decision is not upheld on appeal, the RBOCs would be able to provide in-region
long distance telecommunications services immediately without satisfying the
statutory conditions requiring competition at the local level. Reversal of the
Fifth Circuit's decision would likely have an unfavorable effect on the
Company's business for at least two reasons. First, RBOCs currently have an
incentive to foster competition within their service areas so that they can
qualify to offer in-region inter-LATA long distance services. The Texas District
Court's decision would have removed this incentive by allowing RBOCs to offer
in-region inter-LATA long distance service without regard to their progress in
opening their local markets to competition. Second, the Company is legally able
to offer its customers both long distance and local exchange services, which
Ameritech currently may not do in its regions. The Company believes that this
ability to offer "one-stop shopping" gives the Company a marketing advantage
that it would no longer enjoy if the Fifth Circuit's September 4 ruling is not
upheld on appeal.
On August 7, 1998, the FCC released a Memorandum Opinion and Order ("MO&O")
and Notice of Proposed Rule Making ("NPRM") proposing to ease regulations on the
deployment of advanced data services such as high-speed internet access and
video telephony by ILECs. In its MO&O, the FCC clarified that advanced
telecommunications facilities and services offered by ILECs are subject to
Sections 251 and 252 of the Telecommunications Act (regarding terms of and
procedures for interconnection with local exchange carriers), and that the
facilities and equipment used to provide advanced services are network elements
that must be provided to new entrants on an unbundled basis. The FCC also held
that ILECs must offer for resale, at wholesale rates, any advanced services that
they offer to subscribers that are not telecommunications carriers. SBC has
petitioned the Eighth Circuit to review the MO&O in an effort to obtain
permission to offer advanced services free of the unbundling and resale
requirements.
In its NPRM, however, the FCC proposed to permit ILECs to form separate
affiliates that could offer advanced services without giving competitors access
to network elements at discounted prices. Thus, the separate affiliates could
install new data equipment to upgrade ILEC networks to Digital Subscriber Line
standards without having to share the new networks with competitors. To the
extent that the affiliates provided interstate exchange access service, they
would be presumed to be nondominant and therefore not subject to price cap or
rate of return regulation for advanced services, and would not be required to
file tariffs for such services. The ILECS, however, would be required to give
their competitors and the new affiliates access on an equitable basis to the
ILECs' central offices to install data equipment, and would also have to provide
access on an equitable basis to local loops conditioned for data use. The FCC's
proposal would not change the existing prohibition on the provision of services
by ILECs across LATA boundaries, although the FCC stated that it would take
comments on easing LATA restrictions in special cases. At least one ILEC is
expected to seek reconsideration of the FCC's NPRM. It is unclear at this time
whether the FCC's proposal will ultimately be adopted in its present form or
what effect such adoption may have, and the NPRM's impact on the Company is
therefore uncertain.
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Other Regulations. In general, the FCC has a policy of encouraging the
entry of new competitors, such as the Company, into the telecommunications
industry and preventing anti-competitive practices. Therefore, the FCC has
established different levels of regulation for dominant carriers and nondominant
carriers. For domestic common carrier telecommunications regulation, large ILECs
such as the GTE Companies and the RBOCs are currently considered dominant
carriers, while CLECs such as the Company are considered nondominant carriers.
As a nondominant carrier, the Company is subject to relatively minimal FCC
regulation.
- 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 concerning the
carrier's interstate circuits and deployment of network facilities.
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.
In October 1996, the FCC adopted the Detariffing Order which eliminated
the requirement that nondominant interstate carriers maintain tariffs on
file with the FCC for domestic interstate services, and providing that,
after a nine-month transition period, relationships between interstate
carriers and their customers would be set by contract. Several parties
requested reconsideration and/or filed appeals of the Detariffing Order.
On February 13, 1997, the District of Columbia Circuit stayed
implementation of the Detariffing Order. If the Detariffing Order becomes
effective, nondominant interstate services providers will no longer be
able to rely on the filing of tariffs with the FCC as a means of
providing notice to customers of prices, terms and conditions under which
they offer their interstate services. If the Company cancels its FCC
tariffs as a result of the Detariffing Order, it will need to implement
replacement contracts which could result in substantial legal and
administrative expense.
- 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 change prices for certain services, including
interconnection services provided to CLECs, only within certain
parameters. 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
significantly reduce its regulation of ILEC pricing would greatly enhance
the ability of ILECs to compete against the Company and could have a
material adverse effect on the Company and its ability to meet its
obligations on the Notes. The FCC released an order on December 24, 1996
which 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. On May 21,
1997, the FCC took further action updating and reforming its price cap
plan for ILECs. The changes require ILECs subject to the price cap
regulations 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 which the Company competes. Review of these FCC decisions is
currently pending before the District of Columbia Circuit.
- Local Number Portability. In the Telecommunications Act, Congress sought
to remove a perceived barrier to local telecommunications competition by
requiring local telephone companies to enable customers to keep their
telephone numbers when switching local carriers. Local telephone
companies have already implemented such number portability in Chicago,
New York and Philadelphia, and the policy is scheduled to be implemented
in the rest of the 100 largest Metropolitan Statistical Areas by December
31, 1998. Thereafter, local telephone companies will be required to
implement number portability in other areas within six months of
receiving a request from a telecommunications carrier. In order to
facilitate long-term number portability, the FCC adopted requirements on
May 12, 1998 that the costs associated with number portability (such as
those associated with building and operating
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regional number portability databases) will generally be allocated to all
common carriers based on carriers' intrastate, interstate and
international end-user telecommunications revenues for each region. ILECs
will be permitted to recover costs directly related to providing local
number portability through a monthly end-user charge that would be
subject to FCC review. Carriers other than ILECs, including wireless
carriers and CLECs such as the Company, may recover such costs in any
lawful manner. While it therefore appears that the FCC's policies
regarding local number portability will not have a negative impact on the
Company's financial condition, those policies could change in the future.
Access Charges. The FCC has granted the ILECs significant flexibility in
pricing their interstate special and switched access services on a specific
central office by central office basis. 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 the FCC will grant ILECs
increasing pricing flexibility as the number of interconnections and competitors
increases. In two orders released on December 24, 1996 and May 16, 1997, the FCC
took action to reform the current interstate access charge system. The FCC
adopted an order which makes various reforms to the existing rate structure for
interstate access that are designed to move access charges, over time, to more
cost based rate levels and structures. These changes will reduce access charges
and will shift charges currently based on minutes of use to flat-rate, monthly
per line charges. As a result, the aggregate amount of access charges paid by
long distance carriers to access providers in the United States may decrease.
The FCC also announced that it intends in the future to issue a Report and Order
providing detailed rules for implementing a market-based approach to further
access charge reform. 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. On June 18, 1997, the FCC denied petitions filed
by several ILECs asking the FCC to stay the effectiveness of its access charge
reform decision, although it subsequently granted petitions for reconsideration
by Sprint and various other parties and made relatively minor changes to, among
other things, its requirements regarding the information that ILECs must provide
to IXCs on the presubscribed interexchange carrier charges ("PICCs") that the
ILECs levy on their presubscribed customers. The FCC's access charge order was
appealed to the Eighth Circuit.
On August 19, 1998, the Eighth Circuit issued a unanimous decision
upholding the FCC's access charge order. The Eighth Circuit affirmed the new
access charge structure established by the FCC, including flat-rate PICCs and
increased subscriber line charges ("SLCs") for nonprimary residential and
multibusiness lines. In so doing, the Court denied challenges to the FCC's
decision both from ILECs and IXCs, finding that, contrary to the claims of
ILECs, the FCC had authority to exempt purchasers of unbundled network elements
from contributing to the federal universal service support program through
access charges (see discussion of universal service below). The Eighth Circuit
also rejected ILEC arguments that capping SLCs for primary residential lines
creates an implicit subsidy benefiting single-line consumers at the expense of
multiline businesses and consumers. In addition, the Eighth Circuit held that
the FCC had proceeded in accordance with the Telecommunications Act in
determining that competitive pressures in the local exchange market will not
threaten universal service during the period before the FCC has implemented an
explicit universal service support mechanism. The Eighth Circuit also supported
the FCC's finding that ISPs should be exempt from access charges, agreeing that
it is not clear that ISPs use the telephone network in the same manner as long
distance companies (which are subject to access charges). The Eighth Circuit
rejected the argument of IXCs that the FCC should have prescribed lower access
costs, and supported the FCC's choice of a market-based approach. It is not
possible at this time to assess accurately the impact that the Eight Circuit's
multi-faceted decision will have on the Company's business. On October 6, 1998,
the FCC released a Public Notice asking parties to refresh the record on access
charge reform. It specifically requested comment on pricing flexibility
proposals submitted by two RBOCs and on charging the 6.5% X-factor adjustment,
which is applied annually to reduce ILEC's price cap indices.
ILECs around the country have been contesting whether the obligation to pay
reciprocal compensation to CLECs should apply to local telephone calls from ILEC
customers to ISPs served by CLECs. The ILECs claim that this traffic is
interstate in nature and therefore should be exempt from compensation
arrangements applicable to local, intrastate calls. CLECs have contended that
the interconnection agreements provide no
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exception for local calls to ISPs and reciprocal compensation is therefore
applicable. The FCC recently held that GTE's ADSL service, which provides a
dedicated connection (rather than circuit-switched dial up) that permits an ISP
to provide its end user with high-speed access to the Internet, is a special
access service with more than a de minimis amount of interstate traffic. This
Order (GTE ADSL Order) determined that GTE's ADSL service is properly tariffed
at the federal level but if GTE or any other ILECs were to offer an xDSL service
that is intrastate in nature, that service should be tariffed at the state
level.
Under the Eighth Circuit decisions, the states have primary jurisdiction
over the determination of reciprocal compensation arrangements and as a result,
the treatment of this issue can vary from state to state. Currently, 23 state
commissions (including Wisconsin, Illinois and Michigan), three federal courts
and one state court have ruled that reciprocal compensation arrangements do
apply to calls to ISPs. Certain of these rulings are subject to appeal.
Additional disputes over the appropriate treatment of ISP traffic are pending in
other states. The National Association of Regulatory Utility Commissioners
("NARUC") adopted a resolution in favor of applying reciprocal compensation to
calls to ISPs. The FCC made clear that its GTE ADSL Order did not determine
whether reciprocal compensation is owed pursuant to existing interconnection
agreements, state arbitration decisions and federal court decisions. The FCC
indicated that it intends to issue a separate order specifically addressing
reciprocal compensation issues. The Company anticipates that ISPs will be among
its target customers, and adverse decisions in these proceedings could limit the
Company's ability to service this group of customers profitably.
Universal Service Reform. On May 8, 1997, the FCC issued an order to
implement the provisions of the Telecommunications Act relating to the
preservation and advancement of universal telephone service. The Universal
Service order affirmed Congress' policy principles for universal telephone
service, including quality of service, affordable rates, access to advanced
services, access in rural and high-cost areas, equitable and nondiscriminatory
contributions, specific and predictable support mechanisms and access to
advanced telecommunications services for schools, health care providers and
libraries. The order added "competitive neutrality" to the FCC's universal
service principles by providing that universal service support mechanisms and
rules should not unfairly advantage or disadvantage one provider or technology
over another. All telecommunications carriers providing interstate
telecommunications services, including the Company, must contribute to the
universal service support fund. 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 revenues. Contribution factors vary quarterly and carriers,
including the Company, are billed monthly. Currently, the FCC is assessing such
payments on the basis of a provider's revenue for the previous year. Since the
Company had no significant revenue in 1997, it will not be liable for subsidy
payments in any material amount during 1998. With respect to subsequent years,
however, the Company is currently unable to quantify the amount of subsidy
payments that it will be required to make and the effect that these required
payments will have on its financial condition and results of operation. In
addition, many state PSCs have instituted proceedings to revise state universal
support mechanisms to make them consistent with the requirements of the
Telecommunications Act. 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 May 8th order. The appeals
have been consolidated in the United States Court of Appeals for the Fifth
Circuit where they are currently pending. Oral argument is scheduled for
December 1, 1998. In addition, on July 3, 1997, a number of ILECs filed a
petition for stay of the May 8th order with the FCC. That petition is pending,
as well as several petitions for administrative reconsideration of the order.
International Settlements Policy Reform. On August 6, 1998, the FCC
released a proposal to make significant changes to the application of the
International Settlements Policy. The policy was developed to prevent foreign
monopoly carriers from playing U.S. carriers off against one another to the
disadvantage of those carriers and U.S. ratepayers. The policy requires (1) the
equal division of international accounting rates; (2) nondiscriminatory
treatment of U.S. carriers; and (3) the proportionate return of traffic inbound
to the United States from a particular foreign point among carriers transporting
outbound traffic to that foreign point. The FCC proposed not to apply the policy
to arrangements between U.S. carriers and foreign carriers that lack market
power in WTO Member Countries, and between U.S. carriers and foreign carriers in
WTO Member
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Countries in which U.S. carriers are authorized by the FCC to provide switched
service over international resold private lines. The FCC also proposed to
eliminate substantial reporting requirements for carriers entering into these
types of arrangements. In addition, the FCC proposed to permit carriers to
obtain authority to enter into flexible settlement arrangements for agreements
affecting less than 25 percent of the traffic on a particular international
route without naming the foreign correspondent and without filing the terms and
conditions of the actual agreement. If adopted, the FCC's proposed changes would
enhance the Company's ability to compete in the U.S. market for international
services, but would also intensify competition in that market.
STATE REGULATION
The Company believes that most, if not all, states in which it proposes to
operate will require a certification or other authorization to offer intrastate
services. Many of the states in which the Company operates or intends to operate
are in the process of addressing issues relating to the regulation of CLECs. The
Company will also be subject to tariff filing requirements.
The Company, through its subsidiaries, has obtained intrastate authority
for the provision of a full range of local switched services in Illinois,
Indiana, Michigan and Wisconsin. The Company, through its subsidiaries, plans to
obtain additional state authorities to accommodate its business and network
expansion. However, there can be no assurance that the Company will receive the
authorizations it may seek in the future to the extent it expands into other
states or seeks to provide additional services. In most states, the Company is
required to file tariffs setting forth the terms, conditions and prices for
services that are classified as intrastate.
Some states impose, in addition to tariff filing requirements, reporting,
customer service and quality requirements, as well as unbundling and universal
service requirements. In addition, the Company will be subject to the outcome of
generic proceedings held by state utility commissions to determine state
regulatory policies with respect to ILEC and CLEC competition, geographic
build-out, mandatory detariffing, etc. Certain states, including certain of the
Company's target states, have adopted or have pending proceedings to adopt
specific universal service funding obligations.
The Company believes that, as the degree of intrastate competition
increases, the states will offer the ILECs increasing pricing flexibility. This
flexibility may present the ILECs with an opportunity to subsidize services that
compete with the Company's services with revenues generated from non-competitive
services, thereby allowing ILECs to offer competitive services at lower prices.
The Company cannot predict the extent to which this may occur, but it could have
a material adverse effect on the Company and its ability to meet its obligations
on the Notes.
The Company is also subject to requirements in certain states to obtain
prior approval for, or notify the state commission of, certain events such as
transfers of control, sales of assets, corporate reorganizations, issuances of
stock or debt instruments and related transactions.
LOCAL AUTHORIZATIONS
When constructing a network, the Company generally must obtain municipal
franchises and other permits. These rights are typically the subject of
non-exclusive agreements of finite duration and provide for the payment of fees
or the provision of services to the municipality with no or minimal
compensation. In addition, the Company must secure rights-of-way, pole
attachments and other access rights, which are typically provided under
non-exclusive multi-year agreements that generally contain renewal options. In
some municipalities where the Company has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenues or on a per linear foot basis, as well as post
performance bonds or letters of credit. The Company is actively pursuing, in a
number of cities, permits, franchises and other relevant authorities for use of
rights-of-way and utility and other facilities.
The Company installs its fiber optic cable over both aerial and underground
rights-of-way, which it obtains from electric and other utilities, state highway
departments and other governmental authorities, railroads and other providers.
The Telecommunications Act requires most utilities, including electric
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companies and most ILECs, to provide access to rights-of-way to CLECs on
non-discriminatory terms and conditions and at reasonable rates. However, there
can be no assurance that delays and disputes will not occur in connection with
the Company's existing or planned rights-of-way. See "Risk
Factors--Implementation Risks."
EMPLOYEES
As of September 30, 1998, the Company had approximately 460 full-time
employees and plans to have approximately 650 full-time employees by the end of
1998. None of the Company's employees is represented by a labor union or subject
to a collective bargaining agreement. The Company has not experienced any work
stoppages due to labor disputes and believes that its relations with its
employees are good.
PROPERTIES
The Company is headquartered in Grand Rapids, Michigan and leases offices
and space in a number of locations, primarily for regional management and local
sales offices and network equipment installations. The table below lists the
Company's current facilities, all of which are leased, directly or indirectly,
by the Company:
<TABLE>
<CAPTION>
APPROXIMATE
LOCATION LEASE EXPIRATION(1) SQUARE FOOTAGE
-------- -------------------- --------------
<S> <C> <C>
Grand Rapids, Michigan.................................. December 2001(2) 7,800
August 2002(5) 32,200
Green Bay, Wisconsin.................................... July 2001(3) 6,600
February 2003(3) 6,600
January 2003(5) 1,200
Appleton, Wisconsin..................................... April 2003(3) 4,800
September 2002(5) 4,500
Oshkosh, Wisconsin...................................... September 2002(5) 1,100
Milwaukee, Wisconsin.................................... May 2008(5) 4,900
February 2003(3) 3,500
Madison, Wisconsin...................................... March 2003(5) 6,200
November 2003(3) 3,900
South Bend, Indiana..................................... May 2003(4) 5,500
May 2003(3) 3,500
Bloomington, Indiana.................................... June 2003(4) 8,100
April 2003(3) 3,200
Ft. Wayne, Indiana...................................... May 2003(4) 12,800
June 2003(3) 3,800
Evansville, Indiana..................................... August 2008(4) 7,500
July 2003(3) 3,300
Rockford, Illinois...................................... June 2003(4) 6,500
July 2003(3) 3,100
Kalamazoo, Michigan..................................... October 2008(4) 10,500
</TABLE>
- ---------------
(1) Dates indicate expiration of original term of leases, certain of which also
include automatic or optional renewal terms of one or more years.
(2) Sublease of the Company's principal executive offices under a lease in which
an affiliated company is the lessee. See "Certain Relationships and Related
Transactions."
(3) Lease of office space only.
(4) Lease of network equipment facilities only.
(5) Lease of both office space and network equipment facilities.
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The Company believes that its leased facilities are adequate to meet its
current needs in the markets in which it has deployed or begun to deploy its
networks and that additional facilities are available to meet its development
and expansion needs in existing and planned markets for the foreseeable future.
LEGAL PROCEEDINGS
On September 30, 1997, the U.S. Patent and Trademark Office refused to
grant an application for a registered service mark for the "US Xchange" name on
the grounds that it is merely geographically descriptive of telephone
communication services that are rendered in the United States. The decision of
the U.S. Patent and Trademark Office has been appealed. In the event that the
Company is unable to obtain a reversal of the U.S. Patent and Trademark Office's
decision, the "US Xchange" name will not be accorded the legal protection that a
registered service mark would have provided.
The Company is not a party to any material litigation or any other legal
proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS
The following table sets forth certain information concerning the executive
officers and other key management personnel of the Company, including their ages
as of September 30, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
---- --- -----------
<S> <C> <C>
Ronald H. VanderPol 46 Co-Chairman
Richard Postma 47 Co-Chairman and Chief Executive Officer
David J. Easter 39 Executive Vice President of Planning & Business Development
Donald Offringa 48 Vice President of Finance
Barry Raterink 32 Vice President of Engineering & Network Operations
Lee Thibaudeau 46 Regional President of US Xchange of Wisconsin, L.L.C.
Daniel Fabry 35 Vice President of Marketing
Rick G. Pigeon 33 Vice President of Technology Development
</TABLE>
Ronald H. VanderPol, Co-Chairman and co-founder of the Company, has over 14
years of experience in forming and operating successful telecommunications
companies including Teledial America, Inc. (which he founded in 1983 and which
later became known as US Signal), a switch-based long distance reseller
headquartered in Grand Rapids, MI, which was acquired by LCI International, Inc.
in 1996. In 1989, Mr. VanderPol formed City Signal, Inc., one of the earliest
providers of competitive local exchange services in the United States with CLEC
operations in eight cities, the Michigan operations of which were acquired by
Brooks Fiber Properties, Inc. in 1996 and other components of which were
acquired by Nextlink Communications Inc. and Teleport Communications Group Inc.
Other telecommunications operations which were started by Mr. VanderPol and were
spun-off over the same period of time include Digital Signal, Inc., Teledial
America of North Carolina and ATS Network Services of Memphis, Tennessee.
Richard Postma, Co-Chairman, Chief Executive Officer and co-founder of the
Company, has over 14 years of experience in the telecommunications industry,
having served as the General Counsel to Teledial America, Inc., Teledial America
of North Carolina, Digital Signal, Inc., City Signal, Inc. and US Signal for
various periods between 1983 and 1996. As General Counsel, he served as the lead
individual in both the formation process and subsequent sale of those
operations. During the period from 1983 to December 1997, Mr. Postma was a
partner in the Grand Rapids, Michigan law firm of Miller, Johnson, Snell &
Cummiskey, P.L.C. Mr. Postma has extensive regulatory, legal and management
experience in the telecommunications arena and was instrumental in implementing
the first CAP/CLEC strategy in Michigan.
David J. Easter, Executive Vice President of Planning & Business
Development, has over 11 years of experience in the telecommunications industry.
Prior to joining the Company in September 1996, Mr. Easter was a principal of
Telecom Services, Inc., a telecommunications consultant, since February 1996.
From February 1994 to January 1996, Mr. Easter was the Vice President of Network
Services of US Signal and previously held the position of Director of Network
Services of US Signal since March 1993. Prior thereto, Mr. Easter was a director
of Consolidated Communications Inc., a telecommunications services provider.
Donald Offringa, CPA, Vice President of Finance, has overseen the
financial, tax and risk management matters of the Company and its affiliates
since the Company's inception in August 1996. In June 1995, Mr. Offringa joined
Mr. VanderPol's management team as the Vice President of Finance of RVP
Development Corporation, a position he currently holds. Prior to that time, Mr.
Offringa had been a partner with BDO Seidman, LLP since 1986, where he had
worked with US Signal on various financial advisory matters. He has over 23
years of accounting experience with both private and public companies.
Barry Raterink, Vice President of Engineering & Network Operations, has
over 11 years of experience in the telecommunications industry. Prior to joining
the Company in September 1997, Mr. Raterink was Manager of Engineering, Planning
and Provisioning for the Great Lakes regional operations of Brooks Fiber
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Properties, Inc. since February 1996. From 1986 to January 1996, Mr. Raterink
was Manager of the network planning and provisioning groups for Teledial
America, Inc., US Signal and City Signal, Inc., after having implemented and
managed long distance switch sites for Teledial America, Inc.
Lee Thibaudeau, Regional President of US Xchange of Wisconsin, L.L.C., a
wholly owned subsidiary of the Company, has over 13 years of experience in the
telecommunications industry. Prior to joining the Company in March 1997, Mr.
Thibaudeau was Director of Program Management of Schneider National, Inc., a
trucking company, since February 1996. Mr. Thibaudeau served as Vice
President--Operations of Schneider Communications Incorporated ("SCI"), a
regional facilities-based IXC that was headquartered in Wisconsin and is now a
part of Frontier Communications Corporation, a major IXC ("Frontier"), from 1983
to January 1996.
Daniel Fabry, Vice President of Marketing, has over 13 years of experience
in the telecommunications industry. Prior to joining the Company in March 1997,
Mr. Fabry held the position of Director of Marketing for Schneider Logistics,
Inc., a provider of transportation logistics services, since February 1996. From
December 1994 until February 1996, Mr. Fabry was the Vice President of Product
Development of SCI and Frontier. From February 1993 to December 1994, Mr. Fabry
was the Director of Product Development of SCI.
Rick G. Pigeon, Vice President of Technology Development, has over 12 years
of experience in the telecommunications industry. Prior to joining the Company
in March 1997, Mr. Pigeon was the Director of Product Development for Airadigm
Communications Inc. ("Airadigm"), a PCS provider, from April 1996. Prior to
joining Airadigm, Mr. Pigeon was Senior Manager, Local Operations for Frontier
from August 1995 to April 1996. From October 1993 to August 1995, Mr. Pigeon was
Product Manager at SCI. Prior thereto, Mr. Pigeon was Manager of Network Systems
at SCI.
LIMITED LIABILITY COMPANY OPERATING AGREEMENT
The Operating Agreement of the Company (the "Operating Agreement") became
effective as of August 1, 1996, and provides that the Company's maximum duration
is until December 31, 2030. The Operating Agreement provides that the business
of the Company will be managed by the members of the Company (the "Members").
Messrs. VanderPol and Postma, Co-Chairmen and co-founders of the Company, are
currently the only Members of the Company, holding 99% and 1%, respectively, of
the membership interests in the Company. See "Principal Equity Holder." Members
must act collectively through meetings or written consents and vote in
proportion to their relative membership interests. Except as specifically
provided otherwise in the Operating Agreement, the Company's Articles of
Organization or applicable law, the affirmative vote of the Holders of a
majority in interest of the membership interests in the Company is required for
all decisions of the Members. The Operating Agreement provides for annual
meetings of the Members to be held at the dates, times and places that the
Members determine. Special meetings of the Members for any proper purpose may be
called at any time by the Holders of at least 25% of the membership interests in
the Company.
Except as otherwise specifically provided in the Operating Agreement, a
Member does not have the right to sell, assign, pledge, create a security
interest in, exchange or otherwise transfer all or any part of such Member's
membership interest in the Company without the prior written consent of all the
Members. A person or entity may be admitted as an additional Member in the
Company only with the unanimous consent of the then-current Members and upon
compliance with the conditions imposed, if any, by unanimous consent of the
then-current Members. Admission of a new Member may occur by (i) the Company's
issuance of additional membership interests for consideration to be unanimously
determined by the then-current Members or (ii) as a transferee of a Member's
membership interest or any portion thereof, subject to the terms and conditions
of the Operating Agreement.
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SUMMARY COMPENSATION TABLE
The following table sets forth the compensation paid to the Chief Executive
Officer of the Company and the three executive officers of the Company whose
total annual salary and bonus exceeded $100,000 during 1997.
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
--------------------------------------------- ------------
OTHER ANNUAL SECURITIES ALL OTHER
NAME AND COMPENSATION UNDERLYING COMPENSATION
PRINCIPAL POSITION YEAR SALARY($) BONUS($) ($) OPTIONS(#) ($)
------------------ ---- --------- -------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Richard Postma................ 1997 --(1) --(1) -- -- --
Co-Chairman and
Chief Executive Officer
David J. Easter............... 1997 $111,667 $25,000(2) -- -- --
Executive Vice President of
Planning & Business
Development
Lee Thibaudeau................ 1997 $102,917 $20,000(3) -- -- --
Regional President of US
Xchange of Wisconsin, L.L.C.
Daniel Fabry.................. 1997 $ 90,461 $20,000(3) -- -- --
Vice President of Marketing
</TABLE>
- ---------------
(1) Mr. Postma did not receive any salary or bonus for his services as Chief
Executive Officer of the Company during 1997, during which time he was a
member of a law firm that provided legal services to the Company.
(2) As determined by the Co-Chairmen of the Company, at their discretion. Such
officer does not have an employment agreement with the Company.
(3) As determined by the Company's management in accordance with such officer's
employment agreement. See "--Employment Agreements."
EMPLOYMENT AGREEMENTS
The Company entered into employment agreements with each of Lee Thibaudeau,
Regional President of US Xchange of Wisconsin, L.L.C., a wholly-owned subsidiary
of the Company, Daniel Fabry, Vice President of Marketing, and Rick G. Pigeon,
Vice President of Technology Development (each, an "Employment Agreement"). The
terms of the Employment Agreements of Messrs. Thibaudeau, Fabry and Pigeon
expire on March 16, 2002, March 31, 2002 and April 20, 1999, respectively. The
term of each Employment Agreement is automatically renewable for successive
one-year periods unless terminated by either party by written notice at least 90
days prior to the applicable anniversary date of the agreement. Pursuant to the
Employment Agreements, the Company must pay Messrs. Thibaudeau, Fabry and Pigeon
an annual salary of not less than $130,000, $120,000 and $85,000, respectively.
Each of such officers is eligible under his Employment Agreement for an annual
bonus in such amount as is approved by the Company's management, which the
respective Employment Agreement provides is anticipated at a minimum of $20,000
for each of Messrs. Thibaudeau and Fabry and a maximum of $15,000 for Mr.
Pigeon. In the event that the Company terminates the employment of Mr.
Thibaudeau or Mr. Fabry for any reason other than "just cause" (as defined
therein), the Company must continue to pay the executive's salary and benefits
for a period of one year following the date of termination. Such continuing
salary and benefits obligations are personally guaranteed by Ronald H.
VanderPol, the Company's Co-Chairman and co-founder. See "Certain Relationships
and Related Transactions." The Employment Agreements contain customary
confidentiality, non-competition and non-solicitation provisions which are
effective during the term of the Employment Agreement and for a period of one
year thereafter, unless the executive's employment is terminated by the Company
without "just cause."
Additionally, the Employment Agreements of Messrs. Thibaudeau and Fabry
provide that upon the first to occur of: (i) the sale of the Company's Wisconsin
region assets; (ii) the sale of all of the Company's assets or equity interests;
(iii) the completion of an initial public offering of the Company's equity
interests; or (iv) a
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merger of the Company with another entity in which the Company is not the
surviving entity (each, a "Triggering Event"), the Company will pay Messrs.
Thibaudeau and Fabry the first $1.5 million and $500,000, respectively, of the
net equity of the Wisconsin region (after subtracting the Company's
capitalization and outstanding debt related to the Wisconsin region) ("Equity
Guarantee"). The Company will also pay Messrs. Thibaudeau, Fabry and Pigeon a
specified share (the "Equity Share") of the total net equity following the
occurrence of a Triggering Event, provided, however, that the respective Equity
Guarantee payments described above shall be included in calculating the
applicable Equity Share of Messrs. Thibaudeau and Fabry. Messrs. Thibaudeau,
Fabry and Pigeon's applicable Equity Shares are 5%, 2% and 1%, respectively.
Notwithstanding the above, if the executive's employment is terminated for any
reason during the first five years of his Employment Agreement, the executive
will forfeit 20% of the Equity Guarantee and 20% of the Equity Share for each
year or partial year less than five that the executive is employed by the
Company. Upon the occurrence of a Triggering Event, the executive must execute
an employment agreement and non-compete agreement with the purchaser for a
period of not less than one year, provided that the salary to be paid Messrs.
Thibaudeau, Fabry and Pigeon during such period will not be less than such
executive's annual salary immediately prior to the sale, and further provided
that such employment agreement and non-compete agreement must be consistent with
the terms and conditions of such executive's Employment Agreement.
PRINCIPAL EQUITY HOLDER
Ronald H. VanderPol, the Company's Co-Chairman and co-founder, has provided
the Company with its initial $60 million of equity capital and beneficially owns
99% of the membership interests in the Company. Richard Postma, the Company's
Co-Chairman, Chief Executive Officer and co-founder, owns 1% of the membership
interests in the Company. See "Management--Limited Liability Company Operating
Agreement."
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Ronald H. VanderPol, the Company's Co-Chairman and co-founder, has provided
the Company its initial equity capital of $60 million. Of such amount,
approximately $26 million was invested at December 31, 1997, and the balance was
invested during the first four months of 1998. These funds have been used for
the acquisition of capital assets and funding of operating costs. Of the amounts
invested by Mr. VanderPol, (i) approximately $257,000 and $255,000 represented
the value of management and administrative services provided to the Company
during 1997 and the first nine months of 1998, respectively, by RVP Development
Corporation ("RVP"), a holding company wholly owned by Mr. VanderPol, pursuant
to an Expense Sharing Agreement dated February 1, 1997 between the Company and
RVP (the "RVP Agreement") and (ii) $3,283,750 represented securities contributed
by Mr. VanderPol to the Company. (Mr. VanderPol has agreed to make an additional
cash equity contribution to the Company to the extent, if any, that the Company
realizes less than $3,283,750 upon the disposition of such securities.) Pursuant
to the RVP Agreement, the Company was billed for its pro rata share of employee
compensation costs and facilities expenses for the Company's principal executive
offices in Grand Rapids, Michigan, which were funded by RVP in 1997. Richard
Postma, the Company's Co-Chairman and Chief Executive Officer, also serves as
Co-Chairman of RVP, and Donald Offringa, the Company's Vice President of
Finance, also serves as the Vice President of Finance of RVP. RVP has guaranteed
the payment by the Company of its Bank Credit Facility. See "Description of
Existing Indebtedness."
The Company also leases a corporate aircraft from an entity controlled by
Mr. VanderPol under a lease that is terminable by either party upon 10 days'
prior written notice. The Company made payments to such entity for such aircraft
totalling approximately $69,000 and $80,000 during 1997 and the first nine
months of 1998, respectively.
The Company believes that the above transactions were on terms no less
favorable to the Company than could have been obtained in transactions with
independent third parties.
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Pursuant to Employment Agreements between the Company and certain of its
executive officers, Mr. VanderPol has personally guaranteed the payment of
salary and continuation of benefits for a period of one year following the date
of termination of employment of any of such persons in the event that the
Company terminates such employment agreements for any reason other than "just
cause" (as defined therein). See "Management--Employment Agreements."
DESCRIPTION OF EXISTING INDEBTEDNESS
In August 1997, the Company entered into its $4.0 million Bank Credit
Facility, which was fully utilized as of March 31, 1998. The proceeds of the
Bank Credit Facility have been used for the acquisition of office furniture,
equipment and computer software and for construction costs related to leasehold
improvements of office and switch site locations. At September 30, 1998, the
Company had $3.6 million of outstanding indebtedness under the Bank Credit
Facility. The borrowings bear interest at an annual rate equal to (i) the bank's
prime lending rate less 1/2% or (ii) 2% over the bank's costs of funds, at the
Company's option. The effective annual rate of the Bank Credit Facility was
7.63% at September 30, 1998. The borrowings are payable in monthly installments
of $66,667 through March 31, 2003 and are secured by specific assets of the
Company and US Xchange of Wisconsin, L.L.C., a wholly owned subsidiary of the
Company, and the guarantees of RVP and US Xchange of Wisconsin, L.L.C.
The Bank Credit Facility contains certain affirmative and restrictive
covenants, including, but not limited to, limitations on the Company's ability
to (i) enter into any merger or consolidation or sell, lease, transfer or
dispose of all, substantially all or any material part of its assets, except in
the ordinary course of business, (ii) guarantee, endorse or otherwise become
secondarily liable for or upon the obligations of others, except by endorsement
for deposit in the ordinary course of business or (iii) create, incur, assume or
suffer to exist any mortgage, pledge, encumbrance, security interest, lien or
charge of any kind upon any of its assets. All financial covenants under the
Bank Credit Facility are applicable to RVP and not the Company. At September 30,
1998, RVP was in compliance with all covenant requirements under the Bank Credit
Facility.
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DESCRIPTION OF THE NOTES
The Private Notes were, and the Exchange Notes will be, issued under the
Indenture dated as of June 25, 1998, between the Company, as issuer, and The
Bank of New York, as Trustee. A copy of the Indenture is available upon request
from the Company. The following summary of certain provisions of the Indenture
does not purport to be complete and is subject to, and is qualified in its
entirety by reference to, all the provisions of the Indenture, including the
definitions of certain terms therein and those terms made a part thereof by the
Trust Indenture Act of 1939, as amended. Whenever particular defined terms of
the Indenture not otherwise defined herein are referred to, such defined terms
are incorporated herein by reference to the Indenture. For definitions of
certain capitalized terms used in the following summary, see "--Certain
Definitions" below.
GENERAL
The Notes are unsubordinated, unsecured (except to the extent described
below under "--Security") indebtedness of the Company, limited to $200.0 million
aggregate principal amount, and will mature on July 1, 2008. Interest on the
Notes accrues at the rate of 15% per annum from June 25, 1998, or from the most
recent Interest Payment Date to which interest has been paid or provided for,
payable semi-annually (to Holders of record at the close of business on the
December 15 or June 15 immediately preceding the Interest Payment Date) on
January 1 and July 1 of each year, commencing January 1, 1999. Interest is be
computed on the basis of a 360-day year of twelve 30-day months.
Principal of, premium, if any, and interest on the Notes is payable, and
the Notes may be exchanged or transferred, at the office or agency of the
Company in the Borough of Manhattan, the City of New York (which currently is
the corporate trust office of the Trustee at 101 Barclay Street, 21-W, New York,
New York 10286); provided that, at the option of the Company, payment of
interest may be made by check mailed to the Holders of the Notes at their
addresses as they appear in the Security Register.
The Notes are issued only in fully registered form, without coupons, in
denominations of $1,000 of principal amount and any integral multiple thereof.
See "--Book-Entry; Delivery and Form." No service charge will be made for any
registration of transfer or exchange of Notes, but the Company may require
payment of a sum sufficient to cover any transfer tax or other similar
governmental charge payable in connection therewith.
The Private Notes and the Exchange Notes will be treated as a single class
for all purposes under the Indenture.
NON-CALLABLE
The Notes are non-callable.
REDEMPTION UPON RECEIPT OF PUBLIC EQUITY OFFERING PROCEEDS
At any time prior to July 1, 2001, the Company may redeem up to 35% of the
aggregate principal amount of the Notes with the proceeds of one or more Public
Equity Offerings following which there is a Public Market, at any time or from
time to time in part, at a Redemption Price (expressed as a percentage of
principal amount) of 115%, plus accrued interest, if any, to the Redemption
Date; provided that (i) Notes representing at least 65% of the aggregate
principal amount of Notes originally issued remain outstanding after each such
redemption and (ii) notice of any such redemption is mailed within 60 days of
such Public Equity Offering.
The selection of the Notes for redemption will be made by the Trustee in
compliance with the requirements of the principal national securities exchange,
if any, on which the Notes are listed or, if the Notes are not listed on a
national securities exchange, by lot or by such other method as the Trustee in
its sole discretion shall deem to be fair and appropriate; provided that no Note
of $1,000 in principal amount or less shall be redeemed in part. If any Note is
to be redeemed in part only, the notice of redemption relating to such Note
shall state the portion of the principal amount thereof to be redeemed. A new
Note in principal amount
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equal to the unredeemed portion thereof will be issued in the name of the Holder
thereof upon cancellation of the original Note.
SINKING FUND
There are no sinking fund payments required for the Notes.
SECURITY
Pursuant to the Indenture, the Company has purchased and pledged to the
Trustee, as security for the benefit of the Holders of the Notes, approximately
$79.6 million of Pledged Securities which the Company believes will be
sufficient, upon receipt of scheduled interest and principal payments thereon,
to provide for payment in full of the first six scheduled interest payments due
on the Notes.
The Pledged Securities are held by the Trustee in the Pledge Account.
Interest earned on the Pledged Securities will be added to the Pledge Account.
Pursuant to the Pledge Agreement, immediately prior to an Interest Payment Date,
the Company may either deposit with the Trustee from funds otherwise available
to the Company cash sufficient to pay the interest scheduled to be paid on such
date or the Company may direct the Trustee to release from the Pledge Account
proceeds sufficient to pay interest then due on the Notes. In the event that the
funds or Pledged Securities held in the Pledge Account exceed the amount
sufficient, in the opinion of a nationally recognized firm of independent public
accountants selected by the Company, to provide for payment in full of the first
six scheduled interest payments due on the Notes (or, in the event any interest
payments have been made, an amount sufficient to provide for payment in full of
any interest payments remaining, up to and including the sixth scheduled
interest payment), the Trustee will be permitted to release to the Company, at
the Company's request, any such excess amount. A failure to pay interest on the
Notes in a timely manner through the first six scheduled Interest Payment Dates
will constitute an immediate Event of Default under the Indenture, with no grace
or cure period. The Pledged Securities and Pledge Account will also secure the
repayment of the principal amount of, and premium, if any, on the Notes.
Under the Pledge Agreement, once the Company makes the first six scheduled
interest payments on the Notes, all of the remaining funds or Pledged
Securities, if any, will be released from the Pledge Account and thereafter the
Notes will be unsecured.
RANKING
The Notes are unsubordinated, unsecured (except to the extent described
above under "--Security") indebtedness of the Company, rank pari passu in right
of payment with all unsubordinated, unsecured indebtedness of the Company, rank
senior in right of payment to all subordinated indebtedness of the Company and
are subordinated to the claims of holders of any secured indebtedness of the
Company with respect to the assets securing such secured indebtedness. Moreover,
the Company is a holding company, and the Notes are effectively subordinated to
all existing and future liabilities (including trade payables) of the Company's
subsidiaries. As of September 30, 1998, the total amount of indebtedness of the
Company (parent only) was $203.6 million, of which $200.0 million represented
the Notes and $3.6 million was secured indebtedness, to which the Notes are
subordinated to the extent of the value of the assets securing such
indebtedness. See "Capitalization" and "Description of Existing Indebtedness."
As of September 30, 1998, the Company's subsidiaries had approximately $9.1
million in the aggregate of liabilities (excluding intercompany payables), to
which the Notes are effectively subordinated. See "Risk Factors--Priority of
Holders of Secured Indebtedness" and "--Holding Company Structure; Structural
Subordination of the Notes."
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
covenants and other provisions of the Indenture. Reference is made to the
Indenture for the definition of any other capitalized term used herein for which
no definition is provided.
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"Acquired Indebtedness" means Indebtedness of a Person existing at the time
such Person becomes a Restricted Subsidiary or assumed in connection with an
Asset Acquisition by a Restricted Subsidiary and not Incurred in connection
with, or in anticipation of, such Person becoming a Restricted Subsidiary or
such Asset Acquisition.
"Adjusted Consolidated Net Income" means, for any period, the aggregate net
income (or loss) of the Company and its Restricted Subsidiaries for such period
determined in conformity with GAAP; provided that the following items shall be
excluded in computing Adjusted Consolidated Net Income (without duplication):
(i) the net income (or loss) of any Person that is not a Restricted Subsidiary,
except (x) with respect to net income, to the extent of the amount of dividends
or other distributions actually paid to the Company or any of its Restricted
Subsidiaries by such Person during such period and (y) with respect to net
losses, to the extent of the amount of Investments made by the Company or any
Restricted Subsidiary in such Person during such period; (ii) solely for the
purposes of calculating the amount of Restricted Payments that may be made
pursuant to clause (C) of the first paragraph of the "Limitation on Restricted
Payments" covenant described below (and in such case, except to the extent
includable pursuant to clause (i) above), the net income (or loss) of any Person
accrued prior to the date it becomes a Restricted Subsidiary or is merged into
or consolidated with the Company or any of its Restricted Subsidiaries or all or
substantially all of the property and assets of such Person are acquired by the
Company or any of its Restricted Subsidiaries; (iii) the net income of any
Restricted Subsidiary to the extent that the declaration or payment of dividends
or similar distributions by such Restricted Subsidiary of such net income is not
at the time permitted by the operation of the terms of its charter or any
agreement, instrument, judgment, decree, order, statute, rule or governmental
regulation applicable to such Restricted Subsidiary; (iv) any gains or losses
(on an after-tax basis) attributable to Asset Sales; (v) except for purposes of
calculating the amount of Restricted Payments that may be made pursuant to
clause (C) of the first paragraph of the "Limitation on Restricted Payments"
covenant described below, any amount paid or accrued as dividends on Preferred
Stock of the Company or any Restricted Subsidiary owned by Persons other than
the Company and any of its Restricted Subsidiaries; (vi) all extraordinary gains
and extraordinary losses; and (vii) any compensation expense paid or payable
solely with Capital Stock (other than Disqualified Stock) of the Company or any
options, warrants or other rights to acquire Capital Stock (other than
Disqualified Stock) of the Company.
"Adjusted Consolidated Net Tangible Assets" means the total amount of
assets of the Company and its Restricted Subsidiaries (less applicable
depreciation, amortization and other valuation reserves), except to the extent
resulting from write-ups of capital assets (excluding write-ups in connection
with accounting for acquisitions in conformity with GAAP), after deducting
therefrom (i) all current liabilities of the Company and its Restricted
Subsidiaries (excluding intercompany items) and (ii) all goodwill, trade names,
trademarks, patents, unamortized debt discount and expense and other like
intangibles, all as set forth on the most recent quarterly or annual
consolidated balance sheet of the Company and its Restricted Subsidiaries,
prepared in conformity with GAAP and filed with the Commission or provided to
the Trustee pursuant to the "Commission Reports and Reports to Holders"
covenant.
"Affiliate" means, as applied to any Person, any other Person directly or
indirectly controlling, controlled by, or under direct or indirect common
control with, such Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as applied to any Person, means the
possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of such Person, whether through the
ownership of Voting Stock, including, without limitation, membership interests,
by contract or otherwise.
"Asset Acquisition" means (i) an investment by the Company or any of its
Restricted Subsidiaries in any other Person pursuant to which such Person shall
become a Restricted Subsidiary or shall be merged into or consolidated with the
Company or any of its Restricted Subsidiaries; provided that such Person's
primary business is similar, related, ancillary or complementary to the
businesses of the Company and its Restricted Subsidiaries on the date of such
investment or (ii) an acquisition by the Company or any of its Restricted
Subsidiaries of the property and assets of any Person other than the Company or
any of its Restricted Subsidiaries that constitute substantially all of a
division, operating unit or line of business of such Person;
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provided that the property and assets acquired are similar, related, ancillary
or complementary to the businesses of the Company and its Restricted
Subsidiaries on the date of such acquisition.
"Asset Sale" means any sale, transfer or other disposition (including by
way of merger, consolidation or sale-leaseback transaction) in one transaction
or a series of related transactions by the Company or any of its Restricted
Subsidiaries to any Person other than the Company or any of its Restricted
Subsidiaries of (i) all or any of the Capital Stock of any Restricted
Subsidiary, (ii) all or substantially all of the property and assets of an
operating unit or business of the Company or any of its Restricted Subsidiaries
or (iii) any other property and assets (other than the Capital Stock or other
Investment in an Unrestricted Subsidiary) of the Company or any of its
Restricted Subsidiaries outside the ordinary course of business of the Company
or such Restricted Subsidiary and, in each case, that is not governed by the
provisions of the Indenture applicable to mergers, consolidations and sales of
all or substantially all of the assets of the Company; provided that "Asset
Sale" shall not include (a) sales, transfers or other dispositions of inventory,
receivables and other current assets, (b) sales, transfers or other dispositions
of assets constituting a Restricted Payment permitted to be made under the
"Limitation on Restricted Payments" covenant, (c) sales, transfers or other
dispositions of assets with a fair market value (as certified in an Officers'
Certificate) not in excess of $2 million in any transaction or series of related
transactions, (d) sales, transfers or other dispositions of assets for
consideration at least equal to the fair market value of the assets sold or
disposed of, to the extent that the consideration received would constitute
property or assets of the kind described in clause (B) of the first paragraph of
the "Limitation on Asset Sales" covenant, (e) a disposition of cash or Temporary
Cash Investments, (f) the lease, assignment of a lease or sublease of any real
or personal property in the ordinary course of business, (g) foreclosures on
assets, (h) pledges of assets or stock by the Company or any of its Restricted
Subsidiaries otherwise permitted under the Indenture, including such pledges
securing Indebtedness under the Credit Agreement or (i) sale-leaseback
transactions permitted to be made under the "Limitation on Sale-Leaseback
Transactions" covenant described below.
"Average Life" means, at any date of determination with respect to any debt
security, the quotient obtained by dividing (i) the sum of the products of (a)
the number of years from such date of determination to the dates of each
successive scheduled principal payment of such debt security and (b) the amount
of such principal payment by (ii) the sum of all such principal payments.
"Board of Directors" means, with respect to any Person, the members, board
of directors or equivalent governing body of such Person.
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non-voting) in equity of such Person, whether outstanding on the
Closing Date or issued thereafter, including, without limitation, all Common
Stock, Preferred Stock or Membership Interests.
"Capitalized Lease" means, as applied to any Person, any lease of any
property (whether real, personal or mixed) of which the discounted present value
of the rental obligations of such Person as lessee, in conformity with GAAP, is
required to be capitalized on the balance sheet of such Person.
"Capitalized Lease Obligations" means, as of any time, the liability in
respect of a Capitalized Lease that would at such time be required to be
capitalized and reflected as a liability on a balance sheet prepared in
accordance with GAAP.
"Change of Control" means such time as (i) (a) prior to the occurrence of a
Public Market, a "person" or "group" (within the meaning of Sections 13(d) and
14(d)(2) of the Exchange Act) becomes the ultimate "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act) of Voting Stock representing a
greater percentage of the total voting power of the Voting Stock of the Company,
on a fully diluted basis, than is beneficially owned by the Existing Controlling
Holder on such date and (b) after the occurrence of a Public Market, a "person"
or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange
Act) becomes the ultimate "beneficial owner" (as defined in Rule 13d-3 under the
Exchange Act) of more than 35% of the total voting power of the Voting Stock of
the Company on a fully diluted basis and such ownership represents a greater
percentage of the total voting power of the Voting Stock of the Company, on a
fully
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diluted basis, than is held by the Existing Controlling Holder on such date; or
(ii) individuals who on the Closing Date constitute the Board of Directors
(together with any new Directors whose election by the Board of Directors or
whose nomination by the Board of Directors for election by the Holders of the
Company's Voting Stock was approved by a vote of at least two-thirds of the
members of the Board of Directors then in office who either were members of the
Board of Directors on the Closing Date or whose election or nomination for
election was previously so approved) cease for any reason to constitute a
majority of the members of the Board of Directors then in office.
"Closing Date" means the date on which the Notes are originally issued
under the Indenture.
"Consolidated EBITDA" means, for any period, Adjusted Consolidated Net
Income for such period plus, to the extent such amount was deducted in
calculating such Adjusted Consolidated Net Income, (i) Consolidated Interest
Expense, (ii) income taxes (other than income taxes (either positive or
negative) attributable to extraordinary and non-recurring gains or losses or
sales of assets), (iii) depreciation expense, (iv) amortization expense and (v)
all other non-cash items reducing Adjusted Consolidated Net Income (other than
items that will require cash payments and for which an accrual or reserve is, or
is required by GAAP to be, made), less all non-cash items increasing (or, in the
case of a loss, decreasing) Adjusted Consolidated Net Income, all as determined
on a consolidated basis for the Company and its Restricted Subsidiaries in
conformity with GAAP; provided that, if any Restricted Subsidiary is not a
Wholly Owned Restricted Subsidiary, Consolidated EBITDA shall be reduced (to the
extent not otherwise reduced in accordance with GAAP) or increased (in the case
of a loss) by an amount equal to (A) the amount of the Adjusted Consolidated Net
Income attributable to such Restricted Subsidiary multiplied by (B) the
percentage of the Capital Stock of such Restricted Subsidiary not "beneficially
owned" on the last day of such period by the Company or any of its Restricted
Subsidiaries.
"Consolidated Interest Expense" means, for any period, the aggregate amount
of interest in respect of Indebtedness (including, without limitation,
amortization of original issue discount on any Indebtedness and the interest
portion of any deferred payment obligation, calculated in accordance with the
effective interest method of accounting; all commissions, discounts and other
fees and charges owed with respect to letters of credit and bankers' acceptance
financing; the net costs associated with Interest Rate Agreements; and interest
in respect of Indebtedness that is Guaranteed or secured by the Company or any
of its Restricted Subsidiaries) and the interest component of Capitalized Lease
Obligations paid, accrued or scheduled to be paid or to be accrued by the
Company and its Restricted Subsidiaries during such period; excluding, however,
(i) any amount of such interest of any Restricted Subsidiary if the net income
of such Restricted Subsidiary is excluded in the calculation of Adjusted
Consolidated Net Income pursuant to clause (iii) of the definition thereof (but
only in the same proportion as the net income of such Restricted Subsidiary is
excluded from the calculation of Adjusted Consolidated Net Income pursuant to
clause (iii) of the definition thereof) and (ii) any premiums, fees and expenses
(and any amortization thereof) payable in connection with the offering of the
Notes, all as determined on a consolidated basis (without taking into account
Unrestricted Subsidiaries) in conformity with GAAP.
"Consolidated Leverage Ratio" means, on any Transaction Date, the ratio of
(i) the aggregate amount of Indebtedness of the Company and its Restricted
Subsidiaries on a consolidated basis outstanding on such Transaction Date to
(ii) the aggregate amount of Consolidated EBITDA for the then most recent four
fiscal quarters for which financial statements of the Company have been filed
with the Commission or provided to the Trustee pursuant to the "Commission
Reports and Reports to Holders" covenant described below (such four fiscal
quarter period being the "Four Quarter Period"); provided that, in making the
foregoing calculation, pro forma effect shall be given to the following events
which occur from the beginning of the Four Quarter Period through the
Transaction Date (the "Reference Period"): (A) the Incurrence of the
Indebtedness with respect to which the computation is being made and (if
applicable) the application of the net proceeds therefrom, including to
refinance other Indebtedness, as if such Indebtedness was incurred, and the
application of such proceeds occurred, at the beginning of the Four Quarter
Period; (B) the Incurrence, repayment or retirement of any other Indebtedness by
the Company and its Restricted Subsidiaries since the first day of the Four
Quarter Period as if such Indebtedness was incurred, repaid or retired at the
beginning of the Four Quarter Period; (C) in the case of Acquired Indebtedness,
the related acquisition, as if such
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acquisition occurred at the beginning of the Four Quarter Period; and (D) any
acquisition or disposition by the Company and its Restricted Subsidiaries of any
company or any business or any assets out of the ordinary course of business,
whether by merger, stock purchase or sale or asset purchase or sale or any
related repayment of Indebtedness, in each case since the first day of the Four
Quarter Period, assuming such acquisition or disposition had been consummated on
the first day of the Four Quarter Period and after giving pro forma effect to
net cost savings that the Company reasonably believes in good faith could have
been achieved during the Four Quarter Period as a result of such acquisition or
disposition (provided that both (1) such cost savings were identified and
quantified in an Officers' Certificate delivered to the Trustee at the time of
the consummation of the acquisition or disposition and (2) with respect to each
acquisition or disposition completed prior to the ninetieth day preceding such
date of determination, actions were commenced or initiated by the Company within
90 days of such acquisition or disposition to effect such cost savings
identified in such Officers' Certificate and with respect to any other
acquisition or disposition, such Officers' Certificate sets forth the specific
steps to be taken within the 90 days after such acquisition or disposition to
accomplish such cost savings); provided that for purposes of calculating this
ratio, if any Restricted Subsidiary is not a Wholly Owned Restricted Subsidiary,
the aggregate amount of Indebtedness of the Company and its Restricted
Subsidiaries shall be reduced by an amount equal to (X) the amount of
Indebtedness attributable to such Restricted Subsidiary multiplied by (Y) the
percentage of the Capital Stock of such Restricted Subsidiary not "beneficially
owned" on the last day of such period by the Company or any of its Restricted
Subsidiaries.
"Consolidated Net Worth" means, at any date of determination, Capital Stock
as set forth on the most recently available quarterly or annual consolidated
balance sheet of the Company and its Restricted Subsidiaries (which shall be as
of a date not more than 90 days prior to the date of such computation, and which
shall not take into account Unrestricted Subsidiaries), less any amounts
attributable to Disqualified Stock or any equity security convertible into or
exchangeable for Indebtedness, the cost of treasury stock, if any, and the
principal amount of any promissory notes receivable from the sale of the Capital
Stock of the Company or any of its Restricted Subsidiaries, each item to be
determined in conformity with GAAP (excluding the effects of foreign currency
exchange adjustments under Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 52).
"Credit Agreement" means the Credit Agreement, dated August 28, 1997,
between the Company and Comerica Bank.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Directors" means, with respect to any Person, the members of the Board of
Directors of such Person.
"Disqualified Stock" means any class or series of Capital Stock of any
Person that by its terms or otherwise is (i) required to be redeemed prior to
the Stated Maturity of the Notes, (ii) redeemable at the option of the Holder of
such class or series of Capital Stock at any time prior to the Stated Maturity
of the Notes or (iii) convertible into or exchangeable for Capital Stock
referred to in clause (i) or (ii) above or Indebtedness having a scheduled
maturity prior to the Stated Maturity of the Notes; provided that any Capital
Stock that would not constitute Disqualified Stock but for provisions thereof
giving Holders thereof the right to require such Person to repurchase or redeem
such Capital Stock upon the occurrence of an "asset sale" or "change of control"
occurring prior to the Stated Maturity of the Notes shall not constitute
Disqualified Stock if the "asset sale" or "change of control" provisions
applicable to such Capital Stock are no more favorable to the Holders of such
Capital Stock than the provisions contained in "Limitation on Asset Sales" and
"Repurchase of Notes upon a Change of Control" covenants described below and
such Capital Stock, or the agreements or instruments governing the redemption
rights thereof, specifically provides that such Person will not repurchase or
redeem any such stock pursuant to such provision prior to the Company's
repurchase of such Notes as are required to be repurchased pursuant to the
"Limitation on Asset Sales" and "Repurchase of Notes upon a Change of Control"
covenants described below.
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"Excess Proceeds" has the meaning set forth in the final sentence of the
first paragraph of the "Limitation on Asset Sales" covenant.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Existing Controlling Holder" means Ronald H. VanderPol and his Affiliates.
"Fair market value" means the price that would be paid in an arm's-length
transaction between an informed and willing seller under no compulsion to sell
and an informed and willing buyer under no compulsion to buy, as determined in
good faith by the Board of Directors, whose determination shall be conclusive if
evidenced by a Board Resolution; provided that (x) the fair market value of any
security registered under the Exchange Act shall be the average of the closing
prices, regular way, of such security for the 20 consecutive trading days
immediately preceding the sale of Capital Stock and (y) in the event the
aggregate fair market value of any other property (other than cash or cash
equivalents) received by the Company exceeds $30 million, the fair market value
of such property shall be determined by a nationally recognized investment
banking firm or a nationally recognized firm having appraisal expertise in the
specific area which is the subject of such determination and set forth in their
written opinion which shall be delivered to the Trustee.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Closing Date, including, without limitation,
those set forth in the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants and statements
and pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as are approved by a significant segment of the
accounting profession. All ratios and computations contained or referred to in
the Indenture shall be computed in conformity with GAAP applied on a consistent
basis, except that calculations made for purposes of determining compliance with
the terms of the covenants and with other provisions of the Indenture shall be
made without giving effect to (i) the amortization of any expenses incurred in
connection with the offering of the Notes and (ii) except as otherwise provided,
the amortization of any amounts required or permitted by Accounting Principles
Board Opinion Nos. 16 and 17.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness of any other Person and,
without limiting the generality of the foregoing, any obligation, direct or
indirect, contingent or otherwise, of such Person (i) to purchase or pay (or
advance or supply funds for the purchase or payment of) such Indebtedness of
such other Person (whether arising by virtue of partnership arrangements, or by
agreements to keep-well, to purchase assets, goods, securities or services
(unless such purchase arrangements are on arm's-length terms and are entered
into in the ordinary course of business), to take-or-pay, or to maintain
financial statement conditions or otherwise) or (ii) entered into for purposes
of assuring in any other manner the obligee of such Indebtedness of the payment
thereof or to protect such obligee against loss in respect thereof (in whole or
in part); provided that the term "Guarantee" shall not include endorsements for
collection or deposit in the ordinary course of business. The term "Guarantee"
used as a verb has a corresponding meaning.
"Incur" means, with respect to any Indebtedness, to incur, create, issue,
assume, Guarantee or otherwise become liable for or with respect to, or become
responsible for, the payment of, contingently or otherwise, such Indebtedness,
including an "Incurrence" of Acquired Indebtedness; provided that a change in
GAAP that results in an obligation of such Person becoming Indebtedness shall be
deemed not to be an Incurrence of such Indebtedness by such Person and that
neither the accrual of interest nor the accretion of original issue discount
shall be considered an Incurrence of Indebtedness.
"Indebtedness" means, with respect to any Person at any date of
determination (without duplication), (i) all indebtedness of such Person for
borrowed money, (ii) all obligations of such Person evidenced by bonds,
debentures, notes or other similar instruments, (iii) all obligations of such
Person in respect of letters of credit or other similar instruments (including
reimbursement obligations with respect thereto, but excluding obligations with
respect to letters of credit (including trade letters of credit) securing
obligations (other than obligations described in clause (i) or (ii) above or
(v), (vi) or (vii) below) entered into in the ordinary course of business of
such Person to the extent such letters of credit are not drawn upon or, if drawn
upon, to the
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extent such drawing is reimbursed no later than the third Business Day following
receipt by such Person of a demand for reimbursement), (iv) all obligations of
such Person to pay the deferred and unpaid purchase price of property or
services, which purchase price is due more than six months after the date of
placing such property in service or taking delivery and title thereto or the
completion of such services, except Trade Payables, (v) all Capitalized Lease
Obligations of such Person, (vi) all Indebtedness referred to in clauses (i)
through (v) hereof of other Persons secured by a Lien on any asset of such
Person, whether or not such Indebtedness is assumed by such Person; provided
that the amount of such Indebtedness shall be the lesser of (A) the fair market
value of such asset at such date of determination and (B) the amount of such
Indebtedness, (vii) all Indebtedness of other Persons Guaranteed by such Person
to the extent such Indebtedness is Guaranteed by such Person and (viii) to the
extent not otherwise included in this definition, obligations under Currency
Agreements and Interest Rate Agreements. The amount of Indebtedness of any
Person at any date shall be the outstanding balance at such date (or, in the
case of a revolving credit or other similar facility, the total amount of funds
outstanding on the date of determination) of all unconditional obligations as
described above and, with respect to contingent obligations, the maximum
liability upon the occurrence of the contingency giving rise to the obligation,
provided that (A) the amount outstanding at any time of any Indebtedness issued
with original issue discount is the face amount of such Indebtedness less the
remaining unamortized portion of the original issue discount of such
Indebtedness at the time of its issuance as determined in conformity with GAAP,
(B) money borrowed and set aside at the time of the Incurrence of any
Indebtedness in order to prefund the payment of the interest on such
Indebtedness shall not be deemed to be "Indebtedness" so long as such money is
held to secure the payment of such interest and (C) Indebtedness shall not
include any liability for federal, state, local or other taxes.
"Interest Rate Agreement" means any interest rate protection agreement,
interest rate future agreement, interest rate option agreement, interest rate
swap agreement, interest rate cap agreement, interest rate collar agreement,
interest rate hedge agreement, option or future contract or other similar
agreement or arrangement.
"Investment" in any Person means any direct or indirect advance, loan or
other extension of credit (including, without limitation, by way of Guarantee or
similar arrangement; but excluding advances to customers in the ordinary course
of business that are, in conformity with GAAP, recorded as accounts receivable
on the balance sheet of the Company or its Restricted Subsidiaries and travel
and similar advances to Persons in the ordinary course of business) or capital
contribution to (by means of any transfer of cash or other property to others or
any payment for property or services for the account or use of others), or any
purchase or acquisition of Capital Stock, bonds, notes, debentures or other
similar instruments issued by, such Person and shall include (i) the designation
of a Restricted Subsidiary as an Unrestricted Subsidiary and (ii) the fair
market value of the Capital Stock (or any other Investment), held by the Company
or any of its Restricted Subsidiaries, of (or in) any Person that has ceased to
be a Restricted Subsidiary, including without limitation, by reason of any
transaction permitted by clause (iii) of the "Limitation on the Issuance and
Sale of Capital Stock of Restricted Subsidiaries" covenant described below;
provided that the fair market value of the Investment remaining in any Person
that has ceased to be a Restricted Subsidiary shall not exceed the aggregate
amount of Investments previously made in such Person valued at the time such
Investments were made less any net reduction of such Investments. For purposes
of the definition of "Unrestricted Subsidiary" and the "Limitation on Restricted
Payments" covenant described below, (i) "Investment" shall include the fair
market value of the assets (net of liabilities (other than liabilities to the
Company or any of its Restricted Subsidiaries)) of any Restricted Subsidiary at
the time that such Restricted Subsidiary is designated an Unrestricted
Subsidiary, (ii) the fair market value of the assets (net of liabilities (other
than liabilities to the Company or any of its Restricted Subsidiaries)) of any
Unrestricted Subsidiary at the time that such Unrestricted Subsidiary is
designated a Restricted Subsidiary shall be considered a reduction in
outstanding Investments and (iii) any property transferred to or from an
Unrestricted Subsidiary shall be valued at its fair market value at the time of
such transfer.
"Investment Grade Securities" means (i) securities issued or directly and
fully guaranteed or insured by the United States government or any agency or
instrumentality thereof (other than Temporary Cash Investments), (ii) debt
securities or debt instruments with a rating of BBB+ or higher by S&P or Baa1 or
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higher by Moody's or the equivalent of such rating organization, or, if no
rating of S&P or Moody's then exists, the equivalent of such rating by any other
nationally recognized securities rating agency, but excluding any debt
securities or instruments constituting loans or advances among the Company and
its Subsidiaries, and (iii) investments in any fund that invests exclusively in
investments of the type described in clauses (i) and (ii) which fund may also
hold cash pending investment and/or distribution.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien,
adverse claim or charge of any kind (including, without limitation, any
conditional sale or other title retention agreement or lease in the nature
thereof or any agreement to give any security interest).
"Membership Interests" means, with respect to any Person, any and all
membership interests, participations or other equivalents (however designated,
whether voting or non-voting) in equity of such Person, whether outstanding on
the Closing Date or issued thereafter.
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means, (a) with respect to any Asset Sale, the proceeds
of such Asset Sale in the form of cash or Temporary Cash Investments, including
payments in respect of deferred payment obligations (to the extent corresponding
to the principal, but not interest, component thereof) when received in the form
of cash or Temporary Cash Investments (except to the extent such obligations are
financed or sold with recourse to the Company or any Restricted Subsidiary) and
proceeds from the conversion of other property received when converted to cash
or Temporary Cash Investments, net of (i) brokerage commissions and other
commissions, fees and expenses (including fees and expenses of counsel,
accountants and investment bankers) related to such Asset Sale and any
relocation expenses incurred as a result thereof, (ii) provisions for all taxes
(whether or not such taxes will actually be paid or are payable) as a result of
such Asset Sale without regard to the consolidated results of operations of the
Company and its Restricted Subsidiaries, taken as a whole, (iii) payments made
to repay Indebtedness or any other obligation outstanding at the time of such
Asset Sale that either (A) is secured by a Lien on the property or assets sold
or (B) is required to be paid as a result of such sale and (iv) appropriate
amounts to be provided by the Company or any Restricted Subsidiary as a reserve
against any liabilities associated with such Asset Sale, including, without
limitation, pension and other post-employment benefit liabilities, liabilities
related to environmental matters and liabilities under any indemnification
obligations associated with such Asset Sale, all as determined in conformity
with GAAP and (b) with respect to any issuance or sale of Capital Stock, the
proceeds of such issuance or sale in the form of cash or Temporary Cash
Investments, including payments in respect of deferred payment obligations (to
the extent corresponding to the principal, but not interest, component thereof)
when received in the form of cash or Temporary Cash Investments (except to the
extent such obligations are financed or sold with recourse to the Company or any
Restricted Subsidiary) and proceeds from the conversion of other property
received when converted to cash or Temporary Cash Investments, net of attorney's
fees, accountants' fees, underwriters' or placement agent's fees, discounts or
commissions and brokerage, consultant and other fees incurred in connection with
such issuance or sale and net of taxes paid or payable as a result thereof.
"Note Amount" has the meaning set forth in the second paragraph of the
"Limitation on Asset Sales" covenant described below.
"Offer to Purchase" means an offer to purchase Notes by the Company from
the Holders commenced by mailing a notice to the Trustee and each Holder
stating: (i) the covenant pursuant to which the offer is being made and that all
Notes validly tendered will be accepted for payment on a pro rata basis; (ii)
the purchase price and the date of purchase (which shall be a Business Day no
earlier than 30 days nor later than 60 days from the date such notice is
mailed)(the "Payment Date"); (iii) that any Note not tendered will continue to
accrue interest pursuant to its terms; (iv) that, unless the Company defaults in
the payment of the purchase price, any Note accepted for payment pursuant to the
Offer to Purchase shall cease to accrue interest on and after the Payment Date;
(v) that Holders electing to have a Note purchased pursuant to the Offer to
Purchase will be required to surrender the Note, together with the form entitled
"Option of the Holder to Elect Purchase" on the reverse side of the Note
completed, to the Paying Agent at the address specified in the notice prior to
the close of business on the Business Day immediately preceding the Payment
Date; (vi) that Holders will be entitled to withdraw their election if the
Paying Agent receives, not later than the close of
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business on the third Business Day immediately preceding the Payment Date, a
facsimile transmission or letter setting forth the name of such Holder, the
principal amount of Notes delivered for purchase and a statement that such
Holder is withdrawing its election to have such Notes purchased; and (vii) that
Holders whose Notes are being purchased only in part will be issued new Notes
equal in principal amount to the unpurchased portion of the Notes surrendered;
provided that each Note purchased and each new Note issued shall be in a
principal amount of $1,000 or an integral multiple thereof. On the Payment Date,
the Company shall (i) accept for payment on a pro rata basis Notes or portions
thereof tendered pursuant to an Offer to Purchase; (ii) deposit with the Paying
Agent money sufficient to pay the purchase price of all Notes or portions
thereof so accepted; and (iii) deliver, or cause to be delivered, to the Trustee
all Notes or portions thereof so accepted together with an Officers' Certificate
specifying the Notes or portions thereof accepted for payment by the Company.
The Paying Agent shall promptly mail to the Holders of Notes so accepted payment
in an amount equal to the purchase price, and the Trustee shall promptly
authenticate and mail to such Holders a new Note equal in principal amount to
any unpurchased portion of the Note surrendered; provided that each Note
purchased and each new Note issued shall be in a principal amount of $1,000 or
an integral multiple thereof. The Company will publicly announce the results of
an Offer to Purchase as soon as practicable after the Payment Date. The Trustee
shall act as the Paying Agent for an Offer to Purchase. The Company will comply
with Rule 14e-1 under the Exchange Act and any other securities laws and
regulations thereunder to the extent such laws and regulations are applicable,
in the event that the Company is required to repurchase Notes pursuant to an
Offer to Purchase.
"Permitted Investment" means (i) an Investment in the Company or a
Restricted Subsidiary or a Person which will, upon the making of such
Investment, become a Restricted Subsidiary or be merged or consolidated with or
into or transfer or convey all or substantially all its assets to, the Company
or a Restricted Subsidiary; provided that such person's primary business is
similar, related, ancillary or complementary to the businesses of the Company
and its Restricted Subsidiaries on the date of such Investment; (ii) Temporary
Cash Investments and Investment Grade Securities; (iii) payroll, travel and
similar advances to cover matters that are expected at the time of such advances
ultimately to be treated as expenses in accordance with GAAP; (iv) any
Investment acquired by the Company or any of its Restricted Subsidiaries (x) in
exchange for any other Investment or accounts receivable held by the Company or
any such Restricted Subsidiary in connection with or as a result of a
bankruptcy, workout, reorganization or recapitalization of the issuer of such
other Investment or accounts receivable or an Affiliate of such issuer, (y) as a
result of a foreclosure by the Company or any of its Restricted Subsidiaries
with respect to any secured Indebtedness or other transfer of title with respect
to any secured Indebtedness in default or (z) in satisfaction of a judgment; (v)
any Investment acquired in consideration for the issuance of Capital Stock
(other than Disqualified Stock) or the proceeds of the issuance of Capital Stock
(other than Disqualified Stock) to the extent such amounts have not been
previously used to support a Restricted Payment pursuant to clause (C)(2) of the
first paragraph of the "Limitation on Restricted Payments" covenant described
below or clause (iii) or (iv) of the second paragraph of the "Limitation on
Restricted Payments" covenant described below or used to support the Incurrence
of Indebtedness pursuant to clause (viii) of the second paragraph of part (a)
under the "Limitation on Indebtedness" covenant described below and Investments
acquired as a capital contribution; provided that such proceeds shall be used on
or prior to 60 days after their receipt by the Company; (vi) Guarantees
permitted by the "Limitation on Indebtedness" covenant described below; (vii)
loans or advances to employees of the Company or any Restricted Subsidiary that
do not in the aggregate exceed at any one time outstanding $2 million; (viii)
Currency Agreements and Interest Rate Agreements permitted under the "Limitation
on Indebtedness" covenant described below; (ix) Investments in prepaid expenses,
negotiable instruments held for collection and lease, utility and workers'
compensation, performance and other similar deposits; (x) Investments in debt
securities or other evidences of Indebtedness that are issued by companies
engaged in the Telecommunications Business; provided that when each Investment
pursuant to this clause (x) is made, the aggregate amount of Investments
outstanding under this clause (x) does not exceed $3 million; (xi) Strategic
Investments and Investments in any Permitted Joint Venture in an amount not to
exceed $20 million at any one time outstanding; (xii) an Investment in any
Person the primary business of which is similar, related, ancillary or
complementary to the businesses of the Company and its Subsidiaries on the date
of such Investment in an amount not to exceed at any time outstanding the sum of
(x) $23 million plus
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(y) 10% of the Company's Consolidated EBITDA, if positive, for the immediately
preceding four fiscal quarters (valued in each case as provided in the
definition of "Investments"); (xiii) securities received in connection with
Asset Sales to the extent constituting non-cash consideration permitted under
the "Asset Sale" covenant; (xiv) Investments in an amount not to exceed $5
million at any time outstanding; and (xv) Investments existing on the Closing
Date.
"Permitted Joint Venture" means any Unrestricted Subsidiary or any other
Person in which the Company or a Restricted Subsidiary owns, directly or
indirectly, an ownership interest (other than a Restricted Subsidiary) and whose
primary business is similar, related, ancillary or complementary to the
businesses of the Company and its Restricted Subsidiaries at the time of
determination.
"Permitted Liens" means (i) Liens for taxes, assessments, governmental
charges or claims that are being contested in good faith by appropriate legal
proceedings promptly instituted and diligently conducted and for which a reserve
or other appropriate provision, if any, as shall be required in conformity with
GAAP shall have been made; (ii) statutory and common law Liens of landlords and
carriers, warehousemen, mechanics, suppliers, materialmen, repairmen or other
similar Liens arising in the ordinary course of business and with respect to
amounts not yet delinquent or being contested in good faith by appropriate legal
proceedings promptly instituted and diligently conducted and for which a reserve
or other appropriate provision, if any, as shall be required in conformity with
GAAP shall have been made; (iii) Liens incurred or deposits made in the ordinary
course of business in connection with workers' compensation, unemployment
insurance and other types of social security; (iv) Liens incurred or deposits
made to secure the performance of tenders, bids, leases, statutory or regulatory
obligations, bankers' acceptances, surety and appeal bonds, government
contracts, performance and return-of-money bonds and other obligations of a
similar nature incurred in the ordinary course of business (exclusive of
obligations for the payment of borrowed money); (v) easements, rights-of-way,
municipal and zoning ordinances and similar charges, encumbrances, title defects
or other irregularities that do not materially interfere with the ordinary
course of business of the Company or any of its Restricted Subsidiaries; (vi)
Liens (including extensions and renewals thereof) upon real or personal property
acquired after the Closing Date; provided that (a) such Lien is created solely
for the purpose of securing Indebtedness Incurred, in accordance with the
"Limitation on Indebtedness" covenant described below, to finance the cost
(including the cost of design, development, acquisition, construction,
installation, improvement, transportation or integration) of the item of
property or assets subject thereto and such Lien is created prior to, at the
time of or within six months after the later of the acquisition, the completion
of construction or the commencement of full operation of such property, (b) the
principal amount of the Indebtedness secured by such Lien does not exceed 100%
of such cost and (c) any such Lien shall not extend to or cover any property or
assets other than such item of property or assets and any improvements on such
item; (vii) leases or subleases granted to others that do not materially
interfere with the ordinary course of business of the Company and its Restricted
Subsidiaries, taken as a whole; (viii) Liens encumbering property or assets
under construction arising from progress or partial payments by a customer of
the Company or its Restricted Subsidiaries relating to such property or assets;
(ix) any interest or title of a lessor in the property subject to any
Capitalized Lease or operating lease; (x) Liens arising from filing Uniform
Commercial Code financing statements regarding leases; (xi) Liens on property
of, or on shares of Capital Stock or Indebtedness of, any Person existing at the
time such Person becomes, or becomes a part of, any Restricted Subsidiary;
provided that such Liens do not extend to or cover any property or assets of the
Company or any Restricted Subsidiary other than the property or assets acquired;
(xii) Liens in favor of the Company or any Restricted Subsidiary; (xiii) Liens
arising from the rendering of a final judgment or order against the Company or
any Restricted Subsidiary that does not give rise to an Event of Default; (xiv)
Liens securing reimbursement obligations with respect to letters of credit that
encumber documents and other property relating to such letters of credit and the
products and proceeds thereof; (xv) Liens in favor of customs and revenue
authorities arising as a matter of law to secure payment of customs duties in
connection with the importation of goods; (xvi) Liens encumbering customary
initial deposits and margin deposits, and other Liens that are within the
general parameters customary in the industry and incurred in the ordinary course
of business, in each case, securing Indebtedness under Interest Rate Agreements
and Currency Agreements and forward contracts, options, future contracts,
futures options or similar agreements or arrangements designed solely to protect
the Company or any of its Restricted Subsidiaries from fluctuations in interest
rates, currencies or the price of
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commodities; (xvii) Liens arising out of conditional sale, title retention,
consignment or similar arrangements for the sale of goods entered into by the
Company or any of its Restricted Subsidiaries in the ordinary course of business
in accordance with the past practices of the Company and its Restricted
Subsidiaries prior to the Closing Date; (xviii) Liens on or sales of
receivables; and (xix) Liens that secure Indebtedness with an aggregate
principal amount not in excess of $5 million at any time outstanding.
"Pledge Account" means the account established with the Trustee pursuant to
the terms of the Pledge Agreement for the deposit of the Pledged Securities
purchased by the Company with a portion of the net proceeds from the sale of the
Notes.
"Pledge Agreement" means the Collateral Pledge and Security Agreement,
dated as of June 25, 1998, made by the Company in favor of the Trustee,
governing the disbursement of funds from the Pledge Account, as such agreement
may be amended, restated, supplemented or otherwise modified from time to time.
"Pledged Securities" means the U.S. government securities purchased by the
Company and held in the Pledge Account in accordance with the Pledge Agreement.
"Public Equity Offering" means an underwritten primary public offering of
Capital Stock of the Company pursuant to an effective registration statement
under the Securities Act.
A "Public Market" shall be deemed to exist if (i) a Public Equity Offering
has been consummated and (ii) at least 15% of the total issued and outstanding
Capital Stock of the Company immediately prior to the consummation of such
Public Equity Offering has been distributed by means of an effective
registration statement under the Securities Act or sales pursuant to Rule 144
under the Securities Act.
"Restricted Subsidiary" means any Subsidiary of the Company other than an
Unrestricted Subsidiary.
"S&P" means Standard & Poor's Ratings Group, a division of The McGraw-Hill
Companies, and its successors.
"Significant Subsidiary" means, at any date of determination, any
Restricted Subsidiary that, together with its Subsidiaries, (i) for the most
recent fiscal year of the Company, accounted for more than 10% of the
consolidated revenues of the Company and its Restricted Subsidiaries or (ii) as
of the end of such fiscal year, was the owner of more than 10% of the
consolidated assets of the Company and its Restricted Subsidiaries, all as set
forth on the most recently available consolidated financial statements of the
Company for such fiscal year.
"Specified Date" means any Redemption Date, any Payment Date for an Offer
to Purchase or any date on which the Notes first become due and payable after an
Event of Default.
"Stated Maturity" means, (i) with respect to any debt security, the date
specified in such debt security as the fixed date on which the final installment
of principal of such debt security is due and payable and (ii) with respect to
any scheduled installment of principal of or interest on any debt security, the
date specified in such debt security as the fixed date on which such installment
is due and payable.
"Strategic Investments" means (A) Investments that the Board of Directors
has determined in good faith will enable the Company or any of its Restricted
Subsidiaries to obtain additional business that it might not be able to obtain
without making such Investment and (B) Investments in entities the principal
function of which is to perform research and development with respect to
products and services that may be used or useful in the Telecommunications
Business; provided that the Company or one of its Restricted Subsidiaries is
entitled or otherwise reasonably expects to obtain rights to such products or
services as a result of such Investment.
"Strategic Subordinated Indebtedness" means Indebtedness of the Company
Incurred to finance the acquisition of a Person engaged in a business that is
similar, related, ancillary or complementary to the businesses conducted by the
Company or any of its Restricted Subsidiaries, which Indebtedness by its terms,
or by the terms of any agreement or instrument pursuant to which such
Indebtedness is Incurred, (i) is expressly made subordinate in right of payment
to the Notes and (ii) provides that no payment of principal, premium or interest
on, or any other payment with respect to, such Indebtedness may be made prior to
the
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payment in full of all of the Company's obligations under the Notes; provided
that such Indebtedness may provide for and be repaid at any time from the
proceeds of a capital contribution or the sale of Capital Stock (other than
Disqualified Stock) of the Company after the Incurrence of such Indebtedness.
"Subsidiary" means, with respect to any Person, any corporation,
association or other business entity of which 50% or more of the voting power of
the outstanding Voting Stock is owned, directly or indirectly, by such Person
and one or more other Subsidiaries of such Person.
"Telecommunications Assets" means all assets, rights (contractual or
otherwise) and properties, whether tangible or intangible, used or intended for
use in connection with a Telecommunications Business.
"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, voice, fax, video or data
through owned or leased transmission facilities or the provision of Internet
related services, (ii) creating, developing or marketing communications related
network equipment, software and other devices for use in a Telecommunications
Business or (iii) evaluating, participating or pursuing any other activity or
opportunity that is primarily related to those identified in (i) or (ii) above;
provided that the determination of what constitutes a Telecommunications
Business shall be made in good faith by the Board of Directors, whose
determination shall be conclusive if evidenced by a Board Resolution.
"Temporary Cash Investment" means any of the following: (i) direct
obligations of the United States of America or any agency thereof or obligations
fully and unconditionally guaranteed by the United States of America or any
agency thereof, (ii) time deposit accounts, certificates of deposit and money
market deposits maturing within one year of the date of acquisition thereof
issued by a bank or trust company which is organized under the laws of the
United States of America, any state thereof or any foreign country recognized by
the United States of America, and which bank or trust company has capital,
surplus and undivided profits aggregating in excess of $50 million (or the
foreign currency equivalent thereof) and has outstanding debt which is rated "A"
(or such similar equivalent rating) or higher by at least one nationally
recognized statistical rating organization (as defined in Rule 436 under the
Securities Act) or any money-market fund sponsored by a registered broker dealer
or mutual fund distributor, (iii) repurchase obligations with a term of not more
than 30 days for underlying securities of the types described in clauses (i) and
(ii) above entered into with a bank meeting the qualifications described in
clause (ii) above, (iv) commercial paper, maturing not more than one year after
the date of acquisition, issued by a corporation (other than an Affiliate of the
Company) organized and in existence under the laws of the United States of
America, any state thereof or any foreign country recognized by the United
States of America with a rating at the time as of which any investment therein
is made of "P-1" (or higher) according to Moody's or "A-1" (or higher) according
to S&P, (v) securities with maturities of six months or less from the date of
acquisition issued or fully and unconditionally guaranteed by any state,
commonwealth or territory of the United States of America, or by any political
subdivision or taxing authority thereof, and rated at least "A" by S&P or
Moody's, and (vi) investment funds investing 95% or more of their assets in
securities of the type described in clauses (i) through (v) above.
"Trade Payables" means, with respect to any Person, any accounts payable or
any other Indebtedness or monetary obligation to trade creditors created,
assumed or Guaranteed by such Person or any of its Subsidiaries arising in the
ordinary course of business in connection with the acquisition of goods or
services.
"Transaction Date" means, with respect to the Incurrence of any
Indebtedness by the Company or any of its Restricted Subsidiaries, the date such
Indebtedness is to be Incurred and, with respect to any Restricted Payment, the
date such Restricted Payment is to be made.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below; and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Restricted
Subsidiary (including any newly acquired or newly formed Subsidiary of the
Company) to be an Unrestricted Subsidiary unless such Subsidiary owns any
Capital Stock of, or owns or holds any Lien on any property of, the Company or
any Restricted Subsidiary; provided that (A) any Guarantee by the Company or any
Restricted Subsidiary of any Indebtedness of the Subsidiary being so designated
shall be deemed an
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"Incurrence" of such Indebtedness and an "Investment" by the Company or such
Restricted Subsidiary (or both, if applicable) at the time of such designation;
(B) either (I) the Subsidiary to be so designated has total assets of $1,000 or
less or (II) if such Subsidiary has assets greater than $1,000, such designation
would be permitted under the "Limitation on Restricted Payments" covenant
described below; and (C) if applicable, the Incurrence of Indebtedness and the
Investment referred to in clause (A) of this proviso would be permitted under
the "Limitation on Indebtedness" and "Limitation on Restricted Payments"
covenants described below. The Board of Directors may designate any Unrestricted
Subsidiary to be a Restricted Subsidiary; provided that (i) no Default or Event
of Default shall have occurred and be continuing at the time of or after giving
effect to such designation and (ii) all Liens and Indebtedness of such
Unrestricted Subsidiary outstanding immediately after such designation would, if
Incurred at such time, have been permitted to be Incurred (and shall be deemed
to have been Incurred) for all purposes of the Indenture. Any such designation
by the Board of Directors shall be evidenced to the Trustee by promptly filing
with the Trustee a copy of the Board Resolution giving effect to such
designation and an Officers' Certificate certifying that such designation
complied with the foregoing provisions.
"Voting Stock" means with respect to any Person, Capital Stock of any class
or kind ordinarily having the power to vote for the election of Directors of
such Person.
"Wholly Owned" means, with respect to any Subsidiary of any Person, the
ownership of all of the outstanding Capital Stock of such Subsidiary (other than
any Director's qualifying investments or investments by foreign nationals
mandated by applicable law) by such Person or one or more Wholly Owned
Subsidiaries of such Person.
COVENANTS
LIMITATION ON INDEBTEDNESS
(a) The Company will not, and will not permit any of its Restricted
Subsidiaries to, Incur any Indebtedness (other than the Notes and Indebtedness
existing on the Closing Date); provided that the Company may Incur Indebtedness
if, after giving effect to the Incurrence of such Indebtedness and the receipt
and application of the proceeds therefrom, the Consolidated Leverage Ratio would
be greater than zero and less than 6:1.
Notwithstanding the foregoing, the Company and any Restricted Subsidiary
(except as specified below) may Incur each and all of the following: (i)
Indebtedness outstanding at any time in an aggregate principal amount not to
exceed $100.0 million, less any amount of such Indebtedness permanently repaid
as provided under the "Limitation on Asset Sales" covenant described below; (ii)
Indebtedness owed (A) to the Company evidenced by a promissory note or (B) to
any Restricted Subsidiary; provided that any event which results in any such
Restricted Subsidiary ceasing to be a Restricted Subsidiary or any subsequent
transfer of such Indebtedness (other than to the Company or another Restricted
Subsidiary) shall be deemed, in each case, to constitute an Incurrence of such
Indebtedness not permitted by this clause (ii); (iii) Indebtedness issued in
exchange for, or the net proceeds of which are used to refinance or refund, then
outstanding Indebtedness (other than Indebtedness Incurred under clause (i),
(ii), (iv), (vi) or (ix) of this paragraph) and any refinancings thereof in an
amount not to exceed the amount so refinanced or refunded (plus premiums,
accrued interest, fees and expenses); provided that Indebtedness the proceeds of
which are used to refinance or refund the Notes or Indebtedness that is pari
passu with, or subordinated in right of payment to, the Notes shall only be
permitted under this clause (iii) if (A) in case the Notes are refinanced in
part or the Indebtedness to be refinanced is pari passu with the Notes, such new
Indebtedness, by its terms or by the terms of any agreement or instrument
pursuant to which such new Indebtedness is outstanding, is expressly made pari
passu with, or subordinate in right of payment to, the remaining Notes, (B) in
case the Indebtedness to be refinanced is subordinated in right of payment to
the Notes, such new Indebtedness, by its terms or by the terms of any agreement
or instrument pursuant to which such new Indebtedness is issued or remains
outstanding, is expressly made subordinate in right of payment to the Notes at
least to the extent that the Indebtedness to be refinanced is subordinated to
the Notes and (C) such new Indebtedness, determined as of the date of Incurrence
of such new Indebtedness, does not mature prior to the Stated Maturity of the
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Indebtedness to be refinanced or refunded, and the Average Life of such new
Indebtedness is at least equal to the remaining Average Life of the Indebtedness
to be refinanced or refunded; provided that in no event may Indebtedness of the
Company be refinanced by means of any Indebtedness of any Restricted Subsidiary
pursuant to this clause (iii); (iv) Indebtedness (A) in respect of performance,
surety, appeal bonds and completion guaranties provided in the ordinary course
of business, (B) under Currency Agreements and Interest Rate Agreements;
provided that such agreements (a) are designed solely to protect the Company or
its Restricted Subsidiaries against fluctuations in foreign currency exchange
rates or interest rates and (b) do not increase the Indebtedness of the obligor
outstanding at any time other than as a result of fluctuations in foreign
currency exchange rates or interest rates or by reason of fees, indemnities and
compensation payable thereunder, and (C) arising from agreements providing for
indemnification, adjustment of purchase price or similar obligations, or from
Guarantees or letters of credit, surety bonds or performance bonds securing any
obligations of the Company or any of its Restricted Subsidiaries pursuant to
such agreements, in any case Incurred in connection with the disposition of any
business, assets or Restricted Subsidiary (other than Guarantees of Indebtedness
Incurred by any Person acquiring all or any portion of such business, assets or
Restricted Subsidiary for the purpose of financing such acquisition), in a
principal amount not to exceed the gross proceeds actually received by the
Company or any Restricted Subsidiary in connection with such disposition; (v)
Indebtedness of the Company, to the extent the net proceeds thereof are promptly
(A) used to purchase Notes tendered in an Offer to Purchase made as a result of
a Change in Control or (B) deposited to defease the Notes as described below
under "Defeasance"; (vi) Guarantees of the Notes and Guarantees of Indebtedness
of the Company by any Restricted Subsidiary provided the Guarantee of such
Indebtedness is permitted by and made in accordance with the "Limitation on
Issuance of Guarantees by Restricted Subsidiaries" covenant described below;
(vii) Indebtedness (including Guarantees) Incurred to finance the cost
(including the cost of design, development, acquisition, construction,
installation, improvement, transportation or integration) to acquire equipment,
inventory or network assets (including acquisitions by way of acquisitions of
real property, leasehold improvements, Capitalized Leases and acquisitions of
the Capital Stock of a Person that becomes a Restricted Subsidiary to the extent
of the fair market value of the equipment, inventory or network assets so
acquired) by the Company or a Restricted Subsidiary after the Closing Date;
(viii) Indebtedness of the Company not to exceed, at any one time outstanding,
two times (A) the Net Cash Proceeds received by the Company after the Closing
Date as a capital contribution or from the issuance and sale of its Capital
Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of
the Company, to the extent such capital contribution or Net Cash Proceeds have
not been used pursuant to clause (C)(2) of the first paragraph or clause (iii),
(iv), (vi) or (vii) of the second paragraph of the "Limitation on Restricted
Payments" covenant described below or clause (ix) of the definition of Permitted
Investments to support the making of a Restricted Payment and (B) 80% of the
fair market value of property (other than cash and Temporary Cash Investments)
received by the Company after the Closing Date from the sale of its Capital
Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of
the Company, to the extent such capital contribution or sale of Capital Stock
has not been used pursuant to clause (iii), (iv), (vi) or (vii) of the second
paragraph of the "Limitation on Restricted Payments" covenant described below to
make a Restricted Payment, provided that such Indebtedness does not mature prior
to the Stated Maturity of the Notes and has an Average Life longer than the
remaining Average Life of the Notes; (ix) Indebtedness Incurred by the Company
or any of its Restricted Subsidiaries constituting reimbursement obligations
with respect to letters of credit in the ordinary course of business, including,
without limitation, letters of credit in respect of workers' compensation claims
or self insurance, or other Indebtedness with respect to reimbursement type
obligations regarding workers' compensation claims; provided that upon the
drawing of such letters of credit or the Incurrence of such Indebtedness, such
obligations are reimbursed within 30 days following the earlier of such drawing
or Incurrence; (x) Acquired Indebtedness; (xi) Strategic Subordinated
Indebtedness; and (xii) Subordinated Indebtedness of the Company (in addition to
Indebtedness permitted under clauses (i) through (xi) above) in an aggregate
principal amount outstanding at any time not to exceed $100 million, less any
amount of such Indebtedness permanently repaid as provided under the "Limitation
on Asset Sales" covenant described below.
(b) Notwithstanding any other provision of this "Limitation on
Indebtedness" covenant, the maximum amount of Indebtedness that the Company or a
Restricted Subsidiary may Incur pursuant to this "Limitation
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on Indebtedness" covenant shall not be deemed to be exceeded, with respect to
any outstanding Indebtedness due solely to the result of fluctuations in the
exchange rates of currencies.
(c) For purposes of determining any particular amount of Indebtedness under
this "Limitation on Indebtedness" covenant, (1) Guarantees, Liens or obligations
with respect to letters of credit supporting Indebtedness otherwise included in
the determination of such particular amount shall not be included and (2) any
Liens granted pursuant to the equal and ratable provisions referred to in the
"Limitation on Liens" covenant described below shall not be treated as
Indebtedness. For purposes of determining compliance with this "Limitation on
Indebtedness" covenant, in the event that an item of Indebtedness meets the
criteria of more than one of the types of Indebtedness described in the above
clauses, the Company, in its sole discretion, shall classify, and from time to
time may reclassify, such item of Indebtedness and only be required to include
the amount and type of such Indebtedness in one of such clauses.
LIMITATION ON RESTRICTED PAYMENTS
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, (i) declare or pay any dividend or make any distribution
on or with respect to its Capital Stock (other than (x) dividends or
distributions payable solely in its Capital Stock (other than Disqualified
Stock) or in options, warrants or other rights to acquire Capital Stock and (y)
pro rata dividends or distributions on Common Stock of Restricted Subsidiaries
held by Persons other than the Company or any of its Restricted Subsidiaries),
(ii) purchase, redeem, retire or otherwise acquire for value any Capital Stock
of (A) the Company or an Unrestricted Subsidiary (including options, warrants or
other rights to acquire such Capital Stock) held by any Person or (B) a
Restricted Subsidiary (including options, warrants or other rights to acquire
such Capital Stock) held by any Affiliate of the Company (other than a Wholly
Owned Restricted Subsidiary) or any Holder (or any Affiliate of such Holder) of
5% or more of the Capital Stock of the Company, (iii) make any voluntary or
optional principal payment, or voluntary or optional redemption, repurchase,
defeasance, or other acquisition or retirement for value, of Indebtedness of the
Company that is subordinated in right of payment to the Notes or (other than the
purchase, redemption, repurchase or other acquisition of such subordinated
Indebtedness purchased in anticipation of satisfying a sinking fund obligation,
principal installment or final maturity, in each case due within six months of
the date of acquisition), and (iv) make any Investment, other than a Permitted
Investment, in any Person (such payments or any other actions described in
clauses (i) through (iv) above being collectively "Restricted Payments") if, at
the time of, and after giving effect to, the proposed Restricted Payment: (A) a
Default or Event of Default shall have occurred and be continuing, (B) the
Company could not Incur at least $1.00 of Indebtedness under the first paragraph
of part (a) of the "Limitation on Indebtedness" covenant or (C) the aggregate
amount of all Restricted Payments (the amount, if other than in cash, to be
determined in good faith by the Board of Directors, whose determination shall be
conclusive and evidenced by a Board Resolution) made after the Closing Date
shall exceed the sum of (1) 50% of the aggregate amount of the Adjusted
Consolidated Net Income (or, if the Adjusted Consolidated Net Income is a loss,
minus 100% of the amount of such loss) (determined by excluding income resulting
from transfers of assets by the Company or a Restricted Subsidiary to an
Unrestricted Subsidiary) accrued on a cumulative basis during the period (taken
as one accounting period) beginning on the first day of the fiscal quarter
immediately following the Closing Date and ending on the last day of the last
fiscal quarter preceding the Transaction Date for which reports have been filed
with the Commission or provided to the Trustee pursuant to the "Commission
Reports and Reports to Holders" covenant described below plus (2) the aggregate
Net Cash Proceeds received by the Company after the Closing Date as a capital
contribution or from the issuance and sale permitted by the Indenture of its
Capital Stock (other than Disqualified Stock) to a Person who is not a
Subsidiary of the Company, including an issuance or sale permitted by the
Indenture of Indebtedness of the Company for cash subsequent to the Closing Date
upon the conversion of such Indebtedness into Capital Stock (other than
Disqualified Stock) of the Company, or from the issuance to a Person who is not
a Subsidiary of the Company of any options, warrants or other rights to acquire
Capital Stock of the Company (in each case, exclusive of any Disqualified Stock
or any options, warrants or other rights that are redeemable at the option of
the Holder, or are required to be redeemed, prior to the Stated Maturity of the
Notes), in each case except to the extent such Net Cash Proceeds are used to
support the Incurrence of Indebtedness pursuant to clause (viii) of the second
paragraph under the "Limitation on
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Indebtedness" covenant, or the making of Permitted Investments in accordance
with clause (v) of the definition of such term or pursuant to clause (vi) of the
second paragraph of this "Limitation on Restricted Payments" covenant, plus (3)
an amount equal to the net reduction in Investments (other than reductions in
Permitted Investments and pursuant to clause (vi) of the second paragraph of
this covenant) in any Person resulting from payments of interest on
Indebtedness, dividends, repayments of loans or advances, or other transfers of
assets, in each case to the Company or any Restricted Subsidiary or from the Net
Cash Proceeds from the sale of any such Investment (except, in each case, to the
extent any such payment or proceeds are included in the calculation of Adjusted
Consolidated Net Income), or from redesignations of Unrestricted Subsidiaries as
Restricted Subsidiaries (valued in each case as provided in the definition of
"Investments"), not to exceed, in each case, the amount of Investments
previously made by the Company or any Restricted Subsidiary in such Person or
Unrestricted Subsidiary.
The foregoing provision shall not be violated by reason of: (i) the payment
of any dividend within 60 days after the date of declaration thereof if, at said
date of declaration, such payment would comply with the foregoing paragraph;
(ii) the redemption, repurchase, defeasance or other acquisition or retirement
for value of Indebtedness that is subordinated in right of payment to the Notes
including premium, if any, and accrued and unpaid interest, with the proceeds
of, or in exchange for, Indebtedness Incurred under clause (iii) of the second
paragraph of part (a) of the "Limitation on Indebtedness" covenant; (iii) the
repurchase, redemption or other acquisition of Capital Stock of the Company or
an Unrestricted Subsidiary (or options, warrants or other rights to acquire such
Capital Stock) in exchange for, or out of the proceeds of a capital contribution
or a substantially concurrent offering of, Capital Stock (other than
Disqualified Stock) of the Company (or options, warrants or other rights to
acquire such Capital Stock); (iv) the making of any principal payment or the
repurchase, redemption, retirement, defeasance or other acquisition for value of
Indebtedness of the Company which is subordinated in right of payment to the
Notes in exchange for, or out of the proceeds of a capital contribution or a
substantially concurrent offering of, Capital Stock (other than Disqualified
Stock) of the Company (or options, warrants or other rights to acquire such
Capital Stock); (v) payments or distributions, to dissenting Holders of Capital
Stock pursuant to applicable law, pursuant to or in connection with a
consolidation, merger or transfer of assets that complies with the provisions of
the Indenture applicable to mergers, consolidations and transfers of all or
substantially all of the property and assets of the Company; (vi) Investments in
any Person the primary business of which is similar, related, ancillary or
complementary to the businesses of the Company and its Restricted Subsidiaries
on the date of such Investments; provided that the aggregate amount of
Investments outstanding at any time pursuant to this clause (vi) does not exceed
the sum of (a) $20 million plus (b) the amount of Net Cash Proceeds received by
the Company after the Closing Date as a capital contribution or from the sale of
its Capital Stock (other than Disqualified Stock) to a Person that is not a
Subsidiary of the Company, except to the extent such Net Cash Proceeds are used
to support the Incurrence of Indebtedness pursuant to clause (viii) of the
second paragraph of part (a) under the "Limitation on Indebtedness" covenant or
to support the making of Restricted Payments pursuant to clause (C)(2) of the
first paragraph, or clauses (iii) or (iv) of this paragraph, of this "Limitation
on Restricted Payments" covenant, plus (c) the net reduction in Investments made
pursuant to this clause (vi) resulting from distributions on or repayments of
such Investments or from the Net Cash Proceeds from the sale of any such
Investment (except in each case to the extent any such payment or proceeds is
included in the calculation of Adjusted Consolidated Net Income) or from such
Person becoming a Restricted Subsidiary (valued in each case as provided in the
definition of "Investments"), provided that the net reduction in any Investment
shall not exceed the amount of such Investment; (vii) Investments acquired in
exchange for Capital Stock (other than Disqualified Stock) of the Company;
(viii) the declaration or payment of dividends on the Capital Stock of the
Company following a Public Equity Offering of such Capital Stock, of up to 6%
per annum of the Net Cash Proceeds received by the Company in such Public Equity
Offering; (ix) prior to the occurrence of a Public Market, the purchase,
redemption, retirement or other acquisition for value of Capital Stock of the
Company or options to purchase such Capital Stock, held by any current or former
employee, Director or consultant of the Company or a Restricted Subsidiary (or
their estates or beneficiaries under their estates), upon the death, disability,
retirement, termination of employment or pursuant to the terms of any agreement
under which such Capital Stock or options were issued; provided that the
aggregate consideration paid for such purchase, redemption, retirement or other
acquisition for value of such Capital
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Stock or options after the Closing Date does not exceed (A) in any calendar
year, $2 million or (b) $5 million in the aggregate (unless such repurchases are
made with the proceeds of insurance policies and the Capital Stock is purchased
from the executors, administrators, testamentary trustees, heirs, legatees or
beneficiaries); (x) the declaration or payment of dividends and other
distributions to Members of the Company in an amount equal to the income tax
liability incurred by such Members as a result of any amount of consolidated
income or gain of the Company allocated to such Members for federal income tax
purposes, computed at the highest federal and state rates applicable to such
Members; and (xi) other Restricted Payments in an aggregate amount not to exceed
$2 million; provided that, except in the case of clauses (i) and (iii), no
Default or Event of Default shall have occurred and be continuing or occur as a
consequence of the actions or payments set forth therein.
Each Restricted Payment permitted pursuant to the preceding paragraph
(other than the Restricted Payment referred to in clause (ii) thereof, an
exchange of Capital Stock for Capital Stock or Indebtedness referred to in
clause (iii) or (iv) thereof and an Investment referred to in clauses (vi) and
(vii) thereof), and the Net Cash Proceeds from any capital contribution or any
issuance of Capital Stock referred to in clauses (iii) and (iv), shall be
included in calculating whether the conditions of clause (C)(2) of the first
paragraph of this "Limitation on Restricted Payments" covenant have been met
with respect to any subsequent Restricted Payments. In the event the proceeds of
an issuance of Capital Stock of the Company are used for the redemption,
repurchase or other acquisition of the Notes, or Indebtedness that is pari passu
with the Notes, then the Net Cash Proceeds of such issuance shall be included in
clause (C)(2) of the first paragraph of this "Limitation on Restricted Payments"
covenant only to the extent such proceeds are not used for such redemption,
repurchase or other acquisition of Indebtedness.
Any Restricted Payments made other than in cash shall be valued at fair
market value. The amount of any Investment "outstanding" at any time shall be
deemed to be equal to the amount of such Investment on the date made, less the
return of capital to the Company and its Restricted Subsidiaries with respect to
such Investment by distribution, sale or otherwise (up to the amount of such
Investment on the date made).
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES
The Company will not, and will not permit any Restricted Subsidiary to,
create or otherwise cause or suffer to exist or become effective any consensual
encumbrance or restriction of any kind on the ability of any Restricted
Subsidiary to (i) pay dividends or make any other distributions permitted by
applicable law on any Capital Stock of such Restricted Subsidiary owned by the
Company or any other Restricted Subsidiary, (ii) pay any Indebtedness owed to
the Company or any other Restricted Subsidiary, (iii) make loans or advances to
the Company or any other Restricted Subsidiary or (iv) transfer any of its
property or assets to the Company or any other Restricted Subsidiary.
The foregoing provisions shall not restrict any encumbrances or
restrictions: (i) existing on the Closing Date in the Credit Agreement, the
Indenture or any other agreements in effect on the Closing Date, and any
extensions, refinancings, renewals or replacements of such agreements; provided
that the encumbrances and restrictions in any such extensions, refinancings,
renewals or replacements are no less favorable in any material respect to the
Holders than those encumbrances or restrictions that are then in effect and that
are being extended, refinanced, renewed or replaced; (ii) existing under or by
reason of applicable law, rule, regulation or order; (iii) existing with respect
to any Person or the property or assets of such Person acquired by the Company
or any Restricted Subsidiary, existing at the time of such acquisition and not
incurred in contemplation thereof, which encumbrances or restrictions are not
applicable to any Person or the property or assets of any Person other than such
Person or the property or assets of such Person so acquired; (iv) in the case of
clause (iv) of the first paragraph of this "Limitation on Dividend and Other
Payment Restrictions Affecting Restricted Subsidiaries" covenant, (A) that
restrict in a customary manner the subletting, assignment or transfer of any
property or asset that is a lease, license, conveyance or contract or similar
property or asset, (B) existing by virtue of any transfer of, agreement to
transfer, option or right with respect to, or Lien on, any property or assets of
the Company or any Restricted Subsidiary not otherwise prohibited by the
Indenture, (C) arising or agreed to in the ordinary course of business, not
relating to any Indebtedness, and that do not, individually or in the aggregate,
detract from the value of property or assets of the Company
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or any Restricted Subsidiary in any manner material to the Company or any
Restricted Subsidiary or (D) entered into in connection with purchase money
obligations for property acquired in the ordinary course of business that impose
restrictions of the nature discussed in clause (iv) of the first paragraph of
this "Limitation on Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries" covenant on the property so acquired; (v) with respect to a
Restricted Subsidiary and imposed pursuant to an agreement that has been entered
into for the sale or disposition of all or substantially all of the Capital
Stock of, or the property and assets of, such Restricted Subsidiary; or (vi)
contained in the terms of any Indebtedness or any agreement pursuant to which
such Indebtedness was issued if (A) the encumbrance or restriction applies only
in the event of a payment default or a default with respect to a financial
covenant contained in such Indebtedness or agreement, (B) the encumbrance or
restriction is not materially more disadvantageous to the Holders of the Notes
than is customary in comparable financings (as determined in good faith by the
Board of Directors, whose determination shall be conclusive if evidenced by a
Board Resolution) and (C) the Board of Directors determines that any such
encumbrance or restriction will not materially affect the Company's ability to
make principal or interest payments on the Notes; (vii) restrictions on cash or
other deposits imposed by customers under contracts entered into in the ordinary
course of business; (viii) customary provisions in joint venture agreements and
other similar agreements entered into in the ordinary course of business; and
(ix) any encumbrances or restrictions of the type referred to in clauses (i)
through (iv) of the first paragraph of this covenant imposed by any amendments,
modifications, renewals, restatements, increases, supplements, refundings,
replacements or refinancings of the contracts referred to in clauses (i) through
(vi) above; provided that such amendments, modifications, renewals,
restatements, increases, supplements, refundings, replacements or refinancings
are, in the good faith judgment of the Board of Directors, not materially
disadvantageous to the Holders than those contained in the restriction prior to
such amendment, modification, renewal, restatement, increase, supplement,
refunding, replacement or refinancing. Nothing contained in this "Limitation on
Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries"
covenant shall prevent the Company or any Restricted Subsidiary from (1)
creating, incurring, assuming or suffering to exist any Liens otherwise
permitted in the "Limitation on Liens" covenant described below or (2)
restricting the sale or other disposition of property or assets of the Company
or any of its Restricted Subsidiaries that secure Indebtedness of the Company or
any of its Restricted Subsidiaries.
LIMITATION ON THE ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED SUBSIDIARIES
The Company will not sell, and will not permit any Restricted Subsidiary,
directly or indirectly, to issue or sell, any Capital Stock of a Restricted
Subsidiary (including options, warrants or other rights to purchase such Capital
Stock) except (i) to the Company or a Wholly Owned Restricted Subsidiary; (ii)
issuances of Director's qualifying shares or sales to foreign nationals of
Capital Stock of foreign Restricted Subsidiaries, to the extent required by
applicable law; (iii) if, immediately after giving effect to such issuance or
sale, such Restricted Subsidiary would no longer constitute a Restricted
Subsidiary and any Investment in such Person remaining after giving effect to
such issuance or sale would have been permitted to be made under the "Limitation
on Restricted Payments" covenant if made on the date of such issuance or sale;
or (iv) issuances or sales of Common Stock or Membership Interests of a
Restricted Subsidiary, provided that the Company or such Restricted Subsidiary
applies the Net Cash Proceeds, if any, of any such sale in accordance with
clause (A) or (B) of the "Limitation on Asset Sales" covenant described below.
LIMITATION ON ISSUANCES OF GUARANTEES BY RESTRICTED SUBSIDIARIES
The Company will not permit any Restricted Subsidiary, directly or
indirectly, to Guarantee any Indebtedness of the Company which is pari passu
with or subordinate in right of payment to the Notes ("Guaranteed
Indebtedness"), unless (i) such Restricted Subsidiary simultaneously executes
and delivers a supplemental indenture to the Indenture providing for a Guarantee
(a "Subsidiary Guarantee") of payment of the Notes by such Restricted Subsidiary
and (ii) such Restricted Subsidiary waives and will not in any manner whatsoever
claim or take the benefit or advantage of, any rights of reimbursement,
indemnity or subrogation or any other rights against the Company or any other
Restricted Subsidiary as a result of any payment by such Restricted Subsidiary
under its Subsidiary Guarantee; provided that this paragraph shall not be
applicable to any Guarantee of any Restricted Subsidiary (x) that existed at the
time such Person became
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a Restricted Subsidiary and was not Incurred in connection with, or in
contemplation of, such Person becoming a Restricted Subsidiary or (y) of
Indebtedness Incurred under the Credit Agreement supporting Indebtedness
thereunder Incurred prior to the Closing Date. If the Guaranteed Indebtedness is
(A) pari passu with the Notes, then the Guarantee of such Guaranteed
Indebtedness shall be pari passu with, or subordinated to, the Subsidiary
Guarantee or (B) subordinated to the Notes, then the Guarantee of such
Guaranteed Indebtedness shall be subordinated to the Subsidiary Guarantee at
least to the extent that the Guaranteed Indebtedness is subordinated to the
Notes.
Notwithstanding the foregoing, any Subsidiary Guarantee by a Restricted
Subsidiary may provide by its terms that it shall be automatically and
unconditionally released and discharged upon (i) any sale, exchange or transfer,
to any Person not an Affiliate of the Company, of all of the Company's and each
Restricted Subsidiary's Capital Stock in, or all or substantially all the assets
of, such Restricted Subsidiary (which sale, exchange or transfer is not
prohibited by the Indenture) or (ii) the release or discharge of the Guarantee
which resulted in the creation of such Subsidiary Guarantee, except a discharge
or release by or as a result of payment under such Guarantee.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, enter into, renew or extend any transaction (including,
without limitation, the purchase, sale, lease or exchange of property or assets,
or the rendering of any service) with any Holder (or any Affiliate of such
Holder) of 5% or more of any class of Capital Stock of the Company or with any
Affiliate of the Company or any Restricted Subsidiary, except upon fair and
reasonable terms no less favorable to the Company or such Restricted Subsidiary
than could be obtained, at the time of such transaction or, if such transaction
is pursuant to a written agreement, at the time of the execution of the
agreement providing therefor, in a comparable arm's-length transaction with a
Person that is not such a Holder or an Affiliate.
The foregoing limitation does not limit, and shall not apply to (i)
transactions (A) approved by a majority of the disinterested members of the
Board of Directors or (B) for which the Company or a Restricted Subsidiary
delivers to the Trustee a written opinion of a nationally recognized investment
banking firm or a nationally recognized firm having appraisal expertise in the
specific area which is the subject of such determination stating that the
transaction is fair to the Company or such Restricted Subsidiary from a
financial point of view; (ii) any transaction solely between the Company and any
of its Restricted Subsidiaries or solely between Restricted Subsidiaries; (iii)
the payment of reasonable and customary regular fees to, and reasonable and
customary indemnity provided on behalf of, officers, Directors, employees or
consultants of the Company or any of its Subsidiaries; (iv) any payments or
other transactions pursuant to any tax-sharing agreement between the Company and
any other Person with which the Company files a consolidated tax return or with
which the Company is part of a consolidated group for tax purposes; (v) any
agreement as in effect as of the Closing Date or any amendment thereto (so long
as any such amendment is not disadvantageous to the Holders in any material
respect); (vi) the existence of, or the performance by the Company or any of its
Restricted Subsidiaries of its obligations under the terms of, any Limited
Liability Company Operating Agreement or Articles of Organization (including any
registration rights agreement or purchase agreement related thereto) to which it
is a party as of the Closing Date and any similar agreements which it may enter
into thereafter (so long as any such similar agreement is not disadvantageous to
the Holders in any material respect); or (vii) any Restricted Payments not
prohibited by the "Limitation on Restricted Payments" covenant. Notwithstanding
the foregoing, any transaction or series of related transactions covered by the
first paragraph of this "Limitation on Transactions with Shareholders and
Affiliates" covenant and not covered by clauses (ii) through (vii) of this
paragraph, the aggregate amount of which exceeds $3 million in value, must be
approved or determined to be fair in the manner provided for in clause (i)(A) or
(B) above.
LIMITATION ON LIENS
The Company will not, and will not permit any Restricted Subsidiary to,
create, incur, assume or suffer to exist any Lien on any of its assets or
properties of any character (including, without limitation, licenses), or
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any shares of Capital Stock or Indebtedness of any Restricted Subsidiary,
without making effective provision for all of the Notes and all other amounts
due under the Indenture to be directly secured equally and ratably with (or, if
the obligation or liability to be secured by such Lien is subordinated in right
of payment to the Notes, prior to) the obligation or liability secured by such
Lien.
The foregoing limitation does not apply to (i) Liens existing on the
Closing Date, including Liens securing obligations under the Credit Agreement;
(ii) Liens granted after the Closing Date on any assets or Capital Stock of the
Company or its Restricted Subsidiaries created in favor of the Holders; (iii)
Liens with respect to the assets of a Restricted Subsidiary granted by such
Restricted Subsidiary to the Company or a Restricted Subsidiary to secure
Indebtedness owing to the Company or such other Restricted Subsidiary; (iv)
Liens securing Indebtedness which is Incurred to refinance secured Indebtedness
which is permitted to be Incurred under clause (iii) of the second paragraph of
part (a) of the "Limitation on Indebtedness" covenant; provided that such Liens
do not extend to or cover any property or assets of the Company or any
Restricted Subsidiary other than the property or assets securing the
Indebtedness being refinanced; (v) Liens on the Capital Stock of, or any
property or assets of, a Restricted Subsidiary securing Indebtedness of such
Restricted Subsidiary permitted under the "Limitation on Indebtedness" covenant;
(vi) Liens on the Capital Stock of Restricted Subsidiaries securing Indebtedness
Incurred under clause (vii) of the second paragraph of part (a) of the
"Limitation on Indebtedness" covenant; or (viii) Permitted Liens.
LIMITATION ON SALE-LEASEBACK TRANSACTIONS
The Company will not, and will not permit any Restricted Subsidiary to,
enter into any sale-leaseback transaction involving any of its assets or
properties whether now owned or hereafter acquired, whereby the Company or a
Restricted Subsidiary sells or transfers such assets or properties and then or
thereafter leases such assets or properties or any part thereof or any other
assets or properties which the Company or such Restricted Subsidiary, as the
case may be, intends to use for substantially the same purpose or purposes as
the assets or properties sold or transferred.
The foregoing restriction does not apply to any sale-leaseback transaction
if (i) the lease is for a period, including renewal rights, of not in excess of
three years; (ii) the lease secures or relates to industrial revenue or
pollution control bonds; (iii) the transaction is solely between the Company and
any Wholly Owned Restricted Subsidiary or solely between Wholly Owned Restricted
Subsidiaries; or (iv) the Company or such Restricted Subsidiary, within 12
months after the sale or transfer of any assets or properties is completed,
applies an amount not less than the net proceeds received from such sale in
accordance with clause (A) or (B) of the first paragraph of the "Limitation on
Asset Sales" covenant described below.
LIMITATION ON ASSET SALES
The Company will not, and will not permit any Restricted Subsidiary to,
consummate any Asset Sale, unless (i) the consideration received by the Company
or such Restricted Subsidiary is at least equal to the fair market value of the
assets sold or disposed of and (ii) at least 75% of the consideration received
consists of (x) cash or Temporary Cash Investments or the assumption of
Indebtedness of the Company or any Restricted Subsidiary of the Company (other
than Indebtedness that is subordinated to the Notes) and release from all
liability on the Indebtedness assumed (which release shall be in writing
executed by all creditors with respect thereto), or (y) Voting Stock of a Person
engaged in the Telecommunications Business that will upon receipt thereof be or
become a Restricted Subsidiary; provided that this clause (ii) shall not apply
to long-term assignments of capacity in a telecommunications network. In the
event and to the extent that the Net Cash Proceeds received by the Company or
any of its Restricted Subsidiaries from one or more Asset Sales occurring on or
after the Closing Date in any period of 12 consecutive months exceed 10% of
Adjusted Consolidated Net Tangible Assets (determined as of the date closest to
the commencement of such 12-month period for which a consolidated balance sheet
of the Company and its Subsidiaries has been filed with the Commission pursuant
to the "Commission Reports and Reports to Holders" covenant described below),
then the Company shall or shall cause the relevant Restricted Subsidiary to (i)
within 12 months after the date Net Cash Proceeds so received exceed 10% of
Adjusted Consolidated Net Tangible Assets (A) apply an amount equal to such
excess Net Cash Proceeds to permanently repay unsubordinated Indebtedness of the
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Company, or any Restricted Subsidiary providing a Subsidiary Guarantee pursuant
to the "Limitation on Issuances of Guarantees by Restricted Subsidiaries"
covenant or Indebtedness of any other Restricted Subsidiary, in each case owing
to a Person other than the Company or any of its Restricted Subsidiaries or (B)
invest an equal amount, or the amount not so applied pursuant to clause (A) (or
enter into a definitive agreement committing to so invest within 12 months after
the date of such agreement), in property or assets (other than current assets)
of a nature or type or that are used in a business (or in a company having
property and assets of a nature or type, or engaged in a business) similar,
related, ancillary or complementary to the nature or type of the property and
assets of, or the businesses of, the Company and its Restricted Subsidiaries
existing on the date of such investment (as determined in good faith by the
Board of Directors, whose determination shall be conclusive if evidenced by a
Board Resolution) and (ii) apply (no later than the end of the 12-month period
referred to in clause (i) immediately above) such excess Net Cash Proceeds (to
the extent not applied pursuant to clause (i)) as provided in the following
paragraph of this "Limitation on Asset Sales" covenant. The amount of such
excess Net Cash Proceeds required to be applied (or to be committed to be
applied) during such 12-month period as set forth in clause (i) of the preceding
sentence and not applied as so required by the end of such period shall
constitute "Excess Proceeds."
If, as of the first day of any calendar month, the aggregate amount of
Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to this
"Limitation on Asset Sales" covenant totals at least $5 million, the Company
must commence, not later than the fifteenth Business Day of such month, and
consummate, an Offer to Purchase from the Holders on a pro rata basis, and an
offer to purchase any outstanding pari passu Indebtedness with similar
provisions requiring the Company to make an offer to purchase such Indebtedness,
in an aggregate principal amount of Notes and such pari passu Indebtedness equal
to (A) with respect to the Notes, the product of such Excess Proceeds multiplied
by a fraction, the numerator of which is the outstanding principal amount of the
Notes and the denominator of which is the sum of the outstanding principal
amount of the Notes and such pari passu Indebtedness (the product hereinafter
referred to as the "Note Amount"), and (B) with respect to the pari passu
Indebtedness, the excess of the Excess Proceeds over the Note Amount, at a
purchase price equal to 100% of the outstanding principal amount of the Notes or
such pari passu Indebtedness, as the case may be, on the relevant Payment Date
or such other date set forth in the documentation governing the pari passu
Indebtedness, plus, in each case, accrued interest (if any) to the Payment Date
or such other date set forth in the documentation governing the pari passu
Indebtedness. If the aggregate purchase price of the Notes and such pari passu
Indebtedness tendered pursuant to the Offer to Purchase is less than the Excess
Proceeds, the remaining Excess Proceeds will be available for use by the Company
for general corporate purposes. Upon the consummation of any Offer to Purchase
in accordance with the terms of the Indenture where the Excess Proceeds exceeds
the principal amount of the Notes, the amount of Net Cash Proceeds from Asset
Sales subject to any future Offer to Purchase shall be reset to zero.
REPURCHASE OF NOTES UPON A CHANGE OF CONTROL
The Company must commence, within 30 days of the occurrence of a Change of
Control, and consummate an Offer to Purchase for all Notes then outstanding, at
a purchase price equal to 101% of their outstanding principal amount, plus
accrued interest (if any), to the Payment Date.
There can be no assurance that the Company will have sufficient funds
available at the time of any Change of Control to make any debt payment
(including repurchases of Notes) required by the foregoing covenant (as well as
may be contained in other securities of the Company which might be outstanding
at the time). The above covenant requiring the Company to repurchase the Notes
will, unless consents are obtained, require the Company to repay all
Indebtedness then outstanding which by its terms would prohibit such Note
repurchase, either prior to or concurrently with such Note repurchase.
COMMISSION REPORTS AND REPORTS TO HOLDERS
The Company shall supply the Trustee and each Holder or shall supply to the
Trustee for forwarding to each Holder, without cost to such Holder, copies of
all reports and other information which it shall file from time to time with the
Commission.
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EVENTS OF DEFAULT
The following events are defined as "Events of Default" in the Indenture:
(a) default in the payment of principal of (or premium, if any, on) any Note
when the same becomes due and payable at maturity, upon acceleration, redemption
or otherwise; (b) default in the payment of interest on any Note when the same
becomes due and payable, and such default continues for a period of 30 days;
provided that a failure to make any of the first six scheduled interest payments
on the Notes on the applicable Interest Payment Date will constitute an Event of
Default with no grace or cure period; (c) default in the performance or breach
of the provisions of the Indenture applicable to mergers, consolidations and
transfers of all or substantially all of the assets of the Company or the
failure to make or consummate an Offer to Purchase in accordance with the
"Limitation on Asset Sales" or "Repurchase of Notes Upon a Change of Control"
covenants; (d) the Company defaults in the performance of or breaches any other
covenant or agreement of the Company in the Indenture or under the Notes (other
than a default specified in clause (a), (b) or (c) above) and such default or
breach continues for a period of 30 consecutive days after written notice by the
Trustee or the Holders of 25% or more in aggregate principal amount of the Notes
then outstanding; (e) there occurs with respect to any other issue or issues of
Indebtedness of the Company or any Significant Subsidiary having an outstanding
principal amount of $5 million or more in the aggregate for all such issues of
all such Persons, whether such Indebtedness now exists or shall hereafter be
created, (I) an event of default that has caused the Holder thereof to declare
such Indebtedness to be due and payable prior to its Stated Maturity and such
Indebtedness has not been discharged in full or such acceleration has not been
rescinded or annulled within 30 days of such acceleration and/or (II) the
failure to make a principal payment at the final (but not any interim) fixed
maturity and such defaulted payment shall not have been made, waived or extended
within 30 days of such payment default; (f) any final judgment or order (not
covered by insurance) for the payment of money in excess of $5 million in the
aggregate for all such final judgments or orders against all such Persons
(treating any deductibles, self-insurance or retention as not so covered) shall
be rendered against the Company or any Significant Subsidiary and shall not be
paid or discharged, and there shall be any period of 30 consecutive days
following entry of the final judgment or order that causes the aggregate amount
for all such final judgments or orders outstanding and not paid or discharged
against all such Persons to exceed $5 million during which a stay of enforcement
of such final judgment or order, by reason of a pending appeal or otherwise,
shall not be in effect; (g) a court having jurisdiction in the premises enters a
decree or order for (A) relief in respect of the Company or any Significant
Subsidiary in an involuntary case under any applicable bankruptcy, insolvency or
other similar law now or hereafter in effect, (B) appointment of a receiver,
liquidator, assignee, custodian, trustee, sequestrator or similar official of
the Company or any Significant Subsidiary or for all or substantially all of the
property and assets of the Company or any Significant Subsidiary or (C) the
winding up or liquidation of the affairs of the Company or any Significant
Subsidiary and, in each case, such decree or order shall remain unstayed and in
effect for a period of 30 consecutive days; (h) the Company or any Significant
Subsidiary (A) commences a voluntary case under any applicable bankruptcy,
insolvency or other similar law now or hereafter in effect, or consents to the
entry of an order for relief in an involuntary case under any such law, (B)
consents to the appointment of or taking possession by a receiver, liquidator,
assignee, custodian, trustee, sequestrator or similar official of the Company or
any Significant Subsidiary or for all or substantially all of the property and
assets of the Company or any Significant Subsidiary or (C) effects any general
assignment for the benefit of creditors; or (i) the Pledge Agreement shall cease
to be in full force and effect or enforceable in accordance with its terms.
If an Event of Default (other than an Event of Default specified in clause
(g) or (h) above that occurs with respect to the Company) occurs and is
continuing under the Indenture, the Trustee or the Holders of at least 25% in
aggregate principal amount of the Notes then outstanding by written notice to
the Company (and to the Trustee if such notice is given by the Holders), may,
and the Trustee at the request of such Holders shall, declare the principal of,
premium, if any, and accrued interest on, the Notes to be immediately due and
payable. Upon a declaration of acceleration, such principal, premium, if any,
and accrued interest shall be immediately due and payable. In the event of a
declaration of acceleration because an Event of Default set forth in clause (e)
above has occurred and is continuing, such declaration of acceleration shall be
automatically rescinded and annulled if the event of default triggering such
Event of Default pursuant to clause (e) shall be remedied or cured by the
Company or the relevant Significant Subsidiary or waived by the
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Holders of the relevant Indebtedness within 60 days after the declaration of
acceleration with respect thereto. If an Event of Default specified in clause
(g) or (h) above occurs with respect to the Company, the principal of, premium,
if any, and accrued interest on, the Notes then outstanding shall ipso facto
become and be immediately due and payable without any declaration or other act
on the part of the Trustee or any Holder. The Holders of at least a majority in
principal amount of the outstanding Notes by written notice to the Company and
to the Trustee, may waive all past defaults and rescind and annul a declaration
of acceleration and its consequences if (i) all existing Events of Default,
other than the nonpayment of the principal of, premium, if any, and interest on,
the Notes that have become due solely by such declaration of acceleration, have
been cured or waived and (ii) the rescission would not conflict with any
judgment or decree of a court of competent jurisdiction. For information as to
the waiver of defaults, see "--Modification and Waiver" below.
The Holders of at least a majority in aggregate principal amount of the
outstanding Notes may direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee. However, the Trustee may refuse to follow any
direction that conflicts with law or the Indenture, that may involve the Trustee
in personal liability, or that the Trustee determines in good faith may be
unduly prejudicial to the rights of Holders of Notes not joining in the giving
of such direction and may take any other action it deems proper that is not
inconsistent with any such direction received from Holders of Notes. A Holder
may not pursue any remedy with respect to the Indenture or the Notes unless: (i)
the Holder gives the Trustee written notice of a continuing Event of Default;
(ii) the Holders of at least 25% in aggregate principal amount of outstanding
Notes make a written request to the Trustee to pursue the remedy; (iii) such
Holder or Holders offer the Trustee indemnity satisfactory to the Trustee
against any costs, liability or expense; (iv) the Trustee does not comply with
the request within 60 days after receipt of the request and the offer of
indemnity; and (v) during such 60-day period, the Holders of a majority in
aggregate principal amount of the outstanding Notes do not give the Trustee a
direction that is inconsistent with the request. However, such limitations do
not apply to the right of any Holder of a Note to receive payment of the
principal of, premium, if any, or interest on, such Note or to bring suit for
the enforcement of any such payment, on or after the due date expressed in the
Notes, which right shall not be impaired or affected without the consent of the
Holder.
The Indenture will require certain officers of the Company to certify, on
or before a date not more than 90 days after the end of each fiscal year, that a
review has been conducted of the activities of the Company and its Restricted
Subsidiaries and the Company's and its Restricted Subsidiaries' performance
under the Indenture and that the Company has fulfilled all obligations
thereunder, or, if there has been a default in the fulfillment of any such
obligation, specifying each such default and the nature and status thereof. The
Company will also be obligated to notify the Trustee of any default or defaults
in the performance of any covenants or agreements under the Indenture.
CONSOLIDATION, MERGER AND SALE OF ASSETS
The Company will not consolidate with, merge with or into, or sell, convey,
transfer, lease or otherwise dispose of all or substantially all of its property
and assets (as an entirety or substantially an entirety in one transaction or a
series of related transactions) to, any Person or permit any Person to merge
with or into the Company unless: (i) the Company shall be the continuing Person,
or the Person (if other than the Company) formed by such consolidation or into
which the Company is merged or that acquired or leased such property and assets
of the Company shall be a corporation organized and validly existing under the
laws of the United States of America or any jurisdiction thereof and shall
expressly assume, by a supplemental indenture, executed and delivered to the
Trustee, all of the obligations of the Company on all of the Notes and under the
Indenture; (ii) immediately after giving effect to such transaction, no Default
or Event of Default shall have occurred and be continuing; (iii) immediately
after giving effect to such transaction on a pro forma basis, the Company or any
Person becoming the successor obligor of the Notes shall have a Consolidated Net
Worth equal to or greater than the Consolidated Net Worth of the Company
immediately prior to such transaction; (iv) immediately after giving effect to
such transaction on a pro forma basis the Company, or any Person becoming the
successor obligor of the Notes, as the case may be, could Incur at least $1.00
of Indebtedness under the first paragraph of the "Limitation on Indebtedness"
covenant; provided that this clause (iv) shall
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not apply to (x) a consolidation, merger or sale of all (but not less than all)
of the assets of the Company if all Liens and Indebtedness of the Company or any
Person becoming the successor obligor on the Notes, as the case may be, and its
Restricted Subsidiaries outstanding immediately after such transaction would, if
Incurred at such time, have been permitted to be Incurred (and all such Liens
and Indebtedness, other than Liens and Indebtedness of the Company and its
Restricted Subsidiaries outstanding immediately prior to the transaction, shall
be deemed to have been Incurred) for all purposes of the Indenture or (y) a
consolidation, merger or sale of all or substantially all of the assets of the
Company if immediately after giving effect to such transaction on a pro forma
basis, the Company or any Person becoming the successor obligor of the Notes
shall have a Consolidated Leverage Ratio equal to or less than the Consolidated
Leverage Ratio of the Company immediately prior to such transaction; and (v) the
Company delivers to the Trustee an Officers' Certificate (attaching the
arithmetic computations to demonstrate compliance with clauses (iii) and (iv)
above) and Opinion of Counsel, in each case stating that such consolidation,
merger or transfer and such supplemental indenture complies with this provision
and that all conditions precedent provided for herein relating to such
transaction have been complied with; provided, however, that clauses (iii) and
(iv) above do not apply if, in the good faith determination of the Board of
Directors, whose determination shall be conclusive if evidenced by a Board
Resolution, the principal purpose of such transaction is to change the state or
form of incorporation of the Company; and provided further that any such
transaction shall not have as one of its purposes the evasion of the foregoing
limitations.
DEFEASANCE
Defeasance and Discharge. The Indenture provides that the Company will be
deemed to have paid and will be discharged from any and all obligations in
respect of the Notes on the 123rd day after the deposit referred to below, and
the provisions of the Indenture will no longer be in effect with respect to the
Notes (except for, among other matters, certain obligations to register the
transfer or exchange of the Notes, to replace stolen, lost or mutilated Notes,
to maintain paying agencies and to hold monies for payment in trust) if, among
other things, (A) the Company has deposited with the Trustee, in trust, cash or
Temporary Cash Investments and/or U.S. Government Obligations that through the
payment of interest and principal in respect thereof in accordance with their
terms will provide money in an amount sufficient to pay the principal of,
premium, if any, and accrued interest on the Notes on the Stated Maturity of
such payments in accordance with the terms of the Indenture and the Notes, (B)
the Company has delivered to the Trustee (i) either (x) an Opinion of Counsel to
the effect that Holders will not recognize income, gain or loss for federal
income tax purposes as a result of the Company's exercise of its option under
this "Defeasance" provision and will be subject to federal income tax on the
same amount and in the same manner and at the same times as would have been the
case if such deposit, defeasance and discharge had not occurred, which Opinion
of Counsel must be based upon (and accompanied by a copy of) a ruling of the
Internal Revenue Service to the same effect unless there has been a change in
applicable federal income tax law after the Closing Date such that a ruling is
no longer required or (y) a ruling directed to the Trustee received from the
Internal Revenue Service to the same effect as the aforementioned Opinion of
Counsel and (ii) an Opinion of Counsel to the effect that the creation of the
defeasance trust does not violate the Investment Company Act of 1940 and after
the passage of 123 days following the deposit, the trust fund will not be
subject to the effect of Section 547 of the United States Bankruptcy Code or
Section 15 of the New York Debtor and Creditor Law, (C) immediately after giving
effect to such deposit on a pro forma basis, no Event of Default, or event that
after the giving of notice or lapse of time or both would become an Event of
Default, shall have occurred and be continuing on the date of such deposit or
during the period ending on the 123rd day after the date of such deposit, and
such deposit shall not result in a breach or violation of, or constitute a
default under, any other agreement or instrument to which the Company or any of
its Subsidiaries is a party or by which the Company or any of its Subsidiaries
is bound and (D) if at such time the Notes are listed on a national securities
exchange, the Company has delivered to the Trustee an Opinion of Counsel to the
effect that the Notes will not be delisted as a result of such deposit,
defeasance and discharge; provided that if simultaneously with the deposit of
the cash or Temporary Cash Investments and/or U.S. Government Obligations
referred to in (A) above, the Company has caused an irrevocable, transferrable,
standby letter of credit to be issued by a bank with capital and surplus
exceeding the principal amount of the Notes then outstanding, expiring not
earlier than 180 days
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from its issuance, in favor of the Trustee, which permits the Trustee to draw an
amount equal to the principal, premium, if any, and accrued interest on the
Notes through the expiry date of the letter of credit, then the Company will be
deemed to have paid and discharged any and all obligations in respect of the
Notes on the date of the deposit and issuance of the letter of credit.
Defeasance of Certain Covenants and Certain Events of Default. The
Indenture further provides that the provisions of the Indenture will no longer
be in effect with respect to clauses (iii) and (iv) under "Consolidation, Merger
and Sale of Assets" and all the covenants described herein under "Covenants,"
clause (c) under "Events of Default" with respect to such clauses (iii) and (iv)
under "Consolidation, Merger and Sale of Assets," clause (d) under "Events of
Default" with respect to such other covenants and clauses (c), (d), (e), (f) and
(g) under "Events of Default" shall be deemed not to be Events of Default upon,
among other things, the deposit with the Trustee, in trust, of cash or Temporary
Cash Investments and/or U.S. Government Obligations that through the payment of
interest and principal in respect thereof in accordance with their terms will
provide money in an amount sufficient to pay the principal of, premium, if any,
and accrued interest on the Notes on the Stated Maturity of such payments in
accordance with the terms of the Indenture and the Notes, the satisfaction of
the provisions described in clauses (B)(ii), (C) and (D) of the preceding
paragraph and the delivery by the Company to the Trustee of an Opinion of
Counsel to the effect that, among other things, the Holders will not recognize
income, gain or loss for federal income tax purposes as a result of such deposit
and defeasance of certain covenants and Events of Default and will be subject to
federal income tax on the same amount and in the same manner and at the same
times as would have been the case if such deposit and defeasance had not
occurred.
Defeasance and Certain Other Events of Default. In the event the Company
exercises its option to omit compliance with certain covenants and provisions of
the Indenture with respect to the Notes as described in the immediately
preceding paragraph and the Notes are declared due and payable because of the
occurrence of an Event of Default that remains applicable, the amount of cash or
Temporary Cash Investments and/or U.S. Government Obligations on deposit with
the Trustee will be sufficient to pay amounts due on the Notes at the time of
their Stated Maturity but may not be sufficient to pay amounts due on the Notes
at the time of the acceleration resulting from such Event of Default. However,
the Company will remain liable for such payments.
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company
and the Trustee with the consent of the Holders of not less than a majority in
aggregate principal amount of the outstanding Notes; provided, however, that no
such modification or amendment may, without the consent of each Holder affected
thereby, (i) change the Stated Maturity of the principal of, or any installment
of interest on, any Note, (ii) reduce the principal of, premium, if any, or
interest on, any Note, (iii) change the place or currency of payment of
principal of, or premium, if any, or interest on, any Note, (iv) impair the
right to institute suit for the enforcement of any payment on or after the
Stated Maturity (or, in the case of a redemption, on or after the Redemption
Date) of any Note, (v) reduce the above-stated percentage of outstanding Notes
the consent of whose Holders is necessary to modify or amend the Indenture, (vi)
waive a default in the payment of principal of, premium, if any, or interest on
the Notes or (vii) reduce the percentage or aggregate principal amount of
outstanding Notes the consent of whose Holders is necessary for waiver of
compliance with certain provisions of the Indenture or for waiver of certain
defaults.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS OR EMPLOYEES
The Indenture provides that no recourse for the payment of the principal
of, premium, if any, or interest on any of the Notes or for any claim based
thereon or otherwise in respect thereof, and no recourse under or upon any
obligation, covenant or agreement of the Company in the Indenture, or in any of
the Notes or because of the creation of any Indebtedness represented thereby,
shall be had against any Director, officer, employee or controlling person of
the Company or of any successor Person thereof. Each Holder, by accepting the
Notes, waives and releases all such liability.
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CONCERNING THE TRUSTEE
The Indenture provides that, except during the continuance of a Default,
the Trustee will not be liable, except for the performance of such duties as are
specifically set forth in the Indenture. If an Event of Default has occurred and
is continuing, the Trustee will use the same degree of care and skill in its
exercise of the rights and powers vested in it under the Indenture as a prudent
person would exercise under the circumstances in the conduct of such person's
own affairs.
The Indenture and the provisions of the Trust Indenture Act of 1939, as
amended, incorporated by reference therein contain limitations on the rights of
the Trustee, should it become a creditor of the Company, to obtain payment of
claims in certain cases or to realize on certain property received by it in
respect of any such claims, as security or otherwise. The Trustee is permitted
to engage in other transactions; provided, however, that, if it acquires any
conflicting interest, it must eliminate such conflict or resign.
BOOK-ENTRY; DELIVERY AND FORM
The certificates representing the Notes are issued in definitive, fully
registered form without interest coupons. Exchange Notes issued in exchange for
Private Notes sold in reliance on Rule 144A under the Securities Act will be
evidenced by one or more Global Notes in definitive, fully registered form
without interest coupons and will be deposited with the Trustee as custodian
for, and registered in the name of, the nominee of DTC in New York., New York.
Exchange Notes issued in exchange for Private Notes sold in offshore
transactions pursuant to Regulation S under the Securities Act, will be
evidenced by one or more Global Notes which will be deposited with the Trustee
as custodian for, and registered in the name of a nominee of, DTC for the
accounts of Euroclear and Cedel Bank.
Global Notes transferred to Institutional Accredited Investors who are not
Qualified Institutional Buyers ("Non-Global Purchasers") will be in definitive,
fully registered form without interest coupons ("Certificated Notes"). Upon the
transfer of Certificated Notes to a Qualified Institutional Buyer or in
accordance with Regulation S under the Securities Act, such Certificated Notes
will, unless the relevant Global Note has previously been exchanged in whole for
Certificated Notes, be exchanged for an interest in a Global Note.
Ownership of beneficial interests in a Global Note will be limited to
persons who have accounts with DTC ("participants") or persons who hold
interests through participants. Ownership of beneficial interests in a Global
Note will be shown on, and the transfer of that ownership will be effected only
through, records maintained by DTC or its nominee (with respect to interests of
participants) and the records of participants (with respect to interests of
persons other than participants). Qualified Institutional Buyers may hold their
interests in a Restricted Global Note directly through DTC if they are
participants in such system, or indirectly through organizations which are
participants in such system.
Investors may hold their interests in a Regulation S Global Note directly
through Cedel Bank or Euroclear, if they are participants in such systems, or
indirectly through organizations that are participants in such systems. Cedel
Bank and Euroclear will hold interests in the Regulation S Global Notes on
behalf of their participants through DTC.
So long as DTC, or its nominee, is the registered owner or Holder of a
Global Note, DTC or such nominee, as the case may be, will be considered the
sole owner or Holder of the Notes represented by such Global Note for all
purposes under the Indenture and the Notes. No beneficial owner of an interest
in a Global Note will be able to transfer that interest except in accordance
with DTC's applicable procedures, in addition to those provided for under the
Indenture and, if applicable, those of Euroclear and Cedel Bank.
Payments of the principal of, and premium if any, and interest on, a Global
Note will be made to DTC or its nominee, as the case may be, as the registered
owner thereof. Neither the Company, the Trustee nor any Paying Agent will have
any responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interests in a Global Note or
for maintaining, supervising or reviewing any records relating to such
beneficial ownership interests.
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The Company expects that DTC or its nominee, upon receipt of any payment of
principal of, premium, if any, or interest on a Global Note, will credit
participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of such Global Note as
shown on the records of DTC or its nominee. The Company also expects that
payments by participants to owners of beneficial interests in such Global Note
held through such participants will be governed by standing instructions and
customary practices, as is now the case with securities held for the accounts of
customers registered in the names of nominees for such customers. Such payments
will be the responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in same-day funds. Transfers
between participants in Euroclear and Cedel Bank will be effected in the
ordinary way in accordance with their respective rules and operating procedures.
The Company expects that DTC will take any action permitted to be taken by
a Holder of Notes (including the presentation of Notes for exchange as described
below) only at the direction of one or more participants to whose account the
DTC interests in a Global Note is credited and only in respect of such portion
of the aggregate principal amount of Notes as to which such participant or
participants has or have given such direction. However, if there is an Event of
Default under the Notes, DTC will exchange the applicable Global Note for
Certificated Notes, which it will distribute to its participants and which may
be legended as set forth below under the heading "Transfer Restrictions."
The Company understands that DTC is: a limited purpose trust company
organized under the laws of the State of New York, a "banking organization"
within the meaning of New York Banking Law, a member of the Federal Reserve
System, a "clearing corporation" within the meaning of the Uniform Commercial
Code and a "Clearing Agency" registered pursuant to the provisions of Section
17A of the Exchange Act. DTC was created to hold securities for its participants
and facilitate the clearance and settlement of securities transactions between
participants through electronic book-entry changes in accounts of its
participants, thereby eliminating the need for physical movement of certificates
and certain other organizations. Indirect access to the DTC system is available
to others such as banks, brokers, dealers and trust companies that clear through
or maintain a custodial relationship with a participant, either directly or
indirectly ("indirect participants").
Although DTC, Euroclear and Cedel Bank are expected to follow the foregoing
procedures in order to facilitate transfers of interests in a Global Note among
participants of DTC, Euroclear and Cedel Bank, respectively, they are under no
obligation to perform or continue to perform such procedures, and such
procedures may be discontinued at any time. Neither the Company nor the Trustee
will have any responsibility for the performance by DTC, Euroclear or Cedel Bank
or their respective participants or indirect participants of their respective
obligations under the rules and procedures governing their operations.
If DTC is at any time unwilling or unable to continue as a depositary for
the Global Notes and a successor depositary is not appointed by the Company
within 90 days, the Company will issue Certificated Notes in exchange for the
Global Notes. Holders of an interest in a Global Note may receive Certificated
Notes in accordance with DTC's rules and procedures in addition to those
provided for under the Indenture.
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UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
Bryan Cave LLP, special counsel to the Company, has advised the Company
that the following discussion as to legal matters is its opinion as to the
material United States federal income tax consequences of an exchange of Private
Notes for Exchange Notes and the ownership of Notes, as well as certain
potential federal income tax consequences to the Company of the Notes. The
opinion of Bryan Cave LLP is based on current provisions of the U.S. Internal
Revenue Code of 1986, as amended (the "Code"), applicable final, temporary and
proposed Treasury Regulations ("Treasury Regulations"), judicial authority, and
current administrative rulings and pronouncements of the Internal Revenue
Service (the "IRS") and is conditioned upon certain facts concerning the
Company, all as of the date hereof. There can be no assurance that the IRS will
not take a contrary view, and no ruling from the IRS has been or will be sought
by the Company. Legislative, judicial, or administrative changes or
interpretations may be forthcoming that could alter or modify the statements and
conclusions set forth herein. Any such changes or interpretations may or may not
be retroactive and could affect the tax consequences to Holders of the Notes.
The opinion does not purport to deal with all aspects of taxation that may
be relevant to particular Holders of the Notes in light of their personal
investment or tax circumstances, or to certain types of investors (including
individual retirement accounts and other tax deferred accounts, insurance
companies, financial institutions, broker-dealers, direct or indirect equity
owners in the Company or tax-exempt organizations) subject to special treatment
under the U.S. federal income tax laws. This discussion does not deal with
special tax situations, such as the holding of the Notes as part of a straddle
with other investments, or situations in which the functional currency of a
Holder of Notes is not the U.S. dollar. In addition, this discussion deals only
with Notes held as capital assets within the meaning of Section 1221 of the
Code.
For purposes of this discussion, the term "U.S. Holder" means an individual
citizen or resident of the U.S., a corporation, limited liability company or
partnership created or organized in the U.S. or under the law of the U.S. or any
state thereof (including the District of Columbia), an estate the income of
which is includible in gross income for U.S. federal income tax purposes
regardless of its source, or a trust if a court within the U.S. is able to
exercise primary supervision over the administration of the trust and one or
more U.S. persons has the authority to control all substantial decisions of the
trust (or, under certain circumstances, a trust the income of which is
includible in gross income for U.S. federal income tax purposes regardless of
its source). The term "Non-U.S. Holder" means any person other than a U.S.
Holder.
THE TAX TREATMENT MAY VARY DEPENDING UPON A HOLDER'S PARTICULAR SITUATION.
HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE PARTICULAR TAX
CONSEQUENCES TO THEM OF PURCHASING, EXCHANGING, HOLDING AND DISPOSING OF THE
NOTES, INCLUDING THE APPLICABILITY AND EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX
LAWS.
THE EXCHANGE
The exchange of Private Notes for Exchange Notes should not be treated as a
taxable transaction for United States federal income tax purposes because the
Exchange Notes will not be considered to differ materially in kind or extent
from the Private Notes. Rather, the Exchange Notes received by a Holder of
Private Notes should be treated as a continuation of the Private Notes in the
hands of such Holder. As a result, there should be no material federal income
tax consequences to Holders exchanging Private Notes for Exchange Notes.
PERSONS CONSIDERING THE EXCHANGE OF THE PRIVATE NOTES FOR EXCHANGE NOTES
SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE FEDERAL INCOME TAX
CONSEQUENCES AND THE TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY OTHER TAXING
JURISDICTION OF SUCH AN EXCHANGE.
THE NOTES
Under applicable authorities, the Notes should be treated as indebtedness
for U.S. federal income tax purposes. If the Notes are treated as equity, the
Company may be treated as a publicly traded partnership and,
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as such, be subject to U.S. federal income tax as a corporation. In such event,
the amount of any actual or constructive distributions on any such Note would
first be taxable to the Holder as dividend income to the extent, if any, of the
Company's current and accumulated earnings and profits, and next would be
treated as a nontaxable return of capital to the extent of the Holder's tax
basis in the Note, with any remaining amount treated as gain from the sale of a
Note. Further, payments on the Notes treated as equity to Non-U.S. Holders would
not be eligible for the portfolio interest exception from U.S. withholding tax,
and dividends thereon would be subject to United States withholding tax at a
flat rate of 30% (or lower applicable treaty rate) and gain from their sale or
other taxable disposition might also be subject to U.S. tax. In addition, in the
event of equity treatment, the Company would not be entitled to deduct interest
on the Notes for U.S. federal income tax purposes. Finally, the liability of the
Company for corporate income tax, if the Notes were treated as equity, could
affect the cash flow of the Company and, thus, its ability to meet its
obligations on the Notes. The remainder of this discussion assumes that the
Notes will constitute indebtedness of the Company for such tax purposes.
U.S. HOLDERS
INTEREST
Interest on the Notes generally will be includable in the income of a U.S.
Holder as ordinary income at the time such interest is received or accrued, in
accordance with such U.S. Holder's method of accounting for United States
federal income tax purposes. The Company expects that the Notes will not be
issued with original issue discount within the meaning of the Code.
SALE OR OTHER DISPOSITION
In general, upon the sale, exchange or redemption of a Note, a U.S. Holder
will generally recognize taxable gain or loss equal to the difference between
(i) the amount of cash proceeds and the fair market value of any property
received on the sale, exchange or redemption (not including any amount
attributable to accrued but unpaid interest) and (ii) the U.S. Holder's adjusted
tax basis in the Note. A U.S. Holder's adjusted tax basis in a Note generally
will be equal to the cost of the Note to such U.S. Holder.
Gain or loss realized on the sale, exchange or redemption of a Note
generally will be capital gain or loss. Under recently enacted legislation, in
general, long-term capital gains recognized by an individual U.S. Holder will be
subject to a maximum federal income tax rate of 20% in respect of property held
for more than one year, effective for taxable years ending after December 31,
1997. The distinction between capital gain or loss and ordinary income or loss
is also relevant for purposes of, among other things, limitations with respect
to the deductibility of capital losses.
An exchange of Notes pursuant to the Exchange Offer should not be
considered a taxable event.
NON-U.S. HOLDERS
In general, subject to the discussion below concerning backup withholding:
(a) payments of principal or interest on the Notes by the Company or
any paying agent to a beneficial owner of a Note that is a Non-U.S. Holder
will not be subject to U.S. federal withholding tax, provided that, in the
case of interest, (i) such Non-U.S. Holder does not own, actually or
constructively, a 10% or more interest in the capital or profits of the
Company, within the meaning of Section 871(h)(3) of the Code, (ii) such
Non-U.S. Holder is not a "controlled foreign corporation" (within the
meaning of the Code) that is related, directly or indirectly, to the
Company through stock ownership, (iii) such Non-U.S. Holder is not a bank
receiving interest described in Section 881(c)(3)(A) of the Code, and (iv)
the certification requirements under Section 871(h) or Section 881(c) of
the Code and Treasury Regulations thereunder (summarized below) are
satisfied;
(b) a Non-U.S. Holder of a Note will not be subject to U.S. federal
income tax on gains realized on the sale, exchange or other disposition of
such Note, unless (i) such Non-U.S. Holder is an individual who is present
in the U.S. for 183 days or more in the taxable year of such sale, exchange
or other
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disposition, and certain conditions are met, (ii) such gain is effectively
connected with the conduct by the Non-U.S. Holder of a trade or business in
the U.S. and, if certain tax treaties apply, is attributable to a U.S.
permanent establishment maintained by the Non-U.S. Holder, or (iii) the
Non-U.S. Holder is subject to Code provisions applicable to certain U.S.
expatriates;
(c) a Note held by an individual who is not a citizen or resident of
the U.S. at the time of his death will not be subject to U.S. federal
estate tax as a result of such individual's death, provided that, at the
time of such individual's death, the individual does not own, actually or
constructively, a 10% or more interest in the capital or profits of the
Company and payments with respect to such Note would not have been
effectively connected with the conduct by such individual of a trade or
business in the U.S.
To satisfy the certification requirements referred to in (a)(iv) above,
Sections 871(h) and 881(c) of the Code and currently effective Treasury
Regulations thereunder require that either (i) the beneficial owner of a Note
must certify, under penalties of perjury, to the Company or its paying agent, as
the case may be, that such owner is a Non-U.S. Holder and must provide such
owner's name and address, and U.S. taxpayer identification number ("TIN"), if
any, or (ii) a securities clearing organization, bank or other financial
institution that holds customer's securities in the ordinary course of its trade
or business (a "Financial Institution") and holds the Note on behalf of the
beneficial owner thereof must certify, under penalties of perjury, to the
Company or its paying agent, as the case may be, that such certificate has been
received from the beneficial owner and must furnish the payor with a copy
thereof. A certificate described in this paragraph is effective only with
respect to payments of interest made to the certifying Non-U.S. Holder after
delivery of the certificate in the calendar year of its delivery and the two
immediately succeeding calendar years. Under temporary Treasury Regulations,
such requirement will be fulfilled if the beneficial owner of a Note certifies
on IRS Form W-8, under penalties of perjury, that it is a Non-U.S. Holder and
provides its name and address, and any Financial Institution holding the Note on
behalf of the beneficial owner files a statement with the withholding agent to
the effect that it has received such a statement from the beneficial owner (and
furnishes the withholding agent with a copy thereof).
Treasury Regulations released on October 6, 1997, as modified by Notice
98-16 dated March 27, 1998 (the "New Regulations"), and effective for payments
made after December 31, 1999, subject to transition rules, provide alternative
methods for satisfying the certification requirements described above. The New
Regulations require, in the case of Notes held by a foreign partnership, that
(i) the certification be provided by the partners rather than by the foreign
partnership and (ii) the partnership provide certain information, including a
U.S. taxpayer identification number. A look-through rule would apply in the case
of tiered partnerships.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the
U.S. and if interest on the Note, or gain realized on the sale, exchange or
other disposition of the Note, is effectively connected with the conduct of such
trade or business and, if certain tax treaties apply, is attributable to a U.S.
permanent establishment maintained by the Non-U.S. Holder in the U.S., the
Non-U.S. Holder, although exempt from U.S. federal withholding tax (provided
that the certification requirements discussed in the next sentence are met),
will generally be subject to regular U.S. federal income tax on such interest or
gain in the same manner as if it were a U.S. Holder. In lieu of the certificate
described above, such a Non-U.S. Holder will be required, under currently
effective Treasury Regulations, to provide the Company with a properly executed
IRS Form 4224 in order to claim an exemption from withholding tax. In addition,
if such Non-U.S. Holder is a foreign corporation, it may be subject to a branch
profits tax equal to 30% (or such lower rate provided by an applicable treaty)
of its effectively connected earnings and profits for the taxable year, subject
to certain adjustments. For purposes of the branch profits tax, interest on a
Note and any gain recognized on the sale, exchange or other disposition of a
Note will be included in the earnings and profits of such Non-U.S. Holder if
such interest or gain is effectively connected with the conduct of a trade or
business in the U.S. In general, for payments made after December 31, 1999,
under the New Regulations a Non-U.S. Holder with effectively connected income
must provide to the Company, either directly or through an intermediary, a valid
IRS Form W-8 to claim an exemption from withholding.
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Non-U.S. Holders should consult with their tax advisors regarding U.S. and
foreign tax consequences with respect to the Notes.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Backup withholding of U.S. federal income tax at a rate of 31% may apply to
payments made in respect of a Note to a Holder that is not an "exempt recipient"
and that fails to provide certain identifying information (such as the Holder's
TIN) in the manner required. Generally, individuals are not exempt recipients,
whereas corporations and certain other entities are exempt recipients. Payments
made in respect of a Note must be reported to the IRS, unless the Holder is an
exempt recipient or otherwise establishes an exemption.
In the case of payments of interest on a Note to a Non-U.S. Holder,
Treasury Regulations provide that backup withholding and information reporting
will not apply to payments with respect to which either requisite certification
has been received or an exemption has otherwise been established (provided that
neither the Company nor a paying agent has actual knowledge that the Holder is a
U.S. Holder or that the conditions of any other exemption are not in fact
satisfied).
Payments of the proceeds of the sale of a Note to or through a foreign
office of a broker that is a U.S. person, a "controlled foreign corporation"
(within the meaning of the Code), or a foreign person, 50% or more of whose
gross income from all sources for the three-year period ending with the close of
its taxable year preceding the date of payment was effectively connected with
the conduct of a trade or business within the U.S., or (pursuant to the New
Regulations, for payments made after December 31, 1999) a foreign partnership
with certain U.S. connections, are currently subject to certain information
reporting requirements, unless the payee is an exempt recipient or such broker
has evidence in its records that the payee is a Non-U.S. Holder and has no
actual knowledge that such evidence is false and certain other conditions are
met. Under current Treasury Regulations, payments of the proceeds of a sale of a
Note to or through the U.S. office of a broker will be subject to information
reporting and backup withholding unless the payee certifies under penalties of
perjury as to his or her status as a Non-U.S. Holder and satisfies certain other
qualifications (and no agent or broker who is responsible for receiving or
reviewing such statement has actual knowledge that it is incorrect) and provides
his or her name and address or the payee otherwise establishes an exemption.
Any amounts withheld under the backup withholding rules from a payment to a
Holder of a Note will be allowed as a refund or credit against such Holder's
U.S. federal income tax, provided that the required information is furnished to
the IRS.
In general, the New Regulations do not significantly alter the current
substantive withholding and information reporting requirements but unify current
certification procedures and forms and clarify reliance standards. Under the New
Regulations, special rules apply which permit the shifting of primary
responsibility for withholding to certain financial intermediaries acting on
behalf of beneficial owners. A Holder of a Note should consult with its tax
advisor regarding the application of the backup withholding rules to its
particular situation, the availability of an exemption therefrom, the procedure
for obtaining such an exemption, if available, and the impact of the New
Regulations on payments made with respect to Notes after December 31, 1999.
THE FOREGOING SUMMARY DOES NOT DISCUSS ALL ASPECTS OF UNITED STATES FEDERAL
INCOME TAXATION THAT MAY BE RELEVANT TO A PARTICULAR HOLDER OF NOTES IN LIGHT OF
ITS PARTICULAR CIRCUMSTANCES AND INCOME TAX SITUATION. HOLDERS SHOULD CONSULT
THEIR OWN TAX ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE
PURCHASE, EXCHANGE, OWNERSHIP AND DISPOSITION OF NOTES, INCLUDING THE
APPLICATION AND EFFECT OF STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND THE
POSSIBLE EFFECTS OF CHANGES IN UNITED STATES OR OTHER TAX LAWS.
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PLAN OF DISTRIBUTION
This Prospectus, as it may be amended or supplemented from time to time,
may be used by a broker-dealer in connection with resales of any Exchange Notes
received in exchange for Private Notes acquired by such broker-dealer for its
own account as a result of market-making or other trading activities. Each such
broker-dealer that receives Exchange Notes for its own account in exchange for
such Private Notes pursuant to the Exchange Offer must acknowledge that it will
deliver a prospectus in connection with any resale of such Exchange Notes. The
Company has agreed that, for a period of up to 90 days after the Expiration
Date, it will make this Prospectus, as amended or supplemented, available to any
such broker-dealer that requests copies of this Prospectus in the Letter of
Transmittal for use in connection with any such resale.
The Company will not receive any proceeds from any sale of Exchange Notes
by broker-dealers or any other persons. Exchange Notes received by
broker-dealers for their own account pursuant to the Exchange Offer may be sold
from time to time in one or more transactions in the over-the-counter market, in
negotiated transactions or through the writing of options on the Exchange Notes,
or a combination of such methods of resale, at market prices prevailing at the
time of resale or at negotiated prices. Any such resale may be made directly to
purchasers or to or through brokers or dealers who may receive compensation in
the form of commissions or concessions from any such broker-dealer and/or the
purchasers of any such Exchange Notes. Any broker-dealer that resells Exchange
Notes that were received by it for its own account pursuant to the Exchange
Offer in exchange for Private Notes acquired by such broker-dealer as a result
of market-making or other trading activities and any broker-dealer that
participates in a distribution of such Exchange Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit on any
such resale of Exchange Notes and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. The Letter of Transmittal states that by acknowledging that it will deliver
and by delivering a prospectus, a broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act.
The Company has agreed to pay all expenses incident to the Company's
performance of, or compliance with, the Registration Rights Agreement and will
indemnify the Holders of Private Notes (including any broker-dealers), and
certain parties related to such Holders, against certain liabilities, including
liabilities under the Securities Act.
VALIDITY OF THE EXCHANGE NOTES
The validity of the Exchange Notes will be passed upon for the Company by
Bryan Cave LLP, St. Louis, Missouri.
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The consolidated balance sheets of US Xchange, L.L.C. and subsidiaries as
of December 31, 1997 and 1996 and the related consolidated statements of
operations, members' deficit and cash flows for the year ended December 31, 1997
and the period from August 5, 1996 to December 31, 1996 have been audited by BDO
Seidman, LLP, independent certified public accountants, as set forth in their
report appearing elsewhere herein, and is included in reliance upon such report
given upon the authority of said firm as experts in auditing and accounting.
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GLOSSARY OF SELECTED TERMS
ACCESS CHARGES--The fees paid by long distance carriers to ILECs for
originating and terminating long distance calls on their local networks.
ACCESS TANDEMS--An interconnection point on an ILEC local network where
calls from central offices are aggregated for transmission to other central
offices and IXC facilities.
ADSL (ASYMMETRIC DIGITAL SUBSCRIBER LINE)--Technology currently being
deployed by RBOCs to increase the carrying capacity of their copper wire
networks to provide high speed Internet access, LAN interconnection and other
advanced data services. RBOCs can increase the speeds and capacity of these
networks by equipping them with high speed modems.
AIN (ADVANCED INTELLIGENT NETWORK)--A term indicating a network
architecture concept with three basic elements: (i) Signal Control Points, or
SCPs, which are computers that hold databases in which customer-specific
information is used by the network to route calls stored; (ii) Signal Switching
Points, or SSPs, which are digital telephone switches that can communicate with
SCPs and obtain customer-specific instructions as to how a call should be
completed; and (iii) Signal Transfer Points, or STPs, which are packet switches
that shuttle messages between SSPs and SCPs.
ATM (ASYNCHRONOUS TRANSFER MODE)--ATM is a high-speed data-packet switching
and transmission technology that allows the simultaneous transmission of voice,
data, and video over a single network. Information is organized into standard
53-byte cells, which allows ATM to be very efficient and to achieve high
throughput levels.
BACKBONE EXTENSIONS--Fiber optic connections to remote areas not within the
backbone ring network.
BANDWIDTH--The relative range of frequencies that can be passed without
distortion by a transmission medium. The amount of bandwidth determines the
information-carrying capability of the transmission medium, with large
bandwidths permitting increased transmission capacity.
BROADBAND--Broadband communications systems can transmit large quantities
of voice, data and video communications by way of digital or analog signals.
Examples of broadband communications systems include DS-3 fiber optic systems,
which can transmit at a rate of 45 megabits per second, or a broadcast
television station signal that transmits high resolution audio and video
signals. Broadband connectivity is also an essential element for interactive
multimedia applications.
CAP (COMPETITIVE ACCESS PROVIDER)--A company that provides its customers
with an alternative to the local telephone company for local transport of
private line, special access and interstate transport of switched access
telecommunications services. CAPs are the predecessor companies to the CLECs.
CENTRAL OFFICES--The switching centers or central switching facilities of
the ILECs.
CENTREX--Centrex is a service that offers features similar to those of a
Private Branch Exchange (PBX), except the equipment is located at the carrier's
premises and not at the premises of the customer. These features include direct
dialing within a given phone system, voice mail, direct dialing of incoming
calls, and automatic identification of outbound calls, among others. Carriers
with Centrex capabilities can provide these value-added services to a wide range
of customers who do not have the size or the funds to support their own on-site
PBX.
CLEC (COMPETITIVE LOCAL EXCHANGE CARRIER)--A CAP that also provides
switched local telecommunications services.
COLLOCATION--The ability of a CLEC to connect to another LEC's central
office. Physical collocation describes the placing of network connection
equipment inside the LEC's central offices. Virtual collocation is an
alternative to physical collocation pursuant to which an LEC permits another LEC
to connect its network to its LEC's central offices on comparable terms, even
though the network connection equipment is not physically located inside the
ILEC's central offices.
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DEDICATED LINES--Telecommunications lines dedicated or reserved for use
exclusively by particular customers along predetermined routes (in contrast to
telecommunications lines within an ILEC's public switched network).
DIALING PARITY--Allows customers to have 1+ and 0+ service no matter which
local or long distance carrier they choose. For example, when MCI Communications
Corporation first entered the long distance business, customers had to dial a
ten digit prefix before dialing the number they were calling.
DIGITAL--A method of storing, processing and transmitting information
through the use of distinct electronic or optical pulses that represent the
binary code digits 0 and 1. Digital transmission and switching technologies
employ a sequence of these pulses to represent information as opposed to the
continuously variable analog signal. Digital transmission and switching
technologies offer a significant improvement in speed and capacity over analog
techniques, allowing much more efficient and cost-effective transmission of
voice, video and data.
DIVERSE ROUTING--A telecommunications network configuration in which
signals are transported simultaneously along two different paths so that if one
cable is cut, traffic can continue in the other direction without interruption
to its destination. The Company's fiber optic SONET ring networks generally
provide diverse routing.
DIVESTITURE--In 1982, the U.S. Department of Justice forced the breakup of
the old Bell telephone system. The divestiture of AT&T established seven
separate RBOCs and created two distinct segments of telecommunications service:
local and long distance. This laid the groundwork for intense competition in the
long distance industry, but essentially created seven separate regionally-based
local exchange service monopolies.
DOMINANT CARRIER--Carriers with the market power to raise prices, curtail
overall output or engage in predatory pricing.
DLP (DIGITAL LINE POWER)--A digital circuit that is powered from the
central office. DLP technologies permit the digital transmission over power
lines of Internet and data communications at higher speeds than are available in
ADSL or ISDN lines.
DS-0, DS-1, DS-3--Standard telecommunications industry digital signal
formats, which are distinguishable by bit rate (the number of binary digits (0
and 1) transmitted per second). DS-0 service has a bit rate of 64 kilobits per
second. DS-1 service has a bit rate of 1.544 megabits per second and DS-3
service has a bit rate of 45 megabits per second.
DWDM (DENSE WAVELENGTH DIVISION MULTIPLEXING)--Equipment which expands the
carrying capacity of fiber optic networks by dividing the optical signal into
multiple colors or wavelengths. This enables carriers to expand the bandwidth of
their fiber optic networks without adding additional fibers.
FACILITIES-BASED CARRIER--A carrier that owns and operates its own
facilities and networks, as opposed to a non-facilities-based carrier that
aggregates or resells another provider's service. Resellers are present in every
segment of the telecommunications business and profit by buying excess capacity
of the facilities-based carriers at wholesale prices and selling it to the end
user at retail prices. Companies that lease capacity and provide their own
switching and network management are commonly referred to as facilities-based.
FCC--The Federal Communications Commission, an administrative agency of the
U.S. government.
FEATURE GROUP--In switched access tariffs, a "feature group" denotes a
specific and uniform type and quality of local exchange access available to
IXCs, CLECs and other telecommunications companies. There are four levels of
feature groups that are distinguished on the basis of the type of switched
access connection and the transmission quality and range of access features for
originating and terminating traffic.
FIBER MILE--The number of route miles installed (excluding pending
installations) along a telecommunications path multiplied by the number of
fibers along that path. See the definition of "Route Miles" below.
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FIBER OPTICS--Fiber optic cable is the medium of choice for the
telecommunications and cable industries. Fiber is immune to electrical
interference and many environmental factors that affect copper wiring and
satellite transmission. Fiber optic technology involves sending laser light
pulses across glass strands in order to transmit digital information. A strand
of fiber-optic cable is as thick as a human hair yet generally has more capacity
than copper cable the size of a telephone pole.
FIBER-OPTIC RING NETWORK--A network ring configuration that is designed to
ensure complete redundancy. If one segment of the network is damaged or cut, the
traffic is simply re-routed and sent to its destination in the opposite
direction. The Company uses a "self-healing" optical fiber ring architecture
known as SONET. See the definition of "SONET" below.
FRAME RELAY--A high-speed, data-packet switching service used to transmit
data between computers. Frame relay supports data units of variable lengths at
access speeds ranging from 56 kilobits per second to 1.5 megabits per second.
This service is well-suited for connecting LANs, but is not presently
well-suited for voice and video applications due to the variable delays which
can occur. Frame relay was designed to operate at high speeds on modern fiber
optic networks.
ILECS (INCUMBENT LOCAL EXCHANGE CARRIERS)--ILECs connect end users
inter-LATA and also provide the local portion for most long distance calls. The
ILECs are required to serve all residential and business users within a
restricted geographic area defined as a LATA. The market for local exchange
services consists of a number of services and related charges that include (i)
basic dial tone and private line services; (ii) the local origination or
termination of long distinct telephone calls; and (iii) the variable portion of
charges received by the ILECs for long distance calls originating and
terminating within a LATA or for intra-LATA toll services. The local access
business, until recently, has remained the domain of the RBOCs and approximately
1,000 ILECs, including GTE.
INTER-LATA CALLS--Inter-LATA calls are calls that pass from one LATA to
another. Typically, these calls are referred to as long distance calls.
Historically, the ILECs were prohibited from providing Inter-LATA long distance
service.
INTERNET--A global collection of interconnected computer networks which use
a packet-switched transmission technology to transmit or provide access to
information.
INTRA-LATA CALLS--Intra-LATA calls, also known as short haul calls, are
those local calls that originate and terminate within the same LATA. Although
most states allow some form of Intra-LATA competition, dialing parity still does
not exist, and very little ILEC Intra-LATA revenue has been won by competitors
to ILECs.
IP (INTERNET PROTOCOL)--An efficient transmission technology used on the
Internet that breaks voice, data, fax and video communications into packets for
transport so that multiple interspersed data packets can be transmitted over a
single circuit at the same time. The typical packet circuit requires only 8
kilobits of transmission capacity, whereas a standard voice circuit requires 64
kilobits of capacity.
ISDN (INTEGRATED SERVICES DIGITAL NETWORK)--A complex networking concept
designed to provide a variety of voice, data and digital interface standards.
Incorporated into ISDN are many new enhanced services, such as high speed data
file transfer, desk top videoconferencing, telepublishing, telecommuting,
distance learning, remote collaboration, data network linking and home
information services.
ISP (INTERNET SERVICE PROVIDER)--A company that provides subscribers basic
access to the Internet, along with additional services that may include e-mail,
site hosting, web page development, and other Internet- related services, along
with technical support of these services.
IXC--Inter-exchange Carriers, usually referred to as long distance
providers. There are many facilities-based IXCs including AT&T, MCI WorldCom,
Sprint and Frontier, as well as many CLECs that are authorized for IXC service.
KILOBIT--One thousand bits of information.
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LANS (LOCAL AREA NETWORKS)--The interconnection of computers for the
purpose of sharing files, programs and various devices such as work stations,
printers and high-speed modems. LANs may include dedicated computers or file
servers that provide a centralized source of shared files and programs.
LATAS--The geographically defined Local Access and Transport Areas in which
ILECs are authorized to provide local exchange services and between which they
are prohibited from providing long distance services.
LOCAL EXCHANGE CARRIER OR LEC--Provider of local exchange services,
includes the RBOCs, GTE and independent companies such as the Company.
LOCAL LOOP--A circuit that connects an end user to the ILEC central office
within a LATA.
LMDS (LOCAL MULTIPOINT DISTRIBUTION SERVICE)--A high frequency wireless
service that delivers voice, data and other services via cellular-like towers
and roof top receivers that has bandwidth characteristics that are well suited
for voice, data and video transmission.
LONG DISTANCE CARRIERS OR IXCS (INTEREXCHANGE CARRIERS)--Long distance
carriers provide services between local exchanges on an interstate or intrastate
basis. A long distance carrier may offer services over its own or another
carrier's facilities. Major long distance carriers include AT&T, MCI WorldCom,
Sprint and Frontier, but may also include resellers of long distance capacity.
MEGABIT--One million bits of information.
MICROWAVE--Microwave is a wireless transmission platform that has been
widely used for long-haul transmission. Microwave has also been used on a
smaller scale for local loop bypass. An alternative to standard fixed microwave
can be found in the 38GHz spectrum, which is ideal for short-haul local loop
bypass applications. The use of 38GHz is attractive since 38GHz links have
capacity, reliability and operational characteristics comparable to fiber optic
connection and can be set up in a short amount of time at a fraction of the
cost.
NETWORK UNBUNDLING--Unbundling involves the opening up of the various
segments of an ILEC's network for use by other carriers who desire
interconnection. Network unbundling would ensure that fair, cost-based prices
are assigned to each unbundled network element. In an environment such as the
local loop where one group of companies has a clear monopoly on infrastructure,
unbundling is essential in order to ensure that CLECs can provide attractive
services and pricing to potential customers.
NUMBER PORTABILITY--The ability of an end user to change local exchange
carriers while retaining the same telephone number. If number portability does
not exist, customers will have to change phone numbers when they change local
exchange carriers. This is considered to be anti-competitive because customers
are reluctant to change numbers, since they may lose business or confuse those
people trying to call them. It is currently being ascertained whether or not
number portability is technologically and economically feasible, and over what
time frame it can be implemented.
OSS (OPERATIONS SUPPORT SYSTEMS)--The systems which are required to enter,
schedule, provision and track a customer's order from the period of sale to the
installation and testing of service and which include and interface with trouble
management, inventory, billing, collection and customer service systems.
PBX (A PRIVATE BRANCH EXCHANGE)--A switching system within an office
building which allows calls from outside to be routed directly to the individual
instead of through a central number. This PBX also allows for calling within an
office by way of four digit extensions. Centrex is a service which can simulate
this service from an outside switching source, thereby eliminating the need for
a large capital expenditure on a PBX.
PCS (PERSONAL COMMUNICATIONS SERVICE)--A new generation of digital,
two-way, micro-cellular, wireless communications services in the 1.8 to 2.2 GHz
bands that will allow telephony with seamless roaming, high voice reproduction
quality and low cost to the consumer relative to analog cellular. PCS will
eventually support a wide range of services including telephony, voice mail,
e-mail, data transfer, and faxing capabilities.
G-4
<PAGE> 106
PEERING--The commercial practice under which certain ISPs exchange each
other's traffic on the Internet without payment of reciprocal compensation.
Peering relationships involve direct connections between ISP networks, as well
as connections via the conventional Internet backbone at Network Access Points.
POPS (POINTS OF PRESENCE)--Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.
PRIVATE LINE--A private, dedicated telecommunications connection to
different locations (excluding long distance carrier POPs).
RBOCS (REGIONAL BELL OPERATING COMPANIES)--The local telephone companies
established by the Divestiture. The RBOCs were historically prohibited from
providing inter-LATA services and from manufacturing telecommunications
equipment.
RECIPROCAL COMPENSATION--The compensation of a terminating local carrier
(either an ILEC or a CLEC) by the originating carrier (either an ILEC or a CLEC)
for the termination of local calls on its network.
RESELLER--A carrier that does not own transmission facilities, but obtains
communications services from another carrier for resale to the public.
ROUTE MILES--The number of miles of the telecommunications path in which
fiber optic cables are installed as it would appear on a network map. See the
definition of "Fiber Miles" above.
SONET (SYNCHRONOUS OPTICAL NETWORK)--The electronics and network
architecture which enables transmission of voice, video and data (multimedia) at
very high speeds. This state-of-the-art, self-healing ring network offers
advantages over older linear networks in that a cut line or equipment failure
can be overcome by rerouting calls within the network. If the line is cut, the
traffic can be simply reversed and sent to its destination around the other side
of the ring.
SPECIAL ACCESS--The lease of private, dedicated telecommunications lines or
"circuits" along the network of an ILEC or a CLEC (such as the Company), which
lines or circuits run to and from a long distance carrier's POPs. Examples of
special access services are telecommunications lines running between POPs of a
single long distance carrier, from one long distance carrier POP to the POP of
another long distance carrier or from an end user to its long distance carrier
POP. Special access services do not require the use of switches.
SWITCH--A sophisticated computer that accepts instructions from a caller in
the form of a telephone number. Like an address on an envelope, the numbers tell
the switch where to route the call. The switch opens or closes circuits or
selects the paths or circuits to be used for transmission of information.
Switching is a process of interconnecting circuits to form a transmission path
between users. Switches allow local telecommunications service providers to
connect calls directly to their destination, while providing advanced features
and recording connection information for future billing.
SWITCHED ACCESS TRANSPORT SERVICES--Transportation of switched traffic
along dedicated lines between the ILEC central offices and long distance carrier
POPs.
SWITCHED SERVICES--These services are the greatest source of revenue for
carriers. While some CLEC networks simply provide special access capacity for
other carriers, those carriers authorized to provide switched service are in a
position to generate significantly greater revenue.
TELECOMMUNICATIONS ACT--The Telecommunications Act of 1996.
TIER I MARKET--Metropolitan markets in the United States with a population
greater than two million.
TIER II MARKET--Metropolitan markets in the United States with populations
ranging from 750,000 to two million.
G-5
<PAGE> 107
TIER III MARKET--Metropolitan markets in the United States with populations
ranging from 100,000 to 750,000.
UNBUNDLED NETWORK ELEMENTS-- Unbundled network elements means the network
elements of ILECs that are made available to CLECs and other providers of
telecommunications services in accordance with the network unbundling
contemplated by the Telecommunications Act. Network elements are facilities or
equipment used in the provision of telecommunications services and include
features, functions and capabilities that are provided by means of such
facilities or equipment (including subscriber numbers, databases, signaling
systems and information sufficient for billing and collection or used in the
transmission, routing or other provision of telecommunications services).
UNIVERSAL SERVICE--Universal Service is a public policy that states that
all households should have access to basic telephone service at affordable
rates. Thus far only large ILECs and RBOCs have been bound by Universal Service
requirements to provide basic dial tone services to all residences in their
operating region and have thus qualified for subsidies. It has not yet been
determined whether CLECs and other entrants into the local arena will be
obligated to provide Universal Service.
G-6
<PAGE> 108
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS:
Consolidated Balance Sheets, September 30, 1998 and December
31, 1997.................................................. F-2
Consolidated Statements of Operations, Nine Months and Three
Months Ended September 30, 1998 and 1997.................. F-3
Consolidated Statements of Members' Capital (Deficit), Nine
Months Ended September 30, 1998 and 1997.................. F-4
Consolidated Statements of Cash Flows, Nine Months Ended
September 30, 1998 and 1997............................... F-5
Notes to Unaudited Consolidated Financial Statements........ F-6
CONSOLIDATED AUDITED FINANCIAL STATEMENTS:
Report of Independent Certified Public Accountants.......... F-9
Consolidated Balance Sheets, December 31, 1997 and 1996..... F-10
Consolidated Statements of Operations, Year Ended December
31, 1997 and Period From August 5, 1996 (date of
inception) to December 31, 1996........................... F-11
Consolidated Statements of Members' Deficit, Year Ended
December 31, 1997 and Period From August 5, 1996 (date of
inception) to December 31, 1996........................... F-12
Consolidated Statements of Cash Flows, Year Ended December
31, 1997 and Period From August 5, 1996 (date of
inception) to December 31, 1996........................... F-13
Notes to Consolidated Financial Statements.................. F-14
</TABLE>
F-1
<PAGE> 109
US XCHANGE, L.L.C.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents................................. $ 71,837,287 $ 100,590
Restricted investments.................................... 24,905,484 --
Accounts receivable, net.................................. 1,526,126 145,235
Other current assets...................................... 984,149 160,608
------------ -----------
TOTAL CURRENT ASSETS................................... 99,253,046 406,433
------------ -----------
Networks and Equipment
Leasehold improvements.................................... 2,074,050 488,403
Furniture and equipment................................... 12,846,072 2,843,204
Network systems in process................................ 71,489,346 24,825,481
------------ -----------
86,409,468 28,157,088
Less accumulated depreciation and amortization............ 2,480,126 189,347
------------ -----------
Net Networks and Equipment.................................. 83,929,342 27,967,741
------------ -----------
Other Assets
Restricted investments.................................... 58,807,788 --
Debt issuance costs, net.................................. 6,743,154 --
Miscellaneous............................................. 49,354 11,096
------------ -----------
TOTAL OTHER ASSETS..................................... 65,600,296 11,096
------------ -----------
TOTAL ASSETS........................................... $248,782,684 $28,385,270
============ ===========
LIABILITIES AND MEMBERS' DEFICIT
Current Liabilities
Accounts payable.......................................... $ 11,836,625 $ 5,318,493
Accrued liabilities....................................... 10,344,040 205,166
Current maturities of long-term debt...................... 800,000 600,000
------------ -----------
TOTAL CURRENT LIABILITIES.............................. 22,980,665 6,123,659
Advances from affiliated company............................ -- 21,038,789
Long-Term Debt
15% Senior Notes.......................................... 200,000,000 --
Note payable, less current maturities..................... 2,800,000 2,189,000
------------ -----------
TOTAL LIABILITIES...................................... 225,780,665 29,351,448
------------ -----------
Members' Capital (Deficit)
Capital contributions..................................... 60,000,000 5,000,000
Accumulated deficit....................................... (36,997,981) (5,966,178)
------------ -----------
TOTAL MEMBERS' CAPITAL (DEFICIT)....................... 23,002,019 (966,178)
------------ -----------
$248,782,684 $28,385,270
============ ===========
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
F-2
<PAGE> 110
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES........................ $ 4,128,955 $ 28,308 $ 2,144,552 $ 28,308
------------ ------------ ------------ ------------
Costs and Expenses
Costs of communication
services (excluding
depreciation and
amortization, shown
separately below).......... 9,455,274 153,926 5,448,128 140,867
Selling, general and
administrative............. 18,901,677 2,171,675 8,178,668 1,379,585
Depreciation and
amortization............... 2,290,778 67,649 1,219,883 41,803
------------ ------------ ------------ ------------
TOTAL COSTS AND EXPENSES... 30,647,729 2,393,250 14,846,679 1,562,255
------------ ------------ ------------ ------------
Loss from operations.......... (26,518,774) (2,364,942) (12,702,127) (1,533,947)
------------ ------------ ------------ ------------
Interest Expense................ (7,178,744) -- (6,534,638) --
------------ ------------ ------------ ------------
Interest Income................. 2,665,715 -- 2,454,050 --
------------ ------------ ------------ ------------
NET LOSS................... $(31,031,803) $ (2,364,942) $(16,782,715) $ (1,533,947)
============ ============ ============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
F-3
<PAGE> 111
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF MEMBERS' CAPITAL (DEFICIT)
(UNAUDITED)
<TABLE>
<CAPTION>
CAPITAL ACCUMULATED
CONTRIBUTIONS DEFICIT TOTAL
------------- ------------ ------------
<S> <C> <C> <C>
Balance, December 31, 1997.......................... $ 5,000,000 $ (5,966,178) $ (966,178)
Members' capital contributions.................... 55,000,000 -- 55,000,000
Net loss.......................................... -- (31,031,803) (31,031,803)
----------- ------------ ------------
Balance, September 30, 1998......................... $60,000,000 $(36,997,981) $ 23,002,019
=========== ============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
F-4
<PAGE> 112
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
1998 1997
------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (31,031,803) $ (2,364,942)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 2,476,978 67,649
Provision for doubtful accounts........................... 113,000 --
Interest earned on restricted investments................. (1,243,489) --
Changes in assets and liabilities:
Accounts receivable.................................... (1,493,891) (25,185)
Other current assets................................... (823,541) (74,012)
Accounts payable....................................... 6,518,133 479,369
Accrued liabilities.................................... 10,138,874 34,782
------------- ------------
NET CASH USED IN OPERATING ACTIVITIES.................. (15,345,739) (1,882,339)
------------- ------------
INVESTING ACTIVITIES
Purchase of restricted investments........................ (82,469,784) --
Purchase of networks and equipment........................ (58,252,380) (11,752,005)
Increase in other assets.................................. (38,257) (111,031)
------------- ------------
NET CASH USED IN INVESTING ACTIVITIES.................. (140,760,421) (11,863,036)
------------- ------------
FINANCING ACTIVITIES
Proceeds from long-term debt, net of issuance costs....... 194,281,646 --
Repayment of long-term debt............................... (400,000) --
Advances from affiliated company.......................... 61,211 13,839,346
Members' capital contributions............................ 33,900,000 --
------------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES.............. 227,842,857 13,839,346
------------- ------------
Net Increase in Cash...................................... 71,736,697 93,971
Cash, beginning of period................................. 100,590 --
------------- ------------
Cash, end of period....................................... $ 71,837,287 $ 93,971
------------- ------------
Supplemental Disclosure of Cash Flow Information Interest
paid (net of amounts capitalized)...................... $ 213,869 $ --
============= ============
</TABLE>
During the nine months ended September 30, 1998, affiliated company
advances of $21,100,000 were converted to members' capital contributions.
See accompanying notes to unaudited consolidated financial statements.
F-5
<PAGE> 113
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated balance sheet of US Xchange, L.L.C. (the "Company") at
December 31, 1997 was obtained from the Company's audited balance sheet as of
that date. All other financial statements contained herein are unaudited and, in
the opinion of management, contain all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation. Operating
results for the nine months ended September 30, 1998 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1998. The Company's accounting policies and certain other disclosures are set
forth in the notes to the Company's audited consolidated financial statements as
of and for the year ended December 31, 1997.
2. NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 133 requires companies to recognize all derivative
contracts as either assets or liabilities in the balance sheet and to measure
them at fair value. It is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Historically, the Company has not entered into
derivative contracts for any reason. Accordingly, the Company does not expect
adoption of this Statement will affect its financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position (SOP) 98-1, "Accounting for Costs of
Computer Software Developed or Obtained for Internal Use." Among other
provisions, SOP 98-1 requires that entities capitalize certain internal-use
software costs once certain criteria are met. In April 1998, the AICPA issued
SOP 98-5, "Reporting on the Costs of Start-Up Activities," which, among other
provisions, requires costs of start-up activities and organization costs to be
expensed as incurred. Both SOP 98-1 and 98-5 are effective for fiscal years
beginning after December 15, 1998, though earlier adoption is encouraged. The
Company believes that adoption of SOP 98-1 and 98-5 will not have a material
impact on the Company's consolidated financial position, results of operations
or cash flows.
3. LONG-TERM DEBT
SENIOR NOTES
On June 25, 1998, the Company completed a sale of $200 million principal
amount of 15% Senior Notes due 2008 (the "Notes"). Of the total net proceeds of
approximately $193.1 million, the Company placed approximately $82.5 million,
representing funds, together with interest thereon, sufficient to pay the first
six semi-annual interest payments on the Notes, into an escrow account for the
benefit of the holders. Issuance costs approximating $6.9 million are being
amortized ratably over the term of the debt. Interest accrues on the Notes at
the rate of 15%, payable in cash semi-annually, on January 1 and July 1,
commencing January 1, 1999. The Notes are non-callable and mature on July 1,
2008.
The Notes are unsubordinated, unsecured senior indebtedness of the Company.
The Company's subsidiaries have no obligation to pay amounts due on the Notes
and do not guarantee the Notes. Therefore, the Notes are effectively
subordinated to all existing and future liabilities (including trade payables)
of the Company's subsidiaries.
The Notes are subject to certain covenants that, among other things,
restrict the ability of the Company and certain subsidiaries to incur additional
indebtedness, pay dividends or make distributions or redemptions in respect of
membership interests.
F-6
<PAGE> 114
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTES PAYABLE
On August 28, 1997, the Company entered into a credit facility agreement
with a local bank that provided for borrowings of up to $4,000,000 for the
acquisition of office furniture, equipment and computer software and for
construction costs related to leasehold improvements of office and switch site
locations. In March 1998 the credit facility was fully utilized and converted
into a term note payable in 60 equal monthly installments commencing April 1998.
Amounts borrowed bear interest at 1/2% under the bank's prime rate or 2% over
the bank's cost of funds, at the Company's option. The effective rate was 7.63%
at September 30, 1998. Specific assets and the guarantee of an affiliated
company owned by the Company's majority member secure all borrowings. The credit
facility also requires the affiliated company to maintain minimum debt to
tangible net worth and current ratio levels. At September 30, 1998, the
affiliated company was in compliance with the covenant requirements.
The aggregate principal repayments of such borrowings, is as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1998 (3 months)............................................. $200,000
1999........................................................ 800,000
2000........................................................ 800,000
2001........................................................ 800,000
2002........................................................ 800,000
2003........................................................ 200,000
</TABLE>
4. RELATED PARTY TRANSACTIONS
In connection with the Company's issuance of the Notes, advances from an
affiliated company of $21.1 million were converted to members' capital as of
March 31, 1998.
Under an expense sharing agreement with an affiliated company, the Company
incurred $254,598 relating to management and administrative services for the
nine months ended September 30, 1998.
In June 1997, the Company entered into a lease agreement with another
affiliated company owned by the majority member for aircraft transportation
services. Total travel costs incurred under this agreement during the nine
months ended September 30, 1998 were $79,567.
5. LEASES
The Company leases administrative and sales office facilities, operating
sites and certain equipment under operating leases having initial or remaining
terms of more than one year. Certain of the Company's facility leases include
renewal options, and most leases include provisions for rent escalation to
reflect increased operating costs and/or require the Company to pay certain
maintenance and utility costs. Rental expense under these operating leases
during the nine months ended September 30, 1998 and 1997 was $974,975 and
$30,864, respectively.
One of the administrative office facilities is leased from an affiliated
company owned by the Company's majority member. Rents paid under this lease
agreement during the nine months ended September 30, 1998 and 1997 were $54,261
and $24,716, respectively.
F-7
<PAGE> 115
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Future minimum lease payments under operating leases (assuming renewal of
lease terms in accordance with automatic or optional renewal provisions under
such leases, as applicable) at September 30, 1998, were as follows:
<TABLE>
<CAPTION>
YEAR ENDING OFFICE OPERATING SITE
DECEMBER 31, FACILITIES FACILITIES EQUIPMENT TOTAL
------------ ---------- -------------- --------- ----------
<S> <C> <C> <C> <C>
1998 (3 months)................................ $ 257,428 $ 127,695 $203,765 $ 588,889
1999........................................... 1,058,104 531,158 842,638 2,431,900
2000........................................... 1,064,042 540,078 804,855 2,409,035
2001........................................... 1,075,663 547,493 334,708 1,957,864
2002........................................... 1,087,074 555,088 83,241 1,725,403
2003-2007...................................... 4,868,927 2,917,858 -- 7,786,785
2008-2012...................................... 3,797,157 3,304,193 -- 7,101,350
2013-2017...................................... 128,504 457,067 -- 585,571
========== ========== ======== ==========
</TABLE>
F-8
<PAGE> 116
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
US Xchange, LLC
Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of US Xchange,
LLC and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, members' deficit and cash flows for the
year ended December 31, 1997 and the period from August 5, 1996 to December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of US Xchange,
LLC and subsidiaries at December 31, 1997 and 1996, and the results of their
operations and their cash flows for the year ended December 31, 1997 and the
period from August 5, 1996 to December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ BDO SEIDMAN, LLP
Grand Rapids, Michigan
February 6, 1998
F-9
<PAGE> 117
US XCHANGE, L.L.C.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
----------- ---------
<S> <C> <C>
ASSETS
Current Assets
Cash...................................................... $ 100,590 $ --
Accounts receivable, net.................................. 145,235 --
Other current assets...................................... 160,608 25,675
----------- ---------
TOTAL CURRENT ASSETS................................... 406,433 25,675
----------- ---------
Networks and Equipment
Leasehold improvements.................................... 488,403 --
Furniture and equipment................................... 2,843,204 --
Network systems in process................................ 24,825,481 --
----------- ---------
28,157,088 --
Less accumulated depreciation and amortization............ 189,347 --
----------- ---------
Net Networks and Equipment.................................. 27,967,741 --
----------- ---------
Other Assets................................................ 11,096 --
----------- ---------
TOTAL ASSETS........................................... $28,385,270 $ 25,675
=========== =========
LIABILITIES AND MEMBERS' DEFICIT
Current Liabilities
Accounts payable.......................................... $ 5,318,493 $ --
Accrued liabilities....................................... 205,166 --
Current maturities of long-term debt...................... 600,000 --
----------- ---------
TOTAL CURRENT LIABILITIES.............................. 6,123,659 --
Advances From Affiliated Company............................ 21,038,789 163,485
Long-Term Debt, less current maturities..................... 2,189,000 --
----------- ---------
TOTAL LIABILITIES...................................... 29,351,448 163,485
----------- ---------
Members' Deficit
Capital contributions..................................... 5,000,000 --
Accumulated deficit....................................... (5,966,178) (137,810)
----------- ---------
TOTAL MEMBERS' DEFICIT................................. (966,178) (137,810)
----------- ---------
$28,385,270 $ 25,675
=========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-10
<PAGE> 118
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
AUGUST 5, 1996
YEAR ENDED (DATE OF INCEPTION)
DECEMBER 31, TO DECEMBER 31,
1997 1996
------------ -------------------
<S> <C> <C>
REVENUES.................................................... $ 206,682 $ --
----------- ---------
Costs and Expenses
Cost of communication services (excluding depreciation and
amortization, shown separately below).................. 749,662 --
Selling, general and administrative....................... 5,065,589 137,810
Depreciation and amortization............................. 189,347 --
----------- ---------
TOTAL COSTS AND EXPENSES............................... 6,004,598 137,810
----------- ---------
Loss from operations...................................... (5,797,916) (137,810)
----------- ---------
Interest Expense............................................ 30,452 --
----------- ---------
NET LOSS............................................... $(5,828,368) $(137,810)
=========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-11
<PAGE> 119
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF MEMBERS' DEFICIT
<TABLE>
<CAPTION>
CAPITAL ACCUMULATED
CONTRIBUTIONS DEFICIT TOTAL
------------- ----------- -----------
<S> <C> <C> <C>
Balance, August 5, 1996 (date of inception)............ $ -- $ -- $ --
Net loss for the period........................... -- (137,810) (137,810)
---------- ----------- -----------
Balance, December 31, 1996............................. -- (137,810) (137,810)
Members' capital contributions....................... 5,000,000 -- 5,000,000
Net loss for the year............................. -- (5,828,368) (5,828,368)
---------- ----------- -----------
Balance, December 31, 1997............................. $5,000,000 $(5,966,178) $ (966,178)
========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-12
<PAGE> 120
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
AUGUST 5, 1996
YEAR ENDED (DATE OF INCEPTION)
DECEMBER 31, TO DECEMBER 31,
1997 1996
------------ -------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (5,828,368) $(137,810)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 189,347 --
Provision for doubtful accounts........................... 2,000 --
Changes in assets and liabilities:
Accounts receivable.................................... (147,235) --
Other current assets................................... (134,933) (25,675)
Accounts payable....................................... 5,318,493 --
Accrued liabilities.................................... 205,166 --
------------ ---------
NET CASH USED IN OPERATING ACTIVITIES.................. (395,530) (163,485)
------------ ---------
INVESTING ACTIVITIES
Purchase of networks and equipment.......................... (28,157,088) --
Increase in other assets.................................... (11,096) --
------------ ---------
NET CASH USED IN INVESTING ACTIVITIES.................. (28,168,184) --
------------ ---------
FINANCING ACTIVITIES
Proceeds from long-term debt................................ 2,789,000 --
Advances from affiliated company............................ 20,875,304 163,485
Members' capital contributions.............................. 5,000,000 --
------------ ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES.............. 28,664,304 163,485
------------ ---------
NET INCREASE IN CASH................................... 100,590 --
Cash, beginning of period................................... -- --
------------ ---------
Cash, end of period......................................... $ 100,590 $ --
============ =========
Supplemental Disclosure of Cash Flow Information
Interest paid (net of amounts capitalized)................ $ 12,334 $ --
============ =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-13
<PAGE> 121
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
US Xchange, LLC and its wholly-owned subsidiaries (Company) are a provider
of competitive local telecommunications services in selected cities of the north
central area of the United States. The Company competes with incumbent local
exchange carriers by offering business and residential customers innovative and
customized products, superior customer service and lower costs through the use
of an advanced telecommunications systems network.
The Company was formed August 5, 1996 as a limited liability company. The
Company was in the development stage until one of its subsidiaries began
operations on July 1, 1997. The majority member provided equity capital of
$5,000,000 and an affiliated company of the majority member has provided
advances to fund the Company's operational needs.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of US Xchange,
LLC and its wholly-owned subsidiaries. All significant intercompany transactions
and balances has been eliminated in consolidation.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for cash, accounts receivable, accounts payable and
accrued liabilities approximate their fair value. The carrying amount of
long-term debt also approximates its fair value. Fair value is determined based
on quoted market rates to enter into similar financial instruments.
CASH AND EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts receivables.
The risk is limited due to the large number of entities comprising the Company's
customer base and the dispersion of those entities across many different
industries and geographical areas. Credit is extended based on evaluation of the
customer's financial condition and generally collateral is not required.
Anticipated credit losses are provided for in the consolidated financial
statements and have been within management's expectations.
NETWORKS AND EQUIPMENT
Networks and equipment are stated at cost. Leasehold improvements are
amortized using the straight-line method over their useful life or lease term,
whichever is shorter. Computer software costs are capitalized as part of office
equipment and furniture. Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets as follows:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Telecommunications equipment................................ 5-8
Fiber optic cable........................................... 20
Leasehold improvements...................................... 10-15
Office furniture and equipment.............................. 5-7
</TABLE>
F-14
<PAGE> 122
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Costs directly related to the construction of network systems and
facilities, including interest, are capitalized. Interest expense capitalized in
connection with construction projects amounted to $2,103 in 1997. The Company
had firm commitments for capital expenditures of approximately $17,400,000 at
December 31, 1997.
LONG-LIVED ASSETS
Pursuant to Statement of Accounting Standards (SFAS) No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," the Company periodically reviews long-lived assets for impairment by
comparing the carrying value of the assets to their estimated future
undiscounted cash flows. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
REVENUE RECOGNITION
Revenues are recognized as services are provided to customers.
ADVERTISING COSTS
Costs for advertising, which were approximately $180,000 and $0 for the
years ended December 31, 1997 and 1996, respectively, are expensed as incurred
within the fiscal year.
INCOME TAXES
The Company is treated as a partnership for U.S. federal income tax
purposes. Income and losses are reported on the respective tax returns of the
members, therefore, no provision for federal income taxes has been made in these
consolidated financial statements.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
In June 1997 the Financial Accounting Standards Board (FASB) issued two new
disclosure standards. Both of those new standards are effective for financial
statements for fiscal years beginning after December 15, 1997 and require
comparative information for earlier years to be restated.
SFAS No. 130 "Reporting Comprehensive Income," establishes standards for
reporting and display of comprehensive income, its components and accumulated
balances. Comprehensive income is defined to include all changes in equity
except those resulting from investments by owners and distributions to owners.
Among other disclosures, SFAS No. 130 requires that all items that are required
to be recognized under current accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. The Company had no items of
comprehensive income for the year and period ended December 31, 1997 and 1996,
respectively.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which supersedes SFAS No. 14, establishes standards for the way
that public enterprises report information about operating segments in annual
financial statements and requires reporting of selected information about
operating segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS No. 131 defines
F-15
<PAGE> 123
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
operating segments as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. Management believes that SFAS No. 131 will not have a significant
impact on its financial position, operations or cash flows when adopted.
2. LONG-TERM DEBT
On August 28, 1997, the Company entered into a credit facility agreement
with a local bank that provides borrowings at any time within a one-year period
of up to $4,000,000. At December 31, 1997, borrowings under this line totaled
$2,789,000. Borrowings are to be used for the acquisition of office furniture,
equipment and computer software and for construction costs related to leasehold
improvements of office and switch site locations. Amounts borrowed bear interest
at 1/2% under the bank's prime rate or 2% over the bank's cost of funds, at the
Company's option. The effective rate was 8% at December 31, 1997. Terms of the
agreement provide that borrowings will mature in not more than 60 equal monthly
installments following conversion into a term note payable. The Company intends
to convert all borrowings under the credit facility agreement into a term note
payable during March 1998. Specific assets and the guarantee of an affiliated
company owned by the Company's majority member secure all borrowings. The credit
facility also provides that the affiliated company maintains minimum debt to
tangible net worth and current ratio levels. At December 31, 1997, the
affiliated company was in compliance with the covenant requirements.
The aggregate principal repayments of long-term debt over the next five
years assuming the full capacity under the line is borrowed by March 1998, is as
follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1998........................................................ $600,000
1999........................................................ 800,000
2000........................................................ 800,000
2001........................................................ 800,000
2002........................................................ 800,000
</TABLE>
3. RELATED PARTY TRANSACTIONS
Since its inception, the Company has received $21,038,790 from an
affiliated company owned by the majority member for the acquisition of capital
assets and funding of operating costs. No repayment terms have been specified
for amounts advanced. Included in the above amount is $257,474 relating to
management and administrative services provided by the affiliated company under
an Expense Sharing Agreement. The Company is billed for its pro rata share of
employee compensation costs and facilities expenses.
In June 1997, the Company entered into a lease agreement with another
affiliated company owned by the majority member for aircraft transportation
services. Total travel costs incurred under this agreement for 1997 was $69,083.
4. EMPLOYEE BENEFIT PLAN
In May 1997, the Company established a 401(k) plan which covers
substantially all employees. Employees who are 21 years of age or older are
eligible to participate in the 401(k) plan upon completion of three months of
service, at which time they may voluntarily contribute a percentage of
compensation. Participants are eligible to receive Company matching
contributions after completion of 12 months of service. The Company will match
50% of the participant's contribution up to a maximum of 3% of such
participant's eligible annual compensation. Matching contributions vest to the
participant over a five-year period. The Company was not required to make a
contribution to the plan for 1997.
F-16
<PAGE> 124
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LEASES
The Company leases administrative and sales office facilities, operating
sites and certain equipment under operating leases having initial or remaining
terms of more than one year. Certain of the Company's facility leases include
renewal options, and most leases include provisions for rent escalation to
reflect increased operating costs and/or require the Company to pay certain
maintenance and utility costs. Rental expense under these operating leases was
$83,459 in 1997.
One of the administrative office facilities is leased from an affiliated
company owned by the Company's majority member. Rents paid under this lease
agreement during 1997 amounted to $25,000.
Future minimum lease payments under operating leases (assuming renewal of
lease terms in accordance with automatic or optional renewal provisions under
such leases, as applicable) at December 31, 1997, were as follows:
<TABLE>
<CAPTION>
YEAR ENDING OFFICE OPERATING SITE
DECEMBER 31, FACILITIES FACILITIES EQUIPMENT TOTAL
------------ ---------- -------------- --------- ----------
<S> <C> <C> <C> <C>
1998........................................... $ 372,450 $ 160,648 $67,716 $ 600,814
1999........................................... 422,548 224,600 68,316 715,464
2000........................................... 423,903 228,539 33,832 686,274
2001........................................... 429,722 230,792 600 661,114
2002........................................... 436,331 233,037 -- 669,368
2003-2007...................................... 1,968,186 1,190,324 -- 3,158,510
2008-2012...................................... 1,229,094 1,199,705 -- 2,428,799
2013-2017...................................... 15,954 60,980 -- 76,934
========== ========== ======= ==========
</TABLE>
F-17
<PAGE> 125
[NETWORK ARCHITECTURE CHART OMITTED]
<PAGE> 126
============================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THE EXCHANGE OFFER OTHER THAN THOSE CONTAINED
IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER
TO BUY ANY SECURITY OTHER THAN THE EXCHANGE NOTES OFFERED HEREBY, NOR DOES IT
CONSTITUTE AN OFFER TO SELL TO, OR THE SOLICITATION OF ANY OFFER TO BUY FROM,
ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NETHER THE DELIVERY OF THIS PROSPECTUS NOR ANY EXCHANGE MADE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HERE IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary....................................... 6
Risk Factors.................................. 14
Use of Proceeds............................... 28
Capitalization................................ 28
Selected Consolidated Financial Data.......... 29
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................. 31
The Exchange Offer............................ 37
Business...................................... 44
Management.................................... 64
Principal Equity Holder....................... 67
Certain Relationships and Related
Transactions................................ 67
Description of Existing Indebtedness.......... 68
Description of the Notes...................... 69
United States Federal Income Tax
Considerations.............................. 97
Plan of Distribution.......................... 101
Validity of the Exchange Notes................ 101
Independent Certified Public Accountants...... 101
Glossary of Selected Terms.................... G-1
Index to Consolidated Financial Statements.... F-1
</TABLE>
UNTIL MARCH 24, 1999, ALL DEALERS EFFECTING TRANSACTIONS IN THE EXCHANGE
NOTES, WHETHER OR NOT PARTICIPATING IN THE EXCHANGE OFFER, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
===============================================================
===============================================================
[USXCHANGE LOGO]
OFFER TO EXCHANGE
15% SENIOR NOTES DUE
JULY 1, 2008
FOR ALL OUTSTANDING
15% SENIOR NOTES DUE
JULY 1, 2008
US XCHANGE, L.L.C.
NOVEMBER 24, 1998
===============================================================
