<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 22, 1999
REGISTRATION NUMBER 333-82151
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------------
INFOHIGHWAY COMMUNICATIONS CORPORATION
(Exact Name of Registrant as Specified in Charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 76-0530551
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</TABLE>
1770 MOTOR PARKWAY, SUITE 300
HAUPPAUGE, NEW YORK 11788
(516) 582-2222
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
------------------------------
JOSEPH A. GREGORI
CHIEF EXECUTIVE OFFICER
INFOHIGHWAY COMMUNICATIONS CORPORATION
1770 MOTOR PARKWAY, SUITE 300
HAUPPAUGE, NEW YORK 11788
(516) 582-2222
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Agent for Service)
------------------------------
COPIES TO:
<TABLE>
<S> <C>
ROBERT G. REEDY MICHAEL L. FALTISCHEK
PORTER & HEDGES, L.L.P. PAUL RUBELL
700 LOUISIANA RUSKIN, MOSCOU, EVANS & FALTISCHEK, P.C.
HOUSTON, TEXAS 77002-2764 170 OLD COUNTRY ROAD
(713) 226-0674 MINEOLA, NEW YORK 11501
(516) 663-6600
</TABLE>
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / / __________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / __________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / __________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES EXCHANGE COMMISSION, ACTING PURSUANT TO
SAID SECTION 8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION, DATED SEPTEMBER 22, 1999
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
PROSPECTUS
1,600,000 SHARES
[LOGO]
INFOHIGHWAY COMMUNICATIONS CORPORATION
COMMON STOCK
This is InfoHighway Communications Corporation's initial public offering of
common stock. We expect that the initial public offering price will be between
$9.00 and $11.00 per share. After the offering, we expect that the common stock
will trade on the American Stock Exchange under the symbol "IW."
INVESTING IN THE COMMON STOCK INVOLVES RISKS WHICH ARE DESCRIBED IN "RISK
FACTORS" BEGINNING ON PAGE 8 OF THIS PROSPECTUS.
---------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
<S> <C> <C>
Public offering price................................................... $ $
Underwriting discount................................................... $ $
Proceeds, before expenses, to us........................................ $ $
</TABLE>
The underwriters may also purchase up to an additional 240,000 shares at the
public offering price, less the underwriting discount, within 45 days from the
date of this prospectus to cover over-allotments. See "Underwriting."
---------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------
WEATHERLY SECURITIES CORPORATION
WESTPORT RESOURCES INVESTMENT SERVICES, INC.
, 1999
<PAGE>
INSIDE FRONT COVER OF PROSPECTUS:
Graphic Depicting Products and Services of InfoHighway
1) High Speed Internet 2) Web Services 3) Data Networking 4) Local Phone Service
5) Long Distance 6) Network Design 7) Wiring
[InfoHighway Logo]
http://www.infohwy.com
INSIDE BACK COVER OF PROSPECTUS:
[InfoHighway Logo]
Communicating at the speed of now!
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Summary............................................................ 3
Risk Factors.................................................................. 8
Use of Proceeds............................................................... 23
Dividend Policy............................................................... 24
Capitalization................................................................ 25
Dilution...................................................................... 27
Selected Financial Data....................................................... 29
Management's Discussion and Analysis of Pro Forma Financial Condition and
Results of Operations....................................................... 32
Management's Discussion and Analysis Of Financial Condition and Results of
Operations Combined and Founding Companies.................................. 51
Business...................................................................... 65
Management.................................................................... 95
Certain Relationships and Related Transactions................................ 107
Principal Stockholders........................................................ 116
Description of Capital Stock.................................................. 120
Shares Eligible for Future Sale............................................... 127
Underwriting.................................................................. 131
Legal Matters................................................................. 134
Experts....................................................................... 134
Where You Can Find More Information........................................... 134
Index to Financial Statements................................................. F-1
</TABLE>
---------------------
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS PROSPECTUS AND MAY
NOT CONTAIN ALL THE INFORMATION THAT MAY BE IMPORTANT TO YOU. YOU SHOULD READ
THE ENTIRE PROSPECTUS, INCLUDING THE FINANCIAL DATA AND RELATED NOTES, BEFORE
MAKING AN INVESTMENT DECISION. EXCEPT AS OTHERWISE NOTED, THE INFORMATION IN
THIS PROSPECTUS:
- ASSUMES THAT INFOHIGHWAY COMMUNICATIONS CORPORATION HAS ACQUIRED ALL OF
THE FOUNDING COMPANIES;
- ASSUMES THAT THE UNDERWRITERS' OVER-ALLOTMENT OPTION IS NOT EXERCISED;
- ASSUMES AN INITIAL PUBLIC OFFERING PRICE OF $10.00 PER SHARE; AND
- GIVES EFFECT TO A 1.922704 TO 1 REVERSE SPLIT OF OUR COMMON STOCK IN JUNE
1999.
THE COMPANY
InfoHighway Communications Corporation, which was formerly known as OmniLynx
Communications Corporation, acquired ARC Networks, Inc. on June 30, 1999. We
will acquire InfoHighway International, Inc. and AXCES, Inc. simultaneously with
and as a condition of the closing of this offering. Prior to the completion of
the acquisition of ARC, we had not conducted any operations other than in
connection with the acquisitions. The following is a description of the founding
companies:
AXCES, INC. AXCES is a provider of long-distance services to metropolitan
residential customers and is based in Houston, Texas. AXCES currently has
approximately 160,000 customers located primarily in Chicago, Dallas, Houston
and San Antonio. AXCES is licensed in 20 states and operates in the Southwestern
Bell and Ameritech regions. AXCES has been in business since 1994 and accounted
for 52% of our pro forma combined revenues for the six months ended June 30,
1999.
INFOHIGHWAY INTERNATIONAL, INC. InfoHighway International is a business
oriented Internet service provider based in Houston, Texas. InfoHighway
International was founded in 1994 and was one of the earliest Internet service
providers in the nation. InfoHighway International specializes in offering
high-speed Internet access and other Internet services to small to medium-sized
business and residential customers in Texas, New York, New Jersey and Florida.
Our high-speed Internet access services, called InfoHighway-TM- DSL and
InfoHighway-TM- Connect, are faster than most comparably priced offerings from
our competitors. InfoHighway International also offers additional Internet
services including web-hosting and data backup services. InfoHighway
International accounted for approximately 6% of our pro forma combined revenues
for the six months ended June 30, 1999.
ARC NETWORKS, INC. ARC is a competitive local telephone company based in
New York and has been in business since 1993. ARC offers local telephone
service, long distance, network wiring and other network services to customers
primarily in New York and to a lesser degree in New Jersey and Florida. ARC
accounted for approximately 42% of our pro forma combined revenues for the six
months ended June 30, 1999.
3
<PAGE>
The combination of these three companies creates an extensive product mix,
and produces efficiencies by combining sales and marketing efforts,
administrative and billing operations and customer service. Our complementary
product lines will enable us to become a full service telecommunications
company. We will offer both a combination of services for customer convenience
and a wide array of individual services for specific applications. We intend to
service both residential and commercial customers.
THE OFFERING
<TABLE>
<S> <C>
Common stock we are
offering................. 1,600,000 shares
Common stock outstanding
after this offering(1)... 4,587,242 shares
Use of proceeds............ We expect that the net proceeds from this offering will
be approximately $13.3 million. We intend to use these
proceeds for:
- repayment of certain indebtedness of InfoHighway
and the founding companies;
- capital expenditures for hardware to enable us to
serve additional buildings;
- general working capital purposes; and
- future acquisitions of telecommunications
companies.
American Stock Exchange
Symbol................... IW
</TABLE>
- ---------------------
(1) The calculation of the number of shares of common stock outstanding after
the offering consists of:
- 1,600,000 shares to be sold in the public offering;
- 939,000 shares issued to the founders of InfoHighway and other investors;
and
- 2,048,242 shares to be issued to the shareholders of the founding
companies.
The number of shares of common stock outstanding after the offering in the table
above does not include 4,034,410 shares which are issuable pursuant to
contingent common stock issue rights and various warrants, options, convertible
notes and convertible preferred stock. For a detailed description of these
additional shares, see "Capitalization."
---------------------
EXECUTIVE OFFICES
Our executive offices are located at 1770 Motor Parkway, Suite 300,
Hauppauge, New York 11788. Our telephone number is (516) 582-2222.
---------------------
RISK FACTORS
Investing in the common stock involves risks which are described in "Risk
Factors" beginning on page 8 of this prospectus.
---------------------
4
<PAGE>
SUMMARY PRO FORMA COMBINED FINANCIAL DATA INFORMATION
InfoHighway acquired ARC on June 30, 1999. We will acquire InfoHighway
International and AXCES simultaneously with and as a condition of the closing of
this offering. For financial statement presentation purposes, AXCES has been
identified as the accounting acquiror. The following table presents summary
unaudited pro forma combined financial information for InfoHighway, as adjusted
for:
- the effects of the acquisition of the founding companies on a historical
basis;
- the effects of certain pro forma adjustments to the historical financial
statements;
- the consummation of the offering and our use of the estimated net
proceeds; and
- the reverse stock split.
The pro forma combined financial data does not purport to represent what our
results of operations or financial position actually would have been had these
events, in fact, occurred on the date or at the beginning of the period
indicated, nor are they intended to project our results of operations or
financial position for any future date or period. See "Selected Financial Data"
and the Unaudited Pro Forma Combined Financial Statements and the notes thereto
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
PRO FORMA COMBINED
------------------------------------
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1998 JUNE 30, 1999
----------------- -----------------
(IN THOUSANDS)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA(1):
Revenues................................................................. $ 46,373 $ 19,366
Cost of services......................................................... 22,719 10,731
----------------- -----------------
Gross profit............................................................. 23,654 8,635
Selling, general and administrative expenses(2).......................... 20,741 7,632
Depreciation and amortization(3)......................................... 4,376 2,372
----------------- -----------------
Loss from operations..................................................... (1,463) (1,369)
Interest expense, net(4)................................................. (412) (233)
----------------- -----------------
Loss before income taxes................................................. (1,875) (1,602)
Provision for income taxes(5)............................................ 547 115
----------------- -----------------
Net loss before dividends on preferred stock............................. (2,422) (1,717)
Dividends on preferred stock............................................. 841 420
----------------- -----------------
Net loss applicable to common stockholders............................... $ (3,263) $ (2,137)
----------------- -----------------
----------------- -----------------
Net loss per share - basic and diluted................................... $ (.89) $ (.58)
----------------- -----------------
----------------- -----------------
Shares used in computing pro forma net loss per share(6)................. 3,654 3,654
----------------- -----------------
----------------- -----------------
OTHER DATA:
Gross margin............................................................. 51.0% 44.6%
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
------------------------------------
PRO FORMA
COMBINED(7) AS ADJUSTED(8)
----------------- -----------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)................................................ $ (9,190) $ 4,130
Total assets............................................................. 41,512 48,163
Total debt, including current portion.................................... 9,309 2,640
Stockholders' equity..................................................... 20,251 33,571
</TABLE>
- ------------------------
(1) The pro forma combined statement of operations data assume that the
acquisition of the founding companies and the offering were closed on
January 1, 1998.
(2) Reflects adjustments to salaries, bonuses and benefit amounts to reflect
those established in contractual agreements with key management personnel of
the founding companies.
(3) Reflects the amortization of excess purchase price relating to the
acquisitions which has been allocated to goodwill and other identifiable
intangible assets to be amortized over periods of 3 to 10 years for pro
forma purposes. Also reflects annual amortization of the customer list
acquired in connection with InfoHighway International's acquisition of Eden
Matrix over the estimated useful life of three years and annual depreciation
on property and equipment also acquired in the acquisition of Eden Matrix
over the estimated useful life of five years. InfoHighway International
acquired Eden Matrix, an Austin, Texas-based Internet service provider, in
January 1999.
(4) Reflects the reduction in interest expense due to the planned repayment and
planned conversion of certain debt in connection with the acquisitions.
(5) Assumes all income is subject to a federal corporate tax rate of 34%.
(6) The number of shares includes:
- 939,000 shares outstanding immediately prior to the offering,
- 2,048,242 shares to be issued to the owners of the founding companies as
consideration for the acquisitions, and
- 666,900 shares to be sold in the offering the proceeds of which will be
used to repay debt.
Does not include:
- 933,100 of the 1,600,000 shares to be sold in the offering whose proceeds
will be used for capital expenditures and general working capital
purposes, or
- 4,034,410 shares which are issuable pursuant to contingent common stock
issue rights and various warrants, options, convertible notes and
convertible preferred stock, since their effect would be antidilutive.
(7) The pro forma combined balance sheet data assume that the acquisitions of
the founding companies occurred on June 30, 1999.
(8) Adjusted for the sale of the 1,600,000 shares of common stock included in
the offering and the application of the net proceeds therefrom. See "Use of
Proceeds."
6
<PAGE>
SUMMARY HISTORICAL FINANCIAL INFORMATION FOR THE FOUNDING COMPANIES
The following table presents certain summary historical statement of
operations data for each of the founding companies for the years ended December
31, 1996, 1997 and 1998, and the six months ended June 30, 1998 and 1999. This
information should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Combined and Founding
Companies" and the financial statements and notes thereto included in this
prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
AXCES, INC.
Revenues.................................................. $ 8,468 $ 19,474 $ 30,280 $ 17,349 $ 10,095
Gross profit.............................................. 4,508 11,471 20,391 12,041 6,650
Operating income.......................................... 773 2,426 2,253 3,656 1,624
Net cash provided by (used in) operating activities....... 762 269 (1,249) 1,367 3,842
Net cash provided by (used in) investing activities....... (260) (642) (348) (38) 205
Net cash provided by (used in) financing activities....... (111) 43 1,671 (10) (1,734)
EBITDA(1)................................................. 835 2,561 2,456 3,745 1,736
INFOHIGHWAY INTERNATIONAL, INC.
Revenues.................................................. 426 915 1,385 797 1,100
Gross profit.............................................. 208 267 389 287 508
Operating loss............................................ (483) (1,389) (1,211) (455) (466)
Net cash used in operating activities..................... (250) (604) (587) (79) (196)
Net cash used in investing activities..................... (121) (216) (147) (125) (122)
Net cash provided by financing activities................. 354 820 734 204 318
EBITDA(1)................................................. (431) (1,214) (950) (313) (205)
ARC NETWORKS, INC.
Revenues.................................................. 5,583 9,648 13,931 6,660 8,171
Gross profit.............................................. 509 753 2,280 969 1,477
Operating loss............................................ (947) (2,378) (1,592) (415) (570)
Net cash provided by (used in) operating activities....... (424) (479) (594) 392 (721)
Net cash used in investing activities..................... (416) (83) (485) (446) (39)
Net cash provided by financing activities................. 903 567 1,203 101 737
EBITDA(1)................................................. (930) (1,942) (1,185) (250) (351)
</TABLE>
- ------------------------
(1) EBITDA as used in this prospectus consists of earnings before interest,
income taxes, depreciation and amortization. It is calculated by adding to
net income the amounts for interest expense, all income taxes, depreciation
expense and amortization expense. We have included EBITDA data because it is
a measure commonly used in the telecommunications industry and the
significance attached to this measure by most Wall Street security analysts
who follow our industry. Based on our experience in the industry, we believe
that EBITDA is an important tool for measuring the performance of companies
in the industry (including potential acquisition targets) in several areas
such as liquidity, operating performance and leverage. In addition, lenders
use EBITDA as a criterion in evaluating companies in the industry. EBITDA is
not a measure of financial performance determined under generally accepted
accounting principles, should not be considered as an alternative to net
income as a measure of performance or to cash flows as a measure of
liquidity, and is not necessarily comparable to similarly titled measures of
other companies.
7
<PAGE>
RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD
CAREFULLY CONSIDER THE FOLLOWING FACTORS AS WELL AS THE OTHER INFORMATION
CONTAINED IN THIS PROSPECTUS.
IF OUR NEWLY-ASSEMBLED MANAGEMENT TEAM IS UNABLE TO OPERATE THE COMBINED
COMPANIES EFFECTIVELY AND RECOGNIZE THE ANTICIPATED COST SAVINGS, OUR FUTURE
RESULTS OF OPERATIONS MAY BE SIGNIFICANTLY WORSE THAN THOSE PRESENTED IN THIS
PROSPECTUS.
Our business is difficult to evaluate because we have a limited combined
operating history. InfoHighway was incorporated in December 1996 and acquired
ARC on June 30, 1999. We will acquire InfoHighway International and AXCES
simultaneously with and as a condition of the closing of the offering. As a
result, the pro forma combined financial results presented in this prospectus
may not be indicative of the actual results which might have occurred if our
operations and management teams had been combined during the periods presented,
and may not be representative of future results.
OUR FAILURE TO SUCCESSFULLY INTEGRATE THE FOUNDING COMPANIES COULD CAUSE
INTERRUPTION OF OUR BUSINESS AND OPERATIONS.
The acquisition of the founding companies involves a number of risks,
including:
- the incurrence of unforseen or higher than anticipated expenses;
- integration of each founding company's respective equipment, service
offerings, networks and technologies, financial and information systems
and brand names;
- coordination of geographically separated facilities and work forces;
- coordination of their respective sales, marketing and service development
efforts; and
- maintenance of standards, controls, procedures and policies.
The process of integrating the operations of the founding companies could
cause interruption of, or loss in momentum of our business and operations
activities, including those of the businesses acquired.
IF WE ARE UNABLE TO REVERSE THE HISTORICAL LOSSES OF CERTAIN OF OUR FOUNDING
COMPANIES, WE MAY NOT BE ABLE TO ACHIEVE PROFITABILITY IN ALL OF OUR BUSINESS
SEGMENTS.
Two of the three founding companies have incurred substantial historical net
operating losses and experienced negative cash flow during recent periods. As a
result, we had a historical combined deficit, prior to giving effect to the
acquisition of ARC, of approximately $4.1 million as of June 30, 1999. In
addition, the independent auditors' reports of ARC and InfoHighway International
contain explanatory paragraphs describing the uncertainty as to the ability of
each of those companies to
8
<PAGE>
continue as a going concern. We currently intend to increase our capital
expenditures and operating expenses significantly in order to:
- integrate the founding companies;
- expand our networks to support additional expected customers in existing
and future markets; and
- market and provide our services to a growing number of potential
customers.
See "Management's Discussion and Analysis of Pro Forma Financial Condition and
Results of Operations--Operations."
IF THE MARKET PRICE OF OUR COMMON STOCK EXCEEDS $16.00, WE WILL INCUR
SIGNIFICANT ADDITIONAL AMORTIZATION EXPENSE IN THE FUTURE.
We will record intangible assets of $29.2 million associated with the
acquisitions. Such amounts will result in an annual amortization charge which
will decline over time from approximately $3.6 million in the first year to $1.6
million in the tenth year. If the 10-day average closing price of the common
stock exceeds $16.00 and $21.00 per share during the three year period following
this offering, we will be required to record significant additional intangible
assets related to the contingent common stock issue rights based upon the market
value of the common stock at that time. As a result, our net income and earnings
per share will be adversely affected in each of those years. See "Management's
Discussion and Analysis of Pro Forma Financial Condition and Results of
Operations--Operations."
OUR BUSINESS MODEL IS UNPROVEN AND WE MAY NOT BE SUCCESSFUL IN IMPLEMENTING OUR
BUSINESS STRATEGY. IN ADDITION, OUR PRODUCTS AND SERVICES MAY NOT ACHIEVE
SIGNIFICANT MARKET ACCEPTANCE.
We are a competitive local telephone company providing Internet access and
data communications services combined with traditional telephone services using
emerging technology. A competitive local telephone company provides local
telephone services in competition with the traditional local phone company. A
traditional local telephone company is an established provider of dedicated and
local telephone services to all or virtually all telephone subscribers within
its service area. As such, our business strategy is unproven. To be successful,
we must, among other things, develop and market services that are widely
accepted by small to medium-sized businesses and consumers. Our InfoHighway DSL
and InfoHighway Connect services have only been launched in limited areas, and
may not achieve broad commercial acceptance.
In addition, the prices we charge for certain services are in some cases
higher than those charged by our competitors for similar services. A sufficient
number of customers may not be willing to pay the prices we charge for our
services. Additionally, prices for digital communications services have fallen
historically, and prices in the industry in general, and for the services we
offer, and plan to offer, are expected to continue to fall. We have provided,
and expect in the future to provide,
9
<PAGE>
price discounts to customers that subscribe to multiple services. In addition,
we may be required to reduce prices periodically to respond to competition and
to generate increased sales volume. Accordingly, we may not be able to build a
profitable enterprise based upon our current business model. See "Management's
Discussion and Analysis of Pro Forma Financial Condition and Results of
Operations" and "Business--Business Strategy."
OUR LENGTHY SALES CYCLE FOR COMMERCIAL BUILDINGS AND MULTIPLE DWELLING UNITS
REQUIRES US TO INCUR SIGNIFICANT EXPENSES IN ADVANCE OF THE RECEIPT OF REVENUES.
Our practice of marketing to commercial buildings and multiple dwelling
units either through real estate management companies or landlords has taken
significant effort to date and the sales cycle is lengthy. Further, we have
targeted new construction as one of our principal markets. This market is
subject to construction delays and other conditions beyond our control. During
this lengthy sales cycle, we incur significant expenses in advance of the
receipt of revenues. Therefore, any long-term failure to roll out our services
could have a material adverse effect on our cash flows and revenue recognition.
See "Business--Customers."
IF OUR LOCAL AND LONG DISTANCE SERVICE PROVIDERS REFUSE OR ARE UNABLE TO PROVIDE
THEIR SERVICES FOR OUR RESALE, WE WILL BE UNABLE TO PROVIDE THOSE SERVICES TO
OUR CUSTOMERS.
The majority of our current revenues are derived from the resale of local
and long distance telephone services supplied by other telecommunications
providers. We currently purchase services from Bell Atlantic Corp., Frontier
Communications of the West, Inc., AT&T Corp. and Coastal Telephone Services
Limited Company and sell these services to our customers. The refusal or
inability of these service providers to supply local and long distance services
to us for our resale would result in our inability to deliver our local and long
distance telephone services to our customers and would cause a corresponding
loss of revenues.
IF WE ARE UNABLE TO OBTAIN SPACE TO LOCATE OUR FACILITIES FROM THE LOCAL
TELEPHONE COMPANIES, WE MAY INCUR DELAYS AND INCREASED EXPENSES IN CONNECTION
WITH THE DELIVERY OF OUR SERVICES.
We are dependent on Bell Atlantic, Southwestern Bell Telephone Company and
other competitive local telephone companies, such as Level 3 Communications,
Inc., for space to locate our equipment in certain geographical areas. However,
space may not be available in the facilities we request and we may experience
initial rejections of our applications to obtain space from the traditional
local telephone companies. In addition, many of the companies are our
competitors. Also, physical space may become exhausted in certain areas as
demand increases. The rejection of our applications for space could result in
delays in and increased expenses associated with, the roll out of our services
in our target markets.
10
<PAGE>
IF WE ARE UNABLE TO ENTER INTO INTERCONNECTION AGREEMENTS WITH THE TRADITIONAL
LOCAL TELEPHONE COMPANIES, WE WILL BE UNABLE TO LOCATE OUR EQUIPMENT IN THEIR
FACILITIES AND PROVIDE OUR SERVICES.
In order to locate our equipment in the traditional telephone companies, we
will be required to enter into and implement interconnection agreements in each
of our target markets with the appropriate traditional local telephone
companies. These interconnection agreements govern the relationship between us
and the traditional local telephone companies. Since interconnection agreements
are subject to interpretation by both parties, differences in interpretation may
arise that cannot be resolved on favorable terms to us. Also, the
interconnection agreements are subject to state commission, FCC and judicial
oversight. Modifications of the terms, conditions or prices of our future
interconnection agreements by these governmental bodies, or disputes with
traditional local telephone companies over the terms of the interconnection
agreements generally, may have a material adverse effect on our ability to
deliver our services. See "Business--Telecommunications Services--Long Distance
Services."
IF WE ARE UNABLE TO OBTAIN TRANSMISSION FACILITIES FROM OUR PROVIDERS, WE MAY BE
UNABLE TO PROVIDE OUR INTERNET SERVICES TO OUR CUSTOMERS IN A TIMELY MANNER.
We lease the majority of our transmission and transport facilities in our
network. We are dependent on multiple providers, including MCI WorldCom, Inc.,
Savis Communications, Level 3, AT&T, Winstar Communications, Inc. and Taylor
Communications for these transmission and transport facilities. Many of these
companies are currently experiencing delays in providing these facilities.
Switching vendors and shifting traffic to an alternative provider may cause
temporary delays in providing service to our customers. Several of these
providers currently are or may become our competitors in the future and may act
slowly to provide facilities to us. Also, failure of these carriers to provide
their facilities to us may materially harm our business. The risks inherent in
utilizing third party providers include the possible inability to negotiate and
renew favorable supply agreements and dependence on the timeliness of the fiber
optic transport providers in processing our orders for transmission facilities.
IF WE ARE UNABLE TO OBTAIN THE NECESSARY EQUIPMENT ON ACCEPTABLE TERMS, WE MAY
NOT BE ABLE TO DELIVER OUR PRODUCTS AND SERVICES TO OUR CUSTOMERS.
We purchase digital subscriber line or DSL and other data transmission
equipment from AccessLan Communications, Inc. DSL is a high-speed modem
technology that provides data services over existing telephone lines. We also
rely on other companies to supply key components of our network infrastructure,
including networking equipment. These components are only available in the
quantities and quality we require from sole or limited sources. If our vendors
or their equipment fail to perform as expected, selecting alternative suppliers
may delay and require us to
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change our offerings. We may not be able to obtain such equipment within the
time frames required by us at an affordable cost, or at all.
IF OUR PROVIDERS FAIL TO DELIVER ACCURATE AND TIMELY CALL DETAIL RECORDS, WE
WILL BE UNABLE TO PROPERLY BILL OUR CUSTOMERS.
The accurate and prompt billing of our customers is dependent upon the
timeliness and accuracy of call detail records, including those provided by
providers whose services we resell. We can give no assurance that the current
providers will continue to provide, or that new providers, including traditional
local telephone companies, will provide, accurate information on a timely basis.
Any provider's failure to do so would materially adversely effect our ability to
properly bill our customers.
THE QUALITY OF THE WIRING AND EQUIPMENT USED BY THE TRADITIONAL LOCAL TELEPHONE
COMPANIES MAY IMPACT THE QUALITY OF OUR SERVICES.
We are dependent upon the technology and capabilities of the traditional
local telephone companies to meet certain telecommunications needs of our
customers and maintain our service standards. We are highly dependent on the
quality and availability of the traditional local telephone companies' copper
lines and their maintenance of such lines. We may not be able to obtain the
copper lines from the traditional local telephone companies at quality levels
satisfactory to us. The failure to obtain such services at satisfactory quality
levels would affect our ability to deliver quality local and long distance
telephone service, high-speed Internet access and data networking services.
WE HAVE MINIMUM PURCHASE AGREEMENTS WHICH MAY SUBJECT US TO HIGHER COSTS IN THE
FUTURE.
We have entered into minimum purchase agreements with several of our service
providers that commit us to minimum monthly purchase amounts regardless of our
actual usage charges. These minimum purchase agreements range from month to
month to as long as five years. We may be required to purchase such minimum
amounts in future periods. If we are unable to grow our business in future
periods, these minimum purchase agreements could cause our expenses to increase
without any corresponding increase in revenues. See
"Business--Telecommunications Services--Long Distance Service."
IF THE OVERALL TELECOMMUNICATIONS MARKET CONTINUES TO BE DOMINATED BY LARGE
COMPANIES, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY AND OBTAIN SUFFICIENT
MARKET SHARE.
Our industry is highly competitive, and we expect competition to intensify
in the future. We do not have a significant market share in any of our markets.
Most of our actual and potential competitors have substantially greater
financial, technical, marketing and other resources, including brand or
corporate name recognition, than we do. A continuing trend towards business
combinations and alliances in the communications industry may create significant
new competitors for us. In addition,
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we believe that the traditional distinctions between the local, long distance
data and Internet access markets are eroding. As these markets and companies
converge, the remaining competitors may be more dominant and have greater market
share than they do today. These competitors may provide a bundled package of
communications products, including local, long distance and DSL services, that
compete directly with the products we offer. These entities may also offer
services sooner and at more competitive rates than we do. Finally, recent
Federal Communications Commission rules make it substantially easier for many
non-U.S. communications companies to enter the U.S. market. This may further
increase the number of our competitors.
COMPETITION IN THE LONG DISTANCE SERVICES MARKET IS INTENSE AND GROWING, AND WE
MAY BE UNABLE TO COMPETE EFFECTIVELY.
- CUSTOMER TURNOVER. The long distance industry is characterized by a high
level of customer turnover. Our revenue has been, and is expected to
continue to be, negatively affected by customer turnover. Historically,
the customer turnover for our long distance segment has been as high as 8%
of our customers per month.
- EFFECT OF NEW RATES AND RATE PLANS. AT&T, MCI WorldCom, Sprint Corporation
and other carriers have implemented price plans aimed at residential
customers with significantly simplified rate structures. This may lower
long distance prices. Long distance carriers have made similar offerings
available to the small and medium-sized businesses we primarily serve,
creating additional pricing competition and creating pressure on gross
margins. If we are unable to reduce costs in a timely manner, our margins
may be significantly reduced.
- ENTRANCE OF THE TRADITIONAL LOCAL TELEPHONE COMPANIES INTO THE IN-REGION
LONG DISTANCE MARKET. The traditional local telephone companies such as
Southwestern Bell, Ameritech Corporation and Bell Atlantic are currently
precluded from providing long distance services to customers in each of
the regions in which they currently provide local telephone services. We
anticipate that a number of these phone companies will seek authority to
provide in-region long distance services in 1999 and beyond. In-region
long distance service for a traditional local telephone company simply
means long distance service between two points inside its region. For
example, Bell Atlantic recently filed to seek approval to provide long
distance services to customers in New York and Massachusetts. Once
traditional local telephone companies are allowed to offer in-region long
distance services, they will be in a position to offer single-source local
and long distance service.
COMPETITION IN THE LOCAL SERVICES MARKET IS INTENSE AND GROWING, AND WE MAY BE
UNABLE TO COMPETE EFFECTIVELY.
- NEED TO COMPETE WITH TRADITIONAL PROVIDERS. In the local communications
market, our primary competitor is currently the traditional local
telephone company serving each geographic area. For example, Southwestern
Bell and Bell Atlantic
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are our competitors in each of the areas in which we resell their local
telephone services. Traditional local telephone companies benefit from:
- longstanding relationships with their customers;
- greater financial and technical resources;
- the ability to subsidize local services with revenues from other
businesses; and
- recent regulations that relax price restrictions and decrease regulatory
oversight of traditional local telephone companies.
If the traditional local telephone companies are allowed additional
flexibility to offer discounts to large customers, engage in aggressive
discount pricing practices, or charge competitors excessive fees for
interconnection to their networks, the revenue of their competitors,
including us, could be materially adversely affected.
- ENTRANCE OF LARGE LONG DISTANCE AND OTHER CARRIERS INTO THE LOCAL MARKET.
We also face competition in local markets from other new entrants,
including long distance and other carriers, many of which have
significantly greater financial resources than we do. For example, AT&T,
MCI WorldCom and Sprint have each begun to offer local communications
services in major U.S. markets. Other entities that currently or may offer
local telephone services including companies that have previously operated
as competitive local telephone companies, cable television companies or
electric utilities could, upon entering into appropriate interconnection
agreements or resale agreements with local telephone companies, offer
single-source local and long distance services similar to those offered by
us.
COMPETITION IN THE DATA SERVICES MARKET IS EXTREMELY COMPETITIVE AND
CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGES, AND WE MAY BE UNABLE TO COMPETE
EFFECTIVELY.
The market for data communications and Internet access services is extremely
competitive and characterized by rapid technological innovation. There are no
substantial barriers to entry, and we expect that competition will intensify in
the future. We expect significant competition from a large variety of companies,
including:
- long distance service providers such as AT&T and MCI WorldCom;
- cable modem service providers such as Time Warner Communications and
Cablevision;
- Internet service providers such as Covad Communications Group, Inc. and
Northpoint Communications Group, Inc.;
- online service providers such as America Online, Inc. and Verios;
- wireless data services providers such as Winstar and Teligent, Inc.; and
- other companies focusing on DSL services.
These companies may offer competing products with price or other characteristics
that are more attractive than our own.
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IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES, WE MAY LOSE CUSTOMERS TO
COMPETITORS WHO ARE SUCCESSFUL.
The communications industry has been, and is likely to continue to be,
subject to:
- rapid and significant technological change, including continuing
developments in DSL technology, which does not presently have widely
accepted standards;
- frequent introductions of new services and alternative technologies,
including new technologies for providing high-speed data services; and
- evolving industry standards.
We expect that new products and technologies will emerge that may be
superior to, or may not be compatible with, some of our products or
technologies. Changes in technology could cause more competitors to enter the
industry in which we have recently begun to compete. Also, technological
changes, including advancements in the capabilities of the existing copper
telephone wires, emerging wireless technologies and Internet services and
technologies, could result in lower retail rates for communications services.
Failure to adapt successfully to any technological change or obsolescence, or
the failure to obtain access to important technologies, could cause us to lose
customers to competitors who successfully obtain such technologies.
IF WE ARE UNABLE TO OBTAIN ADDITIONAL CAPITAL, WE MAY NOT BE ABLE TO COMPLETE
FUTURE NETWORK EXPANSION AND ACQUISITIONS.
NETWORK EXPANSION. We estimate that our capital needs will be approximately
$0.7 million in 1999 and $1.5 million in 2000. If the amount needed for our
expansion plans increases materially over these amounts or we otherwise do not
have sufficient cash resources to fund these costs, we may need to revise or
curtail our expansion plans.
ACQUISITIONS. We currently intend to use our common stock to fund a portion
of the purchase price for any future acquisitions. If our common stock does not
maintain an acceptable trading price in the public markets or if potential
acquisition candidates are unwilling to accept our common stock, we may require
additional capital to complete any acquisitions. If we are unable to raise
additional capital, we may be required to revise or curtail our acquisition
plans.
OUR FUTURE INDEBTEDNESS MAY SUBJECT US TO FINANCIAL AND OPERATING RESTRICTIONS.
We intend to enter into negotiations with commercial banks to provide us
with a credit facility to be used for acquisitions, working capital, capital
expenditures and other general corporate purposes. Any such credit facility or
other debt financing will require that we make certain financial covenants which
could limit our operational and financial flexibility. In addition, incurring
debt would increase our leverage and make us more vulnerable to economic
downturns and limit our ability to compete. See "Management's Discussion and
Analysis of Pro Forma Financial Condition and Results of Operations--Pro Forma
Liquidity and Capital Resources."
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IF THE DEMAND FOR HIGH-SPEED INTERNET ACCESS AND OTHER DATA COMMUNICATION
SERVICES DOES NOT CONTINUE TO GROW, WE MAY NOT BE SUCCESSFUL IN IMPLEMENTING OUR
BUSINESS STRATEGY.
The market for high-speed Internet access and related services is relatively
new and characterized by rapidly changing technology, evolving industry
standards, changes in customer needs and frequent new product and service
introductions. If the market for high-speed Internet access services fails to
develop, develops more slowly than expected, or becomes saturated with
competitors, or if the high-speed Internet access and services we offer are not
broadly accepted, our business, operating results and financial condition will
be materially adversely affected.
HACKERS, COMPUTER VIRUSES AND OTHER DISRUPTIVE PROBLEMS COULD POSE SECURITY
RISKS AND CAUSE MATERIAL INTERRUPTIONS IN THE SERVICES WE PROVIDE.
Our networks may be vulnerable to unauthorized access, computer viruses and
other disruptive problems. Internet service providers and corporate networks
have experienced interruptions in service as a result of accidental or
intentional actions of Internet users, current and former employees and others.
Unauthorized access could also potentially jeopardize the security of
confidential information stored in the computer systems of our customers and
such customers' end-users, which might result in our liability to our customers
and also might deter potential customers. We may not be able to implement
security measures in a timely manner or to our various customers' satisfaction,
or that can not be circumvented. Eliminating computer viruses and alleviating
other security problems may require interruptions, delays or cessation of
service to our customers and such customers' end-users, which could cause us to
lose customers. See "Business--Network Architecture and Technology."
OUR SUCCESS IS HEAVILY DEPENDENT UPON OUR RETENTION OF CERTAIN OF OUR EXECUTIVE
OFFICERS AND KEY EMPLOYEES AND THE HIRING OF ADDITIONAL PERSONNEL.
Our success depends to a significant extent upon the abilities and continued
efforts of our management team, particularly Joseph A. Gregori, our Chief
Executive Officer and other members of our senior management team and key
employees. The loss of any of these individuals could materially adversely
affect us. Our success will also depend upon our ability to hire and retain
additional personnel, including technical and sales personnel. Competition for
qualified personnel in the communications industry is intense. Difficulty in
hiring and retaining personnel could materially adversely affect our ability to
manage and support our operations. See "Management" and "Business--Employees."
THE INCREASE OF CURRENT GOVERNMENTAL SURCHARGES AND FEES ON OUR GROSS REVENUES
WOULD ADVERSELY AFFECT OUR BUSINESS.
Telecommunications providers pay a variety of surcharges and fees related to
providing interstate and intrastate services. Interstate surcharges include
those imposed at the federal level and those imposed by various state regulators
on intrastate services. The division of our services between interstate services
and
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intrastate services is a matter of interpretation and may in the future be
contested by the FCC or relevant state commissions. A change in the
characterization of the jurisdiction of our services could cause an increase in
our payment obligations. In addition, pursuant to periodic revisions by state
and federal regulators of the applicable surcharges, we may be subject to
increases in the surcharges and fees currently paid.
OUR BUSINESS IS HIGHLY REGULATED AND MAY BE ADVERSELY AFFECTED BY FUTURE CHANGES
IN GOVERNMENTAL REGULATIONS RELATING TO OUR INDUSTRY.
Our services are subject to significant federal, state and local government
regulation. Delays in receiving required regulatory approvals, or new regulatory
requirements, may materially adversely affect our business, prospects, financial
condition and results of operation. In particular, we face the following
regulatory risks:
- NEED TO COMPLY WITH FEDERAL REGULATIONS. We are regulated at the federal
level by the FCC. We are required to file and maintain domestic and
international tariffs containing the currently effective rates, terms and
conditions of service for our long distance services. We are also required
to maintain an FCC authorization to provide international services. We are
also required to comply with FCC regulations concerning changing a
customer's local or long distance provider. The FCC has the authority to
sanction us or revoke our authorization if we violate applicable law.
- NEED TO COMPLY WITH STATE LAW. Our local and long distance services are
also subject to state law. In the states where we offer local or long
distance services, we are required to file and maintain tariffs containing
the currently effective rates, terms and conditions of service. We are
also required to maintain state authorization to provide local or long
distance services. Some states also must approve changes in the ownership
of AXCES and ARC, as well as the issuance of the securities contemplated
by this offering. We are also required to comply with state regulations
concerning changing a customer's local or long distance provider. We have
been involved in several legal proceedings in various states in which it
was alleged that we violated these regulations, some of which are still
pending. See "--We may incur additional liability as a result of
allegations of slamming and cramming," and "Business--Legal Proceedings."
Our retail marketing program is subject to state laws and regulations. The
states have the authority to sanction us or revoke our authorization if we
violate applicable law.
WE MAY INCUR ADDITIONAL LIABILITY AS A RESULT OF ALLEGATIONS OF SLAMMING AND
CRAMMING.
Federal and state law prohibits the practices known as "slamming" and
"cramming." Slamming is a practice whereby telephone companies switch a
customer's local or long distance provider without the customer's permission.
Cramming is a
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practice whereby unauthorized charges are included on a customer's telephone
bill. We have been involved in a number of legal proceedings in various states
in which we were alleged to have been engaged in the practices of slamming and
cramming. There have been approximately 17 lawsuits and administrative
proceedings filed against us alleging slamming and 2 lawsuits or administrative
proceedings alleging cramming, some of which are still pending. See
"Business--Legal Proceedings." We may be penalized again for possible slamming
practices in the future, and such penalty, whether in the form of a fine or a
suspension of our right to conduct business, may have a material adverse impact
on our operating results. In addition, certain of our service providers have the
right to terminate their agreements with us if we fail to comply with certain
restrictions against slamming and cramming contained in our resale agreements
with them.
WE MAY BE LIABLE FOR THE TRANSMISSION OF INDECENT, LIBELOUS OR COPYWRITTEN
MATERIALS BY OUR INTERNET SUBSCRIBERS.
Laws governing use of the Internet, including taxation of transactions,
privacy, security, digital signatures, and encryption are continually under
consideration at the state and federal level. In particular, the law governing
the liability of online service providers and Internet access providers for
participating in the hosting or transmission of objectionable materials or
information currently remains unsettled. In addition, several private parties
have filed lawsuits seeking to hold Internet service providers accountable for
information they transmit. We cannot predict the outcome of this litigation or
the potential for the imposition of liability on Internet service providers for
information that they host, distribute or transport. To the extent that we
become parties to future litigation or there are new regulations, such
litigation or new regulations could subject us to significant monetary fines or
damage awards. See "Business--Government Regulations--Internet Regulations"
OTHER COMPANIES MAY USE SIMILAR MARKS IN CERTAIN GEOGRAPHIC AREAS IN WHICH WE
WILL CONDUCT BUSINESS AND MAY CONTEST THE USE OF OUR MARKS AND SEEK MONETARY
DAMAGES.
Even though we are using the marks "InfoHighway Communications" and
"InfoHighway" in the United States, other companies in many different industries
have preexisting rights to similar names within defined territories. Certain
companies may have the right to use similar names for telecommunications
services within established areas. Any of these companies could contest our use
of our name and seek monetary damages. If any other companies are successful
with their claims to our name, we may be required to either obtain a license
from them for the use of the name "InfoHighway," or be required to change our
name within certain defined territories. Either result would cause us to incur
additional expenses. If we are required to change our name, we may lose the
goodwill associated with the "InfoHighway" name in our markets.
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OUR MANAGEMENT AND PRINCIPAL STOCKHOLDERS WILL CONTROL A MAJORITY OF OUR STOCK,
AND THEIR INTERESTS MAY CONFLICT WITH THOSE OF OUR STOCKHOLDERS.
Our executive officers, directors and principal stockholders together will
beneficially own approximately 67.7% of the outstanding common stock after
completion of this offering. Accordingly, these stockholders will be able to
determine the composition of our board of directors, will retain the voting
power to approve all matters requiring stockholder approval and will continue to
have significant influence over our affairs. This concentration of ownership
could have the effect of delaying or preventing a change in control of or
otherwise discouraging a potential acquiror from attempting to obtain control of
us, which in turn could have a material adverse effect on the market price of
the common stock or prevent our stockholders from realizing a premium over the
then prevailing market prices for their shares of common stock. See "Management"
and "Principal Stockholders."
FAILURE OF COMPUTER SYSTEMS AND SOFTWARE PRODUCTS TO BE YEAR 2000 COMPLIANT
COULD NEGATIVELY IMPACT OUR BUSINESS.
Some computers, software, and other equipment include computer codes in
which calendar year data is abbreviated to only two digits. Some of these
computer systems could fail to operate properly if they interpret "00" to mean
1900, rather than 2000. This problem is widely known as the "year 2000 problem."
We are highly dependent on our computer systems and those of third party
suppliers, vendors and customers. The year 2000 problem affects some of our
computers, software, and other equipment, including the computers which run our
administrative functions. If we fail to properly identify, correct and test our
computer systems for the year 2000 problem, our business operations could be
adversely affected. In addition, the computer systems used by our service
providers such as billing vendors, telecommunications service providers, our
customers and other third parties, may not function properly by the year 2000. A
failure of our service providers to cause their computers systems to be year
2000 compliant could have an adverse effect on our ability to deliver services
to our customers. See "Management's Discussion and Analysis of Pro Forma
Financial Condition and Results of Operations--Year 2000 Compliance--Combined."
THE ABSENCE OF AN ACTIVE PUBLIC MARKET FOR OUR COMMON STOCK MAY MAKE IT
DIFFICULT FOR YOU TO RESELL YOUR SHARES AT OR ABOVE THE OFFERING PRICE, AND OUR
STOCK PRICE MAY FLUCTUATE.
Prior to this offering, there has been no public market for the common
stock, and there can be no assurance that an active public market for the common
stock will develop or be sustained after the offering. The initial public
offering price will be determined by negotiation between us and the underwriters
based upon several factors and may not be indicative of the market price of the
common stock after the offering. See "Underwriting" for a discussion of the
factors to be considered in determining the initial public offering price. The
trading price of the common stock could be subject to wide fluctuations in
response to factors included in this prospectus, many of which are beyond our
control. In addition, in recent years the
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stock market has experienced extreme price and volume fluctuations. These
fluctuations have had a substantial effect on the market prices for many
emerging growth companies, often unrelated to the operating performance of the
specific companies. Such market fluctuations could adversely affect the price of
our common stock.
SALES OF SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK MAY ADVERSELY AFFECT OUR STOCK
PRICE AND MAKE FUTURE OFFERINGS TO RAISE CAPITAL MORE DIFFICULT.
Sales of a large number of shares of our common stock in the market after
this offering or the perception that sales may occur could cause the trading
price of our common stock to drop. There will be approximately 4,587,242 shares
of our common stock outstanding immediately after the offering. The 1,600,000
shares sold in the offering, plus any shares issued upon exercise of the
underwriters' overallotment option, are freely tradeable.
RESTRICTED SECURITIES AND LOCK-UP AGREEMENT. A total of 2,822,242 shares of
common stock outstanding are restricted securities as defined in Rule 144 of the
Securities Act. In addition, there are approximately 4,034,410 shares which are
issuable pursuant to contingent common stock issue rights and various warrants,
options, convertible notes and convertible preferred stock, 416,917 of which are
not subject to the lock-up agreement. Of the shares not subject to the lock-up
agreement, 296,250 shares are eligible for sale in the public market on May 19,
2000 and 120,667 shares are eligible for sale on the first anniversary of the
offering, subject to the restrictions of Rule 144.
REGISTRATION RIGHTS. The holders of 280,667 of those shares can require us
to register their shares for resale at any time beginning one year after the
closing of this offering. In addition, 165,000 shares of common stock have been
registered for resale by Benchmark Equity Group for a period of 90 days, which
period shall begin 90 days after the closing of this offering.
Subsequent sales of these shares or the perception that those sales might
occur could materially adversely affect the price of our common stock and make
it more difficult for us to raise funds through future offerings of common
stock. See "Shares Eligible for Future Sale."
YOU WILL EXPERIENCE IMMEDIATE, SUBSTANTIAL DILUTION IN THE NET TANGIBLE BOOK
VALUE OF THE SHARES YOU PURCHASE.
Purchasers of our common stock in this offering:
- will pay a price per share that substantially exceeds the value on a per
share basis of our assets after we subtract from those assets our
intangible assets and our liabilities;
- will incur immediate dilution in net tangible book value of $9.05 per
share;
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- will contribute a majority of the funds we will need to complete our
initial acquisitions and repay indebtedness, but will own only 34.9% of
the outstanding shares of our common stock and 30.8% of the voting
interest; and
- may experience further dilution in the net tangible value of their common
stock as a result of future issuances of common stock.
See "--If we are unable to obtain additional capital, we may not be able to
complete future acquisitions" and "Dilution."
WE MAY ISSUE PREFERRED STOCK WHOSE TERMS COULD ADVERSELY AFFECT THE VOTING POWER
OR VALUE OF OUR COMMON STOCK.
Our certificate of incorporation authorizes us to issue, without the
approval of our stockholders, one or more classes or series of preferred stock
having such preferences, powers and relative, participating, optional and other
rights, including preferences over our common stock respecting dividends and
distributions, as our board of directors may determine. The terms of one or more
classes or series of preferred stock could adversely impact the voting power or
value of our common stock. For example, we might afford holders of preferred
stock the right to elect some number of our directors in all events or on the
happening of specified events or the right to veto specified transactions.
Similarly, the repurchase or redemption rights or liquidation preferences we
might assign to holders of preferred stock could affect the residual value of
the common stock.
Upon the completion of this offering we will have two series of preferred
stock outstanding:
- SERIES A PREFERRED STOCK. Upon completion of this offering there will be
1,206,673 shares of series A preferred stock outstanding. Since the series
A preferred stock has a conversion rate which is dependent upon the
current market price of our common stock, the number of shares issuable
upon its conversion will vary inversely with the market price of our
common stock. This means that as our stock price drops, the dilution
caused by the conversion of the series A preferred stock will increase.
However, the maximum shares of common stock issuable upon conversion of
the outstanding series A preferred stock is approximately 362,000 shares.
Beyond that point, the series A stockholders may require that we redeem
their shares for the price of $1.00 per share plus any accrued but unpaid
dividends.
- SERIES B PREFERRED STOCK. Upon completion of this offering there will be
60,000 shares of series B preferred stock outstanding. Holders of the
series B preferred stock have the same voting rights as the holders of our
common stock on an as-converted basis. Since the dividends payable on the
series B preferred stock are payable either in cash or additional series B
preferred stock, the voting rights of our common stockholders could be
further diluted. Also, in addition to their dividend and liquidation
preferences, the series B preferred stockholders are entitled to receive
dividends and liquidation
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distributions at the same time and on the same basis as the holders of our
common stock.
See "Description of Capital Stock--Preferred Stock."
PROVISIONS IN OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DELAY OR PREVENT A
CHANGE IN CONTROL OF OUR COMPANY, EVEN IF THAT CHANGE WOULD BE BENEFICIAL TO OUR
STOCKHOLDERS.
The existence of some provisions in our corporate documents and Delaware law
could delay or prevent a change in control of our company, even if that change
would be beneficial to our stockholders. Our certificate of incorporation and
bylaws contain provisions that may make acquiring control of our company
difficult, including:
- provisions relating to the classification, nomination and removal of our
directors;
- provisions limiting the right to call special meetings of our board and
our stockholders;
- provisions regulating the ability of our stockholders to bring matters for
action at annual meetings of our stockholders;
- a prohibition of action by our stockholders without a meeting; and
- the authorization to issue and set the terms of preferred stock.
WE ENCOURAGE YOU NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING INFORMATION.
This prospectus includes forward-looking statements. We have based these
forward-looking statements on our current expectations and projections about
future events. These forward-looking statements are subject to risks,
uncertainties and assumptions about us, including, among other things:
- the successful implementation of our anticipated growth strategies;
- our ability to integrate our founding companies and future acquisitions;
- continual changes in the telecommunications industry and technology;
- the actions of our competitors;
- market acceptance of our services;
- economic and demographic trends affecting our business; and
- future expenditures for capital projects.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this prospectus might not occur.
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USE OF PROCEEDS
The net proceeds we will receive from the offering, after deducting
estimated underwriting discounts and commissions and offering expenses, are
estimated to be approximately $13.3 million assuming an initial public offering
price of $10.00 per share. The net proceeds will increase to $15.5 million if
the underwriters exercise their over-allotment option in full.
We anticipate that the $13.3 million of net proceeds of this offering will
be used to repay $6.7 million of indebtedness of InfoHighway and the founding
companies. Debt to be repaid is summarized as follows:
- up to $3.0 million of short-term borrowings to be secured by AXCES during
the third quarter of 1999 for the funding of distributions to its owners;
- $2.0 million of bridge financings received by InfoHighway during the first
six months of 1999, of which $1.9 million was utilized to fund operations
and third party services pertaining to the offering;
- $0.9 million of notes payable to shareholders of InfoHighway
International, including $0.5 million of debt incurred during the fourth
quarter of 1998 from Trident III for capital expenditures and working
capital needs; and
- $0.8 million of payments on the short-term revolving credit facility of
ARC.
The indebtedness to be repaid bears interest ranging from 10.0% to 15.9%, with a
weighted average interest rate of approximately 13.0%, and would otherwise
mature at various dates through March 2003. We anticipate that the remaining
$6.6 million of the net proceeds will be used for:
- capital expenditures for hardware to expand our network capabilities to
deliver high speed Internet and data network services;
- general working capital purposes; and
- future acquisitions.
We intend to increase capital expenditures and operating expenses in order
to integrate the founding companies, expand networks to support additional
expected end-users in existing and future markets and to market and provide
services to a growing number of potential end-users. Current capital resources,
including the proceeds of this offering, are anticipated to be sufficient to
fund aggregate capital expenditures and working capital requirements for the
immediate future. At this time, net proceeds earmarked for capital expenditures,
future acquisitions and general working capital purposes total approximately
$2.0 million, $2.0 million, and $2.5 million, respectively.
In connection with our business expansion we expect to increase capital
expenditures in 1999 and 2000. We estimate that for 1999 such amounts will
approximate $0.7 million and for year 2000 up to approximately $1.5 million. The
majority of these capital expenditures will be to support the expansion of
InfoHighway DSL and InfoHighway Connect service offerings. However, our strategy
is based upon
23
<PAGE>
successful acceptance of our products in the marketplace. Accordingly, such
capital expenditures may vary based upon our success.
Future acquisitions may require significant capital. We cannot predict with
certainty what our capital needs will be for future acquisitions, although we
have tentatively dedicated $2.0 million of offering proceeds to fund future
acquisitions.
In June 1999, we received demand letters from three unaffiliated noteholders
for payment of three notes aggregating $0.8 million comprised of an 8% $0.6
million note and two 12% $0.1 million notes. As a result, we renegotiated these
notes in June 1999 include the accrued interest on $0.6 million of the notes and
extended the maturity date of the notes until October 31, 1999. Currently, we
are in discussions with these noteholders and expect to extend the principal
payments until the year 2000. If we are unable to extend these principal
payments, we will have to utilize a portion of our remaining net proceeds to
make such payments.
We believe that the net proceeds of this offering will be sufficient to fund
our aggregate capital expenditures and working capital requirements, including
operating losses, for the foreseeable future. The amounts we actually expend for
these purposes may vary significantly depending upon a number of factors,
including future revenue growth, if any, capital expenditures and the amount of
cash generated by our operations. Additionally, if we determine it would be in
our best interest, we may increase or decrease the number, selection and timing
of entry of our targeted regions. Accordingly, our management will retain broad
discretion in the allocation of the net proceeds remaining after the repayment
of indebtedness in connection with the acquisitions. Although we may use a
portion of the net proceeds to pursue possible acquisitions of businesses,
technologies or products complementary to our current operations in the future,
there are no present understandings, commitments or agreements with respect to
any such acquisitions. Pending use of such net proceeds for the above purposes,
we intend to invest such funds in short-term, interest-bearing, investment-grade
securities. See "Risk Factors--If we are unable to obtain additional capital, we
may not be able to complete future acquisitions" and "Management's Discussion
and Analysis of Pro Forma Financial Condition and Results of Operations."
DIVIDEND POLICY
We have never paid cash dividends and have no plans to do so in the
foreseeable future. Our future dividend policy will be determined by our board
of directors and will depend upon a number of factors, including:
- our financial condition and performance;
- our cash needs and expansion plans;
- income tax consequences; and
- the restrictions Delaware and other applicable laws and our credit
arrangements then impose.
24
<PAGE>
CAPITALIZATION
The following table sets forth the cash, short-term debt and current
maturities of long-term debt and capitalization as of June 30, 1999:
- on a pro forma combined basis to give effect to the acquisition of the
founding companies, and
- on a pro forma combined basis as adjusted to give effect to the offering
and the application of the estimated net proceeds.
See "Use of Proceeds" and Unaudited Pro Forma Combined Financial Statements
and the related notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1999
--------------------
PRO FORMA AS
COMBINED ADJUSTED
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents.............................................. $ 991 $ 8,155
--------- ---------
--------- ---------
Short-term debt and current maturities of long-term debt (1)........... 9,304 2,635
Long-term debt and other long-term liabilities, less current
maturities........................................................... 5 5
Redeemable preferred stock; Series A, 1,206,673 shares issued and
outstanding, pro forma and as adjusted (2)........................... 1,207 1,207
Stockholders' equity
Preferred stock, $.0001 par value, 3,000,000 shares authorized:
Series B, 60,000 shares issued and outstanding,
pro forma and as adjusted........................................ 9,000 9,000
Common stock, $.0001 par value, 25,000,000 shares authorized;
2,987,242 shares issued and outstanding, pro forma; and 4,587,242
shares issued and outstanding, as adjusted (3)................... -- --
Additional paid-in capital........................................... 11,622 24,942
Deficit.............................................................. (371) (371)
--------- ---------
Total stockholders' equity......................................... 20,251 33,571
--------- ---------
Total capitalization............................................. $ 30,767 $ 37,418
--------- ---------
--------- ---------
</TABLE>
- ------------------------
(1) For a description of our debt, see the Notes to Unaudited Pro Forma Combined
Financial Statements and the Notes to the Financial Statements of the
founding companies included elsewhere herein.
(2) Redeemable by holder at $1.00 per share in the event the market price of our
common stock declines below 33% of the initial public offering price.
(3) The calculation of the number of shares of common stock outstanding after
the offering in the table above consists of:
- 1,600,000 shares to be sold in the public offering;
- 939,000 shares issued to the founders of InfoHighway and other investors;
and
- 2,048,242 shares to be issued to the shareholders of the founding
companies.
25
<PAGE>
The number of shares of common stock outstanding after the offering in the
table above does not include:
- 727,511 shares issuable from contingent common stock issue rights which
were issued to certain of our shareholders prior to the acquisition of ARC
and the previous shareholders of ARC and InfoHighway International based
upon the performance of our common stock beginning 90 days after the
completion of this offering;
- 741,000 shares issuable upon exercise of options at $10 per share of which
616,000 will be issued to certain members of our management and board of
directors and 125,000 will be issued to employees upon consummation of the
offering;
- 600,000 shares issuable upon conversion of our series B preferred stock
which will be issued to the shareholders of AXCES at a conversion price of
$15 per share;
- 600,000 shares issuable upon exercise of options at $8 per share which
were granted to certain members of our management in connection with the
terms of their employment;
- 573,333 shares issuable upon exercise of warrants at $8 per share which
were issued in connection with certain bridge loans to InfoHighway prior
to the offering;
- 206,250 shares issuable upon conversion of a convertible promissory note
issued to a former debtholder of ARC at a conversion price of $8 per
share;
- 160,000 shares issuable upon exercise of warrants at $16.50 per share
which will be issued to the underwriters in connection with this offering;
- 159,000 shares issuable upon exercise of options at $5 per share which
will be issued to our management upon consummation of the offering;
- 120,667 shares issuable upon conversion of our series A preferred stock
which was issued to a former debtholder of ARC at a conversion price of
$10 per share;
- 90,000 shares issuable upon exercise of warrants at $8 per share which
were issued to a former debtholder of ARC;
- 36,185 shares issuable upon conversion of warrants at $5.71 which were
issued to John C. Vanderhider, our former Chief Financial Officer prior to
the offering; and
- 20,464 shares issuable upon conversion of warrants at $122.17 per share
which were issued to former warrant holders of ARC.
For a detailed description of these additional shares, see "Description of
Capital Stock," "Shares Eligible for Future Sale," and "Certain
Relationships and Related Transactions."
26
<PAGE>
DILUTION
The deficit in our pro forma combined net tangible book value as of June 30,
1999 was approximately $(9.0) million, or approximately $(3.00) per share, after
giving effect to the acquisitions but before giving effect to the offering. The
deficit in pro forma net tangible book value per share represents the amount by
which our pro forma total liabilities exceed our pro forma net tangible assets
as of June 30, 1999, divided by the number of shares to be outstanding after
giving effect to the acquisitions. After giving effect to the sale of the
1,600,000 shares offered hereby, and applying approximately $6.7 million of the
net proceeds of the offering to repay indebtedness of InfoHighway and the
founding companies, and deducting the estimated underwriting discount and
estimated offering expenses payable by us, our pro forma net tangible book value
as of June 30, 1999 would have been approximately $4.4 million, or approximately
$0.95 per share, based on an assumed initial public offering price of $10.00 per
share. This represents an immediate increase in pro forma net tangible book
value of approximately $3.95 per share to existing shareholders and an immediate
dilution of approximately $9.05 per share to new investors purchasing shares of
this offering. The following table illustrates this per share pro forma
dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share........................... $ 10.00
Pro forma net tangible book value (deficit) per share before this
offering.............................................................. $ (3.00)
Increase per share attributable to new investors.......................... 3.95
---------
As adjusted pro forma net tangible book value per share after the
offering................................................................ 0.95
---------
Dilution per share to new investors....................................... $ 9.05
---------
---------
</TABLE>
The following table summarizes, as of June 30, 1999, the difference between
the existing stockholders and new investors with respect to the number of shares
of common stock purchased from us, the total consideration paid and the average
price per share paid at an assumed initial public offering price of $10.00 per
share (before deducting estimated underwriting discounts and commissions and
offering expenses payable by us):
<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED CONSIDERATION AVERAGE
----------------------- --------------- PRICE PER
NUMBER PERCENT AMOUNT SHARE
------------ --------- --------------- -----------
<S> <C> <C> <C> <C>
Existing stockholders................................... 2,987,242 65.1% $ 3,353,352 $ 1.12
New investors........................................... 1,600,000 34.9% 16,000,000 $ 10.00
------------ --------- ---------------
Total................................................... 4,587,242 100.0% $ 19,353,352
------------ --------- ---------------
------------ --------- ---------------
</TABLE>
The foregoing table does not include 4,034,410 shares which are issuable
pursuant to contingent common stock issue rights and various warrants, options,
convertible notes and convertible preferred stock. See "Management" and Notes to
Unaudited Pro Forma Combined Financial Statements. The following is an analysis
of dilution
27
<PAGE>
per share to new investors assuming the exercise or conversion of all dilutive
equity instruments and convertible debt:
<TABLE>
<CAPTION>
NET
SHARES TANGIBLE BOOK
OUTSTANDING BOOK VALUE VALUE
(000'S) (000'S) PER SHARE
------------- ----------- -----------
<S> <C> <C> <C>
As adjusted pro forma net tangible book value per share after the
offering.................................................................. 4,587 $ 4,365 $ 0.95
Options..................................................................... 200 -- (0.04)
Warrants.................................................................... 144 -- (0.03)
Convertible debt............................................................ 41 -- (0.01)
----- ----------- -----------
4,972 $ 4,365 $ 0.87
----- ----------- -----------
----- ----------- -----------
</TABLE>
Certain options, warrants, series A preferred stock, series B preferred
stock and contingent common stock issue rights were not included in the
supplemental analysis of further dilution assuming the exercise or conversion of
certain equity instruments because to do so would be anti-dilutive. The
following equity instruments were not included in the calculation of further
dilution because their exercise or conversion price was equal to or greater than
the estimated offering price:
<TABLE>
<CAPTION>
NUMBER
OUTSTANDING
-----------
<S> <C>
Options.................................................................................... 741,000
Warrants................................................................................... 190,644
Series A preferred stock................................................................... 120,667
Series B preferred stock................................................................... 600,000
-----------
1,652,311
-----------
-----------
</TABLE>
The 727,511 contingent common stock issue rights were not included in the
above tables because they will become issuable only upon substantial price
appreciation over the estimated offering price. Approximately one-half of the
shares of common stock underlying the contingent common stock issue rights will
issue when the public share price of our common stock reaches a ten-day average
of $16 per share. The remaining shares underlying the contingent common stock
issue rights will issue when the public share price of our common stock reaches
a ten-day average of $21 per share.
If all shares related to the contingent common stock issue rights, the
convertible debt, the convertible preferred stock and the exercise of all
options and warrants are issued, the total shares outstanding would increase to
approximately 8.6 million and we would receive an aggregate of approximately
$23.0 million in proceeds.
28
<PAGE>
SELECTED FINANCIAL DATA
InfoHighway acquired ARC on June 30, 1999. We will acquire InfoHighway
International and AXCES simultaneously with and as a condition of the closing of
this offering. InfoHighway has not conducted any operations to date, except in
connection with this offering and the acquisitions. For financial statement
presentation purposes, AXCES has been identified as the accounting acquiror. The
following selected historical financial data for AXCES for the years ended
December 31, 1994, 1995, 1996, 1997 and 1998, and as of December 31, 1994, 1995,
1996, 1997 and 1998 have been derived from the audited financial statements of
AXCES. The following selected historical financial data for AXCES for the six
months ended June 30, 1998 and 1999, and as of June 30, 1999 have been derived
from the unaudited financial statements of AXCES which have been prepared on the
same basis as the audited financial statements and, in the opinion of AXCES,
reflects all adjustments consisting of normal recurring adjustments, necessary
for a fair presentation of such data. Our summary unaudited pro forma financial
information presents certain data, as adjusted for:
- the effects of the acquisition of the founding companies on a historical
basis;
- the effects of certain pro forma adjustments to the historical financial
statements; and
- the closing of the offering and the application of the proceeds therefrom.
Our pro forma financial data do not purport to represent what our results of
operations or financial position actually would have been had these events, in
fact, occurred on the date or at the beginning of the period indicated, nor are
they intended to project our results of operations or financial position for any
future date or period. See the Unaudited Pro Forma Combined Financial Statements
and the notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1994 1995 1996 1997 1998 1998 1999
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
AXCES:
Revenues................................ $ 667 $ 2,691 $ 8,468 $ 19,474 $ 30,280 $ 17,349 $ 10,095
Cost of services........................ 441 1,606 3,960 8,003 9,889 5,308 3,445
--------- --------- --------- --------- --------- --------- ---------
Gross profit............................ 226 1,085 4,508 11,471 20,391 12,041 6,650
Selling, general and administrative
expenses.............................. 203 823 3,674 8,910 17,934 8,296 4,914
Depreciation and amortization........... 1 7 61 135 204 89 112
--------- --------- --------- --------- --------- --------- ---------
Income from operations.................. 22 255 773 2,426 2,253 3,656 1,624
Interest income (expense), net.......... -- (11) 37 (19) (208) (148) (50)
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes.............. 22 244 810 2,407 2,045 3,508 1,574
Provision (benefit) for income taxes.... 1 74 279 837 (917) (917) --
--------- --------- --------- --------- --------- --------- ---------
Net income.............................. $ 21 $ 170 $ 531 $ 1,570 $ 2,962 $ 4,425 $ 1,574
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
PRO FORMA COMBINED
------------------------------
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED
1998 JUNE 30, 1999
-------------- --------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C>
PRO FORMA COMBINED STATEMENT OF OPERATIONS DATA (1):
Revenues.................................................. $ 46,373 $ 19,366
Cost of services.......................................... 22,719 10,731
-------------- --------------
Gross profit.............................................. 23,654 8,635
Selling, general and administrative expenses (2).......... 20,741 7,632
Depreciation and amortization (3)......................... 4,376 2,372
-------------- --------------
Loss from operations...................................... (1,463) (1,369)
Interest expense, net (4)................................. (412) (233)
-------------- --------------
Loss before income taxes.................................. (1,875) (1,602)
Provision for income taxes (5)............................ 547 115
-------------- --------------
Net loss before dividends on preferred stock.............. $ (2,422) $ (1,717)
Dividends on preferred stock.............................. 841 420
-------------- --------------
Net loss applicable to common stockholders................ $ (3,263) $ (2,137)
-------------- --------------
-------------- --------------
Net loss per share--basic and diluted..................... $ (0.89) $ (0.58)
-------------- --------------
-------------- --------------
Shares used in computing pro forma net loss per share
(6)..................................................... 3,654 3,654
-------------- --------------
-------------- --------------
OTHER DATA:
Gross margin.............................................. 51.0% 44.6%
</TABLE>
<TABLE>
<CAPTION>
AXCES
------------------------------------------------------- AS OF JUNE 30, 1999 (UNAUDITED)
-------------------------------------
AS OF DECEMBER 31, PRO FORMA
------------------------------------------------------- AXCES COMBINED AS ADJUSTED
1994 1995 1996 1997 1998 ACTUAL (7) (8)
----- --------- --------- --------- --------- --------- ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)..... $ 49 $ 127 $ 391 $ 1,538 $ 4,706 $ 6,414 $ (9,190) $ 4,130
Total assets.................. 81 919 2,235 4,735 8,269 7,815 41,512 48,163
Total debt, including current
portion..................... -- 130 19 63 1,734 -- 9,309 2,640
Stockholders' equity.......... 34 204 736 2,306 5,268 6,842 20,251 33,571
</TABLE>
- ------------------------
(1) Assumes the acquisition of the founding companies and the offering were
closed on January 1, 1998.
(2) Reflects adjustments to salaries, bonuses and benefit amounts to reflect
those established in contractual agreements with key management personnel of
the founding companies.
(3) Reflects the amortization of excess purchase price relating to the
acquisition of the founding companies which has been allocated to goodwill
and other identifiable intangible assets to be amortized over periods of 3
to 10 years for pro forma purposes. Also reflects annual amortization of the
customer list acquired in connection with InfoHighway International's
acquisition of Eden Matrix in January 1999 over the estimated useful life of
three years and annual depreciation on property and equipment also acquired
in the acquisition of Eden Matrix over the estimated useful life of five
years.
30
<PAGE>
(4) Reflects the reduction in interest expense due to the planned repayment and
planned conversion of certain debt in connection with the acquisitions.
(5) Assumes all income is subject to a federal corporate tax rate of 34%.
(6) The number of shares includes:
- 939,000 shares outstanding immediately prior to the offering,
- 2,048,242 shares to be issued to the owners of the founding companies, and
- 666,900 shares to be sold in the offering the proceeds of which will be
used to repay debt.
Does not include:
- 933,100 of the 1,600,000 shares to be sold in the offering whose proceeds
will be used for capital expenditures and general working capital
purposes; or
- 4,034,410 shares which are issuable pursuant to contingent common stock
issue rights and various warrants, options, convertible notes and
convertible preferred stock since their effect would be anti-dilutive.
(7) The pro forma combined balance sheet data assume that the acquisition of the
founding companies occurred on June 30, 1999.
(8) Adjusted for the sale of the 1,600,000 shares of common stock included in
the offering and the application of the net proceeds therefrom. See "Use of
Proceeds."
31
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Unaudited
Pro Forma Combined Financial Statements and related notes thereto and "Selected
Financial Data" appearing elsewhere in this prospectus.
SUMMARY
We were formed to become a leading provider of Internet, data and
telecommunications solutions to businesses and consumers. Prior to the
acquisition of ARC, we had conducted no operations. We acquired ARC on June 30,
1999. We will acquire InfoHighway International and AXCES simultaneously with
and as a condition of the closing of this offering. Our services include
high-speed Internet access, local phone services with innovative features, long
distance service at competitive rates, and other value added Internet services
that are under development. On a pro forma basis, the combined operations
generated revenues of $46.4 million and $19.4 million for the year ended
December 31, 1998 and the six months ended June 30, 1999, respectively.
We intend to integrate these businesses and their operations and
administrative functions. This integration process may present opportunities to
reduce costs through the elimination of duplicative functions and through
economies of scale, but will necessitate additional costs and expenditures for
corporate management and administration. The founding companies have been
managed throughout the periods discussed below as independent private companies,
and their results of operations reflect different tax structures (S Corporation
and C Corporations) which have influenced, among other things, their historical
levels of owners' compensation. Except for the compensation and benefits
reductions aggregating $2.6 million for the year ended December 31, 1998, as
provided for in agreements entered into in connection with the acquisition of
the founding companies, no such cost savings were reflected in the pro forma
results of operations data. We will also incur corporate expenses related to
being a public company, implementation of an acquisition program and systems
integration. These various costs and possible cost savings may make comparison
of pro forma operating results not comparable to, nor indicative of, future
performance.
Our plan to integrate the founding companies and become a leading provider
of Internet, data and telecommunications solutions to businesses and consumers
may be impacted by the intense and growing competition we expect to encounter
from the traditional local telephone companies, long distance service providers,
cable modem providers, Internet service providers, satellite data service
providers and the emerging wireless carriers. Some of these entities are
significantly larger than we are and have greater financial, technical and human
resources than we do. In addition, many of them have announced plans to group
multiple telecommunications services into packages offered to customers at
competitive prices. Consequently, pricing for the services which we offer and
plan to offer generally have been declining, and we expect
32
<PAGE>
continued downward pressure on the pricing of the products we sell. See "Risk
Factors" and "Business--Legal Proceedings."
In order to provide some of our services, we must negotiate and maintain
agreements related to interconnection, the location of our equipment at the
local telephone company's facilities, telephone lines and network capacity with
these same competitors as suppliers of telecommunications services. We must also
obtain the approval of, and comply with the regulations of, various governmental
regulatory agencies, which have imposed a variety of surcharges and fees upon
the services we offer and may impose additional charges in the future. These
factors may impact the quality, pricing and speed of deployment of our services.
In connection with the provision of our services, certain claims have been
made against us, including claims for breach of contract, and slamming and
cramming.
BREACH OF CONTRACT. While we continue to perform the work required under
our contract with Mitel Telecommunications Systems, Inc., Mitel has not agreed
to dismiss its claim against ARC. We have an accrued liability regarding this
lawsuit in the amount of approximately $1.3 million as of June 30, 1999, which
amount is reduced as we continue to perform work under the contract. Should we
lose this lawsuit, we could be required to repay Mitel for unfinished work
required by the disputed contract in addition to other unspecified damages.
SLAMMING AND CRAMMING. As a result of the claims against us for slamming
referred to above and the terms of our various settlements with regulatory
authorities, we changed our marketing practices from indirect distribution
methods including sweepstakes and unmanned displays to a direct sales force.
This change in distribution strategy has resulted in a reduction of customer
complaints from approximately 500 in the second quarter of 1998 to approximately
100 in the current calendar quarter and substantially lower sales in the second
half of 1998 and into 1999. For the first six months of 1999, our sales relating
to this distribution channel decreased approximately $7.2 million compared to
the first six months of 1998. As we have continued to build our direct marketing
capabilities we believe that we have stopped the decline in our revenues. We
expect AXCES' revenue growth to resume as we expand these direct marketing
capabilities and introduce sales personnel into new markets. To date, we have
paid approximately $205,000 in settlement of certain claims regarding slamming
and cramming. In addition, we may be subject to other significant fines and
monetary damages of an undeterminable amount and penalties ranging from the
termination of our agreements with certain service providers to the suspension
of our right to conduct business in certain jurisdictions in connection with
these claims.
See "Risk Factors" and "Business--Legal Proceedings."
In addition, we operate in an industry subject to rapid technological
change, our business model is unproven and we have a limited combined operating
history. We may be unable to adapt to this technological change, or we may need
additional capital to remain competitive in such an environment. Also, we may
not be able to successfully integrate the founding companies or future
acquisitions, and we may incur
33
<PAGE>
unforeseen expenses in integrating these companies. See "Risk Factors" and
"Business--Legal Proceedings."
ORGANIZATION
We acquired ARC on June 30, 1999, and will acquire InfoHighway International
and AXCES simultaneously with and as a condition of the closing of this offering
for an aggregate consideration of approximately $28.6 million, assuming an
initial public offering price of $10.00 per share, as described in the following
table:
<TABLE>
<CAPTION>
CONTINGENT COMMON
STOCK ISSUE
COMMON STOCK RIGHTS(1) PREFERRED STOCK
---------------------- ----------------- --------------------------
VALUE OF VALUE OF VALUE OF
ACQUISITION SHARES SHARES SHARES SHARES SHARES SHARES
- ---------------------------------------- --------- ----------- ------- -------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
AXCES................................... 700,000 $ 6,300,000 -- $ -- 60,000(2) $ 9,000,000
InfoHighway International............... 958,166 8,623,494 235,878 -- -- --
ARC..................................... 390,076 3,510,684 152,672 -- 1,206,673(3) 1,206,673
--------- ----------- ------- -------- --------- -------------
Total................................... 2,048,242 $18,434,178 388,550 $ -- 1,266,673 $ 10,206,673
--------- ----------- ------- -------- --------- -------------
--------- ----------- ------- -------- --------- -------------
</TABLE>
- ------------------------
(1) The contingent common stock issue rights entitle the holder to receive
common stock based upon market performance beginning 90 days after this
offering. Approximately one-half of the shares are issuable when the common
stock reaches a 10-day average of $16.00 per share. The remaining one-half
is issuable when the common stock reaches a 10-day average of $21.00 per
share. The rights expire after 3 years. We also issued 338,961 contingent
common stock issue rights to certain of our shareholders prior to the
acquisition of ARC. See "--Contingent Common Stock Issue Rights."
(2) Each share of series B preferred stock is convertible into 10 shares of
common stock at anytime at the option of the holder. The series B preferred
stock is redeemable after 36 months out of a designated portion of our cash
flow. If the common stock trades for an average of $20 per share for 10
consecutive days, we may force the conversion of the series B preferred
stock into common stock.
(3) The series A preferred stock is convertible into common stock at the option
of the holder at any time after 90 days from the closing of this offering or
earlier with the consent of both InfoHighway and the representative of the
underwriters with respect to this offering. The number of shares issuable
upon conversion of the series A preferred stock is dependent on the
conversion rate which is calculated by dividing $1.00 by the lesser of the
offering price or the five-day average closing price ending on the trading
day prior to such conversion date. The series A preferred stock is to be
issued to Trans Global Services, Inc., a former affiliate of ARC, in
exchange for a current note payable from ARC of $1.2 million.
The consideration paid or to be paid in the acquisitions includes:
- common stock;
- contingent common stock;
- series A and series B convertible redeemable preferred stock; and
- warrants to purchase common stock.
In addition, we will be assuming certain of the debt of all of the founding
companies. For purposes of computing the estimated purchase price for accounting
purposes, the value of the common shares issued has been determined using an
34
<PAGE>
estimated fair value of $9.00 per share, which represents a discount of 10% from
the estimated initial public offering price of $10.00 per share due to
restrictions on the sale and transferability of the shares issued. The estimated
purchase price for the acquisitions is based upon preliminary estimates and is
subject to certain purchase price adjustments at and following closing. In the
opinion of management, the final allocation of the purchase price will not
materially differ from these preliminary estimates.
CONTINGENT COMMON STOCK ISSUE RIGHTS. We have issued a total of 727,511
contingent common stock issue rights. We issued 388,550 of these contingent
common stock issue rights to the former shareholders of ARC and InfoHighway
International as a form of purchase consideration as negotiated between us and
those founding companies. The usage of contingent common stock issue rights as
purchase consideration provided a means whereby we could provide incentives for
founding shareholders to continue to focus on activities contributing to share
price appreciation while protecting us from immediate share dilution in the
event the shares were issued outright without performance requirements.
Additionally, we issued the remaining 338,961 contingent common stock issue
rights to certain of our shareholders prior to our acquisition of ARC in order
to maintain certain ownership levels as negotiated between us and the founding
companies. See "Certain Relationships and Related Transactions." For accounting
purposes, no value has been allocated to the contingent common stock issue
rights.
INTANGIBLE ASSETS. We intend to record intangible assets of $29.2 million
associated with the acquisitions. Such amounts will result in an annual
amortization charge of approximately $2.9 million for each of the next 10 years.
If the 10-day average closing price of the common stock exceeds $16.00 and
$21.00 per share, we will be required to record significant additional
intangible assets related to the contingent common stock issue rights based upon
the market value of the common stock at that time. This would increase the
annual amortization charge.
TOTAL DEBT ASSUMED, REPAID OR ELIMINATED. Prior to this offering, the total
amount of debt of the combined companies will be as described in the following
table (in millions):
<TABLE>
<CAPTION>
DEBT OUTSTANDING PRIOR TO OFFERING AMOUNT
- ------------------------------------------------------------------------------------- -----------
<S> <C>
InfoHighway.......................................................................... $ 2.0
ARC.................................................................................. 4.4
AXCES(1)............................................................................. 3.0
InfoHighway International............................................................ 1.4
-----
Total Combined................................................................... $ 10.8
-----
-----
</TABLE>
- ------------------------
(1) Assumes AXCES incurs the maximum of $3.0 million of additional debt, the
proceeds of which may only be used for distribution to MTM Holdings
Corporation, its sole shareholder prior to the offering. To the extent that
AXCES incurs less than $3.0 million of additional debt, the amount of debt
outstanding at the time of the offering and the amount of debt to be repaid
with proceeds
35
<PAGE>
from the offering will be reduced on a dollar for dollar basis. However, the
amount of debt outstanding after the offering will not be affected. See
"--Acquisition of AXCES."
Out of the total combined debt of $10.8 million, the following amounts will
be repaid or eliminated (in millions):
<TABLE>
<CAPTION>
ACTION AMOUNT
- ------------------------------------------------------------------------------------- -----------
<S> <C>
Repayment of debt from offering proceeds(1).......................................... $ 6.7
Conversion of ARC debt to preferred stock............................................ 1.2
InfoHighway International note payable to us eliminated upon consolidation........... 0.2
---
Total debt reduction at time of offering......................................... $ 8.1
---
---
</TABLE>
- ------------------------
(1) Unless noted otherwise below, all of the debt that is to be repaid upon the
consummation of the offering is due to loan covenants that provide for early
debt repayments in the event of a specific debt or equity transaction,
including mergers into publicly traded companies. For a detailed description
of the $6.7 million debt to be repaid, see note 3(d) to the Unaudited Pro
Forma Combined Financial Statements, "--Acquisition of InfoHighway
International," "--Acquisition of ARC," and "--Acquisition of AXCES."
As a result, approximately $2.6 million debt will remain outstanding which is
all short-term, and consists of a $1.7 million convertible note payable to
Consolidated Technology and $0.9 million of notes payable to unrelated parties.
ACQUISITION OF INFOHIGHWAY INTERNATIONAL
The acquisition consideration to be received by the stockholders of
InfoHighway International consists of 958,166 shares of our common stock and
235,878 contingent common stock issue rights. This number of shares includes
85,397 shares of our common stock and 17,584 contingent common stock issue
rights issued to the former shareholder of Eden Matrix. Issuances of contingent
common stock is conditional upon achievement of certain share price targets. The
first 50% of the common stock shall be issued when the price of the common stock
reaches a 10-day average of $16 per share. The remaining 50% of the common stock
shall be issued when the price of the common stock reaches a 10-day average of
$21 per share. For accounting purposes, no value has been allocated to the
contingent common stock issue rights. Additionally, we are assuming InfoHighway
International's outstanding debt, which totaled $1.3 million at June 30, 1999,
as follows:
- $0.5 million of financings received during the fourth quarter of 1998 from
Trident III for capital expenditures and working capital needs which bear
interest at 12% annually;
- $0.3 million related to a unit offering debt during 1998 that bears
interest at 10% annually;
- $0.2 million of notes payable to InfoHighway that bears interest at 12%
annually and will be eliminated from the consolidated financial statements
as an intercompany debt; and
36
<PAGE>
- the balance of approximately $0.3 million primarily pertains to other
related parties bearing interest at a weighted average annual rate of
10.0%.
A total of $0.9 million of debt assumed from InfoHighway International will be
repaid from offering proceeds due to loan covenants that provide for early debt
repayments in the event of certain circumstances, including the merger into a
publicly-traded company.
During January 1999, InfoHighway International acquired the operations of
Eden Matrix, an Internet service provider based in Austin, Texas operated by
AMICI Online Investments, L.L.C. The acquisition consideration approximated $1.0
million, consisting of a $50,000 cash down payment and a short-term note payable
for $0.9 million. During the second quarter of 1999, $0.8 million of the
short-term note payable was converted into 968,750 common shares of InfoHighway
International.
ACQUISITION OF ARC
The acquisition consideration received by the stockholders of ARC consists
of:
- 390,076 shares of our common stock;
- 152,672 contingent common stock issue rights; and
- 20,464 warrants to purchase our common stock.
Issuances of common stock underlying the contingent common stock issue
rights are conditional upon achievement of certain share price targets; 50% of
the common stock shall be issued when the price of the common stock reaches a
10-day average of $16 per share. The remaining 50% of the common stock shall be
issued when the price of the common stock reaches a 10-day average of $21 per
share. For accounting purposes, no value has been allocated to the contingent
common stock issue rights or the warrants.
The warrants to purchase 20,464 shares of our common stock are exercisable
at $122.17 per share and expire in February 2007. These warrants were issued in
exchange for outstanding warrants to purchase ARC common stock.
The merger agreement also provides for the exchange of $1.2 million of an
existing ARC note payable to Trans Global, a former affiliate of ARC, for
1,206,673 shares of series A preferred stock of InfoHighway valued at $1.2
million. The series A preferred stock is convertible into common stock at the
option of the holder at any time after 90 days from the closing of this offering
or earlier with the consent of both InfoHighway and the representative of the
underwriters with respect to this offering. The number of shares issuable upon
conversion of the series A preferred stock is dependent on the conversion rate
which is calculated by dividing $1.00 by the lesser of the offering price or the
five-day average closing price ending on the trading day prior to such
conversion date. If at any time after the closing of this offering, the 5-day
average closing price of the common stock is less than one-third of the price at
which the common stock is sold to the public in this offering, any holder of
series A preferred stock may require us to redeem all of that holder's shares of
series A
37
<PAGE>
preferred stock at the redemption price of $1.00 per share or a total of
$1,206,673. See "Description of Capital Stock--Preferred Stock--Series A 10%
Convertible Preferred Stock."
We have assumed all debt outstanding of ARC, which totaled $4.4 million at
June 30, 1999, which consisted of:
- $2.4 million revolving line of credit due to Consolidated Technology that
bears interest at the prime rate plus 2% until June 17, 1999, and at a
rate of 14% per annum from and after June 17, 1999;
- $1.2 million note payable to Trans Global that bears interest at 10%
annually and will be converted into the series A preferred stock;
- $0.6 million prime plus 2% current note payable; and
- $0.2 million 12% demand notes.
An amendment to the prior loan agreement between ARC and Consolidated
Technology entered into in connection with the merger agreement also provides
for:
- the repayment of $0.8 million of the outstanding balance on the revolving
line of credit due to Consolidated Technology from proceeds of the
offering;
- the issuance of warrants to purchase 90,000 shares of our common stock at
an exercise price of $8.00 per share;
- the exchange of $0.45 million of the revolving line of credit for a note
payable to Consolidated Technology due on January 31, 2000 that is
convertible at the holder's option into 56,250 of our common shares; and
- the balance of the revolving line of credit being exchanged for a note
payable to Consolidated Technology maturing in June 2000 unless converted
earlier by the holder into 150,000 of our common shares.
The balance outstanding under the revolving line of credit was $2.4 million at
June 30, 1999.
ACQUISITION OF AXCES
The acquisition consideration to be received by the stockholders of AXCES
consists of 700,000 shares of our common stock and 60,000 shares valued at $150
per share, of our series B preferred stock. The series B preferred stock is
convertible into 600,000 shares of our common stock at the holder's option and
is redeemable after 36 months out of a designated portion of our cash flow. If
the common stock trades for an average of $20 per share for 10 consecutive days,
we may force the conversion of the series B preferred stock into common stock.
Prior to the closing of the acquisition, AXCES may incur up to $3.0 million
of debt, the proceeds of which may only be used for distribution to MTM Holdings
Corporation, its sole shareholder prior to this offering. We plan to repay the
full amount of this debt incurred by AXCES with proceeds from the offering.
AXCES may distribute to its owner prior to closing of the acquisitions up to
$6.5 million in
38
<PAGE>
cash, including the loan proceeds, provided that the distributions do not
decrease AXCES' working capital below a minimum level. The minimum level is an
amount equal to:
- $600,000; plus
- the amount of AXCES' net income plus noncash expenses for the period from
May 1, 1999 to the closing date of the acquisitions; minus
- the amount of AXCES' net income and noncash expenses in that period used
to settle the litigation shown on the schedule of litigation involving
AXCES attached to the acquisition agreement.
Following the closing of the acquisition, AXCES will pay, or InfoHighway
will cause AXCES to pay, certain tax liabilities of AXCES, MTM Holdings and its
former shareholders attributable to AXCES' operations from January 1, 1999
through the closing date and any fees and expenses of counsel engaged to give
advice on methods to decrease that tax liability. Portions of the tax liability
may be payable over time. Our obligation to pay the tax liability and fees and
expenses of counsel may not exceed $1.6 million in the aggregate or $400,000 in
any calendar quarter. Any amount of tax liability and costs and expenses of
counsel exceeding $1.6 million in the aggregate must be paid by MTM Holdings and
its owners.
Pursuant to the AXCES acquisition agreement, MTM Holdings and its owners
have agreed to indemnify us for any damages incurred in connection with pending
litigation and administrative proceedings on the same basis as we are
indemnified for any breaches of representations and warranties made by AXCES in
the acquisition agreement except that the indemnity does not cover attorneys'
fees and litigation costs. Because of this, MTM Holdings and its owners will be
required to indemnify us for breaches of representations and warranties in the
acquisition agreement and liabilities incurred in the pending litigation to the
extent that such amounts exceed, in the aggregate, $200,000, and for any tax
liability of AXCES, MTM Holdings and its owners that exceeds $1.6 million in the
aggregate. However, the indemnification threshold related to litigation shall
increase to the extent of AXCES' net income plus noncash expenses for the period
from May 1, 1999 until the closing of the acquisition, less any amounts used to
pay agreed settlements of the scheduled litigation. The aggregate liability of
MTM Holdings and its owners may not exceed the value of the shares of our common
stock issued to MTM Holdings on the closing, plus the value of the shares of our
common stock issuable on conversion of the series B preferred stock. The value
of each share of our common stock is set at the initial public offering price.
In addition, the aggregate liability of any owner of MTM Holdings may not exceed
$2,000,000.
OPERATIONS
REVENUES. Our revenues are derived from two principal sources, namely
Internet services and telecommunication services.
39
<PAGE>
INTERNET SERVICES. Internet services are typically billed to a customer
at an established rate per service pursuant to a contract. Contract terms
range from one month to one year. Revenue is recognized over the period that
services are rendered.
TELECOMMUNICATION SERVICES. Services include local telephone service,
private data and voice lines, long distance, network design and wiring and
other network services. For local and long distance telephone service,
revenue is recognized as service is provided to customers. Revenue from our
network design and wiring services is recognized using the percentage of
completion method, measured by the percentage of cost incurred to date to
the total estimated cost for each contract. Revisions in cost estimates and
recognition of losses, if any, on these contracts are reflected in the
accounting period in which the facts become known.
ANTICIPATED TRENDS. We expect that our high-speed Internet services
business will grow significantly due to recent technological advances which
enable us to provide faster transmission speeds at lower costs and lower pricing
than most such services available in today's marketplace. Current plans call for
new product introductions of our InfoHighway DSL and InfoHighway Connect
services. Due primarily to these new offerings, we expect that the rate of
growth in the Internet portion of our business will exceed that of other areas
of our business, with the result that, over time, Internet services will become
an increasing portion of our business. In addition, our Internet gross profit
margin has increased during the first half of 1999. With the introduction of our
InfoHighway DSL and InfoHighway Connect Services, we expect our Internet gross
profit margin to remain at this higher level or further increase and contribute
to increased gross profit margin for the Company. We recognize that the market
for high-speed Internet access is in its early stages, and it is not possible to
predict at this time the ultimate potential of this market and its long-term
percentage of our overall business. Further, there can be no assurance that the
forecasted strong growth in the market for high-speed Internet services will
materialize or that the margins will meet our expectations.
To date, our businesses have not been capital intensive. In connection with
our business expansion we expect to increase capital expenditures in 1999 and
2000. We estimate that for 1999 such amounts will approximate $0.7 million and
for the year 2000 up to approximately $1.5 million, primarily to support the
expansion of our InfoHighway DSL and InfoHighway Connect service offerings.
During the second half of 1998, AXCES changed its marketing strategy from
various indirect distribution channels to a direct sales force approach,
primarily as a result of complaints against us for slamming and cramming, and
the terms of our various settlements with regulatory authorities and in part due
to more stringent regulatory requirements imposed upon telecommunications
providers. This change in distribution strategy resulted in significantly lower
sales during the second half of 1998 and into 1999. As we have continued to
build our direct marketing capabilities we believe that we have stopped the
decline in AXCES' revenues. We expect AXCES'
40
<PAGE>
revenue growth to resume as we expand these direct marketing capabilities and
introduce new sales personnel into new markets.
COST OF REVENUES. Cost of revenues is comprised of carrier costs provided
by the underlying supplier of telephone services for long distance, local and
internet services and material and labor related to network design and wiring
and technical support staff. While we expect overall carrier costs to increase
due to volume growth in our business, we expect unit costs to decline due to
additional volume purchases, thereby contributing to higher gross margins. While
overall material and labor costs are also expected to increase in our network
design and wiring business, we expect the total material and labor costs as a
percentage of sales to remain constant due to the absence of significant volume
purchase opportunities. We have entered into minimum purchase agreements with
several of our service providers that commit us to minimum monthly purchase
amounts regardless of our actual usage charges. If we are unable to exceed these
revenue requirements in future periods, these minimum purchase agreements could
cause our costs of revenues to increase without any corresponding increase in
revenues. See "Business--Telecommunications Services--Long Distance Service."
GROSS PROFIT. Gross profit percentages vary among the founding companies,
primarily because of differences in the mix of products and services and due to
differences in local market demand and competition. The founding companies'
gross profit percentages for telecommunication services has differed
significantly among the founding companies, and has ranged from approximately 8%
to 67% in recent years.
SELLING, GENERAL AND ADMINISTRATIVE COSTS. Selling, general and
administrative costs represent compensation costs of our employees, commissions
paid our direct sales personnel and to third party sales agents, promotional and
other marketing costs, travel and trade shows, cost of billing by third party
providers, bad debt expenses and other overhead costs. We expect increases in
most categories of selling, general and administrative expenses as our revenues
increase, including higher compensation costs due to growth in employees,
increased commissions, promotional and marketing costs, and higher billing costs
due to growth in our customer base. However, we expect these costs to increase
at a lesser rate than the rate of increase in sales, thereby reducing our
operating cost on a per unit basis.
Bad debt as a percentage of sales has been 4%, 6% and 10% respectively for
the years ended December 31, 1996, 1997 and 1998. The increase is due primarily
to the increase in bad debt at AXCES, which was 5%, 9% and 14% respectively for
the corresponding years, and AXCES' relatively larger portion of total combined
revenues, which was 58%, 65% and 66% for the respective years. We expect bad
debt expense as a percentage of sales to decline in 1999, in part due to the
closer screening of accounts at AXCES and in part due to the lower percentage of
total sales accounted for by AXCES.
We expect interest expense to decline approximately $437,000 on an
annualized basis following the offering as a result of the repayment of
approximately $3,669,000
41
<PAGE>
of existing debt with a weighted average interest rate of 11.9% with proceeds
from this offering. See "--Organization--Total Debt Assumed" and "Unaudited Pro
Forma Combined Balance Sheet Adjustments."
GOODWILL AND OTHER INTANGIBLE ASSETS. In July 1996, the SEC issued Staff
Accounting Bulletin No. 97 relating to business combinations immediately prior
to an initial public offering. Staff Accounting Bulletin No. 97 requires that
these combinations be accounted for using the purchase method of accounting.
Under the purchase method, the founding company whose owners receive the largest
portion of voting rights in the combined enterprise is presumed to be the
accounting acquiror. Accordingly, AXCES has been designated as the accounting
acquiror. As a result of the acquisitions of the founding companies, the excess
of the consideration paid over the fair value of the net assets to be acquired
for the founding companies other than the accounting acquiror has been allocated
to goodwill and other identifiable intangible assets to be amortized over
periods of 3 to 10 years.
S CORPORATION ELECTIONS. AXCES' parent company, MTM Holdings, elected to
have AXCES treated as a qualified subchapter S corporation under the Internal
Revenue Code of 1986, as amended, on January 1, 1998. In general, a qualified
subchapter S corporation is not treated as a separate taxable entity, and the
respective gains, income, losses and separately stated tax items are taxed to
the S corporation's shareholders on a pro rata basis.
Consequently, the historical financial statements of AXCES do not reflect an
income tax provision since taxable income flows directly through to its
shareholders. AXCES' qualified subchapter S corporation status will terminate in
connection with its acquisition and future taxable income will be subjected to
income tax in our consolidated tax return.
Prior to the acquisition, AXCES will make distributions to MTM Holdings in
an aggregate amount not to exceed $6.5 million, provided, that such
distributions do not reduce working capital below $0.6 million. AXCES' working
capital as of June 30, 1999 was $6.6 million. The distributions are to be funded
by up to $3.0 million in borrowings and cash balances of AXCES.
INCOME TAXES. We have adopted the liability method of accounting for income
taxes in accordance with Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes. Deferred income taxes are recognized for temporary
differences between financial statement and income tax bases of assets and
liabilities and net operating loss carryforwards, and is measured using enacted
tax rates expected to apply to taxable income in the years in which these
temporary differences are expected to be recovered or settled.
PRO FORMA RESULTS OF OPERATIONS
We acquired ARC on June 30, 1999. We will acquire InfoHighway International
and AXCES simultaneously with and as a condition of the closing of this
offering.
42
<PAGE>
The following summary unaudited pro forma financial information presents certain
data for InfoHighway, as adjusted for:
- the effects of the acquisitions on a historical basis,
- the effects of certain pro forma adjustments to the historical financial
statements, and
- the closing of the offering and the application of the proceeds therefrom.
See "Selected Financial Information" and the Unaudited Pro Forma Combined
Financial Statements and the notes thereto included elsewhere in this
prospectus.
PRO FORMA COMBINED STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER SIX MONTHS ENDED
31, 1998 JUNE 30, 1999
-------------------- --------------------
AMOUNT % AMOUNT %
--------- --------- --------- ---------
(UNAUDITED, IN THOUSANDS EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................................. $ 46,373 100.0% $ 19,366 100.0%
Cost of services......................................... 22,719 49.0 10,731 55.4
--------- --------- --------- ---------
Gross profit............................................. 23,654 51.0 8,635 44.6
Selling, general and administrative expenses............. 20,741 44.7 7,632 39.4
Depreciation and amortization............................ 4,376 9.4 2,372 12.2
--------- --------- --------- ---------
Loss from operations..................................... (1,463) (3.1) (1,369) (7.0)
Interest expense, net.................................... (412) (0.9) (233) (1.2)
--------- --------- --------- ---------
Loss before income taxes................................. (1,875) (4.0) (1,602) (8.2)
Provision for income taxes............................... 547 1.2 115 0.6
--------- --------- --------- ---------
Net loss................................................. (2,422) (5.2) (1,717) (8.8)
Preferred dividend requirement........................... 841 1.8 420 2.2
--------- --------- --------- ---------
Net loss available to common stockholders................ $ (3,263) (7.0) $ (2,137) (11.0)
--------- --------- --------- ---------
--------- --------- --------- ---------
Net loss per share--basic and diluted.................... $ (0.89) $ (0.58)
--------- ---------
--------- ---------
Shares used in computing pro forma net loss per
share--basic and diluted................................. 3,654 3,654
--------- ---------
--------- ---------
</TABLE>
PRO FORMA LIQUIDITY AND CAPITAL RESOURCES
The total acquisition cost of the founding companies is $28.6 million,
reflecting consideration of common stock, contingent common stock issue rights,
series A preferred stock and series B preferred stock. Additionally, total debt
assumed by us related to the founding companies consists of $1.4 million, $4.8
million, and up to $3.0 million, for InfoHighway International, ARC and AXCES,
respectively.
The net proceeds we will receive from the offering, after deducting
estimated underwriting discounts and commissions and offering expenses, are
estimated to be approximately $13.3 million assuming an initial public offering
price of $10.00 per share. We estimate that the net proceeds will be $15.4
million if the underwriters exercise their over-allotment option in full.
43
<PAGE>
We anticipate that the $13.3 million of net proceeds from the offering will
be used to repay $6.7 million of indebtedness of InfoHighway and the founding
companies. Debt to be repaid from offering proceeds is summarized as follows:
- up to $3.0 million short-term borrowings to be secured by AXCES during the
third quarter of 1999 for the funding of undistributed earnings to its
owners;
- $2.0 million of bridge financings received by InfoHighway during the first
six months of 1999, of which $1.9 million was utilized to fund operations
and third party services pertaining to the offering;
- $0.9 million of notes payable to shareholders of InfoHighway
International, including $0.5 million of financings received during the
fourth quarter of 1998 from Trident III for capital expenditures and
working capital needs; and
- $0.8 million of payments on the short-term revolving credit facility of
ARC.
The indebtedness to be repaid bears interest ranging from 10.0% to 15.9%, with a
weighted average interest rate of approximately 13.0%, and would otherwise
mature at various dates through March 2003.
In June 1999, we received demand letters from three unaffiliated noteholders
for payment of three notes aggregating $0.8 million comprised of an 8% $0.6
million note and two 12% $0.1 million notes. As a result, we renegotiated these
notes in June 1999 to include the accrued interest on $0.6 million of the notes
and extended the maturity date of the notes until October 31, 1999. Currently,
we are in discussions with these noteholders and expect to extend the principal
payments until the year 2000. If we are unable to extend these principal
payments, we will have to utilize a portion of our remaining net proceeds to
make such payments.
Unless noted otherwise below, the accelerated payment of assumed debt from
the founding companies is due to loan covenants that provide for early debt
repayments in the event of specific debt or equity transactions, including the
merger into a publicly-traded company.
We anticipate that the remaining $6.6 million of the net proceeds will be
used for capital expenditures, general working capital purposes and future
acquisitions. We intend to increase capital expenditures and operating expenses
in order to integrate the founding companies, expand networks to support
additional expected end-users in existing and future markets and to market and
provide services to a growing number of potential end-users. Current capital
resources, including the proceeds of this offering, are anticipated to be
sufficient to fund aggregate capital expenditures and working capital
requirements for the immediate future. At this time, net proceeds earmarked for
capital expenditures, future acquisitions and general working capital purposes
total approximately $2.0 million, $2.0 million, and $2.5 million, respectively.
AXCES also has a $3.0 million accounts receivable financing program which it may
maintain subject to it continuing to be priced competitively.
44
<PAGE>
In connection with our business expansion we expect to increase capital
expenditures in 1999 and 2000. We estimate that for 1999 such amounts will
approximate $0.7 million and for year 2000 up to approximately $1.5 million. The
majority of these capital expenditures will be to support the expansion of
InfoHighway DSL and InfoHighway Connect service offerings. However, our strategy
is based upon successful acceptance of our products in the marketplace.
Accordingly, such capital expenditures may vary based upon our success.
Future acquisitions may require significant capital. We cannot predict with
certainty what our capital needs will be for future acquisitions, although we
have tentatively dedicated $2.0 million of offering proceeds to fund future
acquisitions. We currently intend to use our common stock to fund a portion of
the purchase price of future acquisitions. If our common stock does not maintain
an acceptable price in the public markets or if potential acquisition candidates
are unwilling to accept our common stock as part of the consideration for the
sale of their businesses, we may have to use more cash to finance our
acquisition program. If we do not have enough cash resources, our ability to
make acquisitions could be limited unless we are able to obtain additional cash
through future debt or equity financings. Incurring debt would increase our
leverage and make us more vulnerable to economic downturns and limit our ability
to compete.
During the first six months of 1999, we utilized bridge financings to meet
our cash flow needs. Bridge financings totaled $2.2 million during this period,
of which $2.0 million remains outstanding at June 30, 1999. Warrants to acquire
an aggregate of 573,333 shares of common stock at an initial exercise price per
share of $8.00 were issued to the bridge lenders; such warrants expire five
years from the date of the bridge loans. Each of the bridge loans bears interest
at 13% annually.
At June 30, 1999, on a pro forma basis after giving effect to the
acquisition of the founding companies, the acquisition of Eden Matrix, the
closing of the offering and the application of its net proceeds, we would have
an aggregate of $8.2 million of cash and cash equivalents, working capital of
$4.1 million, and no long-term debt. At June 30, 1999, minimum purchase
commitments with long-distance and local service providers totaled $28.1 million
and $0.8 million, respectively. Estimated minimum future payments due under the
agreements in the aggregate are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
<S> <C>
1999.................................................................................... $ 5,808
2000.................................................................................... 9,224
2001.................................................................................... 9,171
2002.................................................................................... 4,171
2003.................................................................................... 550
------------
$ 28,924
------------
------------
</TABLE>
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<PAGE>
On a pro forma basis, cash flow generated from the operations of AXCES
serves to offset the operating cash shortfalls incurred from the operations of
InfoHighway International and ARC. InfoHighway International and ARC have
historically suffered recurring losses and negative cash flows from operations
and have working capital and stockholders' deficits that raise substantial doubt
about their abilities to continue as going concerns on a stand-alone basis.
INFOHIGHWAY INTERNATIONAL. In early 1998, InfoHighway International
proceeded on an expansion program involving its InfoHighway DSL and
InfoHighway Connect Internet services to high rise office buildings. This
expansion was predicated on a recapitalization. This recapitalization did
not materialize. With the expansion underway, InfoHighway International
financed operating activities and capital purchases through increases in
accounts payable and short-term borrowings. In the fourth quarter of 1998,
reductions in selling, general and administrative expenses resulting
primarily from staff reductions, coupled with a $0.5 million bridge loan
enabled InfoHighway International to operate at a near break-even EBITDA
level. With a 38% increase in first half 1999 revenues over the first half
of 1998, EBITDA losses decreased by 35% from $313,000 to $205,000. First
half cash flow shortfalls in 1999 have been financed through additional
short-term borrowings, including bridge financings totaling $170,000 from
InfoHighway. InfoHighway International anticipates that small negative cash
flows from operations will continue in the near-term, and expects to manage
this liquidity issue through traditional means, including management of
working capital and short-term borrowings.
ARC. ARC has sustained approximately $7.3 million of net losses since
inception. Historical cash flow shortfalls have been funded by a combination
of related party and external financings. At June 30, 1999, ARC had total
debt of $4.8 million consisting of the following:
- a $2.4 million revolving line of credit with its former parent,
Consolidated Technology;
- a $1.2 million note payable to an affiliate through common ownership by
Consolidated Technology;
- $0.4 million of notes payable to InfoHighway that will be eliminated
from the consolidated financial statements as an intercompany debt; and
- three external current notes aggregating $0.8 million.
Currently, we are in default with respect to certain conditions of our
line of credit agreement with Consolidated Technology regarding eligible
receivables. Additionally, we are past due with respect to approximately
$100,000 of interest on this credit agreement. We have not received any
current notice of defaults from Consolidated Technology. We have also
renegotiated our current notes totaling $0.8 million and have extended the
maturities of each of those until
46
<PAGE>
October 31, 1999. We are currently in discussions with the noteholders and
believe we will be able to extend the maturities of these notes into the
year 2000.
The merger agreement with us provides for:
- the repayment of $0.8 million of the outstanding balance of the
revolving line of credit from proceeds from the offering;
- the exchange of $0.45 million of the revolving line of credit for a
note payable due on January 31, 2000 that is convertible at the
holder's option into 56,250 of our common shares; and
- the balance of the revolving line of credit being exchanged for a note
payable maturing in June 2000 unless converted earlier by the holder
into 150,000 of our common shares.
The $1.2 million note payable to an affiliate is to be exchanged for
1,206,673 shares of our series A preferred stock which is convertible into
common stock at the option of the holder at any time after 90 days from the
closing of this offering or earlier with the consent of both InfoHighway and the
representative of the underwriters with respect to this offering. The number of
shares issuable upon conversion of the series A preferred stock is dependent on
the conversion rate which is calculated by dividing $1.00 by the lesser of the
offering price or the five-day average closing price ending on the trading day
prior to such conversion date.
We expect to generate additional sales of all our Internet and
telecommunications products to our existing and future customers. We also expect
to reduce our underlying costs of providing such services through increased
purchases from our telecommunications suppliers. As we grow our revenues and
customer base, we expect to improve our operating efficiencies with respect to
customer service, technical support and billing functions. Through the
combination of the above, we expect to improve ARC's operating results over
future periods.
We intend to enter into negotiations with commercial banks to provide us
with a credit facility to be used for acquisitions, working capital, capital
expenditures and other general corporate purposes. Any such credit facility or
other debt financing will require that we make certain financial covenants which
could limit our operational and financial flexibility. We may not be able to
obtain financing for our acquisition program at all or on terms we deem
acceptable. As a result, we might be unable to successfully pursue our
acquisition strategy.
Since their respective inceptions, ARC and InfoHighway have suffered losses
and negative cash flows from operations and have working capital deficits and
stockholders' deficits that raise substantial doubt about their respective
abilities to continue as going concerns. It is anticipated that funds received
from this offering will be sufficient to fund their operations for the
foreseeable future. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Combined and Founding Companies"
"--InfoHighway International, Inc.--Liquidity and Capital
47
<PAGE>
Resources--Going Concern," and "--ARC Network, Inc.--Liquidity and Capital
Resources--Going Concern."
INFLATION
Due to the relatively low level of inflation experienced in 1998, inflation
did not have a significant effect on the pro forma results of our operations in
1998. However, there can be no assurances that our business will not be affected
by inflation in the future.
YEAR 2000 COMPLIANCE--COMBINED
Many software applications, computer hardware and related equipment and
systems that use embedded technology, such as microprocessors, rely on two
digits rather than four digits to represent years in performing computations and
decision-making functions. These programs, hardware items and systems may fail
on January 1, 2000 or earlier because they misinterpret "00" as the year 1900
rather than 2000. These failures could have an adverse effect on us because of
our direct dependence on our own applications, equipment and systems and our
indirect dependence on those of third parties.
Our year 2000 program consists of the following phases:
- identifying all items that may be affected by the year 2000;
- investigating those items for year 2000 compliance;
- assessing the potential impact of year 2000 noncompliance;
- designing solutions for noncompliant items;
- repairing and replacing any noncompliant items and testing those
improvements; and
- contingency planning.
Each company we are acquiring has assigned one or more individuals in its
organization year 2000 responsibility. We have also assigned an individual
overall year 2000 responsibility to track and coordinate the efforts of the
individual companies. Each of the founding companies has completed
identification of its mission-critical information technology hardware and
software, including business applications, operations software, service
providers and product suppliers that may be affected by the year 2000. We have
determined that the potential impact of embedded technologies on the founding
companies is not substantial.
We are also contacting various third parties to obtain representations and
assurances that their hardware, embedded technology systems and software which
we use or will impact us are, or will be modified on a timely basis to be, year
2000 compliant. We have contacted all of our primary vendors based on their
importance to our business. These third parties include telecommunications and
billing companies. The founding companies began contacting these third parties
as early as 1998 and
48
<PAGE>
have received responses from approximately 50% to date. All the third parties
that have responded have stated that they are or expect to be year 2000
compliant by the end of 1999. We expect to have this part of our program
completed by the fourth quarter of 1999. To date, our costs associated with
assessing and monitoring the progress of third parties in resolving their year
2000 issues have not been significant, and we do not expect to incur any
material costs in the future relating to this aspect of our year 2000 program.
All of the founding companies are in the solution design phase of their
efforts to determine whether noncompliant information hardware and software
systems can be repaired or replaced. We estimate that we have completed
approximately 90% of this phase and expect to complete it by the fourth quarter
of 1999.
As part of the acquisitions, we are replacing some of their financial and
other systems in order to obtain internal consistency. Some systems we are
replacing happen not to be year 2000 compliant, but we would replace them in all
events this year and are not including the cost of their replacements as a part
of our year 2000 program.
We have decided not to develop formal budgets or perform detailed analysis
of the costs associated with this effort. We based this decision on the low
number of systems that comprise our technical environment and the fact that our
year 2000 efforts are being addressed during the normal course of business. To
date, our external costs of our year 2000 program have not been significant and
we do not expect to incur significant costs in the future. We have not deferred
other information technology projects because of our year 2000 efforts.
We have begun a formal analysis of various failure scenarios, their
potential impact and possible contingency plans. We expect that we will have
completed the development of the necessary contingency plans by the fourth
quarter of 1999 and that these will primarily consist of replacing noncompliant
third-party suppliers and service providers, and developing backup procedures to
handle the failure of any of our internal systems.
We do not anticipate any material adverse effect from year 2000 failures,
but we cannot guarantee that we will achieve total compliance. Factors that give
rise to this uncertainty include our possible failure to identify all
susceptible systems, noncompliance by third parties whose systems and operations
impact us and a possible loss of technical resources to perform the work.
Our most likely worst-case year 2000 noncompliance scenarios are:
- failures of a traditional local telephone company or other service
provider;
- equipment failures;
- an interruption in our ability to bill or collect amounts due from
customers; and
- loss of accurate accounting records.
49
<PAGE>
Depending on the length of any noncompliance or system failure, any of these
situations could have a material adverse impact on our ability to serve our
customers in a timely manner and result in lost business and revenues or
increased costs.
This disclosure is subject to protection under the Year 2000 Information and
Readiness Disclosure Act of 1998, Public Law 105-271, as a "Year 2000 Statement"
and "Year 2000 Readiness Disclosure" as that Act defines those terms.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which established accounting and reporting
standards for derivative instruments and hedging activities. It requires that
entities recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
provisions of this statement, as amended by SFAS No. 137, are effective for all
fiscal quarters of all fiscal years beginning after June 15, 2000. The Financial
Accounting Standards Board recently issued Statement of Financial Accounting
Standards No. 135, "RESCISSION OF FASB STATEMENT NO. 75 AND TECHNICAL
CORRECTIONS." The Statement is effective for financial statements issued for
fiscal years ending after February 15, 1999. We believe that these standards
will not have a material impact on our financial statements or disclosures
thereto.
Statement of Position No. 98-5, "REPORTING ON THE COSTS OF START-UP
ACTIVITIES," requires all start-up and organizational costs to be expensed as
incurred. It also requires all remaining historically capitalized amounts of
these costs existing at the date of adoption to be expensed and reported as the
cumulative effect of a change in accounting principles. Statement of Position
No. 98-5 is effective for all fiscal years beginning after December 31, 1998. We
believe that the adoption of Statement of Position No. 98-5 will not have a
material impact on their financial statements or disclosures thereto.
50
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
COMBINED AND FOUNDING COMPANIES
The following discussions should be read in conjunction with the financial
statements of the founding companies and related notes appearing elsewhere in
this prospectus.
COMBINED FOUNDING COMPANIES GROSS PROFIT DATA
The following unaudited combined financial information does not purport to
present the combined historical results of operations of the founding companies
in accordance with generally accepted accounting principles, but represents
merely a summation of the revenues, cost of services, and gross profit of the
individual founding companies. The historical combined results as shown below
will not be comparable to, and are not necessarily indicative of, anticipated
post-combination results for a number of reasons, including:
- the founding companies were not under common control or management during
the periods presented;
- using the purchase method of accounting, we will revalue the assets
acquired and liabilities assumed at their fair market value and record
goodwill and other intangible assets to be amortized in future periods;
- we will incur additional costs for corporate management and the costs
associated with being a publicly-traded company; and
- we anticipate increased revenues and cost savings once we begin operating
as a combined entity.
The following table sets forth certain historical combined data and such
data of the founding companies as a percentage of revenues for the periods
indicated (dollars in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------- ------------------------------------------
1996 1997 1998 1998 1999
-------------------- -------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues............ $ 14,477 100% $ 30,037 100% $ 45,596 100% $ 24,806 100% $ 19,366 100%
Cost of services.... 9,252 64% 17,546 58% 22,536 49% 11,509 46% 10,731 55%
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Gross profit........ $ 5,225 36% $ 12,491 42% $ 23,060 51% $ 13,297 54% $ 8,635 45%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 AND 1998
REVENUES. Combined revenues declined $5.4 million, or 22%, from $24.8
million in 1998 to $19.4 million in 1999. The revenue decrease was due to a $7.2
million decrease in revenues generated at AXCES.
GROSS PROFIT. Combined gross profit decreased $4.7 million, or 35%, from
$13.3 million in 1998 to $8.6 million in 1999. Overall combined gross profit as
a percentage
51
<PAGE>
of combined revenues was 54% and 45% for the six months ended June 30, 1998 and
1999, respectively.
COMPARISON OF 1998, 1997 AND 1996
REVENUES. Combined revenues increased $15.6 million, or 52%, from $30.0
million for 1997 to $45.6 million for 1998. Combined revenues increased $15.6
million, or 108%, from $14.5 million in 1996 to $30.0 million in 1997. This
increase was primarily attributable to revenue growth experienced at AXCES in
the amount of $11.0 million, or 130%, in 1997 compared to 1996 and $10.8
million, or 55%, in 1998 compared to 1997. In addition, ARC's revenue increased
by $4.1 million, or 73%, in 1997 compared to 1996 and $4.3 million, or 44%, in
1998 compared to 1997 due primarily to ARC's new product offering of Bell
Atlantic local telephone services.
GROSS PROFIT. Combined gross profit increased $10.6 million, or 85%, from
$12.5 million for 1997 to $23.1 million for 1998. Combined gross profit
increased $7.3 million, or 140%, from $5.2 million for 1996 to $12.5 million for
1997. Overall combined gross profit as a percentage of combined revenues was
36%, 42%, and 51% in 1996, 1997 and 1998, respectively. The increase in combined
gross profit was primarily due to significant margin improvement experienced at
AXCES, where gross profits as a percentage of sales was 53%, 59% and 67% in
1996, 1997 and 1998, respectively.
COMBINED LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth selected unaudited cash flow information for
InfoHighway on a historical combined basis (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------ --------------------
1998 1998 1999
------------ --------- ---------
<S> <C> <C> <C>
Net cash provided by (used in) operating activities............................ $ (2,430) $ 1,680 $ 2,925
Net cash provided by (used in) investing activities............................ (980) (609) 44
Net cash provided by (used in) financing activities............................ 3,608 295 (679)
------------ --------- ---------
Net increase in cash and equivalents........................................... $ 198 $ 1,366 $ 2,290
------------ --------- ---------
------------ --------- ---------
</TABLE>
For the six months ended June 30, 1999, on a combined basis, operating
activities generated $2.9 million of cash due to AXCES' generation of $3.8
million, partially offset by ARC's use of $0.7 million and InfoHighway
International's use of $0.2 million. Combined net cash provided by investing
activities approximated $0.1 million, primarily due to sale of property and
equipment and proceeds from related party loans by AXCES, in excess of purchases
of certain intangible assets and property and equipment by InfoHighway
International. Combined financing activities consumed $0.7 million primarily due
to $1.7 million of debt repayments on short-term debt at AXCES which offset
short-term borrowings at InfoHighway International of $0.3 million and ARC of
$0.7 million.
52
<PAGE>
For the six months ended June 30, 1998, on a combined basis, operating
activities generated $1.7 million due to AXCES' generation of $1.4 million and
ARC's generation of $0.4 million, partially offset by InfoHighway
International's use of $0.1 million as described below. Combined net cash used
in investing activities totaled $0.6 million, primarily due to the acquisition
of a long distance customer base at ARC. Combined net cash provided by financing
activities was $0.3 million, due to a rights offering at InfoHighway
International which generated $0.2 million and funding of $0.1 million from
ARC's former asset-based lender.
For the year ended December 31, 1998, on a combined basis, operating
activities consumed $2.4 million of cash due primarily to net losses generated
by InfoHighway International and ARC, and higher investments in accounts
receivable across all companies. Combined net cash used in investing activities
approximated $1.0 million, primarily for a strategic telecommunications
acquisition at ARC and purchases of property and equipment. Combined net cash
provided by financing activities totaled $3.6 million, due to debt and equity
financings from various sources including private placement offerings,
commercial bank lendings, and related party transactions.
At June 30, 1999 on a combined basis, we had an aggregate of $1.0 million of
cash and cash equivalents, and a working capital deficit of $9.2 million.
We intend to increase capital expenditures and operating expenses
significantly in order to integrate the founding companies, expand networks to
support additional expected end-users in existing and future markets and to
market and provide services to a growing number of potential end-users. Current
capital resources, including the proceeds of this offering, are anticipated to
be sufficient to fund aggregate capital expenditures and working capital
requirements for the immediate future.
Our expansion through acquisitions may require significant capital. We
cannot predict with certainty what our capital needs will be for future
acquisitions. We currently intend to use our common stock to fund a portion of
the purchase price of future acquisitions. If our common stock does not maintain
an acceptable price in the public markets or if potential acquisition candidates
are unwilling to accept our common stock as part of the consideration for the
sale of their businesses, we may have to use more cash to finance our
acquisition program. If we do not have enough cash resources, our ability to
make acquisitions could be limited unless we are able to obtain additional cash
through future debt or equity financings. Incurring debt would increase our
leverage and make us more vulnerable to economic downturns and limit our ability
to compete.
We intend to enter into negotiations with a group of commercial banks to
provide us with a credit facility to be used for acquisitions, working capital,
capital expenditures and other general corporate purposes. Any such credit
facility or other debt financing will require that we make certain financial
covenants which could limit our operational and financial flexibility. We cannot
guarantee that we will be able to obtain financing for our acquisition program
or, if available, that it will be available
53
<PAGE>
on terms we deem acceptable. As a result, we might be unable to successfully
pursue our acquisition strategy. See "Management's Discussion and Analysis of
Pro Forma Financial Condition and Results of Operations--Pro Forma Liquidity and
Capital Resources."
AXCES, INC.
RESULTS OF OPERATIONS
The following table sets forth certain historical financial data of AXCES
and that data as a percentage of revenues for the periods indicated (dollars in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------- ------------------------------------------
1996 1997 1998 1998 1999
-------------------- -------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.............. $ 8,468 100% $ 19,474 100% $ 30,280 100% $ 17,348 100% $ 10,095 100%
Cost of services...... 3,960 47% 8,003 41% 9,889 33% 5,307 31% 3,445 34%
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Gross profit.......... 4,508 53% 11,471 59% 20,391 67% 12,041 69% 6,650 66%
SG&A expenses......... 3,674 43% 8,910 46% 17,934 59% 8,296 48% 4,914 49%
Depreciation and
amortization........ 61 1% 135 1% 204 1% 89 -- 112 1%
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Operating income...... $ 773 9% $ 2,426 12% $ 2,253 7% $ 3,656 21% $ 1,624 16%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 AND 1998
REVENUES. Revenues decreased $7.2 million from $17.3 million in 1998 to
$10.1 million in 1999. The decrease in revenues can be attributed primarily to
the results of an extensive study of AXCES' customer base in connection with an
area code change which was completed in May 1998. This action was taken in order
to avoid billing each of these customers for the same telephone number in both
the new and old area codes and to avoid the possibility of additional
allegations of slamming and cramming. AXCES eliminated approximately 60,000
valid customers from the database due to the inability of its billing provider
to properly bill its customers in connection with the new area code change. As a
result, approximately $3.5 million of revenue was lost. In addition, other
factors leading to the decrease in revenues included:
- the elimination of Texas state line charges of approximately $0.8 million;
- the loss of all GTE accounts totaling approximately $0.9 million due to a
changing relationship with its carriers which eliminated its ability to
bill GTE customers under its carriers' billing contracts; and
- an increase in Ameritech returns and allowances of approximately $0.9
million.
As a result of these and other factors including the allegations of slamming
and cramming and the terms of our various settlements with the regulatory
authorities, AXCES re-evaluated its marketing strategy. Consequently, the number
of new customers acquired on a monthly basis was greatly reduced. In addition,
due to
54
<PAGE>
mounting competitive pressure, AXCES' sales price for interstate long distance
was substantially reduced.
GROSS PROFIT. Gross profit decreased $5.4 million from $12.0 million in
1998 to $6.6 million in 1999. Overall gross profit as a percentage of revenues
was 69% and 66% in 1998 and 1999, respectively. The decrease in the gross profit
can be attributed to:
- loss of all GTE accounts; and
- elimination of Texas state line charges.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased $3.4 million or 41% from $8.3 million in 1998
to $4.9 million in 1999. The significant decrease in expense levels was due
primarily to:
- a $1.1 million reduction in compensation expense for the owners in 1999;
and
- significant changes in AXCES' marketing strategy which reduced selling,
general and administrative expenses by 44% or $3.6 million.
Bad debts and other uncollectible amounts were $2.2 million, or 21.8% of
sales for the six months ended June 30, 1999 compared to $1.8 million, or 10.4%
of 1998 sales. The allowance is withheld and uncollectible amounts deducted from
customer remittances by Southwestern Bell Telephone and Ameritech as revenue is
generated. The increased write-off's are a result of higher sales levels in
previous periods which, although previously reserved for, are determined to be
uncollectible in the current period and charged against the allowance.
COMPARISON OF 1998, 1997 AND 1996
REVENUES. Revenues increased $10.8 million, or 55%, from $19.5 million in
1997 to $30.3 million in 1998. Revenues increased $11.0 million, or 130%, from
$8.5 million in 1996 to $19.5 million in 1997. The significant revenue increases
experienced over these periods were primarily attributable to growth in the
customer base resulting from:
- new office openings;
- expanded sales force;
- intensified sales and marketing campaigns; and
- new user fees in 1998 associated with various state and federal
assessments.
GROSS PROFIT. Gross profit increased $8.9 million, or 78%, from $11.5
million in 1997 to $20.4 million in 1998. Gross profit increased $7.0 million,
or 156%, from $4.5 million in 1996 to $11.5 million in 1997. Overall gross
profit as a percentage of revenues was 53%, 59% and 67% in 1996, 1997 and 1998,
respectively. Gross profit percentages have improved dramatically over recent
years due to:
55
<PAGE>
- cost synergies resulting from expanding the customer base from
approximately 9,600 customers at December 31, 1995 to 160,000 customers at
December 31, 1998;
- new user fees in 1998 associated with various state and federal
assessments;
- successful sales and marketing efforts; and
- improved pricing on service offerings.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $9.0 million, or 101%, from $8.9 million in
1997 to $17.9 million in 1998. The significant increase in expense levels was
due primarily to:
- a $2.4 million increase in compensation, benefits and performance bonuses
received by the owners during 1998;
- a $2.1 million increase in sales and marketing-related expenses due to
higher personnel costs resulting from higher average sales force headcount
and increased exhibit space rentals and other promotional expenses; and
- growth in personnel and administrative expenses overall across most
functional areas due to the sustained growth in operations.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth selected information from AXCES' statements
of cash flows (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEARS ENDED DECEMBER 31, 30,
-------------------------------- ---------------------
1996 1997 1998 1998 1999
--------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Net cash provided by (used in) operating activities....... $ 762 $ 269 $ (1,249) $ 1,367 $ 3,842
Net cash provided by (used in) investing activities....... (260) (642) (348) (38) 205
Net cash provided by (used in) financing activities....... (111) 43 1,671 (10) (1,734)
--------- --------- ---------- --------- ----------
Net increase (decrease) in cash and equivalents........... $ 391 $ (330) $ 74 $ 1,319 $ 2,313
--------- --------- ---------- --------- ----------
--------- --------- ---------- --------- ----------
</TABLE>
For the six months ended June 30, 1999, operating activities generated $3.8
million of cash. Net income of $1.6 million, increased collections of accounts
receivable of $2.2 million, provision for doubtful accounts of $1.6 million and
a decrease in federal income tax receivable of $0.6 million were partially
offset by an increase in receivables from related parties of $1.8 million and a
decrease in sales tax payable of $0.4 million.
For the six months ended June 30, 1998, operating activities generated $1.4
million of cash. Net income of $4.4 million, an increase in other accrued
expenses of
56
<PAGE>
$1.4 million, provision for doubtful accounts of $1.9 million and a decrease in
prepaid expenses of $0.1 million were partially offset by an increase in
receivables from related parties of $3.3 million, a decrease in current income
tax payable of $0.6 million, an increase in accounts receivable of $1.5 million
and a decrease in sales tax payable of $0.4 million.
For the year ended December 31, 1998, operating activities consumed $1.2
million of cash as positive cash flow from operations was offset by a
significant investment in working capital, including increases of $7.2 million
and $0.7 million in accounts receivable and tax refund receivables,
respectively. Net cash used in investing activities totaled $0.3 million,
consisting of purchases of property and equipment and note issuances to related
parties of $0.1 million and $0.2 million, respectively. Financing activities
generated $1.7 million consisting of a $1.0 million short-term note payable to
an independent third party lender and a $0.7 million short-term bank line of
credit.
For the year ended December 31, 1997, operating activities generated $0.3
million of cash as positive cash flow from operations was largely offset by
investments in various working capital accounts, primarily a $3.8 million
increase in accounts receivable. Net cash consumed by investing activities
totaled $0.6 million, including purchases of property and equipment and
issuances of notes to related parties of $0.4 million and $0.2 million,
respectively. Minimal financing activities occurred during 1997 as $0.06 million
was raised from proceeds of long-term notes payable and principal payments on
long-term debt totaled $0.02 million.
For the year ended December 31, 1996, operating activities generated $0.8
million of cash as positive cash flow from operations was partially offset by
investments in working capital, including a $1.1 million increase in accounts
receivable. Investing activities, consisting of purchases of property and
equipment, totaled $0.3 million. Financing activities consumed $0.1 million due
primarily to payments on a note payable to a vendor.
AXCES expects to be able to fund its cash needs such as working capital
through cash generated from its operations. AXCES generally funds its purchases
of property and equipment with internally generated cash or debt. AXCES also has
a $3.0 million accounts receivable financing which it expects to maintain if it
remains competitively priced with other forms of financing we may obtain in the
future. However, we expect to be able to fund operations from cash flow and
proceeds from this offering.
57
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
RESULTS OF OPERATIONS
The following table sets forth certain historical financial data of
InfoHighway International and that data as a percentage of revenues for the
periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------- -------------------------------
1996 1997 1998 1998 1999
-------------------- -------------------- -------------------- -------------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues............... $ 426 100% $ 915 100% $ 1,385 100% $ 796 100% $ 1,100
Cost of services....... 218 51% 648 71% 996 72% 509 64% 592
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Gross profit........... 208 49% 267 29% 389 28% 287 36% 508
SG&A expenses.......... 639 150% 1,481 162% 1,339 97% 600 75% 713
Depreciation and
amortization......... 52 12% 175 19% 261 19% 142 18% 261
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Operating loss......... $ (483) (113%) $ (1,389) (152%) $ (1,211) (88%) $ (455) (57%) $ (466)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
<CAPTION>
<S> <C>
Revenues............... 100%
Cost of services....... 54%
---------
Gross profit........... 46%
SG&A expenses.......... 65%
Depreciation and
amortization......... 24%
---------
Operating loss......... (43%)
</TABLE>
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 AND 1998
REVENUES. Revenues increased $0.3 million, or 38%, from $0.8 million in
1998 to $1.1 million in 1999. The significant revenue increase was directly
attributable to the consummation of the acquisition of Eden Matrix during
January 1999.
GROSS PROFIT. Gross profit increased $0.2 million, or 67%, from $0.3
million in 1998 to $0.5 million in 1999. Overall gross profit as a percentage of
revenues was 36% and 46% for 1998 and 1999, respectively. The increase was
primarily due to the acquisition of Eden Matrix.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $0.1 million, or 17%, from $0.6 million in
1998 to $0.7 million in 1999. Despite growth in personnel headcount, selling,
general and administrative expenses as a percent of revenues declined slightly
from 75% in 1998 to 65% in 1999 due to expense efficiencies created by the full
integration of the acquisition of Eden Matrix during the 1999 period.
COMPARISON OF 1998, 1997 AND 1996
REVENUES. Revenues increased $0.5 million, or 55%, from $0.9 million in
1997 to $1.4 million in 1998. Revenues increased $0.5 million, or 125%, from
$0.4 million in 1996 to $0.9 million in 1997. The significant revenue increases
experienced over these periods were primarily attributable to the following:
- overall growth in demand for Internet access services;
- revenue contributions from the acquisition of several Internet service
providers located in Texas and California during 1997; and
- the introduction of the InfoHighway Connect service offering during 1997.
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<PAGE>
InfoHighway Connect is a high-speed Internet service currently offered in office
buildings in Texas, New Jersey and Florida, which provides building tenants
access to a shared high-speed dataline. The InfoHighway Connect service provides
several benefits over traditional dial-up services, including continuous
connection, faster connection speeds, fewer technical problems, lower cost,
increased security and greater usability.
GROSS PROFIT. Gross profit increased $0.1 million from $0.3 million in 1997
to $0.4 million in 1998. Gross profit increased from $0.2 million in 1996 to
$0.3 million in 1997. Overall gross profit as a percentage of revenues was 49%,
29% and 28% in 1996, 1997 and 1998, respectively. Gross profit percentages
declined from 1996 to 1998 due to significant increases in technical support
staff and higher communication costs as InfoHighway International expanded its
network.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased $0.2 million, or 13%, from $1.5 million in
1997 to $1.3 million in 1998. The decline in expenses was primarily attributable
to higher expense levels experienced during 1997 for specific expenses
including:
- non-recurring stock compensation charges;
- higher expenses incurred on the closing of equity offerings; and
- duplicative network and staffing costs on acquisitions prior to full
integration into InfoHighway International.
Selling, general and administrative expenses increased $0.8 million, or 133%,
from $0.6 million in 1996 to $1.5 million in 1997. The increase in expenses was
reflected across most expense categories, due primarily to increased personnel
costs to support revenue growth and the specific 1997 expenses noted above.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth selected information from InfoHighway
International's statements of cash flows (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net cash used in operating activities........................... $ (250) $ (604) $ (587) $ (79) $ (196)
Net cash used in investing activities........................... (121) (216) (147) (125) (122)
Net cash provided by financing activities....................... 354 820 734 204 318
--------- --------- --------- --------- ---------
Net decrease in cash and equivalents............................ $ (17) $ -- $ -- $ -- $ --
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
For the six months ended June 30, 1999, operating activities consumed $0.2
million as the net loss from operations of $0.5 million and increases in
accounts receivable of $0.3 million were partially offset by depreciation and
amortization expenses of $0.3 million, increases in accounts payable of $0.2
million and increases in
59
<PAGE>
deferred revenues of $0.1 million. Investing activities consumed $0.1 million
due to purchases of certain intangible assets and property and equipment.
Financing activities generated $0.3 million due to short-term borrowings.
Amounts charged to allowance for bad debts was $0.1 in 1999 compared to less
than $0.05 million in 1998. In addition, approximately $0.8 million was charged
against revenues for sales returns and allowances. In 1999, InfoHighway
International hired additional staff, to help it better manage its
uncollectibles.
For the six months ended June 30, 1998, operating activities consumed $0.1
million as the net loss from operations of $0.5 million was partially offset by
increases in accounts payable of $0.2 million, depreciation and amortization of
$0.1 million and increases in deferred revenue of $0.1 million. Investing
activities consumed $0.1 million, primarily due to purchases of property and
equipment. Financing activities generated $0.2 million primarily due to a rights
offering to existing shareholders.
For the year ended December 31, 1998, operating activities consumed $0.6
million as the net loss from operations was partially offset by a $0.3 million
increase in accounts payable and accrued expenses. Net cash used in investing
activities totaled $0.1 million due primarily to purchases of property and
equipment. Financing activities generated $0.7 million of cash flow, including
$0.5 million of proceeds from a unit offering of debt and equity securities and
$0.5 million of proceeds from a note payable executed with Trident III during
the fourth quarter, which served to offset net payments of notes payable to
shareholders and repayments of capital lease obligations in the amounts of $0.2
million and $0.1 million, respectively.
For the year ended December 31, 1997, operating activities consumed $0.6
million as the net loss from operations was partially mitigated by increases in
accounts payable and deferred revenues totaling $0.4 million. Approximately $0.2
million was incurred on investing activities for the purchase of property and
equipment. Financing activities generated $0.8 million consisting of $0.2
million of net proceeds from notes payable to shareholders and $0.6 million from
common stock issuances under private placement offerings.
For the year ended December 31, 1996, operating activities consumed $0.3
million as the net loss from operations was partially offset by increases in
accounts payable and deferred revenues totaling $0.2 million. Investing
activities, consisting of purchases of property and equipment, totaled $0.1
million. Financing activities consisted of common stock issuances which raised
$0.4 million in capital for the year.
GOING CONCERN. Since its inception, InfoHighway International has suffered
losses and negative cash flows from operations and has a working capital deficit
and stockholders' deficit that raise substantial doubt about its ability to
continue as a going concern. Its ability to continue as a going concern is
dependent upon the success of its marketing efforts, its ability to produce
sufficient margins to cover operating and overhead expenses and its access to
sufficient funding to enable it to
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<PAGE>
continue operations. InfoHighway International has been funded through its own
operating cash flows, loans received from outside investors and sales of common
stock. It is anticipated that the proceeds from this offering will be sufficient
to fund its operations for the foreseeable future.
ARC NETWORKS, INC.
RESULTS OF OPERATIONS
The following table sets forth certain historical financial data of ARC and
that data as a percentage of revenues for the periods indicated (dollars in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------- -------------------------------
1996 1997 1998 1998 1999
-------------------- -------------------- -------------------- -------------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues............... $ 5,583 100% $ 9,648 100% $ 13,931 100% $ 6,660 100% $ 8,171
Cost of services....... 5,074 91% 8,895 92% 11,651 84% 5,691 85% 6,694
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Gross profit........... 509 9% 753 8% 2,280 16% 969 15% 1,477
SG&A expenses.......... 1,439 26% 2,695 28% 3,465 24% 1,219 18% 1,828
Depreciation and
amortization......... 17 -- 436 5% 407 3% 165 3% 219
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Operating loss......... $ (947) (17%) $ (2,378) (25%) $ (1,592) (11%) $ (415) (6%) $ (570)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
<CAPTION>
<S> <C>
Revenues............... 100%
Cost of services....... 82%
---------
Gross profit........... 18%
SG&A expenses.......... 22%
Depreciation and
amortization......... 3%
---------
Operating loss......... (7%)
</TABLE>
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 AND 1998
REVENUES. Revenues increased $1.5 million, or 22%, from $6.7 million in
1998 to $8.2 million in 1999. Long distance and local telephone revenues
increased $1.5 million, or 32%, from $4.7 million in 1998 to $6.2 million in
1999. The increase is a result of greater market penetration into the local
telephone market, principally New York City, through ARC's reseller programs
with Teleport Communications Group and Winstar Communications, both competitive
local telephone companies, and with Bell Atlantic, the traditional local
telephone company, which began in April 1997. Also contributing was the
aggressive marketing of ARC's long distance telephone service. Data cabling
revenues remained unchanged at $2.0 million.
GROSS PROFITS. Gross profit increased $0.5 million, or 50%, from $1.0
million in 1998 to $1.5 million in 1999. Overall gross profit as a percentage of
revenues was 15% and 18% in 1998 and 1999, respectively. Gross profit on long
distance and local telephone revenue increased $0.6 million, or 300%, from $0.2
million in 1998 to $0.8 million in 1999. Gross profit on data wiring revenues
decreased $0.1 million, or 14%, from $0.7 million in 1998 to $0.6 million in
1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $0.6 million, or 50%, from $1.2 million in
1998 to $1.8 million in 1999. These increases were primarily due to increased
personnel costs associated with revenue growth, establishment of a customer
service operation, the cost of external billing services associated with long
distance and local telephone revenues and
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<PAGE>
administrative and accounting costs. Selling, general and administrative
expenses as a percent of revenues were 18% and 22% in 1998 and 1999,
respectively.
COMPARISON OF 1998, 1997 AND 1996
REVENUES. Revenues increased $4.3 million, or 45%, from $9.6 million in
1997 to $13.9 million in 1998. Revenues increased $4.0 million, or 71%, from
$5.6 million in 1996 to $9.6 million in 1997. Long distance and local telephone
revenues increased $2.6 million, or 36%, from $7.2 million in 1997 to $9.8
million in 1998. Long distance and local telephone revenues increased $2.8
million, or 64%, from $4.4 million in 1996 to $7.2 million in 1997. The increase
in both periods is a result of greater market penetration into the local
telephone market, principally New York City, through ARC's reseller programs
with Teleport, Winstar and Bell Atlantic, which began in April 1997. Also
contributing was the aggressive marketing of ARC's long distance telephone
service. Data wiring revenues increased $1.6 million, or 64%, from $2.5 million
in 1997 to $4.1 million in 1998. Data wiring revenues increased $1.3 million, or
108%, from $1.2 million in 1996 to $2.5 million in 1997. Revenues in both
periods increased principally as a result of services to New York State in
connection with updating its buildings for computers and Internet services. ARC
also was a subcontractor to Mitel Systems, Inc. who was the primary contractor
with New York City schools to rewire classrooms for computer and Internet
services.
GROSS PROFITS. Gross profit increased $1.5 million, or 188%, from $0.8
million in 1997 to $2.3 million in 1998. Gross profit increased $0.3 million, or
60%, from $0.5 million in 1996 to $0.8 million in 1997. Overall gross profit as
a percentage of revenue was 9%, 8% and 16% in 1996, 1997 and 1998, respectively.
Gross profit on long distance and local telephone revenues increased $0.8
million, or 800%, from $0.1 million in 1997 to $0.9 million in 1998. Gross
profit on long distance and local telephone revenues decreased $0.2 million, or
67%, from $0.3 million in 1996 to $0.1 million in 1997. Our total gross profit
and gross profit for the long distance and local telephone market decreased in
1997 as a result of unfavorable performance in ARC's discontinued prepaid
telephone debit card operation. Gross profit on data cabling revenues increased
$0.7 million, or 100%, from $0.7 million in 1997 to $1.4 million in 1998. Gross
profit on data cabling revenues increased $0.5 million, or 250%, from $0.2
million in 1996 to $0.7 million in 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $0.8 million, or 30%, from $2.7 million in
1997 to $3.5 million in 1998. Selling, general and administrative expenses
increased $1.3 million, or 93%, from $1.4 million in 1996 to $2.7 million in
1997. These increases were primarily due to increased personnel costs associated
with revenue growth, establishment of a customer service operation, the cost of
external billing services associated with long distance and local telephone
revenue and administrative and accounting costs. Selling, general and
administrative expenses as a percent of revenue were 26%, 28% and 24% in 1996,
1997 and 1998, respectively. In 1997, ARC recorded a loss on an impaired
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<PAGE>
asset of $0.4 million which was the primary cause of the increase in the 1997
percentage of revenue.
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth selected information from ARC's statements of
cash flows (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net cash provided by (used in) operating activities.............. $ (424) $ (479) $ (594) $ 392 $ (721)
Net cash used in investing activities............................ (416) (83) (485) (446) (39)
Net cash provided by financing activities........................ 903 567 1,203 101 737
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and equivalents.................. $ 63 $ 5 $ 124 $ 47 $ (23)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
For the six months ended June 30, 1999, ARC used cash in operating
activities of $0.7 million. ARC also incurred a net loss of $0.9 million which
was offset by non-cash items of $0.4 million and a net decrease in other working
capital accounts of $0.5 million. Net cash used in investing activities of $0.04
million was primarily for the acquisition of office equipment such as computers.
Net cash provided by financing activities of $0.7 million was the result of an
increase in debt financing received from related parties, offset by $.05 of debt
repayments.
Amounts charged to allowance for doubtful accounts increased by $0.2 million
from June 30, 1999 to $0.3 million, or 3.7% of sales. The principle reason for
this increase was the increase in sales to its local telephone customers who are
typically small to midsize companies. As ARC experienced increased losses,
additional clerical staff and a collection agency were hired to help it better
manage its uncollectibles.
For the six months ended June 30, 1998, ARC generated $0.4 million from
operating activities, primarily by an increase in interim billings in excess of
costs and earnings of $1.2 million and non-cash items of $0.2 million offset by
a net loss of $0.6 million and a decrease in other working capital accounts of
$0.4 million. Net cash used by investing activities of $0.4 million was for the
acquisition of a long distance customer base. Net cash provided by financing
activities of $0.1 million was due to an increase in funding from ARC's former
asset based lender.
For the year ended December 31, 1998, ARC used cash in operating activities
of $0.6 million. ARC also incurred a net loss of $1.9 million which was offset
by non-cash items of $0.9 million and a net decrease in other working capital
accounts of $0.4 million, including a $1.5 million reserve on disputed amounts
under contract. Net cash used in investing activities of $0.5 million was
primarily for the acquisition of a long distance telephone customer base of $0.4
million. Net cash provided by financing
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<PAGE>
activities of $1.2 million was primarily the result of a $2.0 million debt
refinancing received from a related party offset by debt repayments of $0.8
million.
For the year ended December 31, 1997, ARC used cash in operating activities
of $0.5 million. ARC also incurred a net loss of $2.7 million which was offset
by non-cash items of $0.8 million including a write down of $0.4 for an impaired
asset in ARC's prepaid telephone calling card operation and a $1.4 million
decrease in other working capital accounts. Net cash used for investing
activities of $0.1 was for office equipment such as personal computers. Net cash
provided by financing activities of $0.6 million was due to $0.9 million of
loans received to support its operating activities offset by debt repayments of
$0.3 million.
For the year ended December 31, 1996, ARC used cash in operating activities
of $0.4 million. ARC also incurred a net loss of $1.1 million which was
partially offset by non-cash items of $0.1 million and a net decrease in other
working capital accounts of $0.6 million. Net cash used in investing activities
of $0.4 million was for the acquisition of telephone equipment. Net cash
provided by financing activities of $0.9 million resulted from $0.4 million in
loans received from related parties to support its operating activities and $0.4
million to acquire equipment.
GOING CONCERN. Since its inception, ARC has suffered losses and negative
cash flows from operations and has a working capital deficit and stockholders'
deficit that raise substantial doubt about its ability to continue as a going
concern. Its ability to continue as a going concern is dependent upon the
success of its marketing efforts, its ability to produce sufficient margins to
cover operating and overhead expenses and its access to sufficient funding to
enable it to continue operations. ARC has been funded in the past through an
accounts receivable financing of $2.4 million obtained from its former parent,
notes payable received from outside investors and internal cash flows. It is
anticipated that funds received from this offering will be sufficient to fund
its operations for the foreseeable future.
In June 1999, we received demand letters from three unaffiliated noteholders
for payment of three notes aggregating $0.8 million comprised of an 8% $0.6
million note and two 12% $0.1 millions notes. As a result, we renegotiated these
notes in June 1999 to include the accrued interest on $0.6 million of the notes
and extended the maturity date of the notes until October 31, 1999. Currently,
we are in discussions with these noteholders and expect to extend the principal
payments until the year 2000. If we are unable to extend these principal
payments, we will have to utilize a portion of our remaining net proceeds to
make such payments.
Subsequent to December 31, 1998, in order to help fund the operating
activities, ARC's former parent, Consolidated Technology, advanced an additional
$400,000 even though ARC was, and continues to be, in default of certain
provisions of the loan agreement relating to amounts funded in excess of
eligible accounts receivable, unpaid interest of $0.5 million and rent expense.
We expect to successfully resolve these defaults after the completion of this
offering.
64
<PAGE>
BUSINESS
OVERVIEW
We acquired ARC on June 30, 1999. We will acquire InfoHighway International
and AXCES simultaneously with and as a condition of the closing of this
offering. Through these companies, we intend to offer an extensive array of
Internet and telecommunications services to businesses and consumers. These
services will initially include a combination of high-speed Internet access,
local phone and long distance telephone service, and network design and wiring
services. In the future, we intend to offer secure online shopping, virtual
private networks and other advanced data services. Virtual private networks
provide businesses capabilities similar to those of dedicated specific customer
lines through the traditional phone company telephone networks using special
software and dialing plans. We currently operate principally in New York, New
Jersey, Florida, Illinois, Texas and California.
The combination of these three companies creates an extensive product mix,
and produces efficiencies by combining sales and marketing efforts,
administrative operations and customer service. Our complementary product lines
will enable us to become a full service telecommunications company. We will
offer both a combination of services for customer convenience and a wide array
of individual services for specific applications. We intend to service both
residential and small to medium-sized business customers, providing us with a
balance between the long sales cycle of the complex combination of services sold
to businesses and the mass marketing efforts that enjoy a short sales cycle in
the less complex residential arena.
Our current service offerings which we offer for the most part on a stand
alone basis and expect in the future to make available on a combined basis to
all of our customers include the following:
<TABLE>
<S> <C>
Internet Services Our Internet services include high speed service
available either as dedicated direct access or our
InfoHighway DSL and InfoHighway connect products,
dial-up service, web services including web-site
hosting, web-site design, with e-mail services,
and online backup.
Local and Regional We offer a full range of local services including
Telephone Services voice mail, universal messaging services,
conference calling, call return services, call
pick-up, repeat dialing and speed calling. We
provide local services primarily in New York and
to a lesser degree in New Jersey and Florida.
Long Distance Service We offer both domestic interstate and
international switched and dedicated long distance
services including long distance 1+ service, toll
free services, calling card service, and paging
services.
</TABLE>
65
<PAGE>
<TABLE>
<S> <C>
Network Design and Wiring We offer a full range of network wiring design and
Services installation services including premise network
wiring for computers and telephone systems.
</TABLE>
We currently offer a broad range of Internet and telecommunication services
including high speed Internet access, local phone service, long distance, and
other value added data services. Combining ARC's competitive local telephone
company expertise with InfoHighway International's Internet and data background
and AXCES' marketing experience in the resale of telecommunications services, we
will be able to offer an integrated "single bill" solution for customer phone
and Internet needs. By using new technology, we will be able to offer
traditional telecommunication services at a competitive price as well as new
data services not currently available through traditional providers.
Additionally, we provide data services, secure on line data back-up and
virtual private network services. In the future, we intend to offer additional
products such as video conferencing, secure on-line shopping and other Internet
related products.
The following table sets forth the percentage of total pro forma revenue for
each of 1996, 1997 and 1998 and the six months ended June 30, 1999 for each
class of services we provide:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED JUNE
SERVICE 1996 1997 1998 30, 1999
- --------------------------------------------------------------------------- --------- --------- --------- -------------
<S> <C> <C> <C> <C>
Internet................................................................... 3% 3% 3% 6%
Local telephone............................................................ 30% 18% 13% 18%
Long distance.............................................................. 59% 71% 75% 66%
Network design and wiring.................................................. 8% 8% 9% 10%
</TABLE>
In addition, we intend to continue to grow in all of our markets through the
acquisition or merger of complementary technology or service companies. We
intend to use these acquisitions to increase our market share and increase our
Internet and telecommunications products, services and revenues.
One of our objectives is to become a leading provider of multiple services
and expand our product lines to include local service and Internet access to
residential customers in large metropolitan areas where we primarily sell only
long distance service today. In order to achieve this goal, we will continue to
emphasize the following key elements of our operating strategy:
- continue to develop effective marketing campaigns that offer high value to
potential customers through customized telecommunications offerings;
- focus on maintaining highly efficient distribution capabilities with
emphasis on direct contact with our customers utilizing a variety of
channels, such as direct sales, agents, telemarketing and e-commerce;
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<PAGE>
- develop new promotional packages that integrate both local telephone
service and Internet access to our target market;
- expand our product offering to additional cities consistent with our
acquisition strategy; and
- building an operational support system to streamline all customer care and
related billing activities utilizing electronic interfaces and the
Internet.
With our dedicated high-speed Internet services, such as our InfoHighway
Connect service and InfoHighway SDSL and ADSL services currently under trial, we
service or have under contract, over 30 multi-story buildings and other
locations. SDSL and ADSL, synchronous and asynchronous digital subscriber lines,
respectively, are high speed modem technologies that provide data service over
existing telephone lines. These services are significantly faster than dial up
modem connections, yet sell for less than the cost of a dedicated high-speed
connection. We also provide Internet and telecommunications services to over
10,000 access lines, and serve approximately 130,000 residential customers with
long distance service. We believe significant opportunities exist to expand
revenues by cross selling our products and services to current and future
customers in our existing and targeted new markets.
The residential market accounts for a significant portion of our overall
revenues. For the twelve months ended December 31, 1998 and the six months ended
June 30, 1999, residential services accounted for approximately 68% and 56%,
respectively, of our total revenues, with business services accounting for the
remaining 32% and 44%, respectively, of total revenues. We believe the
residential segment of the market is attractive and has been underserved by many
long distance service providers. In addition, we believe residential customers
are receptive to new and innovative marketing programs targeting their specific
segment with custom solutions. We also believe these customers are likely to
switch service providers for an attractive offering.
Each of the founding companies has at least five years of experience in its
respective industry and a seasoned management team.
- Mr. Joseph A. Gregori is our Chief Executive Officer, and has over 13
years in the telecommunications industry. Prior to becoming ARC's
Executive Vice President in 1998, he served as Chief Operating Officer of
PriCellular Corporation, a publicly traded wireless telephone provider,
and President of Nationwide Cellular Service Inc. and its successor
company, MCI Wireless.
- Mr. Peter F. Parrinello, our Chairman of the Board and President, has over
25 years of experience in the telecommunications industry.
- Mr. Peter Karoczkai, our Senior Vice-President of Sales and Marketing has
over 12 years of experience in the telecommunications and computer
industry. Previously, Mr. Karoczkai served as Vice President of Marketing
for Bell Atlantic's Telecom Industry Services developing its wholesale
product and service portfolio and distribution.
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<PAGE>
- Mr. Charles N. Garber, our Chief Financial Officer, has over 25 years
experience in the telecommunications industry. Previously, he served as
Chief Financial Officer for two publicly traded start-ups in the
telecommunications, Internet and media sectors, and as Senior Vice
President, Treasurer and Controller of Cincinnati Bell, Inc.
- Mr. Tony Howlett, our Chief Technology Officer, founded InfoHighway
International and has served as Chief Executive Officer of InfoHighway
International since 1995.
MARKET OPPORTUNITY
There is significant market opportunity for our services brought about by
the Telecommunications Act of 1996, which allows for competition in the local
telecommunications market, and the growing demand for Internet access and data.
We believe that the following market conditions support our business
strategy:
- Demand for Internet service, particularly high-speed Internet for small to
medium-sized business applications and residential users is increasing.
- There is increasing demand by companies and individuals for buildings that
provide access to an advanced telecommunications infrastructure.
- The growing number of telecommunications service providers is creating a
competitive wholesale buyer's market.
- Individuals and businesses currently purchase Internet, data and
telecommunications services from multiple vendors and would be interested
in purchasing these from one provider.
- There is a demand for an alternative to the complexity of the current
voice/ data/Internet supplier mix, and for an alternative to traditional
monopoly providers of local phone service.
Our goal is to attract customers in our target market segments with a
unified product offering including high-speed Internet and telecommunications
service with focus on customer service and superior performance. We believe we
can meet this goal because of the combination of the existing product portfolios
of the founding companies. The Internet is experiencing explosive growth at a
rate of over 100% per year worldwide. Currently, over 147 million people use the
Internet and that number is expected to be over 320 million by the end of the
year 2000 according to Computer Almanac Industry, Inc. 1998. Furthermore,
businesses are embracing the Internet in record numbers. In 1998, 36% of
businesses were online with projected growth to 88% by 2001. We believe the
unique requirements of business data and communications traffic will continue to
drive high-speed Internet and data communications demand. Additionally, the
Telecommunications Act of 1996 deregulated the telecommunications industry by
mandating that competitive local telephone companies such as ourselves be
allowed to provide competitive services using the existing networks and
infrastructure of the traditional local telephone companies.
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<PAGE>
BUSINESS STRATEGY
Our objective is to become one of the leading providers of combined
high-speed Internet service, data services and telecommunications service in
each of the markets in which we operate. Through the founding companies, we
currently have offices or facilities in the following markets: San Diego, New
York, New Jersey, Houston, Dallas, San Antonio, Jacksonville and Chicago. We
intend to combine our high-speed Internet data products with our local and long
distance products and deliver this telecommunications combination to new and
existing customers. Additionally, we may expand the purchase of telephone and
high-speed Internet equipment to further improve our operating margins. We
believe there is significant demand for our products on a stand-alone and
combined basis. We plan on implementing the following business strategy:
MARKET PENETRATION STRATEGY. We are pursuing a strategy of providing
service to small to medium-sized businesses and residential markets by
targeting highly populated, business and residential areas in major U.S.
cities. Additionally, as we reach successful penetration of these markets,
we may continue to deploy telephone and high-speed Internet equipment to
further enhance our operating margins through the utilization of unbundled
network elements, which are various components of the existing traditional
telephone companies' telephone network. Our approach will be to target niche
markets and highly populated areas, including, multi-tenant buildings. For
services such as InfoHighway DSL and InfoHighway Connect, we can locate our
equipment either in the buildings or in the facilities of the traditional
local telephone company. In addition, we will resell the traditional local
telephone company's high-speed data and Internet offerings for a broader
market reach and to expand our product portfolio.
FOCUS ON HIGH-SPEED INTERNET SERVICES. We intend to focus on our
InfoHighway DSL and InfoHighway Connect Internet products, which offer high-
speed Internet access to businesses and to tenants of high rise office and
residential buildings located in selected cities around the country. These
services, called InfoHighway DSL and InfoHighway Connect, are provided by
installing Internet equipment in either the facilities of the traditional
local telephone company or in buildings pursuant to a contract with the
owner of the building. We offer customers Internet access at speeds near
those achieved if they had dedicated high-speed lines and will be able to
provide local and long distance phone service to the tenants as well. For
those customers that sign up for more than one of our services, additional
discounts will be offered across selected product lines. In this manner, we
expect to be able to provide a highly competitive combination of Internet
and telecommunications services to our end-users.
LEVERAGE THE ECONOMICS OF SUCCESS-BASED PENETRATION. To date, we have
only installed our internet equipment for high-speed access after a building
has been signed under contract, thereby limiting our exposure to capital
expenditures. It is
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our intention to deploy telephone equipment only after we have successfully
penetrated our key markets, thereby postponing capital expenditures until we
are well marketed in an area and largely success-based.
PROVIDE A SUPERIOR PRODUCT AND SERVICE SOLUTION. We believe that we can
build a significant competitive position by providing a comprehensive
product offering and service solution to our customers. We will undertake to
provide all of the necessary products and services required to establish and
maintain high-speed Internet and telecommunication services in our target
markets, including:
- providing a service that is superior to other competitors in terms of
speed and responsiveness at a price point that is equal to or lower
than competitive offerings;
- ordering all local and long distance service required to initiate
service providing a single point of contact and hassle free
installation;
- providing all billing and customer service functions on a 24
hour-a-day, 7 day-a-week basis; and
- by providing a responsive, customer-oriented approach to our business
that will distinguish us from traditional phone companies and new
competitors.
ACQUIRE SELECT COMPETITORS IN TARGET MARKETS TO ACCELERATE GROWTH AND
MARKET PENETRATION. The founding companies have in the past acquired small
competitors involved in the Internet service industry and have undertaken
the purchase of a customer base in the telephone sector where it was
determined to be of strategic importance. We intend to continue to seek out
opportunities where we believe that acquisitions provide for either valuable
customer bases and/or accelerated access into a desired market. We believe
that acquisitions can be a valuable part of our overall strategy to expand
our business offerings and achieve faster entry into new markets.
INTERNET SERVICES
INFOHIGHWAY DSL AND INFOHIGHWAY CONNECT INTERNET SERVICES
We have created services called InfoHighway DSL and InfoHighway Connect to
pursue a significant opportunity in the business and residential market. These
high-speed Internet services offered in Texas, New York, New Jersey and Florida
provide customers access to high-speed data lines on a dedicated or shared
basis. Few customers can afford the cost of dedicated high-speed lines by
themselves as provided by the traditional local telephone companies. The current
implementation of InfoHighway DSL and InfoHighway Connect uses dedicated data
lines and standard telephone wiring to provide high-speed Internet and data
network services at speeds up to 24 times faster than a standard 56k modem.
We have entered into an agreement with AccessLan and are currently
negotiating purchase agreements with selected other vendors for DSL and other
equipment. We have tested AccessLan's equipment in our facilities and compared
its performance and
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specific features to other alternative suppliers' equipment. Our testing
concluded that AccessLan's equipment was best suited for our application and
target markets.
The InfoHighway DSL and InfoHighway Connect services provide several
benefits over traditional dial-up services:
- CONTINUOUS CONNECTION. The customer never receives a busy signal since
it is always connected through a network connection rather than a
modem. This is ideal for customers accessing stock tickers, news
updates and other information that require a dedicated connection.
- FEWER TECHNICAL PROBLEMS. Over 90% of technical problems encountered
by Internet users today are modem related. With InfoHighway DSL and
InfoHighway Connect, a network and our equipment provide a continuous
connection.
- LOWER COST. InfoHighway DSL Connect and InfoHighway Connect provide
fast connection speeds at a lower cost than other alternatives such as
ISDN.
- INCREASED SECURITY. As part of the InfoHighway DSL and InfoHighway
Connect services, a basic firewall service is provided at each site to
keep unwanted hackers and other visitors out of customer's networks. A
firewall is a combination of hardware and software that can prevent the
unauthorized access of a network. Additional protection is available
for a fee.
- GREATER USABILITY. Because of the higher speeds, clients can use
additional services that are not practical at lower speeds, such as
video-conferencing, virtual private networks and online data backup. We
already offer data backup and plan to introduce video conferencing and
virtual private networks.
VALUE ADDED INTERNET SERVICES
We are also developing a number of value added services that will be offered
to the InfoHighway DSL and InfoHighway Connect customers. The nature of the
high-speed connection will allow us to provide unique services that will
differentiate us from other companies providing similar services. These services
should also have the effect of increasing client retention, as customers are not
currently able to get this combination of services elsewhere. These services
include:
ONLINE DATA BACKUP. We are able to provide secure online data backup for
clients using the InfoHighway DSL and InfoHighway Connect services. Utilizing
our network at night when usage is very low, a central backup computer remotely
contacts the client's server and downloads files onto archival storage over the
InfoHighway DSL and InfoHighway Connect. The files are encrypted for security
purposes. The benefit of this service is that no personnel or hardware is
required at the customer site. Additionally, the backup data is stored off-site
and thus protected from a catastrophic loss such as fire or flood. Finally, the
backup data is available
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immediately online. The customer can restore or recall the data instantly as
compared to other alternatives which require shipping of physical tapes.
VIRTUAL PRIVATE NETWORKS. Small to medium-sized businesses are recognizing
the value of using the Internet for inter-office communications versus using
expensive private data lines. However, there are security concerns when using
the public Internet to transmit sensitive corporate data. With the InfoHighway
DSL and InfoHighway Connect services, the customer can connect two or more
physically separate networks without transmitting data across the public
Internet. The data flows across our private Intranet allowing for faster
transmission times and greater security.
INTERNET TELEPHONE. As the underlying technology permits, we plan to offer
Internet telephone services such as long distance and local dial tone using
voice over Internet technology to our InfoHighway DSL and InfoHighway Connect
customers. These services may offer additional revenue and further cement the
customer relationship.
DATA COMMUNICATIONS SUPPLIERS. We depend on other telecommunications
companies to provide us with data transmission capacity which we use to provide
our Internet service products. Currently we lease data curcuits from
Southwestern Bell, MCI WorldCom, Savis Communications, Level 3 and Taylor
Communications for periods ranging from month to month to as long as five years.
The following table summarizes our commitments for data circuits from our
major suppliers:
<TABLE>
<CAPTION>
MONTHLY COMMITMENT TOTAL ESTIMATED
PROVIDER AMOUNT COMMITMENT AMOUNT
- ------------------------------- -------------------- ---------------------
<S> <C> <C>
Southwestern Bell $ 16,000 $302,000
MCI WorldCom 18,000 36,000
Taylor Communications 3,500 132,000
Level 3 30,000 up to 540,000
</TABLE>
TELECOMMUNICATIONS SERVICES
LOCAL AND REGIONAL TELEPHONE SERVICE
As a result of the Telecommunications Act of 1996, the traditional local
telephone companies were required to sell at wholesale rates their local
telephone services to other telecommunications providers. A customer may now
keep his existing traditional local telephone service and have it provided by us
at a discounted rate. We entered the local telephone market in 1993, when we
recognized the potential in the local market with over $100 billion of annual
recurring revenue and the marketing advantage provided by offering local service
as a part of a combination of discounted telecommunications services. We offer
an extensive array of local and regional telephone services primarily in New
York, and to a lesser degree in New Jersey and Florida. We have the ability to
install local service facilities at a discount to and that bypass the
traditional local telephone companies.
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As we expand our role in the local market, the focus will be on expanding
services offered and increasing profit margins. To accomplish this, we have
received competitive local telephone status with the Public Service Commission
in New York. This will allow us to purchase the individual components of the
traditional local telephone company's telephone network and to reduce costs and
increase the flexibility of who provides each component of the telephone
network. It is our intention to continue to obtain competitive local telephone
company certification in various other states that we choose to enter.
Since 1993, we have been providing alternative local telephone services to
customers in the metropolitan New York City area. These services offer reliable
disaster-resistant local and regional calling as well as access to long distance
carriers. In addition to adding diversity to a subscriber network, we have been
successful in providing significant savings to our customers.
RELATIONSHIPS WITH TRADITIONAL LOCAL TELEPHONE COMPANIES. We currently
purchase telephone service at wholesale rates from Bell Atlantic and AT&T, which
we resell to our own customers. We purchase this service from Bell Atlantic
under the published tariff rates and have also signed a volume and term
agreement with Bell Atlantic for additional wholesale discounts. Our wholesale
agreement with AT&T has a ten-year term ending in 2003 and requires us to meet
minimum monthly volume commitments totalling $171,000 per annum.
In order to locate our equipment in the traditional local telephone
company's facilities we will be required to enter into and implement
interconnection agreements in each of our target markets with the appropriate
traditional local telephone company. These interconnection agreements govern the
relationship between us and the traditional local telephone companies. Since
interconnection agreements are subject to interpretation by both parties,
differences in interpretation may arise that cannot be resolved on favorable
terms to us. Also, the interconnection agreements are subject to state
commission, FCC and judicial oversight. Future modification to the terms,
conditions or prices of our future interconnection agreements by these
governmental bodies, or disputes with the traditional local telephone companies
over the terms of the interconnection agreements by these governmental bodies,
or disputes with traditional local telephone companies over the terms of the
interconnection agreements generally, may have a material adverse effect on our
business, prospects, operating results and financial condition.
The 1996 Telecommunications Act requires traditional local telephone
companies to interconnect with other carriers and to provide competitive local
telephone companies access to their unbundled network elements. The 1996
Telecommunications Act generally requires that interconnection charges as well
as charges for unbundled network elements be cost-based and nondiscriminatory.
Our nonrecurring and recurring monthly charges for lines may vary greatly. These
rates are subject to the approval of the appropriate state regulatory
commission. The approval process typically involves a lengthy review of the
traditional local telephone company-proposed
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rates in each state. The ultimate rates approved typically depend greatly on the
traditional local telephone company's initial rate proposals and such factors as
the geographic deaveraging/averaging policy of the state public utility
commission. These proceedings are time-consuming and will absorb scarce
resources including legal personnel and cost experts as well as participation by
our management. Consequently, we are subject to the risk that the non-recurring
and recurring charges for lines and other individual components of the
traditional local telephone company's telephone network will increase from time
to time based on new rates proposed by the traditional local telephone company
and approved by state regulatory commissions. Any of the foregoing matters could
result in a material adverse effect on our business, prospects, operating
results and financial condition. See "--Network Architecture and Technology,"
"--Government Regulation" and "--Legal Proceedings."
Additionally, we will need to negotiate interconnection agreements with the
traditional local telephone companies to support our product offerings. In July
1999, we requested interconnection agreements from both Southwestern Bell and
Bell Atlantic covering the following states:
- Southwestern Bell--Texas, Missouri, Oklahoma, Kansas, Arkansas and
Connecticut
- Bell Atlantic--New York, New Jersey, Pennsylvania, Maryland, Connecticut,
Rhode Island, Massachusetts, Vermont, New Hampshire and Maine.
We expect to negotiate these interconnection agreements over the next 90 day
period. The law requires the negotiation period not exceed 130 days unless the
parties are unable to agree on the various terms. Arbitration is required if the
companies are unable to conclude their agreement within the 130-day time frame.
We anticipate signing one-year interconnection agreements with these
telephone companies which will automatically renew on a yearly basis unless
otherwise requested by one of the parties. These agreements are also extensively
regulated by both the state and FCC regulatory agencies.
LONG DISTANCE SERVICE
Today's subscribers are bombarded with various types of calling plans from
long distance companies. However, the restrictions and billing methods with most
of these promotions may raise the actual costs of the service. We offer a
straight forward long distance service for either a switched or dedicated
business customer. The billing rate is a competitive flat rate, seven days a
week, which is billed in six-second increments. We entered the long distance
market in response to demand from our business customers for full service
providers who could deliver a combination of telecommunications services. In
addition to traditional nationwide long distance, we have taken the initiative
to offer new international calling plans for our customers. Further, we offer
our customers dedicated facilities, such as high-speed dedicated lines, to allow
access to our telephone equipment at 60 Hudson Street in New York
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City to allow for connection directly to an international long distance carrier
whose service we resell.
We are exploring opportunities with international telephone companies as
they prepare for deregulation of worldwide telecommunications services.
Currently, we have an arrangement with an international provider that gives us
access to the provider's facilities in New York and Los Angeles and the option
to purchase international usage at the largest provider discount available.
Additionally, we are exploring arrangements with certain competitive local
telephone companies to provide dedicated access to our local facility. This will
allow us to sell a combination of long distance services and to offer discounted
dedicated rates when providing local services from the competitive local
telephone company's facilities. In this manner, very competitive rates can be
offered when using our local phone service. We also offer combined billing and
management reports for our local and long distance services. We are constantly
seeking new markets and alliances as the telecommunications industry continues
to evolve and change due to the effects of deregulation.
We also offer a competitive flat rate with a monthly fee to residential
customers who might not otherwise have been able to obtain a long distance
service as well as to customers attracted to our convenient payment plan. We are
currently licensed to provide our service in 20 states and do so to
approximately 130,000 customers monthly. We have also recently begun to offer
paging services to our customers as the first of other related products that we
intend to distribute to this customer base.
In our residential market, our focus has been on attracting large numbers of
customers through our promotional service offerings. We believe that our
successful marketing techniques in the residential market, coupled with both
local telephone service and Internet access will prove to be an even more
attractive offering to this market segment. Through our direct sales force we
intend to solicit residential customers with various promotional offerings,
including competitive flat rate minute pricing plans. We attribute our success
to maintaining control over the sales and marketing campaigns through our direct
sales force, direct contact with the end-user customer and focusing our efforts
on marketing programs that appeal to various residential and ethnic customers.
We also intend to create customer interest in our products by promoting to a
special or niche interest in our prospective target market by offering a low
promotional price point on a particular portion of our service offering. We
believe that this segment of the marketplace, specific niches of the residential
population are underserved and through creative marketing campaigns including
such promotions as special low rates to international countries will allow us to
be successful in marketing to these customer groups.
We believe that with our marketing experience and the availability of
additional telephone products including local service and Internet access, we
will have an attractive marketing package to sell to our target market. To date,
our sales force has primarily sold our long distance products in Texas and
Illinois. Through the
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combination of the founding companies we will begin to expand upon our products
and open new markets consistent with our expansion plans.
Currently, our sales force consists of approximately 50 employees who
utilize various sales methods in reaching prospective customers. One of our
principal methods of reaching our prospective customers in the residential
market is to station members of our sales force in high traffic retail areas
such as malls, supermarkets, and fairs to promote our products directly. In this
manner, our sales force is able to reach a large prospective audience without
the high fixed selling costs associated with long-term store leases and related
overhead. Additionally, this approach allows us to capitalize on successful
marketing programs and sign up large numbers of customers. To the extent that a
promotional offering does not have the expected appeal, we are able to modify
such and remarket it within days to the same prospective audience.
During 1998, primarily as a result of allegations of slamming and cramming
against us and the terms of various settlements with regulatory authorities and
in part due to changes in the regulatory requirements concerning industry
marketing techniques, we eliminated several successful promotions including
sweepstakes and unmanned displays across our residual markets. These marketing
practices, although very successful in attracting substantial numbers of new
customers, also resulted in an increased number of complaints from customers
alleging the practice of slamming. As a result, we changed our marketing
approach to a direct sales force where we can better verify the identity of our
potential customers and obtain a signed authorization to provide
telecommunications service. Additionally, we instituted strict verification
procedures designed to validate our customer's choice of selecting our long
distance service. As a result of these actions we have concentrated our sales
and marketing focus on the residential segment as discussed above.
Our core residential product offering is long-distance service. We also
provide paging service, 800 service, voice-mail and calling cards, although
these products and services represent a small percentage of total residential
sales. We offer our long distance service through approximately 30 different
pricing plans. However, we generate the vast majority of our sales from several
pricing plans. One of our plans bills a flat rate of $6.95 per month plus
9.9 CENTS per minute for interstate calls and our standard rate for intrastate
calls. International calls are billed at varying prices based on the day and
time, as well as the destination of the call.
We intend to develop additional products and services. In addition to
prepaid calling cards, we will offer a special rate plan for customers who make
a high number of calls to one primary international destination. This plan will
initially be offered to customers with a high number of calls to Mexico. The
success of this initial roll-out will determine the other countries to which we
will provide these services.
We currently have contracts with Frontier Communications and Coastal for
long distance services which we resell to our residential and small to
medium-sized business
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customers. The minimum purchase amounts of our commitment is summarized as
follows:
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003
------------ ------------ ------------ ------------ ----------
<S> <C> <C> <C> <C> <C>
Frontier Communications............ $ 5,585,000 $ 9,000,000 $ 9,000,000 $ 4,200,000 $ 500,000
Coastal............................ $ 53,000 $ 53,000 -- -- --
</TABLE>
We also have established billing arrangements with Southwestern Bell and
Ameritech. Under these agreements both Southwestern Bell and Ameritech provide
billing and collection services to us for our residential customers, and remit
amounts billed and collected net of fees and an allowance for uncollectible
accounts. There are no material minimum purchase amounts required by these
billing arrangements.
NETWORK DESIGN AND WIRING SERVICES
We provide the services of fiber optic technologists for network design and
equipment and wiring installation services. We provide customer solutions for
premise network wiring and system integration. We presently have a network
wiring contract with the State of New York Office of General Services. This
contract enables various state agencies to purchase service directly from us
without the traditional bid process. Under this agreement, we have made strides
in the education market where the Federal Government E Rate program has financed
enhanced data infrastructure in schools and created business arrangements with
companies in various parts of the country to support these needs.
COMBINED SERVICES
We have the ability to offer a combination of all the above services and
offer volume discounts and one-stop shopping for both businesses and residential
customers. Combining services offers additional marketing opportunities as well
as convenience for the customer. Commercial customers have the option of
purchasing local, long distance and dedicated Internet access services over the
same local telephone line delivered to their office. There are few competitive
local telephone companies or other providers in the country offering this range
of services. Residential customers can purchase a unique high-speed Internet
access product as well as local phone service, and long distance in buildings
serviced by us. This capability is an effective marketing tool and provides the
company with a significant identity separate and distinct from others in the
highly competitive telecommunications marketplace.
SALES AND MARKETING
Our marketing goal is to provide a wide range of Internet and
telecommunications related services to our small to medium-sized business
customers and residential customers in our target markets. Our plans include
further expansion into key markets, such as Massachusetts, Connecticut and
several other New England states in addition to other states including
Pennsylvania and Maryland. We currently have a presence and a customer base in
these locations because they contain a large part of
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the population and many of the major markets. The business market is targeted
because of the relatively low penetration of this market for Internet services
and the potential for cross-selling additional services. We believe that our
existing customer base is interested in our combination of products and
services. We also believe that these customers have been traditionally
underserved by larger providers and will look to purchase Internet and
telecommunications services from a single provider. The residential market is
targeted because it provides large numbers of customers who have historically
been serviced by multiple telecommunications providers offering stand-alone
services. For example, most traditional local telephone companies cannot offer
local telephone service, long distance service and Internet access on a single
statement. Additionally, we believe as residential communications needs have
increased, such as the need for multiple phone lines and dial-up Internet
access, the traditional local telephone companies have not kept up with the
growing demand with adequate and flexible service offerings.
In the case of the residential market where we have experience selling long
distance service, we believe that providing access to local telephone service at
prices below the traditional local telephone companies bundled with an Internet
service will be attractive. Though current penetration of Internet service is
low in our residential market, we believe that the advent of low cost personal
computers coupled with the desire of customers for the entertainment and
educational opportunities afforded by the Internet will continue to drive
demand. By combining this product with local service and long distance, we
believe that we will be able to dramatically increase customer retention and
cross-selling opportunities.
During 1998, primarily as a result of allegations of slamming and cramming
against us and the terms of various settlements with regulatory authorities and
in part due to changes in the regulatory requirements concerning industry
marketing techniques, we changed our sales and marketing strategy. Our current
sales and marketing strategy to acquire additional customers is largely focused
on a direct sales approach. We believe that marketing directly to the customer
affords us the opportunity to more fully describe the benefits of our services,
allows for more control over the quality of the marketing and sales
presentations and establishes a clear point of contact with the customer.
Additionally, selling direct to the customer affords us the opportunity to
obtain all required approvals and verifications necessary to provide
telecommunications services.
We plan to leverage our high-speed Internet services as a way to establish
relationships with businesses and consumers alike. By capitalizing on this huge
market opportunity, we will use our Internet offering as our lead product and
then, after successfully reaching our targeted customer, cross-sell our
telecommunications products. Because most businesses already purchase local
phone service and long distance, we will market our telecommunications services
as an alternative to the local telephone companies and as an opportunity to have
one provider handle the business's account. As many of our high-speed Internet
services will involve the configuration and wiring of the customers' premises,
we will be in the position to
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provide additional services, such as virtual private networks and web services
including e-mail, web-site design and web-site hosting.
CUSTOMERS
INTERNET SERVICES. In our Internet service sector, we presently provide or
have agreed to provide service to over 30 buildings who subscribe to our
high-speed InfoHighway DSL and InfoHighway Connect products. The customers we
service with these products are primarily small to medium-sized businesses and
residential customers.
TELECOMMUNICATIONS SERVICES
LOCAL AND LONG DISTANCE SERVICES. In our local and long distance services
sector, we provide data networking and local and long distance services to small
to medium-sized business customers primarily in New York, and to a lesser degree
in New Jersey and Florida. We expect to expand those services to all of our
existing and planned markets. We have already started our marketing efforts to
provide our high-speed internet and web services to these and other business
customers.
We are also involved in a pilot project with Bell Atlantic as a marketing
agent to deliver a package of Internet and telecommunications products to luxury
high rise multiple dwelling units in New York. This pilot project has reinforced
our belief that residential customers want a single provider to offer multiple
telecommunications products while serving as the only point of contact for
service.
In our residential market, we currently service approximately 130,000
customers on a monthly basis with our long distance products. We have recently
introduced a paging product and feel that the ability to offer additional
products to the customer base including local service and Internet access will
both increase customer retention and increase revenue per customer.
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NETWORK DESIGN AND WIRING SERVICES. We have experience as a provider of
network configuration and wiring installation. Over the past two years, we have
generated approximately $8 million in network configuration and wiring revenues.
We have wired several hundred buildings and locations providing voice and data
network capabilities. Our technical team has experience with telephone and
computer network configuration, wiring installations and fiber optics. We
believe that network configuration and wiring installation experience will
enhance our ability to provide our high-speed Internet access products and
services. Some of our largest customers include New York State School districts,
NYC colleges and other state agencies. As of July 31, 1999, we had approximately
$1,550,000 of committed orders for our network design and wiring services.
INTEGRATION STRATEGY
The acquisition of the founding companies creates marketing and operational
synergies that will allow us to bring a complete communications solution to our
customers. Cross-selling opportunities among each of the founding companies'
existing customer bases create significant revenue potential. Billing
integration will allow for single bill capability that will greatly increase
convenience for customers. By combining telecommunications purchasing,
additional volume discounts can be achieved with major vendors and other
strategic partners. Finally, by combining sales and marketing operations and
administration, customer care and billing and collection, additional cost
savings and economies of scale will be achieved.
It is expected that initially, combined and cross-marketed services from the
founding companies will be provided on different types of networks. In the early
stages of integration, we anticipate that we will consolidate our
telecommunications service offerings to take advantage of maximizing vendor
discounts where possible. The technical integration of our operations and
billing systems will be a priority for us. The implementation of our integration
plan will be centered around the development of integrated and expandable
electronic operational support systems that will streamline our operating and
administrative requirements. Our goals for our operational support system
include the following:
- developing application-to-application electronic interfaces with our
vendors including the local telephone companies;
- streamlining customer care requirements including the processing of new
orders and changes to existing customer accounts;
- integrating billing and collection; and
- providing an efficient system of assisting customers reporting problems
with their service.
To accomplish these goals, we expect to utilize a sophisticated, secure,
Internet-based, graphical user interface gateway. This interface will allow our
sales force, agents, customer service representatives as well as our customers
to place orders,
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inquire about an account, review bills and report service troubles
instantaneously. The efficiency of the electronic interface coupled with the
electronic transmittal of transactions to our vendors will allow us to
streamline our service delivery.
We will incur certain expenses in connection with the integration of the
founding companies, which are not expected to be significant. However, the
actual amount of these expenses could be higher than anticipated. Factors that
could increase such costs include any unexpected employee turnover, unforeseen
delays in addressing duplicate facilities once the acquisitions have been
completed and the associated costs of hiring temporary employees, and any
additional fees and charges to obtain consents, regulatory approvals or permits.
We may not achieve the benefits and strategic objectives sought through the
acquisitions. Costs associated with the acquisitions, or liabilities and
expenses associated with the operations of the founding companies, that exceed
our expectations, could have a material adverse effect on our business,
prospects, operating results and financial condition. See "Management's
Discussion and Analysis of Pro Forma Financial Condition and Results of
Operations--Pro Forma Liquidity and Capital Resources."
NETWORK ARCHITECTURE AND TECHNOLOGY
The key design principles of our network are intended to provide:
HIGH-SPEED INTERNET SERVICES. Our InfoHighway DSL and InfoHighway Connect
services were developed to provide dedicated high-speed connections at various
speeds to the Internet. These services provide always-on, secure connections to
the Internet that are up to 24 times faster than a 56k modem. The InfoHighway
DSL service also provides us the ability to configure virtual private networks,
and to manage end-user service configurations from a central location.
REDUNDANCY AND BACKUP. Our network is built to provide maximum uptime for
customers. It maintains multiple connections into the Internet's main network
providers to ensure connectivity even during power outages. It also maintains
all of its data on servers that are backed up by an online data back up system.
This means that in the event of a server outage, data can be immediately
recovered and that data loss and customer down time are minimized. Finally, we
maintain working, ready to deploy spares in our primary computer center so that
any equipment outage is generally not noticed by customers.
FLEXIBLE AND EXPANDABLE NETWORK. We have designed and built our network
with the maximum amount of flexibility in mind. As we grow, we will add capacity
to our network. Through an agreement with multiple major carriers, we are able
to expand our network within 48 hours of being requested. We are also installing
equipment that allows upgradability to new features and allows us to offer new
services in the future. We use servers from Ascend Communications which can be
upgraded to provide new products and services, such as virtual private networks
and transmitting voice telephone traffic through the Internet.
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COMPETITION
The markets for business and consumer telecommunications and data services
are intensely competitive and we expect that such markets will become
increasingly competitive in the future. Our most immediate potential competitors
are the traditional local telephone companies, long distance service providers,
Internet service providers, wireless data service providers and other
competitive local telephone companies. Many of these competitors are offering,
or may soon offer, technologies and services that directly compete with some or
all of our high-speed digital services and telecommunications services. We
believe that the traditional distinctions between the local, long distance, data
and Internet access markets are eroding. The principal bases of competition in
our markets include transmission speed, reliability of service, breadth of
service availability, price/performance, network security, ease of access and
use, combinations of services, customer support, brand recognition, operating
experience, capital availability and exclusive contracts. We believe that we
compare unfavorably with our competitors with regard to, among other things,
brand recognition, operating experience, exclusive contracts, and capital
availability. Many of our competitors and potential competitors have
substantially greater resources than do we and there can be no assurance that we
will be able to compete effectively in our target markets.
TRADITIONAL LOCAL TELEPHONE COMPANIES. BellAtlantic, Ameritech and
Southwestern Bell are the largest traditional local telephone companies present
in our target markets. Each of these traditional local telephone companies
dominates the local telephone market and is aggressively seeking authority to
provide in-region long distance service to its existing customers. The
traditional local telephone companies represent strong competition in all of our
target service areas. The traditional local telephone companies have an
established brand name and reputation for high quality in their service areas,
possess sufficient capital to deploy long distance and high-speed internet
services, have their own copper lines and can combine digital data services with
their existing analog voice services to achieve economies of scale in serving
customers. Certain of the traditional local telephone companies have
aggressively priced their consumer high-speed internet services as low as
$30-$40 per month, placing pricing pressure on our InfoHighway DSL and
InfoHighway Connect services. Accordingly, we may be unable to compete
successfully against the traditional local telephone companies, and any failure
to do so would materially and adversely affect our business, prospects,
operating results and financial condition. See "Risk Factors-- Competition in
our industry is intense and growing, and we may be unable to compete
efficiently."
LONG DISTANCE PROVIDERS. Long distance providers such as AT&T, Sprint, and
MCI WorldCom are the largest long distance providers and have begun or plan to
begin offering local telephone service. Additionally, each of these competitors
has deployed large-scale Internet access and data transport networks, sell
connectivity to businesses and residential customers, and has high brand
recognition. They also have
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interconnection agreements with many of the traditional local telephone
companies and a number of facilities from which they are currently offering or
could begin to offer competitive local telephone services.
COMPETITIVE LOCAL TELEPHONE COMPANIES. Companies such as Teleport
Communications Group, Inc. (acquired by AT&T), Brooks Fiber Properties, Inc.
(acquired by WorldCom) and MFS (acquired by MCI WorldCom) have extensive data
networks based on fiber wiring in many metropolitan areas primarily providing
high-speed digital and voice circuits to large corporations. They also have
interconnection agreements with the traditional local telephone companies
pursuant to which they have acquired facilities in many markets targeted by us.
These companies are modifying or could modify their current business focus to
include residential and small business customers using a combination of services
including local, long distance and DSL service in combination with their current
fiber networks.
INTERNET AND ONLINE SERVICE PROVIDERS. Internet service providers such as
BBN (acquired by GTE), UUNET Technologies (acquired by WorldCom), Earthlink
Networks, Concentric Network, Mindspring Enterprises, Netcom On-Line
Communication Services and PSINet provide Internet access to residential and
business customers, generally using the existing local telephone company's
network at ISDN speeds or below. Some Internet service providers such as UUNET
Technologies in California and New York, HarvardNet Inc. and InterAccess have
begun offering DSL services. In addition, online service providers such as
America Online, MSN (a subsidiary of Microsoft Corp.) and WebTV (acquired by
Microsoft Corp.) provide over the Internet and on proprietary online services
content and applications ranging from news and sports to consumer video
conferencing. These services are designed for broad consumer access over
telecommunications-based transmission media, which enable the provision of
digital services to the significant number of consumers who have personal
computers with modems.
CABLE MODEM SERVICE PROVIDERS. Cable modem service providers such as @Home
Network and MediaOne are deploying high-speed Internet access services over
cable networks. Where deployed, these networks provide similar and in some cases
higher-speed Internet access than we provide. They may also offer these services
at lower prices than our InfoHighway DSL and InfoHighway Connect services and
target residential consumers, as well as business customers. They achieve these
lower prices in part by offering a consumer grade of service, which shares the
capacity available on the cable network among multiple end-users. This
architecture is well-suited to compete with our consumer Internet market but is
less suited to our markets for business Internet access. Also, much of the
current cable infrastructure in the U.S. must be upgraded to support cable
modems, a process which we believe is significantly more expensive and
time-consuming than the deployment of traditional networks. Actual or
prospective cable modem service providers competition may have a significant
negative effect on our ability to secure customers and may create downward
pressure on the prices we can charge for our services. In addition, cable
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modem service providers have or may enter into the telecommunications services
markets.
WIRELESS AND SATELLITE DATA SERVICE PROVIDERS. Wireless and satellite data
service providers are developing wireless and satellite-based Internet
connectivity. We may face competition from these providers and other competitors
using various microwave frequencies. For example, the FCC has adopted new rules
to permit multi-channel microwave distribution system licensees to use their
systems to offer two-way services, including high-speed data, rather than solely
to provide one-way video services. The FCC also recently auctioned spectrum for
local multi-channel distribution system services in all markets. This spectrum
is expected to be used for wireless cable and telecommunications services,
including high-speed digital services. In addition, companies such as Teligent
Inc., Advanced Radio Telecom Corp. and WinStar Communications, Inc., hold
point-to-point microwave licenses to provide services such as voice, data and
video conferencing.
We also may face competition from satellite-based systems. Motorola
Satellite Systems, Inc., Hughes Communications (a subsidiary of General Motors
Corporation), Teledesic and others have filed applications with the FCC for
global satellite networks which can be used to provide high capacity voice and
data services, and the FCC has authorized several of these applicants to operate
their proposed networks.
OTHER COMPETITIVE DATA AND LOCAL TELEPHONE COMPANIES. Other companies such
as Rhythms NetConnections and NorthPoint Communications offer high-speed digital
services similar to ours. The 1996 Act specifically grants competitive local
telephone companies the right to negotiate interconnection agreements with the
traditional local telephone companies. Further, the 1996 Act allows competitive
local telephone companies to enter into interconnection agreements which can be
and are identical to other competitors.
GOVERNMENT REGULATION
OVERVIEW. Our communications services are subject to extensive federal,
state and local regulation. Through ARC and AXCES we hold various federal and
state authorizations for our regulated services. The FCC has jurisdiction over
all our services and facilities to the extent those facilities are used to
provide interstate domestic or international telecommunications services. State
regulatory commissions retain jurisdiction over our facilities and services to
the extent those facilities are used to provide intrastate services. In
addition, local municipal government authorities may require carriers to obtain
licences or franchises to install facilities that cross public rights-of-way.
Most data and Internet services are not currently subject to regulation, though
communications services used for access to the Internet are regulated. Many of
the regulations issued by these federal, state and local regulatory bodies may
change and are the subject of various judicial proceedings, legislative hearings
and administrative proposals. We cannot predict the results of any changes.
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FEDERAL REGULATION. Our provision of telecommunications services must
comply with the requirements of the Communications Act of 1934, as amended by
the 1996 Telecommunications Act, as well as regulations promulgated by the FCC
under the Act. The FCC regulates us as a non-dominant common carrier. Our
interstate and international services are not subject to significant regulation
although we must file tariffs with the FCC for these services. We have obtained
authority from the FCC to provide international services between the United
States and foreign countries. The FCC must approve the transfer of control or
assignment of our international authorization. The FCC has the authority to
condition, modify, cancel or revoke our international authorization if we do not
comply with federal law, or the rules, regulations and policies of the FCC. The
FCC may also impose fines or other penalties for such violations.
The 1996 Act eliminates many of the pre-existing legal barriers to
competition in the telecommunications and video programming communications
businesses, preempts state and local laws that prevent competitive entry, and
sets basic standards for relationships between telecommunications providers. The
law delegates to the FCC and the states broad regulatory and administrative
authority to implement the 1996 Act.
Among other things, the 1996 Act requires traditional local telephone
companies to:
- interconnect their networks with competitors;
- offer to locate competitors' equipment at their premises;
- make available elements of their networks on non-discriminatory,
cost-based terms;
- offer retail services for resale at discounted rates; and
- provide nondiscriminatory access to telephone poles, ducts, conduits, and
rights-of-way.
All competitive local telephone companies, including us, are required to:
- complete calls originated by competing carriers;
- permit resale of services;
- permit users to retain their telephone number when changing carriers; and
- provide equal access for the origination and termination of long distance
calls.
These requirements recognize that local telephone competition is dependent upon
cost-based and non-discriminatory interconnection with and use of traditional
local telephone company networks, including the location of equipment with such
networks. Failure to achieve such interconnection or location of equipment
arrangements could have a material adverse impact on our ability to provide
local telephone services. The
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FCC has adopted specific rules to implement the local competition requirement of
the 1996 Telecommunications Act.
On January 25, 1999, the United States Supreme Court affirmed the authority
of the FCC to establish rules governing interconnection. However, the Supreme
Court remanded to the FCC issues regarding which individual components of the
traditional local telephone companies' telephone network they must make
available to competitive local telephone companies. We cannot predict what
decision the FCC will reach. An adverse decision could affect our local service
product.
The 1996 Act also allows the traditional local telephone companies to enter
the long distance market within their own local service regions upon meeting
certain requirements to open local telephone markets to competition. To date,
the FCC has rejected each traditional local telephone company's application to
provide long distance service and it is uncertain when the FCC will grant the
first request. Bell Atlantic has sought a ruling from the New York Public
Service Commission that it has met the market opening requirements. If approval
is received from the New York Public Service Commission, Bell Atlantic must file
with the FCC for approval. The timing of the various traditional local telephone
companies in-region long distance entry will likely affect the level of
cooperation we receive from each of the traditional local telephone companies.
Long distance companies purchase interstate access service from local
telephone companies to reach end users. Interstate access rates make up a
significant portion of the cost of providing long distance services. On August
5, 1999, the FCC adopted an order that gives traditional local telephone
companies greater flexibility in setting interstate access rates as competition
develops. In part, this flexibility includes the ability to provide term and
volume discounts which may be more advantageous to long distance carriers that
are larger than we are.
The 1996 Telecommunications Act allows the FCC to take explicit regulatory
action in order to encourage the deployment of high-speed, broadband advanced
services to all Americans. The FCC is considering a proposal that would allow
traditional local telephone companies to offer these services through separate
affiliates, whose facilities would not be made available to us or other
competitors for interconnection or resale. Our inability to meet future demand
for broadband local services may put us at a competitive disadvantage.
To date, the FCC has not asserted jurisdiction over companies that provide
Internet access services. However, the FCC is considering the applicability of
access charge and other service fees to Internet service providers. If the FCC
imposes access charges or other service fees on Internet service providers in a
way that affects our services more than that of our competitors, such action
could have a material adverse impact on our business.
STATE REGULATION. We provide intrastate telecommunications that are subject
to various state laws and regulations. To date, we are authorized to operate as
a
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competitive local telephone company in New York, Florida, Michigan and
Connecticut and intend to obtain authorization in the other states necessary to
cover our target regions. We must obtain such authorizations before providing
service. We are also authorized to provide intrastate long distance services in
approximately 20 states. In most states, we are required to file and keep
current tariffs setting forth our rates, terms and conditions for our intrastate
services. We are also subject to various reporting requirements in these states.
Some of the states in which we hold competitive local telephone company and
long distance licenses must approve the changes in ownership of ARC and AXCES,
as well as the issuance of the securities contemplated in this offering.
Applications for approval of the change in ownership of ARC are pending in
California and Pennsylvania. An application for approval of the acquisition of
AXCES is pending in Missouri.
LOCAL GOVERNMENT REGULATION. In certain instances, we may be required to
obtain various permits and authorizations from municipalities in which we
construct and operate our own facilities. In some jurisdictions, we may be
required to pay franchise fees or other fees for access to public rights-of-way.
The actions of municipal governments in imposing conditions on the grant of
permits or other authorizations or their failure to act in granting such permits
or other authorizations could have a material adverse effect on our business,
prospects, operating results and financial condition.
Other existing federal regulations are currently the subject of judicial
proceedings, legislative hearings and administrative proposals, which could
change, in varying degrees, the manner in which communications companies operate
in the U.S. The ultimate outcome of these proceedings, and the ultimate impact
of the 1996 Act or any final regulations adopted pursuant to the 1996 Act on us
or our business cannot be determined at this time but may well be adverse to our
interests. We cannot predict the impact, if any, that future regulation or
regulatory changes may have on our business and there can be no assurance that
such future regulation or regulatory changes will not have a material adverse
effect on our business, prospects, operating results and financial condition.
See "Risk Factors--Our business strategy depends upon securing and maintaining
interconnection agreements with local providers" and "--Our business is highly
regulated and may be adversely affected by future changes in governmental
regulations relating to our industry."
INTERNET REGULATIONS. The law governing the liability of online service
providers and Internet access providers for participating in the hosting or
transmission of objectionable materials or information currently remains
unsettled. Under the terms of the 1996 Telecommunications Act, courts can impose
civil and criminal penalties for the use of interactive computer services for
the transmission of certain indecent or obscene communications. The United
States Supreme Court in 1997 held this provision unconstitutional as it relates
to indecent, but not obscene, communications. In October 1998, Congress enacted
the Child Online Protection Act, which requires
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that online material that is "harmful" to minors be restricted. This law is
currently being challenged and on February 1, 1999 a U.S. District Court judge
issued a preliminary injunction against enforcement of portions of that act. The
U.S. Justice Department has filed an appeal of the February 1999 ruling. Also,
certain states have adopted and other states may adopt similar restrictions on
the transmission of objectionable materials over the Internet. The
constitutionality of such state requirements remains unsettled at this time. In
addition, several private parties have filed lawsuits seeking to hold Internet
service providers accountable for information that they transmit, such as
libelous material and copyrighted material. We cannot predict the outcome of
this litigation or the potential for the imposition of liability on Internet
service providers for information that they host, distribute or transport. These
suits and other regulations could materially change the way Internet service
providers must conduct business and could impact our determination to expand or
continue this business. To the extent that we become parties to future
litigation, such litigation could have a material adverse effect on our
business, prospects, operating results and financial condition.
INTELLECTUAL PROPERTY
We regard our products, services and technology as proprietary and will
attempt to protect it with copyrights, trademarks, trade secret laws,
restrictions on disclosure and other methods. There can be no assurance these
methods will be sufficient to protect our technology. We also generally enter
into confidentiality or license agreements with our employees and consultants,
and generally control access to and distribution of our documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use our products, services or
technology without authorization, or to develop similar technology
independently. In addition, effective copyright, trademark and trade secret
protection may be unavailable or limited in certain foreign countries. There can
be no assurance that the steps we have taken and will take will prevent
misappropriation or infringement of our technology. In addition, litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation could result in substantial costs
and diversion of resources and could have a material adverse effect on our
business, prospects, operating results and financial condition.
"InfoHighway-TM-," "InfoHighway DSL-TM-," "InfoHighway Connect-TM-," "ARC
Networks-TM-," "AXCES-TM-" and the InfoHighway logo names are our marks. This
prospectus contains our other product names, trade names and trademarks and
those of other organizations.
EMPLOYEES
As of May 31, 1999, we had 166 employees employed in engineering, sales,
marketing, customer support and related activities, and general and
administrative functions. None of our employees is represented by a labor union,
and we consider
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our relations with our employees to be good. Our ability to achieve our
financial and operational objectives depends in large part upon the continued
service of our senior management and key technical, sales, marketing and
managerial personnel, and our continuing ability to attract and retain highly
qualified technical, sales, marketing and managerial personnel. Competition for
such qualified personnel is intense, particularly in software development,
network engineering and product management.
FACILITIES
Our facilities are all located in the United States and consist of eight
leased facilities. We lease our corporate headquarters office in Hauppauge, New
York and lease a sales office from a related party in New York City on a
month-to-month basis, and have two branch offices under lease in Houston, Texas.
See "Certain Relationships and Related Transactions." We lease sales offices in
San Antonio and Dallas, Texas, and Chicago, Illinois. We have a warehouse for
our data wiring operations in Hauppauge, New York under lease. Our current
leases have remaining terms ranging from less than six months to four years.
We consider our current facilities adequate for our current needs and
believe that suitable additional or replacement space will be available, as
needed, to accommodate further physical expansion of our operations or
relocation.
LEGAL PROCEEDINGS
From time to time we may be involved in litigation that arises in the normal
course of business operations. As of the date of this prospectus and except as
described below, we are not a party to any litigation that we believe could
reasonably be expected to have a material adverse effect on our business or
results of operations.
ARC
In January 1999, ARC was served with a summons from the State Supreme Court
of New York, County of New York, by Mitel Telecommunications Systems, Inc., for
a breach of contract claim in the amount of $1,715,000 relating to wiring and
installation services for which ARC has been paid in full. As is customary, ARC
recorded this payment as a liability for unearned contracts. ARC believes the
action is without merit and filed a motion to dismiss the action based on
numerous defenses available to it. In addition, ARC continues to perform all
requested services under the contract from Mitel with Mitel's consent, thereby
reducing the liability over time. As of June 30, 1999, ARC estimates that its
maximum exposure resulting from this claim was $1,290,000 and has reduced the
liability to that amount. Since that time, as additional contract work has been
performed, ARC has further reduced the liability to approximately $1 million. In
June 1999, Mitel amended its summons to include Consolidated Technology Group,
Ltd., SIS Capital Corp., Technology Acquisitions, Ltd., and the officers,
directors and shareholders of ARC, Consolidated, SIS and Technology
Acquisitions, Ltd. Consolidated and SIS were parent companies
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of ARC prior to its acquisition in June 1999. Technology Acquisitions is
controlled by Benchmark Equity Group and acquired 67% of ARC prior to our
acquisition of ARC.
In March 1999, ARC was served with a summons from the State Supreme Court of
New York, County of Orange, by an employee of a customer of ARC located in
Thiells, N.Y., for $1,000,000. The employee claims to have fallen over wiring
which was negligently installed by ARC. ARC has a liability insurance policy
which should provide sufficient coverage in the event the plaintiff's claim is
successful. ARC believes the action is without merit and filed a motion to
dismiss the action based on numerous defenses available to it.
AXCES
AXCES has been involved in a number of lawsuits and administrative
proceedings in various states in which it was alleged to have been engaged in
the practices of slamming and cramming. To date, AXCES has paid approximately
$205,000 in settlement of certain of these claims. The following claims have
either been settled or dismissed:
- STATE OF TEXAS V. AXCES, INC. in the 234th Judicial District Court of
Harris County, Texas. The Office of the Attorney General for the State of
Texas brought claims under the Texas Deceptive Trade Practices Act
alleging that AXCES had engaged in slamming. The Office of the Attorney
General sought to restrain certain marketing practices and to assess
damages in excess of $150,000. AXCES settled the case for $55,000 on June
30, 1998. The case was dismissed with prejudice on July 16, 1998.
- THE PUBLIC UTILITY COMMISSION OF TEXAS. In January 1998, AXCES was
notified by the Public Utility Commission of Texas that the Commission
intended to levy fines against AXCES for slamming. In February 1998, AXCES
received a second notice that the Commission intended to levy fines
against AXCES for slamming. On June 11, 1998, the Commission approved a
settlement between AXCES and the Commission. AXCES agreed to pay the
Commission $100,000 in equal monthly installments beginning June 1, 1998,
and continuing until May 1, 1999. The settlement also included Commission
approval of the documents used to obtain new customer authorization for
the transfer of telecommunications services from their current provider to
AXCES.
- PEOPLE OF THE STATE OF ILLINOIS V. AXCES, INCORPORATED in the United
States District Court for the Northern District of Illinois, Eastern
Division. The Attorney General for the State of Illinois alleged AXCES had
engaged in or facilitated the practice of slamming. AXCES settled the case
in March 1999 for $50,000.
- BILL BURNETT V. AXCES. The Oklahoma Corporation Commission/Consumer
Service Division brought two claims of unauthorized switches against
AXCES. Although AXCES denied the allegations, in September 1998, an
administrative
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judge found against AXCES imposing a fine of $15,000 and ordering that
AXCES' Certificate of Convenience and Necessity be revoked if AXCES is
found guilty of any additional slamming acts. AXCES appealed the decision
to the Commissioners of the Oklahoma Commerce Commission. On August 31,
1999, the Commission found that an order should issue adopting the initial
findings and recommendation of the administrative judge, but withdrew the
fine imposed. A final order is due on October 1, 1999.
- WILLIE BURNETT, DIRECTOR OF CONSUMER SERVICES DIVISION V. AXCES, INC. in
the Corporation Commission of the State of Oklahoma. In December 1997, a
complaint was filed by the Director of the Consumer Services Division of
the Oklahoma Corporation against AXCES alleging that AXCES had performed
an unauthorized switch. AXCES settled the matter for $500.
- MATTHEWS V. SOUTHWESTERN BELL in the 55th Judicial District Court of
Harris County, Texas. This case is a putative class action alleging that
Southwestern Bell fraudulently included charges on customers' telephone
bills, a practice referred to as cramming. In June 1999, an order of
non-suit was signed and all claims against AXCES were dismissed.
In addition the following claims are currently pending:
- THE PUBLIC UTILITY COMMISSION OF TEXAS. In May 1999, the Public Utility
Commission informed AXCES that it had received additional complaints
concerning slamming allegations, and that it was seeking administrative
penalties of approximately $400,000. AXCES believes these claims are
without merit and covered by the prior settlement with the Commission.
- THE PUBLIC UTILITY COMMISSION OF TEXAS. In August 1999, AXCES received a
notice from the Public Utility Commission that the Commission intended to
levy fines against AXCES for switching customers' long distance service
without proper authorization. AXCES is currently in the process of
evaluating these claims and has the right to participate in a preliminary
settlement conference with the Commission or may proceed to defend itself
in an administrative hearing.
- STATE OF MISSOURI, EX. REL. JEREMIAH W. (JAY) NIXON V. AXCES, INCORPORATED
in the Circuit Court of Jackson County, Missouri at Kansas City. This case
seeks damages and penalties stemming from allegations of slamming and
cramming on the part of AXCES. The case was removed to federal court and
then remanded back to state court. The parties have engaged in preliminary
discovery and have had some limited settlement discussions.
- FRANCISCO D. SALDIVAR, INDIVIDUALLY AND ON BEHALF OF THE PLAINTIFF CLASS
V. AXCES, INC., D/B/A AXCES GLOBALCOM, INC., AND MICHAEL AVIGNON in the
138th Judicial District of Cameron County, Texas. This case seeks
damages, class certification, and penalties stemming from allegations of
slamming and deceptive advertising with respect to Spanish-speaking
individuals in the
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Brownsville, Texas area. No amount of damages is set forth in the
pleadings and the number of persons potentially affected is not presently
estimable. AXCES has recently answered the suit and is currently
undertaking discovery efforts.
- DARREN PEDROZA, INDIVIDUALLY AND ON BEHALF OF ALL OTHERS SIMILARLY
SITUATED, AXCES, INC., D/B/A AXCES GLOBALCOM, INC., in the 348th Judicial
District Court of Tarrant County, Texas. This case seeks damages and
penalties and potential class certification relating to violations of the
Texas Deceptive Trade Practices Act and Consumer Protection Act. More
specifically, this case involves allegations of unauthorized switches of
long distance service based on the letters of agency that were in use at
the time. No amount of damages is set forth in the pleadings and the
number of persons potentially affected is also not presently estimable.
- DANIEL AND SARA MILLER V. AXCES OF DELAWARE, INC. DBA AXCES, INC. in the
State Court of Johnson County, Kansas. The plaintiffs have brought claims
based on allegations of an unauthorized switch in their long distance
service and appear to have demanded compensation in the range of $5,000 to
$20,000. AXCES recently answered this claim and denied any liability for
the complained of conduct.
- FREDDIE MAE WATSON VS. MTM HOLDINGS CORPORATION AND AXCES, INC. in the
244th Judicial District Court of Ector County, Texas. The plaintiff has
brought claims based on allegations of an unauthorized switch in her long
distance services. She has not stated the amount of damages she is seeking
although the degree of risk or exposure appears relatively nominal. AXCES
recently answered this claim and has denied any liability for the conduct
complained of. It is also AXCES' position that the plaintiff never had an
account with AXCES.
- OFFICE OF THE ATTORNEY GENERAL OF THE STATE OF KANSAS. In December 1998,
AXCES received a subpoena from the Office of the Attorney General of the
State of Kansas, Consumer Protection/Antitrust Division. The subpoena was
issued under the authorization of the Kansas Consumer Protection Act and
sought information with regard to unauthorized switches and the use of
sweepstakes boxes to gather letters of agency. AXCES responded to the
subpoena in January and February of 1999. The Office of the Attorney
General has requested that AXCES agree to assessment of an administrative
penalty in the amount of $100,000, based on the conduct cited in the
initial inquiry. AXCES believes this request is without merit.
Accordingly, AXCES has rejected this proposal, although it is willing to
continue settlement discussions with the State.
- ARKANSAS PUBLIC SERVICES COMMISSION. In November 1998, AXCES received
Staff Interrogatory JPB-1 from the Arkansas Public Services Commission,
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Utilities Division. The interrogatory sought information with regard to
switches in Arkansas consumers' long distance service and complaints
regarding same. AXCES responded to the interrogatory in January of 1999.
Since the date of the response, there has been no further communication
from the Arkansas Public Service Commission, Utilities Division.
- STATE OF WISCONSIN. In November 1998, AXCES received an inquiry from the
State of Wisconsin with regard to a consumer complaint of Mr. Michael
Orville. Pursuant to the states' request, AXCES investigated Mr. Orville's
complaint and provided the State of Wisconsin documents regarding same.
Since December 3, 1998, there has been no further action on this matter.
- JUSTICE COURT OF HARRIS COUNTY. On November 7, 1997, Jolanda Jones filed
a claim in the Justice Court of Harris County alleging AXCES had
improperly switched her long distance telephone service. AXCES filed an
answer denying the allegation. The parties have engaged in written
discovery. Ms. Jones has not pursued her claims since receiving AXCES'
responses to her discovery requests.
- JUSTICE COURT AT HARRIS COUNTY. On June 2, 1999, Hosne Ara Begum filed a
claim in the Justice Court of Harris County alleging that AXCES had
improperly switched his long distance service. AXCES filed an answer
denying the allegation. There have been some preliminary settlement
discussions to try and resolve this matter.
AXCES believes these claims are without merit, that it has meritorious
defenses to them and intends to vigorously defend itself against these
claims.
Pursuant to the AXCES acquisition agreement, MTM and its owners have agreed
to indemnify us for any damages incurred in connection with pending litigation
and administrative proceedings on the same basis as we are indemnified for any
breaches of representations and warranties made by AXCES in the acquisition
agreement except that the indemnity does not cover attorneys' fees and
litigation costs. Because of this, MTM and its owners will be required to
indemnify us for breaches of representations and warranties in the acquisition
agreement and liabilities incurred in the pending litigation to the extent that
such amounts exceed, in the aggregate, $200,000, and for any tax liability of
AXCES, MTM and its owners that exceeds $1.6 million in the aggregate. However,
the indemnification threshold related to litigation shall increase to the extent
of AXCES' net income plus noncash expenses for the period from May 1, 1999 until
the closing of the acquisition, less any amounts used to pay agreed settlements
of the scheduled litigation. The aggregate liability of MTM and its owners may
not exceed the value of the shares of our common stock issued to MTM on the
closing, plus the value of the shares of our common stock issuable on conversion
of the series B preferred stock. The value of each share of our common stock is
set at the initial public offering price. In addition, the aggregate liability
of any owner of MTM may not exceed $2,000,000.
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IN GENERAL
The founding companies have also been subject to other legal proceedings
which have arisen in the ordinary course of business and have not been fully
adjudicated. In addition, we routinely receive inquiries from state and federal
regulatory authorities concerning consumer billing complaints which we respond
to. Although there can be no assurance as to the ultimate disposition of these
matters and the proceedings disclosed above, in the opinion of management, based
upon information available at this time and the availability of indemnification
from AXCES discussed above, the cost of defense or settlement of these actions,
individually or in the aggregate, will not have a material adverse effect on our
financial position or results of operations.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below are the names, ages, and positions of our directors and
executive officers. All directors hold office until their successors are duly
elected and qualified and all executive officers hold office at the pleasure of
the board of directors.
<TABLE>
<CAPTION>
DIRECTOR
NAME AGE POSITION CLASS
- --------------------------------------------- --- --------------------------------------------- -------------
<S> <C> <C> <C>
Joseph A. Gregori........................... 45 Chief Executive Officer and Director Class 3
*Peter Parrinello............................ 50 Chairman, Board of the Directors and Class 3
President
Peter Karoczkai............................. 38 Senior Vice President of Sales and Marketing
Charles N. Garber........................... 51 Chief Financial Officer
*Tony Howlett................................ 30 Chief Technical Officer
*Glenn Kramer................................ 52 President of Internet Services and Director Class 1
*Harry Bennett (1)(2)........................ 54 Director Class 2
Christopher Efird (1)....................... 35 Director Class 1
*Weatherly nominee (1)(2)(3)................. -- Director Class 2
*Michael Macaluso............................ 47 Director Class 3
</TABLE>
- ---------------------
* Appointment will become effective upon closing of this offering.
(1) Member of the compensation committee.
(2) Member of the audit committee.
(3) We have agreed for a period of three years after the date of this
prospectus, if requested by the representative, to use our best efforts to
nominate one person designated by the representative for election to our
board of directors. See "Underwriting."
JOSEPH A. GREGORI. Mr. Gregori became our Chief Executive Officer and a
director upon consummation of the acquisition of ARC in June 1999. Over the last
25 years, Mr. Gregori has had extensive business experience in the wireless
telecommunications industry and public accounting. Prior to joining ARC in June
1998, Mr. Gregori was Chief Operating Officer for PriCellular Corp., (d/b/a,
Cellular One), an AMEX listed rural cellular telephone provider. Mr. Gregori
joined PriCellular in September 1996 and served as Chief Operating Officer until
June 1998, when PriCellular was acquired by American Cellular Corp. From 1986
through April of 1996, Mr. Gregori was employed by Nationwide Cellular Service,
Inc., a Nasdaq listed reseller of cellular telephone service. Mr. Gregori served
in a number of senior positions, including Vice President of Operations, Chief
Operating Officer and finally as President. Nationwide Cellular was acquired by
MCI in October of 1995 and
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Mr. Gregori served as President of MCI Wireless until he resigned his position
in April 1996. Mr. Gregori began his professional career in public accounting
and worked in the audit department of Deloitte Touche (formerly Touche Ross) as
a senior manager. He is an honors graduate (Magna Cum Laude) of Adelphi
University and is a CPA.
PETER PARRINELLO. Mr. Parrinello will become our Chairman of the Board and
President upon the consummation of this offering. Chief Executive Officer and
founder of ARC, Mr. Parrinello was formerly Executive Vice President of Avionics
Research Corporation, where he established the engineering firm's
telecommunications division. In 1993, this division took the name of ARC and
became one of the first re-sellers of local telephone service in the United
States. Mr. Parrinello's background in telecommunications spans over twenty-five
years starting with Military Networks in Southeast Asia in the late 1960's and
early 70's. His professional career began at New York Telephone in Central
Office Operations in 1971 and later moved to Litton Industries during the
establishment of the interconnect industry in 1972. Mr. Parrinello started with
Tel Plus in 1975 during the inception of that company and served to develop new
markets. Seimens Corporation later acquired TelPlus. Mr. Parrinello received his
BS at New York Institute of Technology at Old Westbury (Cum Laude), in
Electrical Engineering and Business Administration.
PETER KAROCZKAI. Mr. Karoczkai has served as our Senior Vice President of
Sales and Marketing since July 1999. From March 1997 through July 1999, Mr.
Karoczkai was Vice President, Marketing and Product Management for Bell Atlantic
Telecom Industry Services, Bell Atlantic Corporation's wholesale division which
has estimated revenues of $1 billion in 1999. From July 1995 through March 1997,
Mr. Karoczkai was the Managing Director, Resale Services of NYNEX Corporation,
where he established the company's resale division. From September 1992 through
July 1995, Mr. Karoczkai was Director, Marketing for NYNEX Mobile Communications
Company, managing NYNEX Mobile's reseller channel and developing channel
strategy for the company's agent, direct and telemarketing distribution. Mr.
Karoczkai began his career in marketing computer networks and services for
technology companies. Mr. Karoczkai received his BS in Marketing Management from
the University of North Carolina at Greensboro and his MBA in Marketing and
International Management from New York University.
CHARLES N. GARBER. Mr. Garber has served as our Chief Financial Officer
since July 1999. From June 1998 through December 1998, Mr. Garber was Chief
Financial Officer at DigiTEC 2000, Inc., a publicly traded telecommunications
startup company. From July 1996 through June 1998, Mr. Garber was Chief
Financial Officer of SpeedUS.com, Inc., a publicly traded Internet and media
startup company. From December 1994 through June 1996, Mr. Garber was Senior
Vice President of Corporate Planning and Strategic Development of ICS
Communications, Inc., a media and telecommunications company. In his twenty-five
year telecommunications career,
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Mr. Garber has held executive positions with AT&T, Bell Atlantic, Cincinnati
Bell, Inc., BellSouth Capital Funding and BellSouth Corporation. Mr. Garber was
involved in AT&T's divestiture of the Bell companies and BellSouth's
diversification program. In addition, he completed over $2 billion in merger and
acquisition transactions and the closings of approximately $2.5 billion in
financings. Mr. Garber is an honors graduate of Virginia Polytechnic Institute &
State University with a BS in Electrical Engineering and an MBA in Finance. He
is a Chartered Financial Analyst and a member of the New York Society of
Security Analysts.
TONY HOWLETT. Mr. Howlett will become our Chief Technical Officer upon
consummation of the acquisition of InfoHighway International. Mr. Howlett
founded InfoHighway International in 1994 and was one of the principal
shareholders of InfoHighway International. Previously, from April 1993 to July
1994 he was the owner of Howlett Consulting Company, a database and networking
consulting firm, and a sales engineer from 1989 to 1993 for MCP, a personal
computer reseller providing networking technologies to Fortune 1000 firms. He
was a contributing editor to Texas Computing Magazine. Mr. Howlett holds a BBA
in Management Information Systems from the University of Houston.
GLENN KRAMER. Mr. Kramer will become our President of Internet Services and
a director upon consummation of the acquisition of InfoHighway International.
Mr. Kramer, a 25-year veteran of the computer industry, has served in a number
of management capacities throughout his career. He served as Southern Regional
Manager for SCM Corporation from 1970 to 1972, as Marketing Manager for National
Business & Security Systems, Inc. from 1972 to 1976 and 1978 to 1987, and as
Eastern Regional Manager of Mylee Digital Sciences, Inc. from 1976 to 1978. As
the President and Chief Executive Officer of Classic Configurations, Inc. from
1987 to 1996, he was the architect of a national computer dealer franchise. He
has also served as a consultant to a number of industry leaders such as Hewlett
Packard, Digital, Novell, and MicroAge. Mr. Kramer attended the University of
Maryland where he pursued a liberal arts education.
HARRY BENNETT. Mr. Bennett will become a director upon consummation of this
offering. Mr. Bennett has served as Chairman and Chief Executive Officer of
TelaLink Network, Ltd. since 1998. Mr. Bennett served as Executive Vice
President, Local Services for AT&T from 1993 to 1998. During his 25-year career
with AT&T, he was responsible for the phone giant's move into local service
markets across the United States after passage of the Telecommunication Act of
1996. Bennett was named to this position January 1, 1996, and was responsible
for local services activities in both the consumer and business markets.
Previously, Bennett had been vice president and general manager for AT&T's
IntraLATA/Local Markets organization, where he led AT&T's activities in
IntraLATA and local access markets, developing new markets to increase AT&T's
revenues from sources other than its traditional long-distance services base.
Bennett joined AT&T in 1973 as an operations supervisor in Washington, D.C. He
later served as National Account Manager in Chicago and then
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Division Manager--Market Management at AT&T Communications. Bennett joined the
headquarters marketing team in 1985 and was later promoted to Director-- Market
Management Center, Service Vice President. A 1968 graduate of the U.S. Military
Academy at West Point, Bennett earned a master's degree in management from the
Massachusetts Institute of Technology, where he was a Sloan Fellow.
CHRISTOPHER EFIRD. Mr. Efird has served as one of our directors since April
1997. Mr. Efird is a principal of Benchmark Equity Group, Inc., one of our
principal stockholders, where his duties include the origination and management
of consolidation and restructuring transactions. Since joining Benchmark at
inception in April 1994, Mr. Efird has participated in the execution of mergers
and acquisitions of domestic and international companies, as well as the
completion of new public equity offerings for the firm's clients. Mr. Efird is a
graduate of Texas A&M University and holds a Masters of Arts degree from Sam
Houston State University with a concentration in the quantitative analysis of
the political risk faced by international companies.
MICHAEL MACALUSO. Mr. Macaluso will become a director upon consummation of
this offering. Mr. Macaluso founded International Printing & Publishing in 1989
and served as President and a director of that company until 1998. International
Printing was a joint venture between Mr. Macaluso and Touche Holdings, a partner
investment fund for a large accounting firm. International Printing recently
merged with another company to form Page/International Communications, a large
sheet-fed printing operation located in Texas. He serves as a director of this
new company. Mr. Macaluso became a principal and a director at AXCES in 1997. He
holds a seat on the board and owns 25% of MTM Holdings, the parent company of
AXCES. A graduate of Canisius College, Mr. Macaluso played professional
basketball and attended graduate school at Golden Gate University in San
Francisco. He brings both operational and merger and acquisition experience to
our board.
CLASSIFIED BOARD
Our board of directors is divided into three classes, each of which,
following a transition period, will serve for three years, with one class being
elected each year at our annual stockholders' meeting. During the transitional
period, the terms of the class 1 directors will expire at the 2000 annual
meeting, while the terms of the class 2 directors and the class 3 directors will
expire at the 2001 and 2002 annual meetings, respectively. Classification of our
board of directors could have the effect of lengthening the time necessary to
change the composition of a majority of the members comprising the board. In
general, at least two annual meetings of stockholders will be necessary for
stockholders to effect a change in a majority of the members of the board.
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COMMITTEES OF THE BOARD OF DIRECTORS
In June 1999, the board of directors established a compensation committee
and an audit committee. The compensation committee makes recommendations
concerning salaries and incentive compensation of our employees and consultants
and administers our incentive plan. The audit committee reviews, acts on and
reports to the board of directors with respect to various auditing and
accounting matters, including reviewing our audit policies, overseeing the
engagement of our independent auditors and developing our financial strategies.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to June 1999, we had no separate compensation or stock option
committee or other board committee performing equivalent functions, and these
functions were performed by our board of directors. In June 1999, we established
compensation, audit and executive committees of our board of directors. The sole
current member of the compensation committee is Christopher Efird with Harry
Bennett and the Weatherly nominee to be named to the committee prior to the
closing of this offering. Mr. Efird will serve as our President until the
closing of this offering at which time Peter Parrinello will become our
President. In June 1999 and in connection with the acquisition of the founding
companies, Mr. Efird was issued contingent common stock issue rights for up to
67,243 shares of our common stock. Upon the closing of this offering, the
compensation committee will be composed of non-employee directors. See
"--Committees of the Board of Directors."
DIRECTOR COMPENSATION
All non-employee directors are reimbursed for travel and other related
expenses incurred in attending meetings of the board of directors. In addition,
each non-employee director serving on the board of directors will be granted
options to purchase 10,000 shares of common stock upon his initial appointment
to the board, and will receive 10,000 additional options upon the date of the
first board meeting in the second calendar quarter of each year pursuant to our
incentive plan. The options will vest immediately and will have an exercise
price equal to the fair market value of the common stock on the date of grant.
EXECUTIVE COMPENSATION
We did not pay any compensation to our executive officers prior to the
acquisition of ARC in June 1999. We anticipate that our Chief Executive Officer
and four most highly compensated executive officers and their annualized base
salaries will be Joseph A. Gregori--$150,000; Peter Parrinello--$160,000; Peter
Karoczkai-- $175,000; Charles N. Garber--$175,000; and Tony Howlett--$120,000.
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SUMMARY COMPENSATION TABLE. The following table sets forth the projected
compensation to be paid by us in 1999 and the actual compensation paid by the
founding companies during 1998 to our chief executive officer and each of the
other four most highly-paid executive officers upon the effectiveness of their
respective employment agreements with us.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
---------------------------------------
ANNUAL COMPENSATION AWARDS
----------------------------------- ------------------------ PAYOUTS
OTHER RESTRICTED SECURITIES -------------
ANNUAL STOCK UNDERLYING ALL OTHER
NAME AND TIME SALARY BONUS COMPENSATION AWARD(S) OPTIONS COMPENSATION
PRINCIPAL POSITION PERIOD(1) ($) ($)(2) ($) ($) (#)(3) ($)
- ------------------------ ----------- --------- --------- ------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Joseph A. Gregori....... 1999 150,000 -- -- -- 480,000 --
Chief Executive 1998(4) 20,000(5) -- -- -- -- --
Officer
Peter Parrinello........ 1999 160,000 -- -- -- 375,000 --
President and Chairman 1998(4) 200,000 15,000 6,000(6) 38,400 -- 5,000(7)
of the board of
directors
Peter Karoczkai......... 1999 175,000 75,000 -- -- 225,000 --
Senior Vice President
of Sales and Marketing
Charles N. Garber....... 1999 175,000 25,000 -- -- 100,000 --
Chief Financial
Officer
Tony Howlett............ 1999 120,000 -- -- -- -- --
Chief Technical 1998(8) 36,500 -- -- -- -- --
Officer
</TABLE>
- --------------------------
(1) For 1999 these amounts represent the annual salaries to be paid pursuant to
their respective employment agreements which will become effective upon the
closing of this offering, except for the employment agreement of Mr. Garber
which became effective July 19, 1999.
(2) Each of these officers are eligible to receive an annual bonus to be
determined at the discretion of the board of directors, with the amount of
the annual bonus for Messrs. Karoczkai and Garber to be up to 50% of their
respective minimum base salaries.
(3) See "Option Grants Prior to Offering" for certain information with respect
to options granted in 1999.
(4) Represents amounts paid in 1998 by ARC.
(5) Represents the portion of Mr. Gregori's $60,000 annual salary he earned from
the inception of his employment in September 1998 through the end of that
year.
(6) Represents a car allowance of $500 per month.
(7) Represents insurance premiums paid by ARC on behalf of Mr. Parrinello.
(8) Represents amounts paid in 1998 by InfoHighway International.
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OPTIONS GRANTS PRIOR TO OFFERING. The following table sets forth
information on grants of stock options to the named persons in the Summary
Compensation Table prior to offering.
OPTION GRANTS PRIOR TO OFFERING
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
----------------------------------------------- VALUE AT ASSUMED
PERCENT OF ANNUAL
NUMBER OF TOTAL RATES OF STOCK PRICE
SECURITIES OPTIONS ESTIMATED APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR PUBLIC OPTION TERM($)(2)
OPTIONS GRANTED EMPLOYEES IN BASE PRICE OFFERING EXPIRATION --------------------
NAME IN 1999 (#) 1999(%) ($/SH) PRICE($)(1) DATE 0% 5%
- -------------------------- --------------- --------------- ------------- ------------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Joseph A. Gregori......... 300,000(3) 20.3 8.00 10.00 6/30/04 600,000 1,428,845
113,443(4) 7.7 10.00(5) 10.00 (6) 0 313,422
66,557(7) 4.5 5.00 10.00 (6) 332,785 516,669
Peter Parrinello.......... 300,000(3) 20.3 8.00 10.00 6/30/04 600,000 1,428,845
47,267(4) 3.2 10.00(5) 10.00 (6) 0 130,590
27,733(7) 1.9 5.00 10.00 (6) 138,665 215,286
Peter Karoczkai........... 225,000(8) 15.2 10.00(5) 10.00 7/19/09 0 1,415,013
Charles N. Garber......... 100,000(8) 6.8 10.00(5) 10.00 7/19/09 0 628,895
<CAPTION>
NAME 10%
- -------------------------- ---------
<S> <C>
Joseph A. Gregori......... 2,431,530
692,580
739,122
Peter Parrinello.......... 2,431,530
288,570
307,978
Peter Karoczkai........... 3,585,921
Charles N. Garber......... 1,593,742
</TABLE>
- --------------------------
(1) Based upon the midpoint of the initial public offering price range of $9.00
to $11.00 of $10.00.
(2) Based on actual option term (five years for options granted to Messrs.
Gregori and Parrinello, and ten years for options granted to Messrs.
Karoczkai and Garber) and annual compounding at rates shown.
(3) These are incentive stock options, to the extent allowed by tax law, granted
under our incentive plan, and which vested one-third in June 1999, and vest
an additional one-third in June 2000 and 2001.
(4) These are incentive stock options, to the extent allowed by tax law, with an
exercise price equal to the actual initial public offering price which were
granted under our incentive plan, and vest ratably each month over the
three-year period from the closing of this offering.
(5) The exercise price of these options is the actual initial public offering
price which for these purposes is assumed to be the midpoint of the initial
public offering price of $10.00.
(6) These options will be granted on and will expire 5 years from the date of
the closing of this offering.
(7) These are incentive stock options, to the extent allowed by tax law, granted
under our incentive plan, and vest on the closing of this offering.
(8) These are incentive stock options, to the extent allowed by tax law, with an
exercise price equal to the actual initial public offering price which were
granted under our incentive plan, and vest ratably one-third on the closing
of this offering and then one-third each on the first and second
anniversaries of the closing of this offering.
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OPTION HOLDINGS. The following table sets forth the number and value of
unexercised stock options in 1999 held by the named persons in the Summary
Compensation Table at the close of the offering.
AGGREGATED OPTION VALUES AT THE CLOSING OF THIS OFFERING
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE- MONEY OPTIONS AT
OPTIONS AT THE CLOSING OF THE CLOSING OF THIS
THIS OFFERING(#) OFFERING($)(1)
SHARES ACQUIRED VALUE -------------------------- --------------------------
NAME ON EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------- --------------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Joseph A. Gregori........... -- -- 166,557 313,443 532,785 400,000
Peter Parrinello............ -- -- 127,733 247,267 338,665 400,000
Peter Karoczkai............. -- -- 75,000 150,000 0 0
Charles N. Garber........... -- -- 33,333 66,667 0 0
</TABLE>
- --------------------------
(1) Value of in-the-money options calculated based on the assumed price per
share of the common stock at the closing of this offering or $10.00.
EMPLOYMENT AGREEMENTS
As of the closing of this offering, we will enter into employment agreements
with Messrs. Gregori, Parrinello, Karoczkai, Howlett and Kramer. Mr. Garber's
employment agreement became effective on July 19, 1999. Each of the agreements:
- provides for a minimum base salary;
- provides for an annual bonus at the discretion of the board of directors
with the amount of the annual bonus for Messrs. Karoczkai and Garber to be
up to 50% of their respective minimum base salaries;
- entitles the employee to participate in all our benefit plans in which
other members of our management participate; and
- has an initial term of three years from their effective date.
In addition, Messrs. Karoczkai's and Garber's employment agreements provide for
the grant of 225,000 and 100,000 incentive stock options, respectively, with an
exercise price equal to the initial public offering price and that vest ratably
one-third on the closing of this offering and then one-third each on the first
and second anniversaries of the closing of the offering. If we terminate the
employee's employment for any reason other than for cause, voluntary resignation
or death, the employee will be entitled to the payment of any annual base salary
and continuation of health insurance benefits for six months, except for Messrs.
Karoczkai and Garber who will be entitled to the payment of any annual base
salary and continuation of health insurance benefits for twelve months. Each
employment agreement contains a covenant limiting competition with us following
the termination of employment for a period of the longer of one year after
commencement of the employment agreement or one year after employment
terminates.
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Under the agreements, "cause" is defined as a determination by the board of
directors that:
- the employee has breached the agreement;
- the employee has willfully failed to substantially perform his duties
thereunder or failed to follow the directives of the board of directors;
or
- the employee has willfully engaged in misconduct which is materially
injurious to InfoHighway.
INCENTIVE PLAN
The description below summarizes all material features of our incentive
plan.
GENERAL. The objectives of our incentive plan, which has been approved by
our board of directors, are to attract and retain selected key employees,
consultants and outside directors, encourage their commitment, motivate their
performance, facilitate their obtaining equity ownership interests by aligning
their personal interests to those of our shareholders and enable them to share
in our long-term growth and success.
SHARES SUBJECT TO INCENTIVE PLAN. Under the incentive plan, we may issue
incentive awards covering at any one time an aggregate of 1,500,000 shares of
our common stock. No more than 1,500,000 shares of our common stock will be
available for incentive stock options. The number of securities available under
the incentive plan and outstanding incentive awards are subject to adjustments
to prevent enlargement or dilution of rights resulting from stock dividends,
stock splits, recapitalization or similar transactions or resulting from a
change in applicable laws or other circumstances.
ADMINISTRATION. The incentive plan will be administered by the compensation
committee of our board of directors. The committee consists only of non-employee
directors, each of whom is:
- an "outside director" under Section 162(m) of the Internal Revenue Code
and
- a "non-employee director" under Rule 16b-3 under the Exchange Act.
The committee may delegate to our chief financial officer or other senior
officers its duties under the incentive plan, except for the authority to grant
incentive awards or take other action on persons who are subject to Section 16
of the Exchange Act or Section 162(m) of the Internal Revenue Code. In the case
of an incentive award to an outside director, the entire board of directors acts
as the committee. Subject to the express provisions of the incentive plan, the
committee is authorized to, among other things, select grantees under the
incentive plan and determine the size, duration and type, as well as the other
terms and conditions, of each incentive award. The committee also construes and
interprets the incentive plan and any related agreements. All determinations and
decisions of the committee are final, conclusive and binding on all parties. We
will indemnify members of the committee against any
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damage, loss, liability, cost or expenses in connection with any claim by reason
of any act or failure to act under the incentive plan, except for an act or
omission constituting willful misconduct or gross negligence.
ELIGIBILITY. Key employees, including our officers, consultants and
non-employee directors are eligible to participate in the incentive plan. A key
employee generally is any of our employees who, in the committee's opinion, is
in a position to contribute materially to our growth, development and financial
success.
TYPES OF INCENTIVE AWARDS. Under the incentive plan, the committee may
grant incentive awards which can be any of the following:
- incentive stock options as defined in Section 422 of the Internal Revenue
Code;
- nonstatutory stock options;
- shares of restricted stock; and
- other stock-based awards.
Incentive stock options and nonstatutory stock options together are called
"options." The terms of each incentive award will be reflected in an incentive
agreement between us and the participant.
OPTIONS. Generally, options must be exercised within 10 years of the grant
date. Incentive stock options may be granted only to employees, and the exercise
price of each incentive stock options may not be less than 100% of the fair
market value of a share of our common stock on the date of grant. The committee
has the discretion to determine the exercise price of each nonstatutory stock
option granted under the incentive plan. To the extent that the aggregate fair
market value of shares of our common stock for which incentive stock options are
exercisable for the first time by any employee during any calendar year exceeds
$100,000, those options must be treated as nonstatutory stock options.
The exercise price of each option is payable in cash or, in the committee's
discretion, by the delivery of shares of common stock owned by the optionee, or
the withholding of shares that would otherwise be acquired on the exercise of
the option, or by any combination of the two.
An employee will not recognize income for federal income tax purposes at the
time an incentive stock option is granted, or on the qualified exercise of an
incentive stock option, but instead will recognize capital gain or loss upon the
subsequent sale of shares acquired in a qualified exercise. The exercise of an
incentive stock option is qualified if a participant does not dispose of the
shares acquired by the participant's exercise within two years after the
incentive stock option grant date and one year after the exercise date. We are
not entitled to a tax deduction for the grant or qualified exercise of an
incentive stock option.
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An optionee will not recognize income for federal income tax purposes, nor
will we be entitled to a deduction, when a nonstatutory stock option is granted.
However, when a nonstatutory stock option is exercised, the optionee will
recognize ordinary income in an amount equal to the difference between the fair
market value of the shares received and the exercise price of the nonstatutory
stock option, and we will generally recognize a tax deduction in the same amount
at the same time.
RESTRICTED STOCK. Restricted stock may be subject to a substantial risk of
forfeiture, a restriction on transferability or rights of repurchase or first
refusal on our behalf, as determined by the committee. Unless the committee
determines otherwise, during the period of restriction, the grantee will have
all other rights of a stockholder, including the right to vote and receive
dividends on the shares.
OTHER STOCK-BASED AWARDS. Other stock-based awards are awards denominated
or payable in, valued in whole or in part by reference to, or otherwise related
to, shares of our common stock. Subject to the terms of the incentive plan, the
committee may determine any terms and conditions of other stock-based awards,
provided that, in general, the amount of consideration we receive shall be
either:
- no consideration other than services actually rendered or to be rendered;
or
- in the case of an award in the nature of a purchase right, consideration
at least equal to 50% of the fair market value of the shares covered by
such grant on the grant date.
Payment or settlement of other stock-based awards will be in shares of common
stock or in other consideration related to such shares.
OTHER TAX CONSIDERATIONS. Upon accelerated exercisability of options and
accelerated lapsing of restrictions upon restricted stock or other incentive
awards in connection with a "change in control", certain amounts associated with
such incentive awards could, depending upon the individual circumstances of the
participant, constitute "excess parachute payments" under Section 280G of the
Internal Revenue Code. Such a determination would subject the participant to a
20% excise tax on those payments and deny us a corresponding deduction. The
limit on deductibility of compensation under Section 162(m) of the Code is also
reduced by the amount of any excess parachute payments. Whether amounts
constitute excess parachute payments depends upon, among other things, the value
of the incentive awards accelerated and the past compensation of the
participant.
Taxable compensation earned by executive officers who are subject to Section
162(m) of the Code with respect to incentive awards is subject to certain
limitations set forth in the incentive plan. Those limitations are generally
intended to satisfy the requirements for "qualified performance-based
compensation," but we may not be able to satisfy these requirements in all
cases, and we may, in our sole discretion, determine in one or more cases that
it is best not to satisfy these requirements even if we can.
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TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL. Except as otherwise
provided in the applicable incentive agreement, if a participant's employment or
other service with us is terminated other than due to his death, disability,
retirement or for cause, his then exercisable options will remain exercisable
until the earlier of their expiration date or 90 days after termination. If this
termination is due to disability or death, his then exercisable options will
remain exercisable until the earlier of their expiration date or one year
following termination. On retirement, his then exercisable options will remain
exercisable for six months. However, incentive stock options will remain
exercisable for three months. On a termination for cause, all his options will
expire at the opening of business on the termination date.
If we undergo a change in control, any restrictions on restricted stock and
other stock-based awards may be deemed satisfied, all outstanding options may
become immediately exercisable and any other stock-based awards may become fully
vested and deemed earned in full, all at the discretion of the committee. These
provisions could in some circumstances have the effect of an "anti-takeover"
defense because, as a result of these provisions, a change in control could be
more difficult or costly.
INCENTIVE AWARDS NONTRANSFERABLE. No incentive award may be assigned, sold
or otherwise transferred by a participant, other than by will or by the laws of
descent and distribution, or be subject to any lien, assignment or charge;
provided, that, the committee may permit nonstatutory stock options to be
transferred to the participant's immediate family or trusts or partnerships
established exclusively for the benefit of his immediate family. An incentive
award may be exercised during the participant's lifetime only by the
participant, the participant's legal guardian or a permitted transferee.
AMENDMENT AND TERMINATION. Our board of directors may amend or terminate
our incentive plan at any time. However, the incentive plan may not be amended,
without shareholder approval, if the amendment would:
- increase the number of shares of common stock which may be issued under
the incentive plan, except in connection with a recapitalization of our
common stock;
- amend the eligibility requirements for employees to purchase our common
stock under the incentive plan; or
- extend the term of the incentive plan.
Without a participant's consent, no termination or amendment of the incentive
plan shall adversely affect in any material way any outstanding incentive award
previously granted to him.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
DESCRIPTION OF CERTAIN PARTIES
The following is a description of the identities of and relationships
between certain parties mentioned in the prospectus. For the complete beneficial
ownership of any of the following persons or entities, see "Principal
Stockholders."
- FRANK M. DELAPE--Mr. DeLape is the sole stockholder and director of
Benchmark. He also serves a director for Technology Acquisitions and
Consolidated Technology. In addition, he and his children are remote
contingent beneficiaries of a variable universal life insurance contract
issued by Lighthouse.
- BENCHMARK EQUITY GROUP, INC.--Benchmark is a Delaware corporation that
owns 579,886 shares of our common stock and 158,363 contingent common
stock issue rights. Benchmark also is the manager of and owns a 1%
membership interest in Emerging Ventures, the other interest holders of
which are unaffiliated with Benchmark or InfoHighway. In addition,
Benchmark owns all of the voting shares of Technology Acquisition. See
Frank M. DeLape.
- TECHNOLOGY ACQUISITIONS, LTD.--Technology Acquisitions is a Bermuda
corporation that purchased all of the 6,392,800 shares of ARC Networks
owned by Consolidated Technology for a total purchase price of $850,000 in
March 1999. Technology Acquisitions will receive 261,645 shares of our
common stock and 102,405 contingent common stock issue rights in
connection with our acquisition of ARC. Technology Acquisitions also owns
17.1% of the outstanding common stock of Consolidated Technology and an
option to purchase an additional 17.1% of the common stock from other
shareholders of Consolidated Technology at any time through April 2000. In
addition for as long as the option is outstanding, Technology Acquisitions
has the right to vote these additional shares of Consolidated Technology.
See Frank M. DeLape and Benchmark.
- CONSOLIDATED TECHNOLOGY GROUP, LTD.--Consolidated Technology is a New York
corporation which holds a $1.85 million promissory note which is
convertible into 206,250 shares of common stock at a conversion price of
$8.00 per share. Consolidated Technology also holds a warrant to purchase
90,000 shares of our common stock at an exercise price of $8.00 per share.
In addition, it owns 14.2% of the common stock of Trans Global. See Frank
M. DeLape and Technology Acquisitions.
- TRANS GLOBAL SERVICES, INC.--Trans Global is a Delaware corporation and
former affiliate of ARC Networks through their common ownership by
Consolidated Technology. Trans Global will receive 1,206,673 shares of our
series A preferred stock upon completion of this offering in exchange for
$1,206,673 of debt ARC owes Trans Global. See Consolidated Technology.
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- EMERGING VENTURES, L.L.C.--Emerging Ventures is a Delaware limited
liability company that owns 97,260 shares of our common stock and 38,067
contingent stock issue rights. See Benchmark and Trident III.
- LIGHTHOUSE CAPITAL INSURANCE COMPANY--Lighthouse is an unaffiliated Cayman
Islands unlimited licensed insurance company. Lighthouse has issued a
variable universal life insurance contract of which Mr. DeLape and his
children are remote contingent beneficiaries. Through this contract,
Lighthouse is the sole stockholder of Trident Equity Management Group. See
Frank M. DeLape.
- TRIDENT EQUITY MANAGEMENT GROUP, INC.--Trident Equity Management Group is
a Cayman Island exempted company that manages Trident III, L.L.C. See
Lighthouse.
- TRIDENT III, L.L.C.--Trident III is Cayman Islands limited liability
company which received 2,298,318 shares of InfoHighway International
common stock in September 1998 in return for a $500,000 bridge loan to
InfoHighway International. Trident III will receive 208,040 shares of our
common stock and 102,405 contingent common stock issue rights in
connection with our acquisition of InfoHighway International. In addition,
Trident III owns a 33% membership interest in Emerging Ventures. See
Trident Equity Management Group.
- MTM HOLDINGS CORPORATION--MTM Holdings is a Texas corporation which is
owned by:
- Timothy Till--37.5%;
- Michael Avignon--37.5%; and
- Michael Macaluso--25.0%.
Messrs. Till and Avignon serve as officers of AXCES while Mr. Macaluso is
a member of our board of directors.
ORGANIZATION OF INFOHIGHWAY
INITIAL CAPITALIZATION. We were initially capitalized with $1,000 provided
by Benchmark for 939,000 shares of our common stock. In August 1998, Benchmark
transferred 236,203 of the 939,000 shares by gift to the following:
- Emerging Ventures--97,260 shares;
- Christopher H. Efird--115,429 shares; and
- Jeffrey W. Tomz--23,514 shares.
Mr. Efird is one of our current directors. Mr. Tomz served as a director until
June 1999.
CONTINGENT COMMON STOCK ISSUE RIGHTS. In June 1999 and in connection with
the acquisitions of the founding companies, we issued a total of 727,511
contingent common stock issue rights to certain of our shareholders prior to the
acquisition of ARC and the previous shareholders of ARC and InfoHighway
International. Of these
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<PAGE>
contingent common stock issue rights, we issued 338,961 to the following of our
shareholders prior to the acquisition of ARC:
- Benchmark--158,363;
- Emerging Ventures--38,067;
- Mr. Efird--67,243;
- Mr. Tomz--13,699; and
- Other non-affiliated shareholders--61,589.
Approximately one-half of these shares are issuable, if at any time within three
years of the issuance of those contingent common stock issue rights, when our
common stock reaches a 10-day average of $16.00 per share. The remaining
one-half are issuable, if at any time within three years of the issuance of the
contingent common stock issue rights, our common stock reaches a 10-day average
of $21.00 per share.
BENCHMARK LETTER AGREEMENT. In September 1998, we entered into a letter
agreement with Benchmark. Under the terms of the agreement, Benchmark agreed to
serve as our non-exclusive agent in connection with an acquisition or
disposition by us for a term of two years. Benchmark's fee under the agreement
is equal to the following:
- five percent of the first $5 million of aggregate consideration;
- four percent of the second $5 million of aggregate consideration;
- three percent of the third $5 million of aggregate consideration; and
- two percent of any consideration over $15 million in the aggregate paid in
connection with an eligible transaction with a minimum fee of $100,000.
The acquisitions of ARC, AXCES and InfoHighway International are excluded from
the fee requirement of the agreement, as amended.
BENCHMARK CONSULTING AGREEMENT. In September 1998, we entered into a
consulting agreement with Benchmark which provided for, among other things, a
monthly consulting fee of $14,000 for a two year period and reimbursement of
expenses incurred during the course of the consulting engagement. In June 1999,
the consulting agreement was amended to waive any accrued or future consulting
fees and to recognize the aggregate amount of expenses to be reimbursed as of
that date to be $105,000.
VANDERHIDER CONSULTING AGREEMENT. During the first quarter of 1999, we
entered into an agreement with John Vanderhider, our former Chief Financial
Officer, for services to be rendered in conjunction with the offering. The
agreement, as amended, provided for, among other things, the granting of
five-year exercisable warrants to purchase 36,185 shares of our common stock at
$5.71 per share in exchange for services rendered. Warrants for 7,237 shares of
common stock vested each month over a period of five months starting in February
1999. Of the warrants for 7,237 shares,
- warrants for 5,201 shares are immediately exercisable upon vesting;
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- warrants for 1,018 shares are exercisable when the common stock has closed
at a price of at least $16.00 per share for 10 consecutive trading days;
and
- warrants for 1,018 shares are exercisable when the common stock has closed
at a price of at least $21.00 per share for 10 consecutive trading days.
BRIDGE LOANS. In March 1999, we issued a $100,000 13% promissory note to
Trident III maturing at the earlier of March 1, 2000 or the closing of an
outside financing with minimum gross proceeds of $500,000. Trident III also
received warrants to purchase an aggregate of 100,000 shares of our common stock
at an exercise price of $8.00 per share subject to certain provisions and terms.
The warrants have a term of five years and have registration rights. In June
1999, we repaid this note out of the proceeds of the $1.5 million June
promissory note offering described below.
In April 1999, we issued a $100,000 13% promissory note to Trident III
maturing at the earlier of April 5, 2000 or the closing of an outside financing
with minimum gross proceeds of $500,000. Trident III also received warrants to
purchase an aggregate of 50,000 shares of our common stock at an exercise price
of $8.00 per share subject to certain provisions and terms. The warrants have a
term of five years and have registration rights. In June 1999, we repaid this
note out of the proceeds of the $1.5 million June promissory note offering
described below.
In June 1999, we issued an aggregate of $1,500,000 13% promissory notes to
ten individual, accredited investors. These notes mature at the earlier of June
22, 2000 or the closing of an outside financing by us with minimum gross
proceeds of $5,000,000. The individual investors also received warrants to
purchase an aggregate of 300,000 shares of common stock at an exercise price of
$8.00 per share. The warrants have a term of five years and have registration
rights.
AFFILIATIONS WITH UNDERWRITERS. We have agreed for a period of three years
after the date of this prospectus, if requested by the representative, to use
our best efforts to nominate one person designated by the representative for
election to our board of directors. In the event the representative elects not
to exercise such right, it may designate a person to receive all notices of
meetings of our board of directors and all other correspondence and
communications sent by us to our board of directors and to attend all such
meetings of our board of directors. We have agreed to reimburse the
representative's designee for his out-of-pocket expenses incurred in connection
with his attendance of meetings of our board of directors.
THE ACQUISITIONS
We acquired ARC on June 30, 1999. We will acquire InfoHighway International
and AXCES simultaneously with and as a condition of the closing of this
offering. Subject to certain adjustments described below, the aggregate
consideration we will pay to acquire the founding companies is approximately
$28.6 million as described in the table below. We will also repay an aggregate
of approximately $6.7 million of indebtedness of InfoHighway and the founding
companies with the proceeds of the offering. The consideration we are paying for
each founding company was determined
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by arm's length negotiations between us and a representative of that founding
company.
<TABLE>
<CAPTION>
CONTINGENT COMMON
COMMON STOCK STOCK ISSUE RIGHTS(1) PREFERRED STOCK
------------------------- ---------------------- -----------------------------
VALUE OF VALUE OF VALUE OF
ACQUISITION SHARES SHARES SHARES SHARES SHARES SHARES
- --------------------------------- ---------- ------------- --------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
AXCES............................ 700,000 $ 6,300,000 -- $ -- 60,000(2) $ 9,000,000
InfoHighway International........ 958,166 8,623,494 235,878 -- -- --
ARC.............................. 390,076 3,510,684 152,672 -- 1,206,673(3) 1,206,673
---------- ------------- --------- ----- -------------- -------------
Total............................ 2,048,242 $ 18,434,178 388,550 $ -- 1,266,673 $ 10,206,673
---------- ------------- --------- ----- -------------- -------------
---------- ------------- --------- ----- -------------- -------------
</TABLE>
- ------------------------
(1) The contingent common stock issue rights entitle the holder to receive
common stock based upon market performance beginning 90 days after this
offering. Approximately one-half of the shares are issuable when the common
stock reaches a 10-day average of $16.00 per share. The remaining one-half
is issuable when the common stock reaches a 10-day average of $21.00 per
share. The rights expire after 3 years. We also issued 338,961 contingent
common stock issue rights to certain of our shareholders prior to the
acquisition of ARC. See "--Organization of InfoHighway--Contingent Common
Stock Issue Rights."
(2) Each share of series B preferred stock is convertible into 10 shares of
common stock at anytime at the option of the holder. The series B preferred
stock is redeemable after 36 months out of a designated portion of our cash
flow. If the common stock trades for an average of $20 per share for 10
consecutive days, we may force the conversion of the series B preferred
stock into common stock.
(3) The series A preferred stock is convertible into common stock at the option
of the holder at any time after 90 days from the closing of this offering or
earlier with the consent of both InfoHighway and the representative of the
underwriters with respect to this offering. The number of shares issuable
upon conversion of the series A preferred stock is dependent on the
conversion rate which is calculated by dividing $1.00 by the lesser of the
offering price or the five-day average closing price ending on the trading
day prior to such conversion date. The series A preferred stock is to be
issued to Trans Global in exchange for a current note payable from ARC of
$1.2 million.
For a complete description of the consideration paid, the debt repaid or assumed
or other material terms of the acquisitions, see "Management's Discussion and
Analysis of Pro Forma Financial Condition and Results of
Operations--Organization."
INDEMNIFICATION BY MTM HOLDINGS AND ITS STOCKHOLDERS. Pursuant to the AXCES
acquisition agreement, MTM Holdings and its owners have agreed to indemnify us
for any damages incurred in connection with pending litigation and
administrative proceedings on the same basis as we are indemnified for any
breaches of representations and warranties made by AXCES in the acquisition
agreement. See "Management's Discussion and Analysis of Pro Forma Financial
Condition and Results of Operations--Organization--Acquisition of AXCES."
CONDITIONS TO CLOSING AXCES AND INFOHIGHWAY INTERNATIONAL ACQUISITIONS. The
closing of the AXCES and InfoHighway International acquisitions are subject to
customary conditions. These conditions include, among others:
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- the accuracy on the closing date of the acquisitions of the
representations and warranties made by the founding companies, their
principal stockholders and InfoHighway;
- the performance of each of their respective covenants included in the
agreements relating to the acquisitions; and
- nonexistence of a material adverse change in the result of operations,
financial condition or business of each founding company.
We can give no assurance that the conditions to the closing of all acquisitions
will be satisfied or waived or that each of the acquisitions will close.
TERMINATION OF AXCES AND INFOHIGHWAY INTERNATIONAL AGREEMENTS. The
acquisition agreements for AXCES and InfoHighway International may be
terminated, under certain circumstances, prior to the closing of this offering:
- by the mutual consent of our board of directors and the boards of
directors of AXCES or InfoHighway International;
- by AXCES or InfoHighway International, their respective stockholders or
us, if the offering and the acquisition of AXCES or InfoHighway
International are not closed by October 31, 1999;
- by us if the schedules to the acquisition agreement are amended to reflect
a material adverse change in AXCES or InfoHighway International; or
- by AXCES or InfoHighway International, their respective stockholders or
us, if a material breach or default under the agreement by one party
occurs and is not waived by the other party.
NON-COMPETE AGREEMENTS. Pursuant to the acquisition agreements, Peter
Parrinello, Michael Macaluso, Michael Avignon, Timothy Till, MTM Holdings, Tony
Howlett, Glenn Kramer, Don Trapp have agreed not to compete with us for a period
of two or three years commencing on the date of closing of the acquisitions. In
addition, pursuant to their employment and consulting agreements with us or
AXCES, as applicable, Joseph Gregori, Peter Parrinello, Peter Karoczkai, Charles
Garber, Michael Macaluso, Michael Avignon, Timothy Till, MTM Holdings, Tony
Howlett and Glenn Kramer have agreed not to compete with us or our subsidiaries
during their respective terms of employment and for a period of one year
thereafter. For information regarding the employment agreements to be entered
into by certain key officers of the founding companies. See
"Management--Executive Compensation; Employment Agreements" and "Real Estate and
Other Transactions--MTM Holdings Consulting Agreement; Subsidiary Employment
Agreements."
REGISTRATION RIGHTS. In connection with the acquisitions, we will grant
certain registration rights to former stockholders of the founding companies.
However, these are subject to provisions in the acquisition agreements that
restrict the transfer of certain percentages of common stock for up to two years
depending upon the performance of the common stock. See "Shares Eligible for
Future Sale."
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<PAGE>
ACQUISITIONS INVOLVING CERTAIN OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS
Persons who are or will become directors, executive officers, or beneficial
owners of 5% or more of our common stock will receive the following
consideration in the acquisitions for their equity interests in the founding
companies and in connection with the terms of their employment with us.
<TABLE>
<CAPTION>
CONTINGENT COMMON
STOCK ISSUE
COMMON STOCK RIGHTS(1)
------------------- ----------------- PREFERRED STOCK OPTIONS,
CERTAIN OFFICERS, DIRECTORS AND VALUE OF VALUE OF ------------------------------ WARRANTS,
PRINCIPAL STOCKHOLDERS SHARES SHARES SHARES SHARES SHARES VALUE OF SHARES OTHER
- -------------------------------------- ------- ---------- ------- -------- ------------ --------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
ARC
Technology Acquisitions, Ltd........ 261,645 $2,354,805 102,405 $-- -- $ -- --
Consolidated Technology Group
Ltd............................. -- -- -- -- -- -- 296,250 (2)
Trans Global Services, Inc........ -- -- -- -- 1,206,673(3) 1,206,673 --
Peter Parrinello.................... 39,060 351,540 15,289 -- -- -- 375,000 (4)
Joseph Gregori...................... -- -- -- -- -- -- 480,000 (5)
AXCES
Michael Avignon(6).................. 262,500 2,362,500 22,500 3,375,000 100,000 (7)
Timothy Till(6)..................... 262,500 2,362,500 -- -- 22,500 3,375,000 75,000 (8)
Michael Macaluso(6)................. 175,000 1,575,000 -- -- 15,000 2,250,000 --
InfoHighway International
Tony Howlett........................ 114,598 1,031,382 23,596 -- -- -- --
Glenn Kramer........................ 44,076 396,684 9,075 -- -- -- --
Trident III......................... 208,040 1,872,360 81,425 -- -- -- 150,000 (9)
</TABLE>
- --------------------------
(1) The contingent common stock issue rights entitle the holder to receive
common stock based upon market performance beginning 90 days after this
offering. Approximately one-half of the shares are issuable when the common
stock reaches a 10-day average of $16.00 per share. The remaining one-half
is issuable when the common stock reaches a 10-day average of $21.00 per
share. The rights expire after 3 years.
(2) Includes:
- 206,250 shares issuable upon conversion at $8.00 per share of a $1.65
million note issued to Consolidated Technology in exchange for outstanding
debt of ARC; and
- 90,000 shares issuable upon exercise of warrants at $8.00 per share which
were issued to Consolidated Technology in connection with the
restructuring of ARC's note to Consolidated Technology.
(3) The series A preferred stock is convertible into common stock at the option
of the holder at any time after 90 days from the closing of this offering or
earlier with the consent of both InfoHighway and the representative of the
underwriters with respect to this offering. The number of shares issuable
upon conversion of the series A preferred stock is dependent on the
conversion rate which is calculated by dividing $1.00 by the lesser of the
offering price or the five-day average closing price ending on the trading
day prior to such conversion date.
(4) Includes:
- 300,000 shares issuable upon exercise of options at $8.00 per share;
- 27,733 shares issuable upon exercise of options at $5.00 per share; and
- 47,267 shares issuable upon exercise of options at $10.00 per share.
(5) Includes:
- 300,000 shares issuable upon exercise of options at $8.00 per share;
- 66,557 shares issuable upon exercise of options at $5.00 per share; and
- 113,443 shares issuable upon exercise of options at $10.00 per share.
(6) Represents each shareholders' proportionate interest in shares of common and
preferred stock issued to MTM Holdings. Each share of series B preferred
stock is convertible into 10 shares of common stock at anytime at the option
of the holder. The series B preferred stock is redeemable after 36 months
out of a designated portion of our cash flow. If the common stock trades for
an average of $20 per share for 10 consecutive days, we may force conversion
of the series B preferred stock into common stock.
(7) Includes:
- 36,977 shares issuable upon exercise of options at $5.00 per share; and
- 63,023 shares issuable upon exercise of options at $10.00 per share.
(8) Includes:
- 27,733 shares issuable upon exercise of options at $5.00 per share; and
- 47,267 shares issuable upon exercise of options at $10.00 per share.
(9) Represents 150,000 shares issuable upon exercise of warrants at $8.00 per
share which were issued to Trident III in connection with certain bridge
loans.
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<PAGE>
For a complete description of the beneficial ownership of our officers,
directors and principal stockholders, see "Principal Stockholders."
REAL ESTATE AND OTHER TRANSACTIONS
ARC LEASE. ARC occupies space leased by Consolidated Technology in New York
City. There is no formal lease agreement between Consolidated Technology and
ARC. Rent is charged by SIS Capital Corp., a Delaware corporation and wholly
owned subsidiary of Consolidated Technology, to ARC which amounted to $23,153,
$27,752 and $14,066 for the years ended December 31, 1996, 1997 and 1998,
respectively.
ARC DEBT. In connection with the acquisition of ARC, $750,000 of the
outstanding balance of approximately $2.4 million on June 30, 1999 on the
revolving line of credit due to Consolidated Technology will be repaid with the
proceeds from the offering. The balance of the revolving line of credit of $1.65
million was exchanged for a 14% convertible note of which $450,000 matures in
January 2000, and the remaining $1.2 million matures in June 2000 if not
previously converted. The outstanding balance of this note is convertible into
shares of common stock at $8.00 per share at Consolidated Technology's option at
any time. In addition, Consolidated Technology has been issued five-year
exercisable warrants to purchase 90,000 shares of common stock at $8.00 per
share in exchange for the restructuring of the debt. Consolidated Technology was
granted piggy back registration rights with respect to the shares issuable upon
conversion of the note and exercise of the warrants. See "Description of Capital
Stock--Registration Rights" and "Shares Eligible for Future Sale."
AXCES PRINTING SERVICES. AXCES purchases printing services from Page/IPP
Communications, L.L.C., a company in which MTM Holdings owns a 30% interest,
from time to time. During 1998 and 1997, AXCES purchased printing services
totaling $281,660 and $284,660, respectively, from Page/IPP. Amounts due
Page/IPP at December 31, 1997 and 1998 were $16,583 and $66,265, respectively.
MTM Holdings is owned as follows: 25% by Michael Macaluso, a director and 5%
beneficial owner of InfoHighway; 37.5% by Michael Avignon, a 5% beneficial owner
of InfoHighway; and 37.5% by Timothy Till, a 5% beneficial owner of InfoHighway.
INFOHIGHWAY INTERNATIONAL DEBT. In connection with the acquisition,
$499,250 owed by InfoHighway International to Trident III pursuant to a loan
agreement dated September 18, 1998, will be repaid from the proceeds of the
offering.
MTM HOLDINGS CONSULTING AGREEMENT. AXCES entered into a consulting
agreement with MTM Holdings, the previous sole shareholder of AXCES. The
consulting agreement is effective on the closing of this offering and has a
three year term subject to early termination rights held by both parties. MTM
Holdings has been engaged to seek out acquisition targets for us in addition to
providing other services towards the consummation of these acquisitions. The
agreement provides for a $115,000 annual retainer, payable in equal monthly
installments, and a commission payable on acquisitions consummated during the
agreement term or within one year
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thereafter. The retainer is an advance of any fees earned. The fee is three
percent of the first million of the purchase price, two percent of the second
million and one percent of any amount over $2 million. The commission will be
decreased by the amount of any retainer previously paid to the owner. The
agreement terminates automatically upon the death or disability of Mr. Michael
Macaluso. Prior to the expiration of the three year term, AXCES may terminate
the agreement with or without cause, and MTM Holdings may terminate the
agreement for any reason. If the agreement is terminated due to Mr. Macaluso's
death, the retainer through the termination date and any unpaid commission must
be paid. If AXCES terminates the agreement without cause, it must pay MTM
Holdings the retainer through the termination date, any commission that is due
and payable and not previously paid, monthly installments on the retainer for
six months following the termination date, and commission on any acquisition
consummated within one year following the termination date that relates to a
potential acquisition that was the subject of a notice from the owner to the
surviving corporation given before the date of termination. The agreement also
contains certain non-competition and non-disclosure provisions that remain in
effect for a period of three years after termination.
SUBSIDIARY EMPLOYMENT AGREEMENTS. During June 1999, AXCES entered into
employment agreements with Michael Avignon and Timothy Till which provide for
the retention of Mr. Avignon and Mr. Till in the capacities of Operations
Manager and MIS Director, respectively, for a three year term commencing upon
the consummation of the offering. The agreements provide each employee an annual
base salary of $160,000 and a monthly car allowance of $1,000 together with one
year non-competition obligations, among other things. Both agreements provide
for an annual bonus payment to each employee. However, Mr. Avignon's annual
bonus is based upon the annual net income performance of AXCES, while Mr. Till's
bonus is payable in an amount at the discretion of our board. Mr. Avignon's
annual bonus is determined as follows:
- if the annual net income of AXCES is less than $3.0 million, Mr. Avignon
will receive no bonus;
- if the annual net income of AXCES is greater than $3.0 million but less
than $5.0 million, Mr. Avignon will receive an annual bonus of $90,000
plus 5% of the amount that annual net income exceeds $3.0 million; or
- if the annual net income of AXCES is greater than $5.0 million, Mr.
Avignon will receive an annual bonus of $190,000 plus 10% of the amount
that annual net income exceeds $5.0 million.
The agreements also contain certain non-competition and non-disclosure
provisions that remain in effect for a period of one year after their
termination.
OUR POLICY
We believe that all of the certain transactions described in this section
were made on terms no less favorable than could have been obtained from third
parties. In the future, any transactions with our directors, officers, employees
or affiliates are anticipated to be minimal and will, in any case, be approved
in advance by a majority of the board of directors, including a majority of
disinterested members of the board of directors.
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PRINCIPAL STOCKHOLDERS
The following table shows, immediately after giving effect to the closing of
the acquisitions and this offering, the beneficial ownership of our common stock
for:
- each person beneficially owning more than 5% of our outstanding common
stock;
- each of our directors;
- each of our executive officers; and
- all of our directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER OFFERING
(2)
-----------------------
BENEFICIAL OWNER (1) NUMBER PERCENT
- -------------------------------------------------------------------------------------------- ---------- -----------
<S> <C> <C>
Frank M. DeLape (3)
Benchmark Equity Group, Inc................................................................. 1,533,876 29.60%
700 Gemini, Suite 100
Houston, Texas 77058
MTM Holdings Corporation (4)................................................................ 1,300,000 25.06%
2500 Wilcrest, Suite 540
Houston, Texas 77042
Technology Acquisitions, Ltd. (5)........................................................... 660,300 13.24%
Clarendon House, 2 Church Street
Hamilton, HM II
Bermuda
Michael Avignon (4)(6)...................................................................... 587,500 11.96%
2500 Wilcrest, Suite 540
Houston, Texas 77042
Timothy Till (4)(7)......................................................................... 562,500 11.51%
Joseph Gregori (8).......................................................................... 480,000 9.47%
Lighthouse Capital Insurance Company (9)
Trident Equity Management Group, Inc.
Trident III, L.L.C.......................................................................... 432,465 9.12%
c/o MeesPierson (Cayman) Ltd.
P.O. Box 2003 GT
Grand Pavilion Comm. Centre
Bougainvillea Way
802 West Bay Road
Grand Cayman BWI
Peter Parrinello (10)....................................................................... 429,349 8.63%
Michael Macaluso (4)(11).................................................................... 325,000 6.86%
2500 Wilcrest, Suite 540
Houston, Texas 77042
Consolidated Technology Group, Ltd. (12).................................................... 296,250 6.07%
700 Gemini, Suite 100
Houston, Texas 77058
Peter Karoczkai (13)........................................................................ 225,000 4.68%
</TABLE>
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<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER OFFERING
(2)
-----------------------
BENEFICIAL OWNER (1) NUMBER PERCENT
- -------------------------------------------------------------------------------------------- ---------- -----------
<S> <C> <C>
Christopher Efird (14)...................................................................... 182,672 3.92%
700 Gemini, Suite 100
Houston, Texas 77058
Tony Howlett (15)........................................................................... 138,194 3.00%
Charles Garber (16)......................................................................... 100,000 2.13%
Glenn Kramer (17)........................................................................... 53,151 1.16%
Harry Bennett (18).......................................................................... 10,000 *
35 Airport Road, Suite 120
Morristown, New Jersey 07960
Weatherly nominee (18)(19).................................................................. 10,000 *
All directors and officers as a group (9 persons) (8,10,11,13-19)........................... 1,953,366 32.27%
</TABLE>
- ---------------------
(1) All persons listed have sole voting and investment power with respect to
their shares unless otherwise indicated. Unless otherwise indicated, the
address of each person listed is 1770 Motor Parkway, Suite 300, Hauppauge,
New York 11788.
(2) Assumes none of these persons intends to acquire shares directly from the
underwriters in connection with this offering. Shares shown include shares
of common stock that could be acquired on exercise of currently outstanding
options which have not vested and do not vest within 60 days hereof. In
addition, the share amounts include shares of common stock which are
issuable in connection with the contingent common stock issue rights.
(3) The number of shares beneficially owned by Mr. DeLape and Benchmark
includes:
- 579,886 shares beneficially held by Benchmark, which is wholly-owned by
Mr. DeLape;
- 261,645 shares beneficially held by Technology Acquisitions all of the
voting stock of which is owned by Benchmark, and of which Mr. DeLape is a
director;
- 296,250 shares beneficially held by Consolidated Technology of which Mr.
DeLape is a director;
- 97,260 shares beneficially held by Emerging Ventures which is managed by
Benchmark; and
- 298,836 shares issuable pursuant to the contingent stock issue rights held
by Benchmark, Emerging Ventures and Technology Acquisitions.
Does not include 358,040 shares beneficially held by Lighthouse which has
issued a variable universal life insurance contract of which Mr. DeLape and
his children are remote contingent beneficiaries. Mr. DeLape disclaims
beneficial ownership of such shares held by Lighthouse and does not have
voting or dispositive power with respect to such shares.
(4) The number of shares beneficially owned by MTM Holdings includes:
- 700,000 shares; and
- 600,000 shares issuable upon conversion of the 60,000 outstanding shares
of our series B preferred stock.
All of these shares of common and preferred were issued to MTM Holdings, the
former sole shareholder of AXCES, as consideration for the acquisition of
AXCES. MTM Holdings is owned by Mr. Till (37.5%), Mr. Avignon (37.5%) and
Mr. Macaluso (25%).
(5) The number of shares beneficially held by Technology Acquisitions includes:
- 261,645 shares held by Technology Acquisitions;
- 296,250 shares beneficially held by Consolidated Technology Group, an
affiliate of Technology Acquisitions; and
- 102,405 shares issuable pursuant to contingent common stock issue rights.
(6) The number of shares beneficially owned by Mr. Avignon includes:
- 262,500 shares;
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- 225,000 shares issuable upon conversion of 22,500 shares of our series B
preferred stock;
- 36,977 shares issuable upon exercise of options at $5.00 per share; and
- 63,023 shares issuable upon exercise of options at $10.00 per share.
The shares of common and preferred were issued to MTM, the former sole
shareholder of AXCES, as consideration for the acquisition of AXCES. The
options at $5.00 per share all vest on the closing of this offering. The
options at $10.00 per share vest ratably each month over the three-year
period following the closing of this offering.
(7) The number of shares beneficially held by Mr. Till includes:
- 262,500 shares;
- 225,000 shares issuable upon conversion of 22,500 shares of our series B
preferred stock;
- 27,733 shares issuable upon exercise of options at $5.00 per share; and
- 47,267 shares issuable upon exercise of options at $10.00 per share.
The shares of common and preferred were issued to MTM, the former sole
shareholder of AXCES, as consideration for the acquisition of AXCES. The
options at $5.00 per share all vest on the closing of this offering. The
options at $10.00 per share vest ratably each month over the three-year
period following the closing of this offering.
(8) The number of shares beneficially held by Mr. Gregori includes
- 300,000 shares issuable upon exercise of options at $8.00 per share;
- 66,557 shares issuable upon exercise of options at $5.00 per share; and
- 113,443 shares issuable upon exercise of options at $10.00 per share.
The options at $8.00 per share vested one-third in June 1999, and vest an
additional one-third in June 2000 and 2001. The options at $5.00 per share
all vest on the closing of this offering. The options at $10.00 per share
vest ratably each month over the three-year period following the closing of
this offering.
(9) The number of shares beneficially held by Lighthouse, Trident Equity
Management Group and Trident III includes:
- 208,040 shares held by Trident III;
- 150,000 shares issuable upon exercise of warrants at $8.00 per share
issued to Trident III in connection with promissory notes we issued prior
to the offering; and
- 81,425 shares issuable pursuant to contingent common stock issue rights.
Trident III is managed by Trident Equity Management Group, Inc., a Cayman
Islands exempted company and a wholly-owned subsidiary of Lighthouse.
(10) The number of shares beneficially held by Mr. Parrinello includes:
- 39,060 shares held by Mr. Parrinello and members of his immediate family
which were issued as consideration for the purchase of ARC;
- 300,000 shares issuable upon exercise of options at $8.00 per share;
- 27,733 shares issuable upon exercise of options at $5.00 per share;
- 47,267 shares issuable upon exercise of options at $10.00 per share; and
- 15,289 shares issuable pursuant to contingent common stock issue rights.
The options at $8.00 per share vested one-third in June 1999, and vest an
additional one-third in June 2000 and 2001. The options at $5.00 per share
all vest on the closing of this offering. The options at $10.00 per share
vest ratably each month over the three-year period following the closing of
this offering.
(11) The number of shares beneficially owned by Mr. Macaluso includes:
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- 175,000 shares; and
- 150,000 shares issuable upon conversion of 15,000 shares of our series B
preferred stock.
The shares of common and preferred were issued to MTM, the former sole
shareholder of AXCES, as consideration for the acquisition of AXCES.
(12) The number of shares beneficially owned by Consolidated Technology
includes:
- 206,250 shares issuable upon conversion at $8.00 per share of a $1.65
million note issued to Consolidated Technology in exchange for outstanding
debt of ARC; and
- 90,000 shares issuable upon exercise of warrants at $8.00 per share which
were issued to Consolidated Technology in connection with the
restructuring of ARC's note to Consolidated Technology.
This does not include 120,667 shares of our common stock which are issuable
upon conversion of the 1,206,673 shares of our series A preferred stock held
by Trans Global, a Delaware public company, of which 14.2% of its common
stock is owned by Consolidated Technology.
(13) Represents shares issuable upon exercise of options at $10.00 per share.
(14) The number of shares beneficially owned by Mr. Efird include:
- 115,429 shares; and
- 67,243 shares issuable pursuant to the contingent common stock issue
rights.
(15) The number of shares beneficially owned by Mr. Howlett includes:
- 114,598 shares which were issued as consideration for the purchase of
InfoHighway International; and
- 23,596 shares issuable pursuant to contingent common stock issue rights.
(16) Represents shares issuable upon exercise of options at $10.00 per share.
These options vest ratably one-third on the closing of this offering and
then one-third each on the first and second anniversaries of the closing of
this offering.
(17) The number of shares beneficially owned by Mr. Kramer includes:
- 44,076 shares, which were issued as consideration for the purchase of
InfoHighway International; and
- 9,075 shares issuable pursuant to contingent common stock issue rights.
(18) Represents shares issuable upon exercise of options at $10.00 issued to
each of our outside directors upon appointment to the board.
(19) We have agreed for a period of three years after the date of this
prospectus, if requested by the representative, to use our best efforts to
nominate one person designated by the representative for election to our
board of directors. See "Underwriting."
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DESCRIPTION OF CAPITAL STOCK
The following description is a summary of the material terms of our capital
stock.
Upon the closing of this offering, our authorized capital stock, after
giving effect to the amendment of our certificate of incorporation, will consist
of 25,000,000 shares of common stock and 3,000,000 shares of preferred stock.
The common stock and preferred stock each have a par value of $.0001 per share.
COMMON STOCK
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding series of preferred stock, the holders of common
stock are entitled to receive ratably such dividends, if any, as may be declared
from time to time by the board of directors out of funds legally available for
that purpose. See "Dividend Policy." In the event of a liquidation, dissolution
or winding up, the holders of our common stock are entitled to share ratably in
all assets remaining after payment of liabilities, subject to prior distribution
rights of preferred stock, if any, then outstanding. The common stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the common stock.
CONTINGENT COMMON STOCK ISSUE RIGHTS
As of the closing of this offering, there will be approximately 727,511
contingent common stock issue rights. These rights were issued to certain of our
founders and to the former shareholders of ARC and InfoHighway International in
connection with the acquisition of those companies. The contingent common stock
issue rights entitle the holder to receive shares of our common stock based upon
its market performance beginning 90 days after the closing of this offering.
Approximately one-half of the shares are issuable when our common stock reaches
a 10-day average of $16.00 per share. The remaining one-half are issuable when
our common stock reaches a 10-day average of $21.00 per share. The rights expire
after three years. No dividends are payable with respect to the rights and the
rights are not transferrable or assignable except by the laws of descent and
distribution, by will or by operation of law. All of the 235,878 contingent
common stock issue rights issued to the former shareholders of InfoHighway
International, except for 81,425 which were issued to Trident III, L.L.C, are
subject to pro rata reduction if the monthly revenues for InfoHighway
International for the full calendar month prior to the closing of this offering
are less than $174,064.
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PREFERRED STOCK
At the direction of our board, we may issue up to 3,000,000 shares of
preferred stock from time to time. Our board may, without any action by holders
of the common stock:
- adopt resolutions to issue preferred stock in one or more classes or
series;
- fix or change the number of shares constituting any class or series of
preferred stock; and
- establish or change the rights of the holders of any class or series of
preferred stock.
The rights that any class or series of preferred stock may evidence may include:
- general or special voting rights;
- preferential liquidation or preemptive rights;
- preferential cumulative or noncumulative dividend rights;
- redemption or put rights; and
- conversion or exchange rights.
We may issue shares of, or rights to purchase, preferred stock the terms of
which might:
- adversely affect voting or other rights evidenced by, or amounts otherwise
payable with respect to, the common stock;
- discourage an unsolicited proposal to acquire us; or
- facilitate a particular business combination involving us.
Any such action could discourage a transaction that some or a majority of our
stockholders might believe to be in their best interests or in which our
stockholders might receive a premium for their stock over its then market price.
SERIES A 10% CONVERTIBLE PREFERRED STOCK. Upon the closing of this
offering, 1,206,673 shares of our series A 10% convertible preferred stock will
be outstanding, of 1,217,000 shares authorized.
- CONVERSION RIGHTS. The series A preferred is convertible into common stock
at the option of the holder at any time after 90 days from the closing of
this offering or earlier with the consent of both us and the
representative of the underwriters with respect to this offering. The
number of shares of common stock issuable upon conversion of the series A
preferred is determined by multiplying the number of shares being
converted by the conversion rate. The conversion rate is calculated by
dividing $1.00 by the lesser of the offering price or the five-day average
closing price ending on the trading day prior to any such conversion date.
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CONVERSION EXAMPLE 1: Assuming the offering price is $10.00 per
share and the five-day closing price of our common stock prior to
conversion is $5.00 per share, the conversion rate would be $1.00
divided by $5.00 or 0.2. We would then be required to issue
approximately 241,335 shares of common stock upon conversion of
all of the 1,206,673 shares outstanding (1,206,673 X 0.2).
CONVERSION EXAMPLE 2: Assuming the offering price is $10.00 per
share and the five-day closing price of our common stock prior to
conversion is $15.00 per share, the conversion rate would be $1.00
divided by $10.00 or 0.1. We would then be required to issue
approximately 120,667 shares of our common stock upon conversion
of all of the 1,206,673 shares outstanding (1,206,673 X 0.1).
- DIVIDENDS. Annual dividends of $.10 per share are payable each March 1,
commencing on March 1, 2000, and are cumulative.
- VOTING RIGHTS. Except as otherwise required by law, the shares of series A
preferred stock have no voting rights.
- REDEMPTION. We may redeem any or all of the shares of series A preferred
stock at any time for the redemption price of $1.00 per share, plus
accrued but unpaid dividends, upon at least 5 days notice. We may also
redeem all and only all of the shares of series A preferred stock if at
any time after the closing of this offering the 5-day average closing
price of the common stock is less than one-third of the price at which the
common stock is sold to the public in this offering. In addition upon the
occurrence of the same event, any holder of series A preferred stock may
require us to redeem all of that holder's shares of series A preferred
stock at the redemption price of $1.00 per share or a total of $1,206,673.
- REGISTRATION RIGHTS. Holders of series A preferred stock have demand
registration rights with respect to the underlying common stock and may
require us to redeem the series A preferred stock at the redemption price
of $1.00 per share if we fail to register the shares within 6 months after
a demand for registration has been made by the holder or if we register
the shares but the registration statement ceases to be current and
effective for more than 30 days.
- LIQUIDATION RIGHTS. The shares of series A preferred stock have a
liquidation right of $1.00 per share, plus accrued but unpaid dividends,
and rank on parity with the series B preferred stock.
SERIES B 8% CUMULATIVE CONVERTIBLE PREFERRED STOCK. Upon the closing of
this offering, all 60,000 authorized shares of our series B 8% cumulative
convertible preferred stock will be outstanding.
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- CONVERSION RIGHTS. Each share of the series B preferred stock is
convertible into 10 shares of common stock at any time at the option of
the holder. If our common stock trades for an average of $20.00 per share
or more for a period of 10 consecutive days, we may force a conversion of
the series B preferred stock into common stock.
- DIVIDENDS. Annual dividends of $12.00 per share are payable quarterly in
cash or in additional shares of series B preferred stock and are
cumulative. In addition, each holder of the series B preferred stock is
entitled to receive any dividend that is paid to the holders of common
stock.
- VOTING RIGHTS. The holders of series B preferred stock shall also have the
same voting rights as, and shall vote with, the holders of the common
stock on an as-converted basis.
- REDEMPTION. We may redeem any or all of the shares of series B preferred
stock at any time beginning 36 months after the closing of this offering
for cash, or assign to the holders a designated portion of our cash flow,
for the redemption price of $150.00 per share, plus accrued but unpaid
dividends, upon at least 30 days notice.
- LIQUIDATION RIGHTS. The shares of series B preferred stock have a
liquidation right of $150.00 per share plus accrued but unpaid dividends,
and rank on parity with the series A preferred stock. In the event of our
liquidation, dissolution or winding up, the holders of the series B
preferred stock, in addition to receiving a liquidation preference, are
entitled to receive liquidating distributions at the same time and on the
same basis as the holders of common stock.
REGISTRATION RIGHTS
Pursuant to certain registration rights agreements, the holders of the
securities listed below are entitled to certain registration rights for the
number of shares of common stock and as indicated below:
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK TYPE OF
TYPE OF SECURITY WITH REGISTRATION RIGHTS REGISTRATION RIGHTS
- ------------------------------------------------- ---------------------------- ---------------------------------
<S> <C> <C>
Common stock..................................... 2,048,242 Piggy back
Contingent common stock issue rights............. 727,511 Piggy back
Series A preferred stock......................... 120,667 Demand and piggy back
Series B preferred stock......................... 600,000 Piggy back
Warrants......................................... 720,031 Piggy back
Underwriter warrants............................. 160,000 Demand and piggy back
Convertible promissory note...................... 206,250 Piggy back
</TABLE>
For a detailed description of these registration rights, see "Shares
Eligible for Future Sale."
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SPECIAL PROVISIONS OF OUR CHARTER, BYLAWS AND DELAWARE LAW
The following charter and bylaw provisions and provisions of Delaware law
may have the effect of delaying, deterring or preventing a change of control.
AUTHORIZATION OF PREFERRED STOCK. As noted above, our board of directors,
without stockholder approval, has the authority under our certificate of
incorporation to issue preferred stock with rights superior to the rights of the
holders of common stock. As a result, preferred stock could
- be issued quickly and easily;
- could adversely affect the rights of holders of common stock; and
- could be issued with terms calculated to delay or prevent a change of
control or make removal of management more difficult.
ELECTION AND REMOVAL OF DIRECTORS. Our charter and bylaws provide for the
division of our board of directors into three classes, as nearly equal in number
as possible, with the directors in each class serving for a three-year term, and
one class being elected each year by our stockholders. Directors may be removed
only for cause. This system of electing and removing directors may tend to
discourage a third party from making a tender offer or otherwise attempting to
obtain control of us and may maintain the incumbency of the board of directors,
as it generally makes it more difficult for stockholders to replace a majority
of directors. See "Management-- Classified Board."
STOCKHOLDER MEETINGS AND WRITTEN CONSENT. Under our bylaws, a special
meeting of the stockholders may be called by:
- the board of directors;
- by written order of a majority of the board;
- the Chairman of the Board;
- the Chief Executive Officer;
- the President; or
- the stockholders by the written request of not less than two-thirds of the
common stock entitled to vote at such meeting.
Our certificate of incorporation provides that stockholders may not act by
written consent and, accordingly, can only act at a meeting.
REQUIREMENTS FOR ADVANCE NOTIFICATION OF STOCKHOLDER NOMINATIONS AND
PROPOSALS. Our bylaws establish advance notice procedures with respect to
stockholder proposals and the nomination of candidates for election as
directors, other than nominations made by or at the direction of the board of
directors or a committee thereof.
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INDEMNIFICATION. Delaware law authorizes Delaware corporations to limit or
eliminate the personal liability of directors for monetary damages for breach of
a director's fiduciary duty of care. The duty of care requires that, when acting
on behalf of the corporation, directors must exercise an informed business
judgment based on all material information reasonably available to them. Absent
the limitations Delaware law authorizes, directors of Delaware corporations are
accountable to those corporations and their stockholders for monetary damages
for conduct constituting gross negligence in the exercise of their duty of care.
Delaware law enables Delaware corporations to limit available relief to
equitable remedies such as injunction or rescission. Our certificate of
incorporation limits the liability of our directors to us or our stockholders to
the fullest extent Delaware law permits, and no member of our board will be
personally liable for monetary damages for breach of the member's fiduciary duty
as a director, except for liability:
- for any breach of the member's duty of loyalty to us or our stockholders;
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- for unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General Corporation
Law; or
- for any transaction from which the member derived an improper personal
benefit.
This provision could have the effect of reducing the likelihood of derivative
litigation against our directors and may discourage or deter our stockholders or
management from bringing a lawsuit against our directors for breach of their
duty of care, even though such an action, if successful, might otherwise have
benefited our stockholders and us. Our bylaws provide indemnification to our
officers and directors and other specified persons with respect to their conduct
in various capacities, and we have entered into agreements with each of our
directors and executive officers which indemnify them to the fullest extent
Delaware law and our certificate of incorporation permit.
STATUTORY BUSINESS COMBINATION PROVISION. Until June 2000, we are subject
to Section 203 of the Delaware General Corporation Law. Section 203 prevents an
"interested stockholder," which is defined generally as a person owning 15% or
more of a Delaware corporation's outstanding voting stock or any affiliate or
associate of that person, from engaging in a broad range of "business
combinations" with the corporation for three years following the date that
person became an interested stockholder unless:
- before that person became an interested stockholder, the board of
directors of the corporation approved the transaction in which that person
became an interested stockholder or approved the business combination;
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- on completion of the transaction that resulted in that person's becoming
an interested stockholder, that person owned at least 85% of the voting
stock of the corporation outstanding at the time the transaction
commenced, other than stock held by:
- directors who are also officers of the corporation; or
- any employee stock plan that does not provide employees with the right
to determine confidentially whether shares held subject to the plan
will be tendered in a tender or exchange offer; or
- following the transaction in which that person became an interested
stockholder, both the board of directors of the corporation and the
holders of 66 2/3% of the outstanding voting stock of the corporation not
owned by that person approve the business combination.
Under Section 203, the restrictions described above also do not apply to
specific business combinations proposed by an interested stockholder following
the announcement or notification of designated extraordinary transactions
involving the corporation and a person who had not been an interested
stockholder during the previous three years or who became an interested
stockholder with the approval of a majority of the corporation's directors, if a
majority of the directors who were directors prior to any person becoming an
interested stockholder during the previous three years or were recommended for
election or elected to succeed those directors by a majority of those directors
approve or do not oppose that extraordinary transaction.
TRANSFER AGENT AND REGISTRAR
American Stock Transfer and Trust Company is the transfer agent and
registrar for our common stock.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. Future sales of substantial amounts of our common stock in the public
market could adversely affect market prices prevailing from time to time. Sales
of substantial amounts of our common stock in the public market after the
restrictions lapse could adversely affect the prevailing market price and our
ability to raise equity capital in the future. Upon the completion of this
offering, we will have 4,587,242 shares of common stock outstanding. This number
will increase to 4,827,242 if the over-allotment option is exercised. Of these
shares, the 1,600,000 shares sold in this offering will be freely tradable
without restriction under the Securities Act, unless held by our "affiliates,"
as that term is defined in Rule 144 under the Securities Act. In addition, we
have registered 165,000 shares of common stock for resale by Benchmark Equity
Group over a period of 90 days beginning 90 days after the closing of this
offering.
SALES OF RESTRICTED SECURITIES
A total of 2,822,242 shares of common stock were issued and sold by us in
reliance on exemptions from the registration requirements of the Securities Act
prior to this offering. These shares are deemed to be "restricted securities"
under Rule 144. All of these shares are eligible for sale in public, subject to
the provisions of Rule 144 under the Securities Act, upon expiration of the
lock-up agreements with representatives of the underwriters as early as one year
from the date of this offering. See "--Lock-up Agreements." In addition, there
will be approximately 4,034,410 shares which are issuable pursuant to contingent
common stock issue rights and various warrants, options, convertible notes and
convertible preferred stock. Of these shares, up to 296,250 shares could be
eligible for sale in the public market, subject to the provisions of Rule 144 on
May 19, 2000, and 120,667 will be eligible for resale beginning one year after
the date of this offering. The remaining 3,617,493 shares of which are issuable
pursuant to contingent common stock issue rights and various warrants, options,
and convertible preferred stock will be eligible for resale, subject to the
provisions of Rule 144 upon expiration of the lock-up agreements. These shares
may be sold in the public market only if registered, or pursuant to an exemption
from registration such as Rule 144, 144(k) or 701 under the Securities Act.
RULE 144. In general, under Rule 144 as currently in effect, a person who
has beneficially owned shares for at least one year is entitled to sell in a
"broker's transaction" or to market makers, within any three-month period
commencing 90 days after the date of this prospectus, a number of shares that
does not exceed the greater of:
- one percent of the number of shares of common stock then outstanding; or
- the average weekly trading volume of the common stock during the four
calendar weeks preceding the required filing of a Form 144 with respect to
such sale.
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Sales under Rule 144 are generally subject to certain manner of sale
provisions and notice requirements and to the availability of current public
information about us. Under Rule 144(k), a person who is not deemed to have been
one of our affiliates at any time during the 90 days preceding a sale, and who
has beneficially owned the shares proposed to be sold for at least two years, is
entitled to sell such shares without having to comply with the manner of sale,
public information, volume limitation or notice provisions of Rule 144. Under
Rule 701 of the Securities Act, persons who purchase shares upon exercise of
options granted prior to the effective date of this offering are entitled to
sell such shares 90 days after the effective date of this offering in reliance
on Rule 144, without having to comply with the holding period requirements of
Rule 144 and, in the case of non-affiliates, without having to comply with the
public information, volume limitation or notice provisions of Rule 144.
LOCK-UP AGREEMENTS
Except for 416,917 shares not subject to the lock up, our directors,
executive officers, all other stockholders and all other option, warrant and
contingent common stock issue right holders, who in the aggregate held all of
the shares of our common stock or securities convertible into our common stock
outstanding immediately prior to the closing of this offering, are subject to
lock-up agreements. Pursuant to these agreements, they have agreed not to
directly or indirectly, offer, sell, contract to sell, grant any option to
purchase, pledge or otherwise dispose of, or, in any manner, transfer all or a
portion of the economic consequences associated with the ownership of any shares
of common stock or any securities convertible into or exercisable or
exchangeable for common stock beneficially owned by them for a period of 24
months after the date of this prospectus, without the prior written consent of
Weatherly Securities Corporation. There are no current intentions to release
shares subject to the lock-up. However, if the average of the closing prices for
our common stock during the last ten trading days of each measurement period
following the closing of this offering, as listed in the table below, is at
least $17.00 per share, then the designated percentage of all of the shares
subject to the lockup then outstanding shall be irrevocably released from such
restrictions:
<TABLE>
<CAPTION>
MEASUREMENT PERIOD PERCENTAGE RELEASED
- ------------------- ---------------------
<S> <C>
12 months 10%
15 months 20%
18 months 30%
21 months 40%
24 months All shares not
previously released
</TABLE>
During the period of lock-up agreement, we may grant options and issue stock
only in the following instances:
- under our incentive plan;
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- in connection with strategic relationships;
- in connection with acquisitions of businesses, technologies or products
complementary to ours.
Provided, that we may only issue such stock if the recipients of such stock
agree to be bound by a lock-up agreement for the remainder of the lock-up
period.
Upon expiration of the lock-up agreements, approximately 6,604,735 shares of
common stock outstanding or issuable upon conversion or exercise of outstanding
securities will become eligible for immediate public resale, subject in some
cases to volume limitations pursuant to Rule 144.
REGISTRATION RIGHTS AGREEMENTS
Pursuant to certain registration rights agreements, the holders of the
securities listed below are entitled to certain registration rights for the
number of shares of common stock and as indicated below:
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
WITH REGISTRATION TYPES OF
TYPE OF SECURITY RIGHTS REGISTRATION RIGHTS
- ------------------------------------------------------ ----------------------- ---------------------------------
<S> <C> <C>
Common stock.......................................... 2,048,242 Piggy back
Common stock contingent issue rights.................. 727,511 Piggy back
Series A preferred stock.............................. 120,667 Demand and piggy back
Series B preferred stock.............................. 600,000 Piggy back
Warrants.............................................. 719,982 Piggy back
Underwriter warrants.................................. 160,000 Demand and piggy back
Convertible promissory note........................... 206,250 Piggy back
</TABLE>
UNDERWRITER WARRANTS. Pursuant to a registration rights agreement entered
into with the representative of the underwriters, the representative has certain
demand and "piggy back" registration rights with respect to the 160,000 shares
of common stock issuable upon exercise of the warrants issued to the
representative in connection with the closing of the offering. The
representative is entitled to one demand registration right during the four year
period beginning one year after the closing of this offering unless a
registration statement is filed and is either withdrawn or does not become
effective in which case, the representative will not have been deemed to
exercise the "demand" registration right.
SERIES A PREFERRED STOCK. Trans Global, the holder of our series A
preferred stock, or its transferees are entitled to "piggy back" and "demand"
registration rights with respect to the shares of common stock issuable upon the
conversion of series A preferred stock. The number of securities requested to be
included in a registration involving the exercise of "piggy back" registration
rights are subject to pro rata reduction upon the request of the managing
underwriter. The managing underwriter may require that the series A holders
agree not to sell the common stock for a six-month period following the closing
of this offering. The series A holders may exercise the "piggy back"
registration rights from the closing of this offering until the underlying
common stock can be sold pursuant to Rule 144(k) of the Securities Act.
129
<PAGE>
In addition, any series A holder or holders who owns 25% of the series A
preferred stock is entitled to "demand" registration rights with respect to the
shares of underlying common stock. The series A holders may exercise their
"demand" registration rights at any time beginning twelve months after the
closing of this offering, if the underlying common stock has not been previously
registered, until the underlying common stock can be sold pursuant to Rule
144(k). The series A holders are entitled to only one "demand" registration
right unless a registration statement is filed and is either withdrawn or does
not become effective. In that event, the series A holders will not have been
deemed to exercise the "demand" registration right.
OTHER SECURITIES. Pursuant to certain registration rights agreements, the
holders of the remaining 4,301,985 shares of common stock with registration
rights are entitled to "piggy back" registration rights. Except for the 296,250
shares of common stock issuable upon conversion of the convertible note issued
to Consolidated Technology and warrants issued with the note, these shares
remain subject to the lock-up agreement even if registered pursuant to these
registration rights. The number of securities request to be included in a
registration involving the exercise of "piggy back" rights are subject to a pro
rata reduction based on the number of shares of common stock held by each such
security holder and any other security holders exercising their respective
registration rights to the extent that we are so advised by the managing
underwriter, if any, that the total number of securities requested to be
included in the underwriting is such as to materially and adversely affect the
success of the offering. The registration rights terminate as to any such
security holder at the later of:
- 3 years after the offering made hereby; or
- such time as such security holder may sell under Rule 144 in a three month
period all registrable securities then held by such holder.
STOCK OPTIONS AND WARRANTS
As of the date of this offering, 1,500,000 shares were subject to
outstanding options under our incentive plan and 879,982 shares were subject to
outstanding warrants to purchase common stock. Except for 90,000 of these
warrants, all of these shares are subject to the lock-up agreements described
above. Approximately 90 days after the date of this prospectus, we intend to
file a registration statement on Form S-8 covering shares issuable under our
incentive plan, thus permitting the resale of such shares in the public market
without restriction under the Securities Act after expiration of the applicable
lock-up agreements. In addition, the holders of the warrants to purchase shares
of common stock are entitled to certain registration rights with respect to such
shares as described above.
130
<PAGE>
UNDERWRITING
Weatherly Securities Corporation is acting as representative for the
underwriters named below in connection with this offering. Each of the
underwriters has severally, not jointly, agreed, subject to the terms and
conditions of the underwriting agreement, among them and our company, to
purchase from us, and we have agreed to sell to them, the number of shares of
common stock set forth below:
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITER OF COMMON STOCK
- ----------------------------------------------------------------------- -----------------
<S> <C>
Weatherly Securities Corporation.......................................
Westport Resources Investment Services, Inc............................
-----------------
Total.................................................................. 1,600,000
-----------------
-----------------
</TABLE>
The underwriters are committed to purchase all the shares of our common
stock we sell in this offering, if they purchase any shares of our common stock,
subject to the terms and conditions of the underwriting agreement.
The underwriters initially propose to offer the shares of our common stock
to the public at the initial public offering price set forth on the cover page
of this prospectus and to certain dealers at such price less concessions not in
excess of $ per share of common stock. Such dealers may re-allow a
concession not in excess of $ per share of common stock to certain other
dealers. After the commencement of this offering, the public offering price,
concession and reallowance may be changed by the representative.
The following table shows the per share and total public offering price, the
underwriting discount we will pay to the underwriters and the proceeds, before
expenses, that we will receive. This information is presented assuming either no
exercise or full exercise by the underwriters of their over-allotment option
discussed below.
<TABLE>
<CAPTION>
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
<S> <C> <C> <C>
Public offering price................................................... $ $ $
Underwriting discount................................................... $ $ $
Proceeds, before expenses, to us........................................ $ $ $
</TABLE>
We estimate our expenses of this offering, exclusive of the underwriting
discount, will be $ .
We have agreed to pay to the representative on behalf of the underwriters a
non-accountable expense allowance equal to 2.6% of the gross proceeds derived
from the sale of the common stock, of which $100,000 has been paid to date. The
non-accountable expense allowance is in addition to the expenses of the offering
described in the previous paragraph.
We have granted to the underwriters an over-allotment option, exercisable
during the 45 day period from the date of this prospectus, to purchase up to
240,000 shares of common stock at the initial public offering price per share of
the common stock we
131
<PAGE>
sell in this offering, less underwriting discounts and the non-accountable
expense allowance. Such option may be exercised only for the purpose of covering
over-allotments, if any, incurred in the sale of the common stock we sell in
this offering. To the extent such option is exercised in whole or in part, each
underwriter will have a firm commitment, subject to certain conditions, to
purchase the number of the additional shares of our common stock proportionate
to its initial commitment.
We have also agreed to sell to the underwriters, for nominal consideration,
warrants to purchase up to 160,000 shares of our common stock. The underwriters
will receive 184,000 warrants if they exercise their over-allotment option in
full. The warrants are initially exercisable at a price of 165% of the initial
public offering price per share of common stock. The warrants may be exercised
for a period of four years, commencing one year from the date of this
prospectus. The warrants provide for adjustment in the number of shares of
common stock issuable upon their exercise and in the exercise price of the
warrants as a result of certain events, including subdivisions and combinations
of our common stock. The warrants grant to their holders certain demand and
piggyback rights to register the common stock issuable upon exercise of the
warrants. The warrants may not be sold, transferred, assigned or pledged for one
year from the effective date of this offering, except to officers or partners of
the underwriters.
We have agreed for a period of three years after the date of this
prospectus, if requested by the representative, to use our best efforts to
nominate one person designated by the representative for election to our board
of directors. In the event the representative elects not to exercise such right,
it may designate a person to receive all notices of meetings of our board of
directors and all other correspondence and communications sent by us to our
board of directors and to attend all such meetings of our board of directors. We
have agreed to reimburse the representative's designee for his out-of-pocket
expenses incurred in connection with his attendance of meetings of our board of
directors.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price of our common stock has
been determined by negotiation between us and the representative and does not
necessarily bear any relationship to our asset value, net worth, or other
established criteria of value. In negotiating the price of our common stock, we
and the representative considered:
- prevailing market conditions,
- the history of and prospects for the industry in which we compete,
- an assessment of our management,
- the prospects of our company, our capital structure, the market for
initial public offerings, and
- certain other factors deemed relevant.
132
<PAGE>
The common stock has been approved for quotation on the American Stock
Exchange under the symbol "IW" subject to office notice of issuance.
Until the distribution of our common stock is completed, the underwriters
and selling group members may engage in transactions that stabilize, maintain or
otherwise affect the price of our common stock. The underwriters may create a
short position by selling more common stock than they are committed to purchase
from us. In that event, the underwriters may choose to reduce their short
position by purchasing shares of our common stock in the open market or by
exercising all or a portion of their over-allotment option.
In addition, the representative, on behalf of the underwriters, may impose
penalty bids on the underwriters. Penalty bids permit the representative to
reclaim the selling concession from the underwriter or selling group member that
sold the shares in this offering.
Selling our common stock short or purchasing shares of our common stock to
either reduce a short position or stabilize the price of our common stock could
result in the maintenance of the price of our common stock at a level higher
than that if no such transactions had occurred. None of these types of
transactions is required. Each of these transactions, if undertaken, may be
discontinued at any time.
The offering of the shares is made for delivery, when, as, and if accepted
by the underwriters and subject to prior sale and to withdrawal, cancellation,
or modification of the offering without notice. The underwriters reserve the
right to reject an order for the purchase of shares in whole or in part.
The underwriters do not expect any sales of shares of common stock to be
made to discretionary accounts.
We and the underwriters have agreed to indemnify each other against, or to
contribute to losses arising out of, certain civil liabilities in connection
with this offering, including liabilities under the Securities Act.
133
<PAGE>
LEGAL MATTERS
The validity of the shares of the common stock offered hereby will be passed
upon for us by Porter & Hedges, L.L.P., Houston, Texas. Certain legal matters in
connection with this offering will be passed upon for the underwriters by
Ruskin, Moscou, Evans & Faltischek, P.C., Mineola, New York.
EXPERTS
The financial statements of InfoHighway Communications Corporation included
in this prospectus and in the registration statement have been audited by BDO
Seidman, LLP, independent certified public accountants, to the extent and for
the periods set forth in their reports appearing elsewhere herein and in the
registration statement, and are included herein in reliance upon such reports
given upon their authority as experts in auditing and accounting.
The financial statements of InfoHighway International, Inc. as of December
31, 1998 and 1997, and for each of the years in the three year period ended
December 31, 1998, have been included elsewhere in this registration statement
in reliance upon the report of KPMG LLP, independent auditors, appearing
elsewhere in the registration statement, and upon their authority as experts in
accounting and auditing.
The audited financial statements of ARC Networks, Inc. included in this
prospectus have been audited by Moore Stephens, P.C., independent public
accountants, as indicated in their report with respect thereto, and are included
herein in reliance upon their authority as experts in giving such report.
The audited financial statements of AXCES, Inc. included in this prospectus
have been audited by Pannell Kerr Forster of Texas, P.C., independent public
accountants, as indicated in their report with respect thereto, and are included
herein in reliance upon their authority as experts in giving such report.
WHERE YOU CAN FIND MORE INFORMATION
This prospectus constitutes a part of a registration statement on Form S-1
that we filed with the SEC under the Securities Act. Upon the completion of the
offering, we will be subject to the informational requirements of the Securities
Exchange Act of 1934 and will file annual and quarterly reports, proxy
statements and other information required by the Exchange Act. The registration
statement and its exhibits and schedules in addition to any reports, statements
or other information we file with the SEC may be inspected and copied at the
public reference facilities maintained by the SEC at 450 Fifth Street, NW,
Washington, D.C. 20594, and at the following regional offices of the SEC: New
York Regional Office, Seven World Trade Center, New York, New York 10048, and
Chicago Regional Office, 500 West Madison Street, Chicago, Illinois 60661.
Copies of such reports and other information may be obtained from the Public
Reference Section of the SEC: 450 Fifth Street, NW, Washington, D.C. 20549, upon
payment of the prescribed fees. In addition, the SEC maintains a web site that
contains reports and information statements and other information regarding
registrants that file electronically with the SEC. Copies of such documents and
the registration statement may also be obtained from the SEC's Internet address
at http://www.sec.gov.
134
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
INFOHIGHWAY COMMUNICATIONS CORPORATION AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
Basis of Presentation.................................................................................. F-2
Unaudited Pro forma Combined Balance Sheet............................................................. F-3
Unaudited Pro forma Combined Statement of Operations................................................... F-4
Notes to Unaudited Pro Forma Combined Financial Statements............................................. F-6
INFOHIGHWAY COMMUNICATIONS CORPORATION HISTORICAL FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants..................................................... F-18
Balance Sheets......................................................................................... F-19
Statements of Loss..................................................................................... F-20
Statements of Stockholders' Equity..................................................................... F-21
Statements of Cash Flows............................................................................... F-22
Notes to Financial Statements.......................................................................... F-23
FOUNDING COMPANIES:
AXCES, INC.
Independent Auditors' Report........................................................................... F-36
Balance Sheets......................................................................................... F-37
Statements of Operations............................................................................... F-38
Statements of Stockholders' Equity..................................................................... F-39
Statements of Cash Flows............................................................................... F-40
Notes to Financial Statements.......................................................................... F-41
INFOHIGHWAY INTERNATIONAL, INC.
Independent Auditors' Report........................................................................... F-51
Balance Sheets......................................................................................... F-52
Statements of Operations............................................................................... F-53
Statements of Stockholders' Equity (Deficit)........................................................... F-54
Statements of Cash Flows............................................................................... F-55
Notes to Financial Statements.......................................................................... F-56
ARC NETWORKS, INC.
Independent Auditors' Report........................................................................... F-62
Consolidated Balance Sheets............................................................................ F-63
Consolidated Statements of Operations.................................................................. F-64
Consolidated Statements of Capital Deficit............................................................. F-65
Consolidated Statements of Cash Flows.................................................................. F-66
Notes to Consolidated Financial Statements............................................................. F-68
</TABLE>
F-1
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The following unaudited pro forma combined financial statements give effect
to the acquisitions by InfoHighway Communications Corporation (f/k/a OmniLynx
Communications Corporation, "InfoHighway") of the outstanding capital stock of
InfoHighway International, Inc. ("InfoHighway International"), ARC Networks,
Inc. ("ARC"), and AXCES, Inc. ("AXCES"), (together, the "founding companies").
InfoHighway and the founding companies are hereinafter referred to as the
Company. InfoHighway acquired ARC effective June 30, 1999; consequently, such
acquisition is reflected in the balance sheet of InfoHighway as of June 30,
1999. InfoHighway will acquire InfoHighway International and AXCES
simultaneously with and as a condition of the closing of InfoHighway's initial
public offering (the "Offering"). All of the acquisitions ("the Acquisitions")
have been accounted for using the purchase method of accounting. With respect to
the Acquisitions, AXCES has been identified as the accounting acquiror for
financial statement presentation purposes. The pro forma combined financial
statements also give effect to an asset acquisition consummated during January
1999 by InfoHighway International (the "Eden Acquisition").
The unaudited pro forma combined balance sheet gives effect to the
Acquisitions and the Offering as if they had occurred on June 30, 1999. The
unaudited pro forma combined statements of operations give effect to these
transactions and the Eden Acquisition as if they had occurred on January 1,
1998.
InfoHighway has preliminarily analyzed the benefits that it expects will be
realized from reductions in salaries, bonuses and certain benefits to the owners
and key management personnel of the founding companies. To the extent the owners
and key management personnel of the founding companies have agreed prospectively
to reductions in salaries, bonuses and benefits, these reductions have been
reflected in the unaudited pro forma combined statements of operations.
Additionally, reductions in interest expense as the result of the planned
repayment of certain debt of the founding companies, as well as through the
conversion of certain debt into preferred stock, have been reflected in the
unaudited pro forma combined statements of operations. With respect to other
potential benefits, InfoHighway has not and cannot quantify these benefits until
completion of the combination of the founding companies. It is anticipated that
these benefits will be offset by costs related to InfoHighway's new corporate
management and by the costs associated with being a public company. However,
because these costs cannot be accurately quantified at this time, they have not
been included in the unaudited pro forma financial information of InfoHighway.
The purchase price of the founding companies (except AXCES, which is the
accounting acquiror) and of InfoHighway has been allocated based on the
estimated fair value of assets acquired and liabilities assumed. The pro forma
adjustments are based on estimates, available information and certain
assumptions and may be revised as additional information becomes available. The
pro forma financial data do not purport to represent what InfoHighway's
financial position or results of operations would actually have been if such
transactions in fact had occurred on the dates stated above and are not
necessarily representative of InfoHighway's financial position or results of
operations for any future period. The unaudited pro forma combined financial
statements should be read in conjunction with the other financial statements and
notes thereto included elsewhere in this Prospectus. Also see "Risk Factors"
included elsewhere herein.
F-2
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
JUNE 30, 1999
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
HISTORICAL
INFOHIGHWAY BASIS PRO FORMA PRO FORMA
AXCES INTERNATIONAL INFOHIGHWAY COMBINED ADJUSTMENTS COMBINED
----------- ------------- ------------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents......... $ 2,607 $ -- $ 984 $ 3,591 $ (2,600) $ 991
Accounts receivable, net.......... 2,500 298 3,764 6,562 -- 6,562
Receivable from related parties... 1,734 -- 170 1,904 (170) 1,734
Federal income tax receivable..... 59 -- -- 59 -- 59
Costs and estimated earnings in
excess of billings on
uncompleted contracts........... -- -- 481 481 -- 481
Prepaid expenses and other current
assets.......................... 455 32 513 1,000 -- 1,000
----------- ------------- ------------- ----------- ------------- -----------
Total current assets............ 7,355 330 5,912 13,597 (2,770) 10,827
PROPERTY AND EQUIPMENT, net......... 361 783 128 1,272 -- 1,272
GOODWILL AND OTHER INTANGIBLE
ASSETS............................ -- 391 10,451 10,842 18,364 29,206
OTHER ASSETS........................ 99 22 86 207 -- 207
----------- ------------- ------------- ----------- ------------- -----------
TOTAL ASSETS........................ $ 7,815 $ 1,526 $ 16,577 $ 25,918 $ 15,594 $ 41,512
----------- ------------- ------------- ----------- ------------- -----------
----------- ------------- ------------- ----------- ------------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)
CURRENT LIABILITIES:
Notes payable..................... $ -- $ 200 $ 800 $ 1,000 $ 2,900 $ 3,900
Notes payable to related
parties......................... -- 1,181 4,397 5,578 (230) 5,348
Capital lease payables............ -- 34 22 56 -- 56
Accounts payable.................. 571 844 5,174 6,589 -- 6,589
Accrued liabilities............... 356 113 1 470 -- 470
Billings in excess of costs and
estimated earnings on
uncompleted contracts........... -- -- 402 402 -- 402
Disputed amounts under contract... -- -- 1,290 1,290 -- 1,290
Current income taxes payable...... -- -- -- -- 1,600 1,600
Other current liabilities......... 13 349 -- 362 -- 362
----------- ------------- ------------- ----------- ------------- -----------
Total current liabilities....... 940 2,721 12,086 15,747 4,270 20,017
LONG-TERM DEBT, net of current
maturities........................ -- -- 5 5 -- 5
NOTES PAYABLE TO RELATED PARTIES.... -- -- 1,147 1,147 (1,147) --
OTHER LONG-TERM LIABILITIES......... 32 -- -- 32 -- 32
REDEEMABLE PREFERRED STOCK.......... -- -- -- -- 1,207 1,207
STOCKHOLDERS' EQUITY (CAPITAL
DEFICIT):
Preferred stock................... -- -- -- -- 9,000 9,000
Common stock...................... 1 2,601 -- 2,602 (2,602) --
Additional paid in capital........ 13 -- 3,534 3,547 8,075 11,622
Retained earnings (deficit)....... 6,829 (3,796) (195) 2,838 (3,209) (371)
----------- ------------- ------------- ----------- ------------- -----------
Stockholders' equity (capital
deficit)...................... 6,843 (1,195) 3,339 8,987 11,264 20,251
----------- ------------- ------------- ----------- ------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY (CAPITAL DEFICIT).......... $ 7,815 $ 1,526 $ 16,577 $ 25,918 $ 15,594 $ 41,512
----------- ------------- ------------- ----------- ------------- -----------
----------- ------------- ------------- ----------- ------------- -----------
<CAPTION>
POST- PRO FORMA
ACQUISITION AS
ADJUSTMENTS ADJUSTED
------------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents......... $ 7,164 $ 8,155
Accounts receivable, net.......... -- 6,562
Receivable from related parties... -- 1,734
Federal income tax receivable..... -- 59
Costs and estimated earnings in
excess of billings on
uncompleted contracts........... -- 481
Prepaid expenses and other current
assets.......................... (513) 487
------------- -----------
Total current assets............ 6,651 17,478
PROPERTY AND EQUIPMENT, net......... -- 1,272
GOODWILL AND OTHER INTANGIBLE
ASSETS............................ -- 29,206
OTHER ASSETS........................ -- 207
------------- -----------
TOTAL ASSETS........................ $ 6,651 $ 48,163
------------- -----------
------------- -----------
LIA
CURRENT LIABILITIES:
Notes payable..................... $ (3,100) $ 800
Notes payable to related
parties......................... (3,569) 1,779
Capital lease payables............ -- 56
Accounts payable.................. -- 6,589
Accrued liabilities............... -- 470
Billings in excess of costs and
estimated earnings on
uncompleted contracts........... -- 402
Disputed amounts under contract... -- 1,290
Current income taxes payable...... -- 1,600
Other current liabilities......... -- 362
------------- -----------
Total current liabilities....... (6,669) 13,348
LONG-TERM DEBT, net of current
maturities........................ -- 5
NOTES PAYABLE TO RELATED PARTIES.... -- --
OTHER LONG-TERM LIABILITIES......... -- 32
REDEEMABLE PREFERRED STOCK.......... -- 1,207
STOCKHOLDERS' EQUITY (CAPITAL
DEFICIT):
Preferred stock................... -- 9,000
Common stock...................... -- --
Additional paid in capital........ 13,320 24,942
Retained earnings (deficit)....... -- (371)
------------- -----------
Stockholders' equity (capital
deficit)...................... 13,320 33,571
------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY (CAPITAL DEFICIT).......... $ 6,651 $ 48,163
------------- -----------
------------- -----------
</TABLE>
F-3
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
INFOHIGHWAY PRO FORMA PRO FORMA
AXCES INTERNATIONAL ARC INFOHIGHWAY TOTAL ADJUSTMENTS COMBINED
--------- ------------- --------- ------------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues.............................. $ 10,095 $ 1,100 $ 8,171 $ -- $ 19,366 $ -- $ 19,366
Cost of services...................... 3,445 592 6,694 -- 10,731 -- 10,731
--------- ------ --------- ----- --------- ----------- -----------
Gross profit.......................... 6,650 508 1,477 -- 8,635 -- 8,635
Selling, general and administrative
expenses............................ 4,914 713 1,828 177 7,632 -- 7,632
Depreciation and amortization......... 112 261 219 -- 592 1,780 2,372
--------- ------ --------- ----- --------- ----------- -----------
Income (loss) from operations......... 1,624 (466) (570) (177) 411 (1,780) (1,369)
Interest income (expense), net........ (50) (63) (302) (17) (432) 199 (233)
--------- ------ --------- ----- --------- ----------- -----------
Income (loss) before income taxes..... 1,574 (529) (872) (194) (21) (1,581) (1,602)
Provision for income taxes............ -- -- -- -- -- 115 115
--------- ------ --------- ----- --------- ----------- -----------
Net income (loss)..................... $ 1,574 $ (529) $ (872) $ (194) $ (21) $ (1,696) $ (1,717)
--------- ------ --------- ----- --------- ----------- -----------
--------- ------ --------- ----- --------- ----------- -----------
Pro forma net loss before dividends on
preferred stock..................... $ (1,717)
Dividends on preferred stock.......... 420
-----------
Pro forma net loss applicable to
common stockholders................. $ (2,137)
-----------
-----------
Net loss per share--basic and
diluted............................. $ (.58)
Shares used in computing pro forma net
loss per share...................... 3,654
</TABLE>
F-4
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
INFOHIGHWAY PRO FORMA PRO FORMA
AXCES INTERNATIONAL ARC INFOHIGHWAY TOTAL ADJUSTMENTS COMBINED
--------- ------------ --------- --------------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues............................. $ 30,280 $ 1,384 $ 13,931 $ -- $ 45,595 $ 778 $ 46,373
Cost of services..................... 9,889 995 11,651 -- 22,535 184 22,719
--------- ------------ --------- ----- --------- ----------- -----------
Gross profit......................... 20,391 389 2,280 -- 23,060 594 23,654
Selling, general and administrative
expenses........................... 17,934 1,339 3,465 -- 22,738 (1,997) 20,741
Depreciation and amortization........ 204 261 407 -- 872 3,504 4,376
--------- ------------ --------- ----- --------- ----------- -----------
Income (loss) from operations........ 2,253 (1,211) (1,592) -- (550) (913) (1,463)
Interest income (expense), net....... (208) (57) (317) -- (582) 170 (412)
--------- ------------ --------- ----- --------- ----------- -----------
Income (loss) before income taxes.... 2,045 (1,268) (1,909) -- (1,132) (743) (1,875)
Provision (benefit) for income
taxes.............................. (917) -- -- -- (917) 1,464 547
--------- ------------ --------- ----- --------- ----------- -----------
Net income (loss).................... $ 2,962 $ (1,268) $ (1,909) $ -- $ (215) $ (2,207) $ (2,422)
--------- ------------ --------- ----- --------- ----------- -----------
--------- ------------ --------- ----- --------- ----------- -----------
Pro forma net loss before dividends
on preferred stock................. $ (2,422)
Dividends on preferred stock......... 841
-----------
Pro forma net loss applicable to
common stockholders................ $ (3,263)
-----------
-----------
Net loss per share--basic and
diluted............................ $ (.89)
Shares used in computing pro forma
net loss per share................. 3,654
</TABLE>
F-5
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
1. GENERAL
InfoHighway Communications Corporation (f/k/a OmniLynx Communications
Corporation, "InfoHighway") was incorporated in December 1996 in the state of
Delaware. InfoHighway was formed to become a leading provider of unified
Internet, data and telecommunications solutions to niche markets representing
the high and low end of the telecommunications marketplace. Prior to the
acquisition of ARC, InfoHighway had conducted no operations. The acquisition of
ARC was consummated on June 30, 1999. InfoHighway International and AXCES will
be acquired concurrently with and as a condition of the closing of the Offering.
The historical financial statements represent the financial position and
results of operations of the founding companies and were derived from the
respective founding companies' financial statements. The periods included in
these pro forma combined financial statements for the individual founding
companies are as of and for the six months ended June 30, 1999 and for the year
ended December 31, 1998. The historical financial statements included elsewhere
herein have been included in accordance with Securities and Exchange Commission
Staff Accounting Bulletin No. 80.
2. ACQUISITION OF FOUNDING COMPANIES
InfoHighway acquired ARC effective June 30, 1999; consequently, such
acquisition is reflected in the balance sheet of InfoHighway as of June 30,
1999. InfoHighway will acquire InfoHighway International and AXCES
simultaneously with and as a condition of the closing of this Offering. The
Acquisitions were accounted for using the purchase method of accounting with
AXCES treated as the accounting acquiror.
The consideration paid or to be paid in the Acquisitions includes (a) common
stock, (b) contingent common stock, and (c) Series A and Series B convertible
redeemable preferred stock. In addition, InfoHighway will be assuming certain of
the debt of all of the founding companies. For purposes of computing the
estimated purchase price for accounting purposes, the value of the common shares
issued has been determined using an estimated fair value of $9.00 per share,
which represents a discount of 10% from the assumed initial public offering
price of $10.00 per share (the midpoint of the range of estimated initial public
offering prices set forth on the cover page of this Prospectus) due to
restrictions on the sale and transferability of the shares issued. The estimated
purchase price for the Acquisitions is based upon preliminary estimates and is
subject to certain purchase price adjustments at and following closing. In the
opinion of management, the final allocation of the purchase price will not
materially differ from these preliminary estimates.
ACQUISITION OF INFOHIGHWAY INTERNATIONAL
The acquisition consideration to be received by the stockholders of
InfoHighway International consists of 958,166 shares of common stock of
InfoHighway and 235,878 shares of contingent common stock of InfoHighway
(including 85,397 shares of common stock of InfoHighway and 17,584 shares of
contingent common stock of InfoHighway earmarked for the Eden Acquisition).
Issuances of contingent common stock is conditional upon achievement of certain
share price targets; 50% of the contingent common stock shall be issued when the
price of the common stock reaches a 10-day average of $16 per share. The
remaining 50% of the contingent common stock reaches a 10-day average of $21 per
share. For accounting purposes, no value has been allocated to the contingent
common stock.
F-6
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITION OF FOUNDING COMPANIES (CONTINUED)
Additionally, the Company is assuming some of InfoHighway International's
outstanding debt, which totaled $1.4 million at June 30, 1999.
During January 1999, InfoHighway International acquired the operations of
Eden Matrix, an Internet service provider based in Austin, Texas operated by
AMICI Online Investments, L.L.C. (the "Eden Acquisition"). The acquisition
consideration approximated $1.0 million, consisting of a $50,000 cash down
payment and a short-term note payable for $0.9 million. During the second
quarter of 1999, $0.8 million of the short-term note payable was converted into
968,750 common shares of InfoHighway International.
ACQUISITION OF ARC
The acquisition consideration received by the stockholders of ARC consists
of 390,076 shares of common stock of InfoHighway and 152,672 shares of
contingent common stock of InfoHighway. Issuances of contingent common stock are
conditional upon achievement of certain share price targets; 50% of the
contingent common stock shall be issued when the price of the common stock
reaches a 10-day average of $16 per share. The remaining 50% of the contingent
common stock shall be issued when the price of the common stock reaches a 10-day
average of $21 per share. For accounting purposes, no value has been allocated
to the contingent common stock.
The merger agreement also provides for the exchange of $1.2 million of an
existing ARC note payable to an affiliated company for Series A 10% Convertible
Preferred Stock, ("Series A Preferred Stock") of InfoHighway valued at $1.2
million. The preferred stock is convertible into common stock at the option of
the holder at any time after 90 days from the closing of this offering or
earlier with the consent of both InfoHighway and the representative of the
underwriters with respect to this offering. The number of shares issuable upon
conversion of the series A preferred stock is dependent on the conversion rate
which is calculated by dividing $1.00 by the lesser of the offering price or the
five-day average closing price ending on the trading day prior to such
conversion date. The preferred stock is redeemable by the holder at $1.00 per
share in the event the Company's common stock declines over 67% of the initial
public offering price.
Additionally, the Company assumed all debt outstanding of ARC upon
consummation of the acquisition effective June 30, 1999, which totaled $3.2
million at June 30, 1999, with the exception of the ARC note payable which will
be exchanged for preferred stock as discussed in the aforementioned paragraph.
The merger agreement also provides for: (a) the repayment of $0.8 million of the
outstanding balance on the revolving line of credit due to the parent of ARC
from proceeds of the Offering, (b) the exchange of $0.45 million of the
revolving line of credit for a note payable due on January 31, 2000 that is
convertible at the holder's option into 56,250 common shares of InfoHighway, and
(c) the balance of the revolving line of credit being exchanged for a note
payable maturing in June 2000 unless converted earlier by the holder into
150,000 common shares of InfoHighway. The balance outstanding under the
revolving line of credit was $2.4 million at June 30, 1999.
ACQUISITION OF AXCES
The acquisition consideration to be received by the stockholders of AXCES
consists of 700,000 shares of common stock of InfoHighway and $9.0 million,
60,000 shares valued at $150 per share, of Series B 8% Cumulative Convertible
Preferred Stock ("Series B Preferred Stock") of InfoHighway. The
F-7
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITION OF FOUNDING COMPANIES (CONTINUED)
Series B Preferred Stock is convertible into 600,000 shares of common stock at
the holder's option and is redeemable at the Company's option after 36 months
out of a designated portion of the Company's cash flow. If the common stock
trades for an average of $20 per share for 10 consecutive days, the Company may
force the conversion of the preferred stock into common stock.
In connection with the acquisition of AXCES, InfoHighway has agreed to
assume up to $3.0 million of indebtedness to be incurred by AXCES prior to the
Offering for distribution to its shareholder. AXCES may distribute up to $6.5
million in cash to its shareholder prior to the closing of the acquisition,
including proceeds from this indebtedness, provided that the distributions do
not decrease AXCES' working capital below a minimum level.
The following table sets forth the components for accounting purposes of the
consideration with respect to the Acquisitions, including 85,397 common shares
and 17,584 contingent common shares earmarked for the Eden Acquisition. The
table does not reflect the S Corporation Distribution and other distributions
noted above to the stockholders of AXCES.
<TABLE>
<CAPTION>
CONTINGENT
COMMON STOCK COMMON STOCK(1) PREFERRED STOCK
------------------------- ---------------------- -------------------------
VALUE OF VALUE OF VALUE OF
ACQUISITION SHARES SHARES SHARES SHARES SHARES SHARES
- ------------------------------------------ ---------- ------------- --------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
InfoHighway International................. 958,166 $ 8,623,494 235,878 $ -- -- $ --
ARC....................................... 390,076 3,510,684 152,672 -- 1,206,673(2) 1,206,673
AXCES..................................... 700,000 6,300,000 -- -- 60,000(3) 9,000,000
---------- ------------- --------- ----- ---------- -------------
2,048,242 $ 18,434,178 388,550 $ -- 1,266,673 $ 10,206,673
---------- ------------- --------- ----- ---------- -------------
---------- ------------- --------- ----- ---------- -------------
</TABLE>
- ------------------------
(1) The contingent common stock issue rights entitle the holder to receive
shares of our common stock based upon its market performance beginning 90
days after the closing of this offering. Approximately one-half of the
shares are issuable if and when the common stock reaches a 10-day average of
$16.00 per share. The remaining one-half are issuable if and when the common
stock reaches a 10-day average of $21.00 per share. The rights expire after
three years.
(2) Shares of Series A 10% Convertible Preferred Stock.
(3) Shares of Series B 8% Convertible Preferred Stock.
For accounting purposes, AXCES is treated as the accounting acquiror, and
accordingly, its financial statements are presented on a historical basis.
F-8
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS
JUNE 30, 1999
(IN THOUSANDS)
3. UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS
The following table represents the unaudited pro forma combined balance
sheet adjustments for InfoHighway Communication Corporation and the founding
companies:
<TABLE>
<CAPTION>
TOTAL
PRO FORMA
(A) (B) ADJUSTMENTS (C) (D)
--------- --------- ------------- --------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents..................................... $ (2,600) $ -- $ (2,600) $ 13,833 $ (6,669)
Accounts receivable, net...................................... -- -- -- -- --
Receivable from related parties............................... -- (170) (170) -- --
Costs and estimated earnings in excess of billings on
uncompleted contracts....................................... -- -- -- -- --
Prepaid expenses and other current assets..................... -- -- -- (513) --
--------- --------- ------------- --------- ---------
Total current assets........................................ (2,600) (170) (2,770) 13,320 (6,669)
PROPERTY AND EQUIPMENT, net..................................... -- -- -- -- --
GOODWILL AND OTHER INTANGIBLE ASSETS............................ -- 18,364 18,364 -- --
OTHER ASSETS.................................................... -- -- -- -- --
--------- --------- ------------- --------- ---------
TOTAL ASSETS.................................................... $ (2,600) $ 18,194 $ 15,594 $ 13,320 $ (6,669)
--------- --------- ------------- --------- ---------
--------- --------- ------------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)
CURRENT LIABILITIES:
Notes payable................................................. $ 3,000 $ (100) $ 2,900 $ -- $ (3,100)
Notes payable to related parties.............................. -- (230) (230) -- (3,569)
Capital lease payables........................................ -- -- -- -- --
Accounts payable.............................................. -- -- -- -- --
Accrued liabilities........................................... -- -- -- -- --
Billings in excess of costs and estimated earnings on
uncompleted contracts....................................... -- -- -- -- --
Disputed amounts under contract............................... -- -- -- -- --
Payable to founding company shareholders...................... -- -- -- -- --
Current income taxes payable.................................. 1,600 -- 1,600 -- --
Other current liabilities..................................... -- -- -- -- --
--------- --------- ------------- --------- ---------
Total current liabilities................................... 4,600 (330) 4,270 -- (6,669)
LONG-TERM DEBT, net of current maturities....................... -- --
NOTES PAYABLE TO RELATED PARTIES................................ -- (1,147) (1,147) -- --
OTHER LONG-TERM LIABILITIES..................................... -- -- -- -- --
REDEEMABLE PREFERRED STOCK...................................... -- 1,207 1,207 -- --
STOCKHOLDERS' EQUITY (CAPITAL DEFICIT):
Preferred stock............................................... -- 9,000 9,000 -- --
Common stock.................................................. -- (2,602) (2,602) -- --
Additional paid in capital.................................... -- 8,075 8,075 13,320 --
Retained earnings (capital deficit)........................... (7,200) 3,991 (3,209) -- --
--------- --------- ------------- --------- ---------
Stockholders' equity (capital deficit)...................... (7,200) 18,464 11,264 13,320 --
--------- --------- ------------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIT).... $ (2,600) $ 18,194 $ 15,594 $ 13,320 $ (6,669)
--------- --------- ------------- --------- ---------
--------- --------- ------------- --------- ---------
<CAPTION>
TOTAL
POST-ACQUISITION
ADJUSTMENTS
-----------------
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents..................................... $ 7,164
Accounts receivable, net...................................... --
Receivable from related parties............................... --
Costs and estimated earnings in excess of billings on
uncompleted contracts....................................... --
Prepaid expenses and other current assets..................... (513)
-------
Total current assets........................................ 6,651
PROPERTY AND EQUIPMENT, net..................................... --
GOODWILL AND OTHER INTANGIBLE ASSETS............................ --
OTHER ASSETS.................................................... --
-------
TOTAL ASSETS.................................................... $ 6,651
-------
-------
LIABILITIES AND STOCKHOLDERS'
CURRENT LIABILITIES:
Notes payable................................................. $ (3,100)
Notes payable to related parties.............................. (3,569)
Capital lease payables........................................ --
Accounts payable.............................................. --
Accrued liabilities........................................... --
Billings in excess of costs and estimated earnings on
uncompleted contracts....................................... --
Disputed amounts under contract............................... --
Payable to founding company shareholders...................... --
Current income taxes payable.................................. --
Other current liabilities..................................... --
-------
Total current liabilities................................... (6,669)
LONG-TERM DEBT, net of current maturities.......................
NOTES PAYABLE TO RELATED PARTIES................................ --
OTHER LONG-TERM LIABILITIES..................................... --
REDEEMABLE PREFERRED STOCK...................................... --
STOCKHOLDERS' EQUITY (CAPITAL DEFICIT):
Preferred stock............................................... --
Common stock.................................................. --
Additional paid in capital.................................... 13,320
Retained earnings (capital deficit)........................... --
-------
Stockholders' equity (capital deficit)...................... 13,320
-------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIT).... $ 6,651
-------
-------
</TABLE>
F-9
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS
JUNE 30, 1999
(IN THOUSANDS)
3. UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS (CONTINUED)
(a) Reflects the estimated distributions of $5.6 million based upon cash
balances of $2.6 million at June 30, 1999 at AXCES and $3.0 million of
projected short-term borrowings, and $1.6 million of current income taxes
related to the S corporation assuming C Corporation treatment. These
short-term borrowings are expected to be repaid with proceeds from the
Offering.
(b) Records the purchase of the remaining founding companies and the
conversion of AXCES' stockholders' equity to reflect InfoHighway's
capital structure recognizing AXCES as the accounting acquiror. The
acquisition of ARC was consummated effective June 30, 1999 and is
appropriately included in InfoHighway's historical balance sheet as of
June 30, 1999 included herein. The combined purchase of the remaining
founding companies will result in goodwill and other identifiable
intangible assets of $18.4 million over the fair value of the
identifiable net assets acquired of all founding companies, excluding
AXCES, since as accounting acquiror no purchase price allocation is
recorded for AXCES.
Total goodwill and other identifiable intangible assets of $29.2 million
have been allocated and assigned lives as follows:
<TABLE>
<CAPTION>
VALUE LIFE
------------- ---------
<S> <C> <C>
Subscriber basis....................................................... $ 391,070 3-4
Non Compete Agreements................................................. 900,000 4
Customer Relationships................................................. 1,276,250 8.33
Goodwill............................................................... 26,638,818 7-10
-------------
$ 29,206,138
-------------
-------------
</TABLE>
The following table summarizes the components of the allocation of the
purchase price for this adjustment (b) as well as for the total goodwill
and other identifiable intangibles recorded on the acquisition of all
founding companies.
<TABLE>
<CAPTION>
SUBTOTAL
------------ EXISTING
BALANCE GOODWILL ON
INFOHIGHWAY SHEET HISTORICAL
INTERNATIONAL INFOHIGHWAY ADJ (B) ARC FINANCIALS AXCES
------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Total Purchase Price:
Common Stock....................... $ 8,623,494 $8,451,000 $ 17,074,494 $ 3,510,684 $ -- $ 6,300,000
Preferred Stock.................... -- -- -- -- -- 9,000,000
------------- ------------ ------------ ------------ ------------ ------------
8,623,494 8,451,000 17,074,494 3,510,684 -- 15,300,000
Less:
Purchase Price attributable to
AXCES............................ -- -- -- -- -- 15,300,000
------------- ------------ ------------ ------------ ------------ ------------
Total Purchase Price attributed to
Acquirees and Promoter............. 8,623,494 8,451,000 17,074,494 3,510,684 -- --
Less Fair Value of Assets acquired
excluding AXCES.................... (1,095,204) (194,225) (1,289,429) (6,940,461) (391,070) --
------------- ------------ ------------ ------------ ------------ ------------
Goodwill and Other Identifiable
Intangibles........................ $ 9,718,698 $8,645,225 $ 18,363,923 $ 10,451,145 $ 391,070 $ --
------------- ------------ ------------ ------------ ------------ ------------
<CAPTION>
CONSOLIDATED
-------------
<S> <C>
Total Purchase Price:
Common Stock....................... $26,885,178
Preferred Stock.................... 9,000,000
-------------
35,885,178
Less:
Purchase Price attributable to
AXCES............................ 15,300,000
-------------
Total Purchase Price attributed to
Acquirees and Promoter............. 20,585,178
Less Fair Value of Assets acquired
excluding AXCES.................... (8,620,960)
-------------
Goodwill and Other Identifiable
Intangibles........................ $29,206,138
-------------
</TABLE>
F-10
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS
JUNE 30, 1999
(IN THOUSANDS)
3. UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS (CONTINUED)
For accounting purposes, the 939,000 shares owned by the InfoHighway
Founders have been valued identically as the shares issued to consummate
the acquisitions with the founding companies. These shares have been
recorded at an estimated fair value of $9.00 per share, which represents
a discount of 10% from the assumed initial public offering price of
$10.00 per share. The value of such shares owned by the InfoHighway
Founders resulted in goodwill which will be amortized over 10 years.
(c) Records the cash proceeds from the issuance of 1.6 million shares of
common stock, net of estimated offering costs. Offering costs primarily
consist of underwriting discounts and commissions, accounting fees, legal
fees and printing expenses.
(d) Records the payment of certain debt of the founding companies which is
expected to be paid from the proceeds of the Offering, and the exchange
of the remaining balance under the revolving line of credit debt into
convertible notes payable.
F-11
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS
JUNE 30, 1999
(IN THOUSANDS)
3. UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS (CONTINUED)
The following table provides a description of such debt including the
interest rate and maturity of such indebtedness.
<TABLE>
<CAPTION>
ANNUAL PRINCIPAL
INTEREST BALANCE PRINCIPAL
DEBT DESCRIPTION RATE @ 6/30/99 REPAYMENT MATURITY DATE
- ---------------------------------------- ----------- --------- ---------- ----------------------------------------
<S> <C> <C> <C> <C>
INFOHIGHWAY INTERNATIONAL--
Unit Offering Subordinated Notes...... 10.0% $ 369,750 $ 369,750 Matures at the sooner of March 31, 2003
or within 90 days of the sale of the
company.
Promissory Note with Robert 10.0% 200,000 100,000 Matures at the sooner of February 28,
Mokterian........................... 2000 or within 90 days of the sale of
the company; $100,000 to be converted
into equity of InfoHighway International
prior to the acquisition, the balance
due at time of Offering.
Promissory Note with Trident III...... 12.0% 499,250 499,250 Matures at the sooner of September 30,
1999 or (i) the earliest of: (a) one or
more debt or equity financings of $1.0
million or more, (b) the merger of the
company into a public company, or (c)
the date of an occurrence of an event of
default.
AXCES--
Projected short-term borrowing........ N/A 3,000,000 3,000,000 AXCES may borrow up to $3.0 million to
fund distributions to its owners,
subject to an operating cash flow
minimum requirement. Such borrowing, if
any, would be repaid with proceeds from
the Offering.
INFOHIGHWAY--AND SUBSIDIARY
Revolving Line of Credit.............. 14% 2,399,724 750,000 Matures as follows: (a) $750,000 at time
of Offering, (b) $450,000 at January 31,
2000 unless converted at holder's option
into 56,250 common shares of
InfoHighway, and (c) the balance
exchangeable into a note payable due
June 2000 unless converted earlier by
holder into 150,000 common shares of
InfoHighway.
Bridge financing from a group of
accredited investors................ 13.0% 1,500,000 1,500,000 Matures at time of Offering.
Bridge financing from a group of
accredited investors................ 13.0% 250,000 250,000 Matures at time of Offering.
Bridge financing from Halcyon, an
independent party................... 13.0% 200,000 200,000 Matures at time of Offering.
----------
$6,669,000
----------
----------
</TABLE>
F-12
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
4. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS ADJUSTMENTS
The following table summarizes the unaudited pro forma combined statement of
operations adjustments (in thousands):
SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
PRO FORMA
(A) (B) (C) ADJUSTMENTS
------- ---- ------- -----------
<S> <C> <C> <C> <C>
Revenues.................................................... $ -- $ -- $ -- $ --
Cost of services............................................ -- -- -- --
------- ---- ------- -----------
Gross profit................................................ -- -- -- --
Selling, general and administrative expenses................ -- -- --
Depreciation and amortization............................... 1,780 -- -- 1,780
------- ---- ------- -----------
Income (loss) from operations............................... (1,780) -- -- (1,780)
Interest income (expense), net.............................. -- 199 -- 199
------- ---- ------- -----------
Income (loss) before income taxes........................... (1,780) 199 -- (1,581)
Provision (benefit) for income taxes........................ -- -- 115 115
------- ---- ------- -----------
Net income (loss)........................................... $(1,780) $199 $ (115) $(1,696)
------- ---- ------- -----------
------- ---- ------- -----------
</TABLE>
(a) Reflects the amortization of excess purchase price relating to the
Acquisitions which has been allocated as noted in Note 3(b).
(b) Reflects the reduction in interest expense due to the planned repayment
and planned conversion of certain debt in connection with the
Acquisitions, and the incremental interest expense for the amortization
of original issue discounts, as provided in the following table.
<TABLE>
<CAPTION>
PRINCIPAL ANNUAL INTEREST
DEBT ISSUE BALANCE INTEREST EXPENSE
DESCRIPTION DATE TO BE REPAID RATE CALCULATION
- ------------------------------------------------------------ ------------------------ ------------ -------- -----------
<S> <C> <C> <C> <C>
INFOHIGHWAY INTERNATIONAL --
Unit Offering Subordinated Notes April 1998-August 1998 $ 369,750 10.00% $ 18,336
Promissory Note with Robert Mokterian February 23, 1999 100,000 10.00% 3,479
Promissory Note with Trident III September 1998- 499,250 12.00% 29,709
January 1999
ARC --
Trans Global Note March 1998 1,206,674(1) 10.00% 59,838
CTG Revolving Line of Credit September 17, 1998 750,000 15.9% 59,134
INFOHIGHWAY --
Bridge financing from a group of accredited investors June 1, 1999 1,500,000 13.00% 15,493
Bridge financing from a group of accredited investors April 14, 1999 250,000 13.00% 6,856
Bridge financing from Halcyon, on independent party June 18, 1999 200,000 13.00% 855
Other debt repaid with bridge financings April 5, 1999 100,000 13.00% 2,030
Other debt repaid with bridge financings March 1, 1999 100,000 13.00% 3,277
-----------
$199,007
-----------
-----------
</TABLE>
F-13
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
4. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS ADJUSTMENTS (CONTINUED)
(1) It is anticipated that this note will be exchanged for Series A 10%
Convertible Redeemable Preferred Stock upon completion of an initial
public offering by the Company.
(c) Reflects the incremental provision for federal and state income taxes
relating to the statement of operations pro forma adjustments and to
reflect income taxes on S corporation operations as if AXCES had been
taxable as a C corporation during the period presented. Assumes all
income is subject to a federal corporate tax rate of 34% and the
non-deductibility of goodwill and intangible asset amortizations.
5. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS ADJUSTMENTS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
PRO FORMA
(A) (B) (C) (D) (E) ADJUSTMENTS
------- ---- ----- ------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
Revenues.................................................... $ -- $ -- $ 778 $ -- $ -- $ 778
Cost of services............................................ -- -- 184 -- -- 184
------- ---- ----- ------- ------- -----------
Gross profit................................................ -- -- 594 -- -- 594
Selling, general and administrative expenses................ -- -- 610 (2,607) -- (1,997)
Depreciation and amortization............................... 3,254 -- 250 -- -- 3,504
------- ---- ----- ------- ------- -----------
Income (loss) from operations............................... (3,254) -- (266) 2,607 -- (913)
Interest income (expense), net.............................. -- 170 -- -- -- 170
------- ---- ----- ------- ------- -----------
Income (loss) before income taxes........................... (3,254) 170 (266) 2,607 -- (743)
Provision (benefit) for income taxes........................ -- -- -- -- 1,464 1,464
------- ---- ----- ------- ------- -----------
Net income (loss)........................................... $(3,254) $170 $(266) $ 2,607 $(1,464) $(2,207)
</TABLE>
(a) Reflects the amortization of excess purchase price totaling $27.0
million relating to the Acquisitions which has been allocated as noted in
Note 3(b). The components of the amortization of the excess purchase
price at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
EXCESS
PURCHASE
PRICE LIVES AMORTIZATION
------------- --------- ------------
<S> <C> <C> <C>
Goodwill........................................................... $ 24,710,000 7-10 $2,856,000
Customer relationships............................................. 1,276,000 8.33 153,000
Non-compete........................................................ 900,000 4 225,000
Subscriber basis................................................... 71,000 3-4 20,000
------------- --- ------------
$ 26,957,000 $3,254,000
</TABLE>
F-14
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
5. UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS ADJUSTMENTS (CONTINUED)
(b) Reflects the reduction in interest expense due to the planned repayment
and planned conversion of certain debt in connection with the
Acquisitions, and the incremental interest expense for the amortization
of original issue discounts, as provided in the following table.
<TABLE>
<CAPTION>
PRINCIPAL ANNUAL INTEREST
DEBT ISSUE BALANCE INTEREST EXPENSE
DESCRIPTION DATE TO BE REPAID RATE CALCULATION
- -- ------------------------ ------------ -------- -----------
<C> <C> <C> <C>
INFOHIGHWAY
INTERNATIONAL
--
April 1998-August 1998 $ 369,750 10.00% $ 26,338
Unit
Offering
Subordinated
Notes
September 1998- 499,250 12.00% 17,563
Promissory January 1999
Note
with
Trident
III
ARC
--
March 1998 1,206,674(1) 10.00% 91,575
Trans
Global
Note
September 17, 1998 750,000 15.9% 34,348
CTG
Revolving
Line of
Credit
-----------
$169,824
-----------
-----------
</TABLE>
(1) It is anticipated that this note will be exchanged for Series A 10%
Convertible Redeemable Preferred Stock upon completion of an initial
public offering by the Company.
(c) Reflects the operating results for the Eden Acquisition for the year
ended December 31, 1998. Also reflects the amortization of the customer
list from the Eden Acquisition which is being amortized over a period of
three years and depreciation of property and equipment acquired which is
being recognized over the average useful life of the property and
equipment of five years.
(d) Adjusts salaries, bonuses and benefit amounts to reflect those
established in contractual agreements between the Company and the owners
and key management personnel of the founding companies.
(e) Reflects the incremental provision for federal and state income taxes
relating to the statement of operations pro forma adjustments and to
reflect income taxes on S corporation operations as if AXCES had been
taxable as a C corporation during the period presented. Assumes all
income is subject to a federal corporate tax rate of 34% and the
non-deductibility of goodwill and intangible asset amortizations.
6. PRO FORMA LOSS PER SHARE
The following table summarizes shares used in computing pro forma loss per
share:
<TABLE>
<S> <C>
InfoHighway Founders............................................. 939,000
Founding Companies:
InfoHighway International...................................... 872,769
ARC............................................................ 390,076
AXCES.......................................................... 700,000
Eden Acquisition................................................. 85,397
Offering(a)...................................................... 666,900
Effect of assumed exercise of common stock warrants and options
(see Note 7)................................................... --
---------
Shares used in computing pro forma loss per share................ 3,654,142
---------
---------
</TABLE>
F-15
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
6. PRO FORMA LOSS PER SHARE (CONTINUED)
(a) Includes only those shares whose proceeds will be used to repay debt.
Those shares totaling 933,100 whose proceeds will be used for capital
expenditures and general working capital purposes have been excluded.
7. COMMON STOCK WARRANTS AND OPTIONS
During the first quarter of 1999, InfoHighway entered into an agreement with
an independent consultant for services to be rendered in conjunction with the
Offering. The agreement, as amended, provided for, among other things, the
granting of five-year exercisable warrants to purchase 86,844 common shares of
the Company at $5.71 per share in exchange for services rendered. The warrants
vest ratably over a period of twelve months from February 17, 1999. The Company
estimated the fair value of the warrants issued during the first quarter of 1999
using the Black-Scholes option pricing model with the following assumptions:
dividend yield of 0%, expected volatility of 46.1%, and a risk free interest
rate of 5.39%. The fair value of the warrants were nominal and recorded as
deferred offering costs.
During the first quarter of 1999, InfoHighway borrowed $100,000 from Trident
III, L.L.C. under a 13% promissory note. In conjunction with this financing,
Trident III, L.L.C. also received warrants to acquire 100,000 shares of common
stock at an initial exercise price per share of $8.00. Such warrants expire
during March 2004. This loan was repaid from the proceeds of the $1.5 million
financing entered into by InfoHighway in the second quarter of 1999.
During the second quarter of 1999, InfoHighway borrowed $100,000 from
Trident III, L.L.C. under a 13% promissory note. In conjunction with this
financing, Trident III, L.L.C. also received warrants to acquire 50,000 shares
of common stock at an initial exercise price per share of $8.00. Such warrants
expire during April 2004. This loan was repaid from the proceeds of the $1.5
million financing entered into by InfoHighway in the second quarter of 1999.
During the second quarter of 1999, InfoHighway borrowed $250,000 from a
group of accredited investors under a 13% promissory note. In conjunction with
this financing, the accredited investors also received warrants to acquire
83,333 shares of common stock at an initial exercise price of $8.00. Such
warrants expire during April 2004.
During the second quarter of 1999, InfoHighway borrowed $1.5 million from a
group of accredited investors under a 13% promissory note. In conjunction with
this financing, the accredited investors also received warrants to acquire
300,000 shares of common stock at an initial exercise price of $8.00. Such
warrants expire during June 2004.
During the second quarter of 1999, InfoHighway borrowed $200,000 from
Halcyon Investment Company, a British Virgin Islands corporation, under a 13%
promissory note. In conjunction with this financing, Halcyon also received
warrants to acquire 40,000 shares of common stock at an initial exercise price
of $8.00. Such warrants expire during June 2004.
During the second quarter of 1999, InfoHighway issued warrants to the parent
of ARC to acquire 90,000 shares of common stock at an initial exercise price of
$8.00. Such warrants expire during June 2004. Additionally, in assuming certain
warrant obligations of ARC, InfoHighway issued warrants to acquire 20,513 shares
of common stock at an initial exercise price of $121.85.
F-16
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
AND FOUNDING COMPANIES
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS (CONTINUED)
7. COMMON STOCK WARRANTS AND OPTIONS (CONTINUED)
The Company estimated the fair value of the warrants issued during the first
and second quarters of 1999, in connection with bridge financings, using the
Black-Scholes option pricing model with the following assumptions: dividend
yield of 0%, expected volatility of 46.1%, and a risk free interest rate of
5.2%. The fair value of the warrants of approximately $23,000 was recorded as a
discount to notes payable and amortized over the terms of the related debt.
During the second quarter of 1999, InfoHighway stockholders approved the
1999 Incentive Stock Option Plan (the "Plan"), which provides for the granting
of stock options to directors, executive officers, certain other employees and
certain non-employee consultants of the Company. The Plan permits the granting
of options for up to 1,500,000 shares of common stock. The Company has granted
stock options to purchase 1,050,000 shares of common stock to certain members of
the executive management team and outside directors of the Company. The exercise
prices of the options range from $5.00 to $10.00 per share and certain options
vest at the IPO and certain options vest over a three year period.
No common stock warrants or stock options were considered exercised for
purposes of computing earnings per share because to do so would be antidilutive.
F-17
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
InfoHighway Communications Corporation
Houston, Texas
We have audited the accompanying balance sheets of InfoHighway
Communications Corporation, formerly known as OmniLynx Communications
Corporation, as of December 31, 1997 and 1998, and the related statements of
loss, stockholders' equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of InfoHighway Communications
Corporation at December 31, 1997 and 1998, and the results of its operations and
its cash flows for the years then ended, in conformity with generally accepted
accounting principles.
BDO SEIDMAN, LLP
May 3, 1999
Houston, Texas
F-18
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, CONSOLIDATED
-------------------- JUNE 30,
1997 1998 1999
--------- --------- -------------
<S> <C> <C> <C>
(UNAUDITED)
<CAPTION>
(NOTE 3)
<S> <C> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents....................................................... $ 940 $ 853 $ 983,914
Accounts receivable, net........................................................ -- -- 3,763,919
Receivable--related party....................................................... -- -- 170,000
Costs and estimated earnings in excess of billings on uncompleted contracts
(Note 5)...................................................................... -- -- 480,950
Deferred offering costs (Note 4)................................................ -- -- 513,403
--------- --------- -------------
Total current assets.......................................................... 940 853 5,912,186
Equipment, net (Note 6)........................................................... -- -- 127,951
Goodwill and other intangible assets.............................................. -- -- 10,451,145
Other assets...................................................................... -- -- 86,241
--------- --------- -------------
Total assets.................................................................. $ 940 $ 853 $ 16,577,523
--------- --------- -------------
--------- --------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Current maturities of long-term debt (Note 7)................................... $ -- $ -- $ 800,000
Note payable (Note 7)........................................................... -- -- 200,000
Current maturities of notes payable--related parties (Notes 3 and 7)............ -- -- 4,197,038
Current maturities of capital leases payable (Note 7)........................... -- -- 21,650
Accounts payable................................................................ -- -- 5,174,196
Accrued liabilities............................................................. -- -- 1,083
Billings in excess of costs and estimated earnings on uncompleted contracts
(Note 5)...................................................................... -- -- 402,173
Disputed amounts under contract................................................. -- -- 1,289,975
--------- --------- -------------
Total current liabilities..................................................... -- -- 12,086,115
Long-term capital lease, net of current maturities (Note 7)....................... -- -- 5,141
Long-term note payable--related party, net of current maturities (Note 7)......... -- -- 1,146,674
--------- --------- -------------
Total Liabilities............................................................. -- -- 13,237,930
--------- --------- -------------
COMMITMENTS (NOTES 10, 11, 12 AND 13)
STOCKHOLDERS' EQUITY (NOTE 9):
Common stock, $.0001 par value, 25,000,000 shares authorized; 909,074, 939,000
and 1,329,076 issued and outstanding.......................................... 91 94 133
Additional paid-in capital...................................................... 909 906 3,533,951
Deficit......................................................................... (60) (147) (194,491)
--------- --------- -------------
Total stockholders' equity.................................................... 940 853 3,339,593
--------- --------- -------------
Total liabilities and stockholders' equity.................................... $ 940 $ 853 $ 16,577,523
--------- --------- -------------
--------- --------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
STATEMENTS OF LOSS
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
---------------------- -----------------------
1997 1998 1998 1999
---------- ---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Selling, general and administrative expenses.................... $ 60 $ 87 $ 43 $ 177,136
Interest expense................................................ -- -- -- 17,208
---------- ---------- ---------- -----------
Net loss...................................................... $ (60) $ (87) (43) $ (194,344)
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
LOSS PER SHARE:
Basic......................................................... $ 0 $ 0 $ 0 $ (.21)
Diluted(1).................................................... N/A N/A N/A N/A
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic......................................................... 909,074 939,000 939,000 939,000
Diluted(1).................................................... N/A N/A N/A N/A
</TABLE>
- ------------------------
(1) There are no securities that would have a dilutive effect at December 31,
1997 and 1998, and June 30, 1998 and 1999.
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
----------------------- PAID-IN STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY
---------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Initial capitalization of the Company at December 31,
1996.................................................... 909,074 $ 91 $ 909 $ -- $ 1,000
Net loss.................................................. -- -- -- (60) (60)
---------- ----- ------------ ----------- ------------
Balance, December 31, 1997................................ 909,074 91 909 (60) 940
Compensation related to common stock granted for services
rendered................................................ 29,926 3 (3) -- --
Net loss.................................................. -- -- -- (87) (87)
---------- ----- ------------ ----------- ------------
Balance, December 31, 1998................................ 939,000 94 906 (147) 853
Issuance of common stock warrants (unaudited) (Note 4).... -- -- 22,400 -- 22,400
Issuance of common stock in connection with acquisition
(unaudited) (Note 3).................................... 390,076 39 3,510,645 -- 3,510,684
Net loss (unaudited)...................................... -- -- -- (194,344) (194,344)
---------- ----- ------------ ----------- ------------
Balance, June 30, 1999 (unaudited) (consolidated)......... 1,329,076 $ 133 $ 3,533,951 $ (194,491) $3,339,593
---------- ----- ------------ ----------- ------------
---------- ----- ------------ ----------- ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
-------------------- -----------------------
1997 1998 1998 1999
--------- --------- --------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss....................................................... $ (60) $ (87) $ (43) $ (194,344)
Adjustments to reconcile net loss to net cash used in operating
activities:
Amortization of notes payable discount......................... -- -- -- 9,714
Increase (Decrease) in Liabilities:
Accounts payable............................................. -- -- -- 900
Accrued expenses............................................. -- -- -- 1,083
--------- --------- --------- ------------
Net cash used in operating activities (60) (87) (43) (182,647)
--------- --------- --------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to related parties.................................... -- -- -- (570,000)
Cash of acquired company....................................... -- -- -- 168,776
--------- --------- --------- ------------
Net cash used in investing activities............................ -- -- -- (401,224)
--------- --------- --------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable.................................... -- -- -- 2,150,000
Payments on notes payable...................................... -- -- -- (200,000)
Increase in deferred offering costs............................ -- -- -- (383,068)
Issuance of common stock....................................... 1,000 -- -- --
--------- --------- --------- ------------
Net cash provided by financing activities........................ 1,000 -- -- 1,566,932
--------- --------- --------- ------------
Net increase (decrease) in cash.................................. 940 (87) (43) 983,061
Cash and cash equivalents at beginning of period................. -- 940 940 853
--------- --------- --------- ------------
Cash and cash equivalents at end of period....................... $ 940 $ 853 $ 897 $ 983,914
--------- --------- --------- ------------
--------- --------- --------- ------------
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
There were no payments of interest or taxes made during the years ended December
31, 1997 and 1998. Payments of interest totaled $17,208 for the six months ended
June 30, 1999. Noncash transactions included the recording of a $22,400 original
issue discount on notes payable during the six months ended June 30, 1999.
(unaudited)
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS
NOTE 1--THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND ORGANIZATION
InfoHighway Communications Corporation (f/k/a OmniLynx Communications
Corporation, "InfoHighway" or the "Company") was incorporated in December 1996
in the State of Delaware. InfoHighway was formed, through strategic
acquisitions, to become a leading provider of unified internet, data and
telecommunications solutions to businesses and consumers.
The Company has conducted no operations to date, except in connection with
its efforts to raise equity capital through an initial public offering ("IPO")
and in completing targeted acquisitions. The Company completed the acquisition
of ARC Networks, Inc. on June 30, 1999. The companies identified for acquisition
to date and which will form the "founding companies" in the contemplated IPO are
described below:
AXCES, INC. (AXCES). AXCES is a switchless long-distance carrier that
resells long-distance service to the low-volume urban residential user,
primarily in Texas. It also offers paging service, 800 service, voice-mail and
calling cards.
INFOHIGHWAY INTERNATIONAL, INC. (INFOHIGHWAY INTERNATIONAL). InfoHighway
International is an internet service provider based in Houston, Texas which
specializes in offering a high-speed internet access product to high-rise office
buildings, including providing value-added internet services to the tenants.
AXCES and InfoHighway International are expected to be acquired
simultaneously with and as a condition to the consummation of the IPO.
ARC ACQUISITION (ARC). ARC Networks, Inc. is a local exchange carrier based
in New York which offers local phone service, long distance, cabling and other
network services to customers primarily in the New York metropolitan area. ARC
was acquired by the Company on June 30, 1999.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated balance sheet includes the accounts of the Company and its
wholly owned subsidiary, ARC Networks, Inc. (ARC). The balances of ARC's assets
and liabilities at the date of acquisition, June 30, 1999, are based on their
fair values and are consolidated in these financial statements. Since the
acquisition is effective at June 30, 1999, there are no results from operations
of ARC reflected in the Company's statement of operations and cash flows. All
material intercompany transactions have been eliminated in consolidation.
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 reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the financial statements and
the reported amounts of revenue and expense during the reporting period. Actual
results could differ from those estimates.
F-23
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTANGIBLES
Intangible assets consist primarily of goodwill recognized in a business
combination and is amortized on a straight line basis over the expected periods
benefitted, ten years. Management assesses the recoverability of the intangible
assets by determining whether the carrying value of the intangible assets can be
recovered through undiscounted future operating cash flows of the acquired
business. The amount of impairment, if any, is measured based on projected
discounted future operating cash flows using a discount rate reflecting the
Company's average cost of funds. The assessment of intangible assets will be
impacted if estimated future operating cash flows are not achieved.
REVENUE RECOGNITION
For local and long distance telephone service, the Company recognizes
revenue as service is provided to customers. For telephone service provided
through the sale of prepaid debit cards the Company invoices the customer,
principally distributors, at a discount from the face amount of the debit card,
when the debit cards are distributed. The Company records the invoiced amount as
deferred revenue and recognizes revenue as telephone usage is provided.
The Company recognizes revenue from its data cable installation services
using the percentage of completion method, measured by the percentage of cost
incurred to date to the total estimated cost for each contract. Revisions in
cost estimates and recognition of losses, if any, on these contracts are
reflected in the accounting period in which the facts become known. Contract
terms provide for billing schedules that differ from revenue recognition and
give rise to costs and estimated profits in excess of interim billings, and
billings in excess of costs and estimated profits. It is reasonably possible
that the amount of costs and estimated profits in excess of billing and billings
in excess of costs and estimated profits may be subject to change in the near
term.
INCOME TAXES
The Company recognizes deferred tax liabilities and assets for the expected
future tax consequences of events that have been recognized differently in the
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement carrying amounts and tax basis of assets and liabilities using enacted
tax rates and laws in effect in the years in which the differences are expected
to reverse. Deferred tax assets are evaluated for realization based on a
more-likely-than-not criteria in determining if a valuation allowance should be
provided. Income tax expense is the tax payable for the year and the change
during the year in deferred tax assets and liabilities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of the Company's financial instruments, consisting
primarily of accounts receivable, accounts payable, notes payable and
capitalized lease obligations, approximates fair value due to the maturity of
these financial instruments and the borrowing costs to the Company.
LONG-LIVED ASSETS
Long-lived assets, which are not to be disposed of, including property and
equipment, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the
F-24
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
asset may not be recoverable. Assets are grouped and evaluated for impairment at
the lowest level for which there are identifiable cash flows that are largely
independent of the cash flows of other groups of assets. The Company deems an
asset to be impaired if a projection of undiscounted future operating cash flows
directly related to the asset, including disposal value if any, is less than its
carrying amount. If an asset is determined to be impaired, the loss is measured
as the amount by which the carrying amount of the asset exceeds fair value. The
Company measures fair value by discounting estimated cash flows.
STOCK-BASED COMPENSATION
The Company continues to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the amount an employee must pay to acquire the
stock. Restricted stock is recorded as compensation cost over the requisite
vesting periods based on the market value on the date of grant. Compensation
cost for shares issued under performance share plans is recorded based upon the
current market value of the Company's stock at the end of each period.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation," established accounting and disclosure
requirements using a fair value-based method of accounting for stock-based
employee compensation plans. The Company has elected to remain on its current
method of accounting as described above, and has adopted the disclosure
requirements of SFAS No. 123.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES", which
established accounting and reporting standards for derivative instruments and
hedging activities. It requires that entities recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The provisions of this statement are effective
for all fiscal quarters of all fiscal years beginning after December 15, 1999.
The Company believes that this standard will not have a material impact on their
financial statements or disclosures thereto.
SOP 98-5, REPORTING ON THE COSTS OF START-UP ACTIVITIES, requires all
start-up and organizational costs to be expensed as incurred. It also requires
all remaining historically capitalized amounts of these costs existing at the
date of adoption to be expensed and reported as the cumulative effect of a
change in accounting principles. SOP 98-5 is effective for all fiscal years
beginning after December 31, 1998. The Company believes that the adoption of SOP
98-5 will not have a material effect on its financial statements.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The unaudited combined interim financial statements for the six month
periods ended June 30, 1998 and 1999 and as of June 30, 1999 have been prepared
on the same basis as the Company's audited financial statements as of and for
the year ended December 31, 1998. In the opinion of management, all adjustments,
consisting of normal, recurring accruals, necessary to present fairly the
F-25
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
financial position of the Company at June 30, 1999, and the results of
operations and cash flows for the six month period ended June 30, 1999 have been
included. The results of operations for such interim period is not necessarily
indicative of the results expected for the full year ending December 31, 1999.
CONCENTRATION OF CREDIT RISK
The Company extends credit to customers which results in accounts receivable
arising from its normal business activities. The financial strength of the
customers is routinely assessed and, based upon factors surrounding the credit
risk of the customers, the Company believes that its receivable credit risk
exposure is limited. Such estimate of the financial strength of customers may be
subject to change in the near term. The Company believes no significant
concentration of credit risk exists with respect to cash.
CASH AND CASH EQUIVALENTS
The Company considers certain highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. At June 30, 1999,
the Company had no cash equivalents.
EQUIPMENT AND DEPRECIATION
Equipment is recorded at cost. Expenditures for normal repairs and
maintenance are charged to expense as incurred. When assets are retired or
otherwise disposed of, their costs and related accumulated depreciation are
removed from the accounts and the resulting gains and losses are included in
operations. Depreciation and amortization are recorded using the straight-line
method over the estimated useful lives of the assets. The following sets forth
the Company's depreciation policy:
<TABLE>
<S> <C>
5-10
Telecommunications equipment..................................... years
Office equipment and computers................................... 5 years
</TABLE>
NOTE 3--ACQUISITION
Effective June 30, 1999, pursuant to an agreement and plan of
reorganization, the Company acquired all of the outstanding shares of ARC. ARC
is a local exchange carrier based in New York which offers local phone service,
long distance, cabling and other network services to customers primarily in the
New York metropolitan area.
Under the terms of the transaction, the Company issued 390,076 shares of
common stock valued at $9.00 per share. In addition, the Company issued 152,672
shares of contingent common stock. Issuances of the shares of the contingent
common stock are conditional upon achievement of certain share price targets;
50% of the contingent common stock shall be issued if and when the price of the
common stock reaches a 10-day average of $16 per share. The remaining 50% of the
contingent common stock shall be issued if and when the price of the common
stock reaches a 10-day average of $21 per share. At June 30, 1999, no value has
been assigned to the contingent common stock. In addition, the Company issued
warrants to purchase 20,464 shares of common stock exercisable at $122 per share
and expire in February 2007.
The merger agreement also provides for the issuance, upon completion of an
initial public offering by the Company, of 1,206,673 shares of Series A 10%
Convertible Preferred Stock ("Series A Preferred
F-26
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--ACQUISITION (CONTINUED)
Stock") valued at $1.2 million to an affiliated company of ARC in exchange for
the cancellation of $1.2 million of an existing ARC note payable to the
affiliated company. The preferred stock is convertible beginning on a date 90
days after this offering into common stock at the lesser of the Offering price
per share or the average of the closing prices during the five day period
preceding the date of conversion. The preferred stock is redeemable by the
holder at $1.00 per share in the event the Company's common stock declines over
67% of the initial public offering price. Dividends are payable on annual
installments on the first day of March each year beginning March 2000. The
Series A Preferred Stock have no voting rights. The Series A Preferred Stock has
liquidation preference rights in the amount of $1.00 per share plus a sum equal
to all unpaid accrued dividends before any payment or distribution upon
dissolution, liquidation or winding up shall be made on any series or class of
capital stock ranking junior to Series A Preferred Stock as to such payment or
distribution, and after all such payments or distributions have been made on any
series or class of capital stock ranking senior to the Series A Preferred Stock
as to such payment or distribution. The Series A Preferred Stock Senior rank to
the Company's common stock. (See Note 7).
The merger agreement also provides for: (a) the repayment of $0.8 million of
the outstanding balance on the revolving line of credit due to the parent of ARC
from proceeds of the Offering, (b) the exchange of $0.45 million of the
revolving line of credit for a note payable due on January 31, 2000 that is
convertible at the holder's option into 56,250 common shares of InfoHighway, and
(c) the balance of the revolving line of credit being exchanged for a note
payable maturing in June 2000 unless converted earlier by the holder into
150,000 common shares of InfoHighway.
The acquisition was accounted for under the purchase method of accounting.
The financial position of ARC is included in the Company's consolidated balance
sheet from the effective date of the acquisition of June 30, 1999.
The consideration paid for ARC measured at the acquisition date was
$3,510,684 of common stock. The purchase price was allocated to the acquired
company's assets and liabilities based upon an estimate of their fair values at
the date of acquisition and resulted in $10,451,145 of goodwill and other
intangible assets, which are being amortized over 4 to 10 years. The purchase
price of the acquisition has been allocated as follows:
<TABLE>
<CAPTION>
FAIR VALUE
-------------
<S> <C>
Purchase consideration..................................................... $ 3,510,684
-------------
-------------
Cash....................................................................... 168,776
Accounts receivable........................................................ 3,763,919
Other current assets....................................................... 611,285
Other long-term assets..................................................... 214,192
Notes payable and long-term debt........................................... (4,833,189)
Accounts payable and accrued expenses...................................... (6,865,444)
-------------
Fair value of net liabilities acquired..................................... (6,940,461)
-------------
-------------
Goodwill and other intangible assets....................................... $ 10,451,145
-------------
-------------
</TABLE>
F-27
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--ACQUISITION (CONTINUED)
The following presents the unaudited pro forma results of operations of the
Company for the year ended December 31, 1997 and 1998 and for the six months
ended June 30, 1998 and 1999, as if the acquisition of ARC had occurred on
January 1, 1997:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED JUNE 30,
DECEMBER 31, --------------------------
1998 1998 1999
------------- ------------ ------------
<S> <C> <C> <C>
Pro forma revenues.................................................... $ 13,930,687 $ 6,659,658 $ 8,171,286
Pro forma operations income (loss).................................... (1,591,985) (414,722) (747,208)
Pro forma net income (loss)........................................... (1,908,812) (597,223) (1,065,983)
Pro forma basic net income (loss) per share........................... (2.03) (0.64) (1.14)
Pro forma diluted net income (loss) per share(1)...................... N/A N/A N/A
</TABLE>
- ------------------------
(1) Inclusion of additional shares under a diluted analysis for the periods
ended December 31, 1997 and 1998, and June 30, 1998 and 1999 is
inappropriate due to the anti-dilutive effect.
The information is not necessarily indicative of the results of operations
and financial position of the Company as they may be in the future or as they
might have been had the business combinations been consummated as of January 1,
1998.
NOTE 4--DEFERRED OFFERING COSTS (UNAUDITED)
Subsequent to December 31, 1998 and as of June 30, 1999, the Company has
incurred expenses totaling approximately $513,403 in connection with a potential
IPO of the Company's common stock. These expenses have been deferred and will be
recognized as costs of the offering upon the completion of the initial public
offering. If no offering takes place, the expenses incurred will be charged to
operations.
NOTE 5--CONTRACTS IN PROGRESS
Costs, estimated profits, and billings on uncompleted contracts are
summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
JUNE 30,
1999
----------
(UNAUDITED)
Costs incurred.............................. $ -- $ -- $1,197,841
<S> <C> <C> <C>
Estimated profits........................... -- -- 426,557
--------- --------- ----------
Totals...................................... -- -- 1,624,398
Billings to date............................ -- -- (1,545,621)
--------- --------- ----------
Net....................................... $ -- $ -- $ 78,777
--------- --------- ----------
--------- --------- ----------
Included in the accompanying balance sheet
under the following captions:
Costs and estimated earnings in excess of
billings on uncompleted contracts......... $ -- $ -- $ 480,950
Billings in excess of costs and estimated
earnings on uncompleted contracts......... -- -- (402,173)
--------- --------- ----------
Net......................................... $ -- $ -- $ 78,777
--------- --------- ----------
--------- --------- ----------
</TABLE>
F-28
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--CONTRACTS IN PROGRESS (CONTINUED)
At June 30, 1999, the Company reclassified certain contracts which are the
subject of litigation in "Disputed amounts under contract" in the amount of
$1,289,975 (See Note 11).
NOTE 6--EQUIPMENT
Equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
JUNE 30,
1999
----------
(UNAUDITED)
Telephone switching equipment............... $ -- $ -- $ 35,935
<S> <C> <C> <C>
Furniture and fixtures...................... -- -- 18,109
Computer equipment.......................... -- -- 146,571
--------- --------- ----------
-- -- 200,615
Less: Accumulated depreciation.............. -- -- (72,664)
--------- --------- ----------
Equipment, net.............................. $ -- $ -- $ 127,951
--------- --------- ----------
--------- --------- ----------
</TABLE>
NOTE 7. NOTES PAYABLE AND CAPITAL LEASES
The Company's notes payable and capital lease obligations consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- --------- JUNE 30,
--------------
1999
--------------
(UNAUDITED)
<S> <C> <C> <C>
Unsecured note payable to accredited investors, bearing interest at 12% due
on demand................................................................. $ -- $ -- $ 250,000
Unsecured note payable to accredited investors, bearing interest at 8%, due
on demand................................................................. -- -- 550,000
Note payable to an independent party, bearing interest at 13%, payable at
time of offering, secured by all of the Company's assets (see discussion
below).................................................................... -- -- 200,000
Revolving line of credit agreement with a related party up to the lesser of
$2.4 million or 85% of eligible receivables, bearing interest at prime
plus 2% (9.75% at June 30, 1999), maturing through June 2000, secured by
all of the Company's assets............................................... -- -- 2,387,038
Note payable to an affiliate, bearing interest at 10%, due in monthly
installments through August 31, 2003, guaranteed by an affiliate (see
discussion below)......................................................... -- -- 1,206,674
Note payable to a group of accredited investors, bearing interest at 13%
payable at time offering, secured by all of the Company's assets (see
discussion below)......................................................... -- -- 1,500,000
Note payable to a group of accredited investors, bearing interest at 13%,
payable at time of offering, secured by all the Company's assets (see
discussion below)......................................................... -- -- 250,000
Capital lease obligations, with interest rates ranging from approximately
16% to 18%, related to the purchase of certain equipment.................. -- -- 26,791
--------- --------- --------------
Total notes payable and capital leases...................................... -- -- 6,370,503
Current portion............................................................. -- -- (5,218,688)
--------- --------- --------------
Long-term portion........................................................... $ -- $ -- $ 1,151,815
--------- --------- --------------
--------- --------- --------------
</TABLE>
F-29
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. NOTES PAYABLE AND CAPITAL LEASES (CONTINUED)
During the second quarter of 1999, InfoHighway borrowed $200,000 from
Halcyon under a 13% promissory note. In conjunction with this financing, Halcyon
also received warrants to acquire 40,000 shares of common stock at an initial
exercise price of $8.00. Such warrants expire during June 2004. (Unaudited)
It is anticipated that the note payable to Trans Global in the amount of
$1.2 million will be exchanged for Series A 10% Convertible Redeemable Preferred
Stock of the Company, valued at $1.2 million, upon completion of an initial
public offering by the Company. The preferred stock is redeemable by the holder
at $1.00 per share in the event the Company's common stock declines over 67% of
the initial public offering price.
During the second quarter of 1999, InfoHighway borrowed $1.5 million from a
group of accredited investors under a 13% promissory note. In conjunction with
this financing, the accredited investors received warrants to acquire 300,000
shares of common stock at an initial exercise price of $8.00. Such warrants
expire during June 2004. (Unaudited)
During the second quarter of 1999, InfoHighway borrowed $250,000 from a
group of accredited investors under a 13% promissory note. In conjunction with
this financing, the accredited investors received warrants to acquire 83,333
shares of common stock at an initial exercise price of $8.00. Such warrants
expire during April 2004. (Unaudited)
During the first quarter of 1999, InfoHighway borrowed $100,000 from Trident
III, L.L.C. under a 13% promissory note. In conjunction with this financing,
Trident III, L.L.C. also received warrants to acquire 100,000 shares of common
stock at an initial exercise price per share of $8.00. Such warrants expire
during March 2004. This loan was repaid from the proceeds of the $1.5 million
financing entered into by InfoHighway in the second quarter of 1999.
During the second quarter of 1999, InfoHighway borrowed $100,000 from
Trident III, L.L.C. under a 13% promissory note. In conjunction with this
financing, Trident III, L.L.C. also received warrants to acquire 50,000 shares
of common stock at an initial exercise price per share of $8.00. Such warrants
expire during April 2004. This note was repaid from the proceeds of the $1.5
million financing entered into by the Company in June 1999. (Unaudited)
During the second quarter of 1999, InfoHighway issued warrants to the former
parent of ARC to acquire 90,000 shares of common stock at an exercise price of
$8.00 in connection with the extension of a debt maturity. Such warrants expire
during June 2004. Additionally, InfoHighway assumed certain warrant obligations
of ARC and issued warrants to acquire 20,513 shares of common stock at an
exercise price of $121.85.
The Company estimated the fair value of the warrants issued during the first
and second quarters of 1999 using the Black-Scholes option pricing model with
the following assumptions: dividend yield of 0%, expected volatility of 46.1%,
and a risk free interest rate of 5.2%. The fair value of the warrants of
approximately $22,000 was recorded as a discount to notes payable and amortized
over the expected lives of the warrants.
No common stock warrants were considered exercised for purposes of computing
earnings per share because to do so would be antidilutive.
F-30
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--INCOME TAXES
For financial reporting purposes, ARC had operating loss carryforwards of
approximately $6,400,000 at December 31, 1998, expiring in 2013. Pursuant to
Section 382 of the Internal Revenue Code of 1986, as amended, utilization of
these losses may be limited in the event of a change in control.
NOTE 9--STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue up to 3,000,000 shares of $.0001 par
value preferred stock. The Board of Directors is authorized to designate the
voting power, preferences, dividends, liquidation rights, redemption and other
features related to the Company's preferred stock. As of December 31, 1997 and
1998 and June 30, 1999, no preferred stock had been issued.
COMMON STOCK
The Company effected a 2,055-for-one stock split in March 1999 of the
outstanding shares of common stock. In addition, the Company increased the
number of authorized shares of common stock to 25,000,000. In April 1999, the
Company effected a .52-for-one reverse stock split of the outstanding shares of
common stock. The effects of the stock split and reverse stock split and the
increase in the shares of authorized common stock have been retroactively
reflected in the accompanying balance sheets and in the notes to the financial
statements.
In June 1999, the Company issued 338,961 contingent common stock issue
rights to certain of the Company's shareholders. The contingent common stock
issue rights entitle the holder to receive shares of the Company's common stock
based upon its market performance beginning 90 days after the closing of an
initial public offering. Approximately one-half of the shares are issuable when
the common stock reaches a 10-day average of $16.00 per share. The remaining
one-half are issuable when the common stock reaches a 10-day average of $21.00
per share. The rights expire after three years.
NOTE 10--STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
1999 INCENTIVE STOCK OPTION PLAN
During April 1999, the Company's stockholders approved the 1999 Incentive
Stock Option Plan, which provides that the Company may grant stock options to
purchase up to 1,500,000 shares of its Common Stock to the Company's employees,
directors or consultants. The terms of the options are determined by the
Company's Board of Directors.
F-31
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTIONS AND WARRANTS (CONTINUED)
A summary of the Company's incentive stock option plan as of June 30, 1999
(unaudited) is presented below:
<TABLE>
<CAPTION>
1999 WTD. AVG.
PLAN EXER. PRICE
--------- -----------
<S> <C> <C>
Options outstanding at December 31, 1998................................................... 0 $ 0.00
Max shares exercisable..................................................................... 0 0.00
Options granted(1)......................................................................... 600,000 8.00
Options exercised.......................................................................... 0 0.00
Options cancelled.......................................................................... 0 0.00
---------
Options outstanding at June 30, 1999....................................................... 600,000 $ 8.00
--------- -----
--------- -----
Options exercisable........................................................................ 200,000 $ 8.00
--------- -----
--------- -----
</TABLE>
- ------------------------
(1) These are incentive stock options which vested one-third in June 1999, and
vest an additional one-third in June 2000 and June 2001. These options
expire in June 2004.
SFAS No. 123 requires the Company to provide pro forma information regarding
net income (loss) applicable to common stockholders and income (loss) per share
as if compensation cost for the Company's stock options granted had been
determined in accordance with the fair value based method prescribed in that
Statement. The Company estimated the fair value of each stock option at the
grant date by using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 1999: dividend yield of 0% for
all years; expected volatility of 46.10%; risk-free interest rates ranging from
6.39%; and expected lives of two years. The per share weighted average fair
value of options granted during the six months ended June 30, 1999 was $.06,
which was estimated on the grant date.
Under the accounting provisions of SFAS No. 123, the Company's net income
(loss) applicable to common stockholders and loss per share would have been
revised to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE SIX MONTHS
ENDED JUNE 30,
DECEMBER 31, (UNAUDITED)
-------------------- ----------------------
1997 1998 1998 1999
--------- --------- --------- -----------
<S> <C> <C> <C> <C>
Net loss:
As reported................................................................. $ (60) $ (87) $ (43) $ (194,344)
Pro forma................................................................... $ (60) $ (87) $ (43) $ (206,103)
Net loss per share: Basic and Diluted
As reported................................................................. $ (0) $ (0) $ (0) $ (0.21)
Pro forma................................................................... $ (0) $ (0) $ (0) $ (0.22)
</TABLE>
F-32
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTIONS AND WARRANTS (CONTINUED)
WARRANTS
Following is a description of the Company's warrants outstanding at June 30,
1999 (unaudited):
<TABLE>
<CAPTION>
NUMBER
DESCRIPTION OF WARRANTS OUTSTANDING
- ----------------------------------------------------------------------------------------------------- -----------
<S> <C>
Common stock warrants (unregistered) issued in connection with services performed with the Company's
initial public offering. The warrants vest ratably over a twelve month period, up to a total of
86,844, beginning February 17, 1999, exercisable at $5.71 per share. The Company estimated the fair
value of the warrants using the Black-Scholes option pricing model with the following assumptions;
dividend yield of 0%, expected volatility 46.1%, and a risk free interest rate of 5.39%. The fair
value of the vested warrants was nominal........................................................... 36,185
Common stock warrants (unregistered) issued in connection with bridge financing during the first
quarter 1999 exercisable at $8.00 per share and expiring March 2004. (See
Note 7)............................................................................................ 100,000
Common stock warrants (unregistered) issued in connection with bridge financing during the second
quarter 1999 exercisable at $8.00 per share expiring April 2004. (See Note 7)...................... 50,000
Common stock warrants (unregistered) issued in connection with bridge financing during the second
quarter 1999 exercisable at $8.00 per share and expiring April 2004. (See Note 7).................. 83,333
Common stock warrants (unregistered) issued in connection with bridge financing during the second
quarter 1999 exercisable at $8.00 per share and expiring June 2004. (See Note 7)................... 300,000
Common stock warrants (unregistered) issued in connection with bridge financing during the second
quarter 1999 exercisable at $8.00 per share and expiring June 2004. (See Note 7)................... 40,000
Common stock warrants (unregistered) issued in connection with the extension of debt. The warrants
were issued during the second quarter 1999 and are exercisable at $8.00 per share and expire June
2004. (See Note 7)................................................................................. 90,000
Common stock warrants (unregistered) issued in connection with the acquisition of ARC during the
second quarter 1999 exercisable at $122.17 per share and expire February 2007...................... 20,464
-----------
Total Warrants................................................................................... 719,982
-----------
-----------
</TABLE>
Pursuant to FASB Statement No. 123, "Accounting for Stock-Based
Compensation," the Company has elected to adopt only the disclosure provision of
SFAS 123 for stock issued to employees and will account for its employee stock
option plan under APB Opinion No. 25 "Accounting for Stock Issued to Employees."
NOTE 11--COMMITMENTS
CONSULTING AGREEMENT
During the first quarter of 1999, InfoHighway entered into an agreement with
an independent consultant for services to be rendered in conjunction with the
Offering. The agreement, as amended,
F-33
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--COMMITMENTS (CONTINUED)
provided for, among other things, the granting of five-year exercisable warrants
to purchase 86,844 common shares of the Company at $5.71 per share in exchange
for services rendered. The warrants vest ratably over a period of twelve months
from February 17, 1999. (Unaudited)
OPERATING LEASES
The Company occupies space at two locations for use in its data cable
installation services business and to support its telephone customer service
center and corporate offices. Both leases contain renewal options and escalation
clauses.
Future minimum rental payments under non-cancelable operating leases having
remaining terms in excess of one year as of December 31, 1998 for each of the
next five years and in the aggregate are:
<TABLE>
<S> <C>
1999.............................................................. $ 103,861
2000.............................................................. 106,978
2001.............................................................. 102,823
2002.............................................................. 95,617
2003.............................................................. 56,767
---------
Total............................................................. $ 466,046
---------
---------
</TABLE>
MINIMUM PURCHASE COMMITMENTS
The Company has entered into agreements with local and long-distance
carriers (the "Carriers") from which it purchases telephone service. Such
agreements include minimum purchase obligations which require monthly payments
based on minimum service usage to the Carriers even if the minimum service is
not used. The minimums are stated in both dollar amounts and usage based on
minutes. Estimated minimum future payments due under the agreements in the
aggregate are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------
<S> <C>
1999........................................................................... $ 4,531,000
2000........................................................................... 6,171,000
2001........................................................................... 6,171,000
2002........................................................................... 1,671,000
2003........................................................................... 43,000
-------------
$ 18,587,000
-------------
-------------
</TABLE>
NOTE 12--LITIGATION
On January 8, 1999, the ARC was served with a summons from the State Supreme
Court of New York, County of New York, by Mitel Telecommunications Systems, Inc.
("Mitel") for a breach of contract claim in the amount of $1,715,000 relating to
cabling and installation services for which the Company has been paid in full.
The Company believes the action is without merit and filed a motion to dismiss
the action based on numerous defenses available to it and that it continues to
perform all requested services under the contract from Mitel. As of June 30,
1999, the Company believes the maximum exposure resulting from this claim will
be $1,289,975 and has recorded a liability for such
F-34
<PAGE>
INFOHIGHWAY COMMUNICATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--LITIGATION (CONTINUED)
amount, however, it is at least reasonably possible that a change in the
estimate may occur in the near term.
On March 26, 1999, ARC was served with a summons from the State Supreme
Court of New York, County of Orange, by an employee of a customer of the Company
located in Thiells, N.Y., for $1,000,000 resulting from a December 1996 fall
over wiring claimed to be negligently installed by the Company. The Company has
a liability insurance policy which provides sufficient coverage in the event the
plaintiff's claim is successful. The Company believes the action is without
merit and filed a motion to dismiss the action based on numerous defenses
available to it.
NOTE 13--SUBSEQUENT EVENTS
The Company has entered into letters of intent to acquire two of the
remaining founding companies on the date the IPO closes. The founding companies
are InfoHighway International, Inc. ("InfoHighway International"), ARC Networks,
Inc. ("ARC"), and AXCES, Inc. ("AXCES"). The Company acquired ARC on June 30,
1999. The aggregate consideration expected to be paid by the Company to acquire
the founding companies is approximately 2,048,242 shares of common stock,
1,206,674 shares of Series A 10% Convertible Redeemable Preferred stock valued
at $1,206,674 and 60,000 shares of Series B 8% Convertible Redeemable Preferred
stock valued at $9,000,000. The Company also issued 388,550 shares of common
stock which vests based on certain stock performance criteria.
The Company will enter into employment agreements with five key officers and
employees of the Company to be effective upon the closing of an initial public
offering. Each of the agreements provides for a minimum base salary, entitles
the employee to participate in all benefit plans in which other members of
management participate; and have an initial term of three years from their
effective date.
In connection with the employment agreements, the Company is obligated to
issue 880,000 options at exercise prices ranging from $5.00 to $10.00, vesting
ratably as follows: one-third on the closing of the offering and then one-third
on each of the first and second anniversaries of the closing of this offering,
325,000 options expire in July 2009 and 575,000 options expire five years from
the closing of an initial public offering. In addition, the Company is committed
to issue 20,050 options to two outside directors upon the completion of an
initial public offering by the Company.
F-35
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders
AXCES, Inc.
We have audited the accompanying balance sheets of AXCES, Inc. as of
December 31, 1997 and 1998, and the related statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of AXCES, Inc. as of December
31, 1997 and 1998 and the results of its operations and its cash flows for each
of the years in the three-year period ended December 31, 1998, in conformity
with generally accepted accounting principles.
April 13, 1999 Pannell Kerr Forster of Texas,
P.C.
Houston, Texas
F-36
<PAGE>
AXCES, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
DECEMBER 31, DECEMBER 31, JUNE 30,
---------------------- 1998 JUNE 30, 1999
1997 1998 ------------- 1999 -------------
---------- ---------- -----------
(NOTES 1 AND (NOTES 1 AND
5) (UNAUDITED) 5)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents............ $ 220,109 $ 293,376 $ 293,376 $2,606,402 $ 2,606,402
Accounts receivable, net of allowance
for doubtful accounts of $457,780
in 1997, $1,248,964 in 1998, and
$514,748 in 1999................... 3,246,686 6,227,738 6,227,738 2,500,148 2,500,148
Receivables from related parties..... -- 220,475 220,475 1,734,378 1,734,378
Federal income tax receivable........ -- 684,000 684,000 59,000 --
Prepaid expenses and other current
assets............................. 381,655 230,802 230,802 454,797 454,797
---------- ---------- ------------- ----------- -------------
Total current assets............... 3,848,450 7,656,391 7,656,391 7,354,725 7,295,725
---------- ---------- ------------- ----------- -------------
Net property and equipment............. 586,629 538,165 538,165 360,975 360,975
Other assets........................... 88,783 74,220 74,220 98,979 98,979
Notes receivable from related
parties.............................. 210,658 -- -- -- --
---------- ---------- ------------- ----------- -------------
Total assets........................... $4,734,520 $8,268,776 $ 8,268,776 $7,814,679 $ 7,755,679
---------- ---------- ------------- ----------- -------------
---------- ---------- ------------- ----------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Note payable......................... $ -- $1,694,969 $ 1,694,969 $ -- $ --
Current portion of long-term debt.... 19,080 20,921 20,921 -- --
Current portion of prizes and
awards............................. 16,389 29,167 29,167 13,333 13,333
Accounts payable..................... 556,931 578,612 578,612 463,420 463,420
Sales tax payable.................... 469,478 421,646 421,646 107,302 107,302
Accrued distributions to
stockholders....................... -- -- 3,600,271 -- 5,727,997
Other accrued expenses............... 341,308 205,570 205,570 356,289 356,289
Current income taxes payable......... 2,249 -- 993,936 -- 499,705
Deferred income taxes................ 904,840 -- 223,440 -- 223,440
---------- ---------- ------------- ----------- -------------
Total current liabilities.......... 2,310,275 2,950,885 7,768,532 940,344 7,391,486
---------- ---------- ------------- ----------- -------------
Long-term debt, less current portion... 43,706 17,772 17,772 -- --
Deferred income taxes.................. 12,502 -- 437,035 -- 318,756
Prizes and awards, less current
portion.............................. 62,361 31,945 31,945 31,945 31,945
---------- ---------- ------------- ----------- -------------
Total liabilities.................. 2,428,844 3,000,602 8,255,284 972,289 7,742,187
---------- ---------- ------------- ----------- -------------
Commitments and contingencies
Stockholder's equity
Common stock, $1.00 par value; 1,000
shares authorized, issued and
outstanding........................ 1,000 1,000 1,000 1,000 1,000
Additional paid-in capital........... 12,492 12,492 12,492 12,492 12,492
Retained earnings.................... 2,292,184 5,254,682 -- 6,828,898 --
---------- ---------- ------------- ----------- -------------
Total stockholders' equity......... 2,305,676 5,268,174 13,492 6,842,390 13,492
---------- ---------- ------------- ----------- -------------
Total liabilities and stockholders'
equity............................... $4,734,520 $8,268,776 $ 8,268,776 $7,814,679 $ 7,755,679
---------- ---------- ------------- ----------- -------------
---------- ---------- ------------- ----------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-37
<PAGE>
AXCES, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30,
------------------------------
YEAR ENDED DECEMBER 31,
---------------------------------------------- (UNAUDITED)
1996 1997 1998 1998 1999
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Revenues.......................... $8,467,506 $ 19,473,981 $ 30,279,621 $ 17,348,606 $ 10,095,372
Cost of revenues.................. 3,959,087 8,002,688 9,889,028 5,307,384 3,445,554
-------------- -------------- -------------- -------------- --------------
Gross profit.................... 4,508,419 11,471,293 20,390,593 12,041,222 6,649,818
Selling, general and
administrative expenses......... 3,673,546 8,910,007 17,934,268 8,296,261 4,913,462
Depreciation and amortization..... 61,379 135,461 203,576 88,960 112,079
-------------- -------------- -------------- -------------- --------------
Operating income................ 773,494 2,425,825 2,252,749 3,656,001 1,624,277
Other income (expense)
Interest income................. 56,694 9,575 63,911 17,440 46,870
Interest expense................ (20,424) (28,529) (271,504) (165,408) (96,931)
-------------- -------------- -------------- -------------- --------------
Income before income tax
provision....................... 809,764 2,406,871 2,045,156 3,508,033 1,574,216
Income tax provision
Current expense................. 261,554 2,936 -- -- --
Deferred expense (benefit)...... 16,730 834,157 (917,342) (917,342) --
-------------- -------------- -------------- -------------- --------------
278,284 837,093 (917,342) (917,342) --
-------------- -------------- -------------- -------------- --------------
Net income...................... $ 531,480 $ 1,569,778 $ 2,962,498 $ 4,425,375 $ 1,574,216
-------------- -------------- -------------- -------------- --------------
-------------- -------------- -------------- -------------- --------------
Basic net income per common
share........................... $ 531 $ 1,570 $ 2,962 $ 4,425 $ 1,574
Diluted net income per common
share........................... $ 531 $ 1,570 $ 2,962 $ 4,425 $ 1,574
Average common shares
outstanding..................... 1,000 1,000 1,000 1,000 1,000
</TABLE>
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA PRO FORMA
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(NOTES 1 AND (NOTES 1 AND (NOTES 1 AND
5) 5) 5)
-------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Net income as reported............ $ 2,962,498 $ 4,425,375 $1,574,216
Pro forma incremental income tax
provision....................... 1,654,412 2,115,311 1,100,901
-------------- -------------- --------------
Pro forma net income.............. $ 1,308,086 $ 2,310,064 $ 473,315
Pro forma net income per common
share........................... $ 1,308 $ 2,310 $ 473
Pro forma average common shares
outstanding..................... 1,000 1,000 1,000
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-38
<PAGE>
AXCES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN RETAINED
COMMON STOCK CAPITAL EARNINGS TOTAL
--------------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Balance, December 31, 1995................................ $ 1,000 $ 12,492 $ 190,926 $ 204,418
Net income................................................ -- -- 531,480 531,480
------ ----------- ------------ ------------
Balance, December 31, 1996................................ 1,000 12,492 722,406 735,898
Net income................................................ -- -- 1,569,778 1,569,778
------ ----------- ------------ ------------
Balance, December 31, 1997................................ 1,000 12,492 2,292,184 2,305,676
Net income................................................ -- -- 2,962,498 2,962,498
------ ----------- ------------ ------------
Balance, December 31, 1998................................ 1,000 12,492 5,254,682 5,268,174
------ ----------- ------------ ------------
Net income (unaudited).................................... -- -- 1,574,216 1,574,216
------ ----------- ------------ ------------
Balance, June 30, 1999 (unaudited)........................ $ 1,000 $ 12,492 $ 6,828,898 $ 6,842,390
------ ----------- ------------ ------------
------ ----------- ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-39
<PAGE>
AXCES, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEARS ENDED DECEMBER 31, 30,
------------------------------------- ----------------------
1996 1997 1998 1998 1999
----------- ----------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities
Net income............................ $ 531,480 $ 1,569,778 $ 2,962,498 $4,425,375 $1,574,216
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Compensation expense recognized from
cancellation of notes receivable
from related parties................ -- -- 210,658 -- --
Loss on sale of property and
equipment......................... -- 13,146 -- -- 63,729
Depreciation and amortization....... 61,379 135,461 203,576 88,960 112,077
Provision for doubtful accounts..... 416,540 1,803,763 4,264,752 1,973,748 1,565,484
Increase (decrease) in deferred
income taxes...................... 16,730 834,157 (917,342) (917,342) --
Change in operating assets and
liabilities:
(Increase) decrease in accounts
receivable.......................... (1,108,607) (3,761,591) (7,245,803) (1,578,103) 2,246,188
Decrease in advances to officers...... 14,926 -- -- -- --
Increase in receivables from related
parties............................. -- -- (20,475) (3,278,422) (1,810,079)
(Increase) decrease in federal income
tax receivable...................... -- -- (684,000) -- 625,000
Decrease (increase) in prepaid
expenses............................ -- (381,655) 150,853 144,137 70,768
Decrease (increase) in other assets... (48,601) 4,307 7,623 (24,769) (16,136)
Increase (decrease) in accounts
payable............................. 447,448 (303,468) 21,681 79,971 (4,699)
Increase (decrease) in current income
taxes payable....................... 249,209 (259,170) (2,249) (597,301) --
Increase (decrease) in other accrued
expenses............................ 124,692 202,836 (135,738) 1,406,833 (144,046)
Increase (decrease) in sales tax
payable............................. 39,334 375,475 (47,832) (355,790) (424,833)
Increase (decrease) in awards and
prizes payable...................... 17,500 36,250 (17,639) -- (15,834)
----------- ----------- ----------- ---------- ----------
Net cash provided by (used in)
operating activities.............. 762,030 269,289 (1,249,437) 1,367,297 3,841,835
----------- ----------- ----------- ---------- ----------
Cash flows from investing activities
Purchases of property and equipment... (259,621) (433,694) (148,172) (37,649) (97,147)
Proceeds from sale of property and
equipment........................... -- 2,000 -- -- 102,000
Proceeds from notes to related
parties............................. -- -- -- -- 200,000
Issuance of notes to related
parties............................. -- (210,658) (200,000) -- --
----------- ----------- ----------- ---------- ----------
Net cash provided by (used in)
investing activities.............. (259,621) (642,352) (348,172) (37,649) 204,853
----------- ----------- ----------- ---------- ----------
Cash flows from financing activities
Payment on note payable to vendor..... (100,000) -- -- -- --
Proceeds from long-term notes
payable............................. -- 62,786 -- -- 67,776
Principal payments on long-term
debt................................ (10,690) (19,285) (24,093) (10,454) (106,469)
Proceeds from short-term notes
payable............................. -- -- 1,694,969 -- --
Principal payments of short-term notes
payable............................. -- -- -- -- (1,694,969)
----------- ----------- ----------- ---------- ----------
Net cash provided by (used in)
financing activities.............. (110,690) 43,501 1,670,876 (10,454) (1,733,662)
----------- ----------- ----------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents........................... 391,719 (329,562) 73,267 1,319,194 2,313,026
Cash and cash equivalents, beginning of
period................................ 157,952 549,671 220,109 220,109 293,376
----------- ----------- ----------- ---------- ----------
Cash and cash equivalents, end of
period................................ $ 549,671 $ 220,109 $ 293,376 $1,539,303 $2,606,402
----------- ----------- ----------- ---------- ----------
----------- ----------- ----------- ---------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
F-40
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION, BUSINESS AND ORGANIZATION
AXCES, Inc. (the "Company") was incorporated in Delaware on January 3, 1994.
Effective January 1, 1997, the two original stockholders of the Company entered
into a Share Exchange Agreement with MTM Holdings Corporation ("MTM"). Each
stockholder transferred and conveyed 500 shares of Company common stock to MTM
in exchange for 37,500 newly issued shares of MTM stock. The Company's assets
and liabilities at January 1, 1997 approximated their fair market values and
thus no adjustment of the carrying values of the assets and liabilities was
required and no goodwill resulted from this business combination.
The Company is a long distance telephone company which has contracted with
Coastal Telephone Services Limited Company ("Coastal") to provide long-haul
transmissions of its traffic. Coastal bills the Company at contractual rates for
the usage of Coastal's long distance system by the Company's residential
customers.
In September 1996, the Company entered into an agreement with Frontier
Communications of the West, Inc. ("Frontier") whereby Frontier provides network
transport and other telecommunication services for the Company's resale to
residential customers on a common carrier basis. This agreement supplements the
agreement with Coastal and allows the Company to expand its service to a wider
geographic area.
The Company has a billing and service contract with Southwestern Bell
Telephone Company ("SWBT") whereby the latter, generally, performs the billing
and collection procedures for a fee. SWBT remits revenues to the Company, net of
fees, bad debts, and other deductions.
In January 1997, the Company entered into an agreement with Ameritech of
Illinois, Indiana, Michigan, Ohio and Wisconsin ("AOCs") and Ameritech Services,
Inc. ("ASI") whereby AOCs will provide billing and collection services to the
Company for its end users. This agreement supplements the agreement with SWBT
and allows the Company to expand its service to a wider geographic area. The
agreement has an initial term of one year with written renewal options, unless
terminated earlier by either party. The agreement has been renewed through March
2000. No guaranteed minimum purchases of services are stipulated in the
contract.
The Company markets its products and services primarily to residential
customers in Texas, Oklahoma, Missouri, Kansas, Illinois, Indiana, Michigan,
Arkansas and Wisconsin. In addition, the Company has received approval of tariff
applications to operate in other mid-western and eastern seaboard states.
UNAUDITED PRO FORMA ADJUSTMENTS
During April 1999, the Company and the stockholders of MTM signed a
definitive agreement with InfoHighway Communications Corporation (f/k/a OmniLynx
Communications Corporation, "InfoHighway"), pursuant to which all of the
Company's undistributed earnings will be distributed to the stockholders of MTM
and its outstanding shares will be exchanged for consideration as described in
Note 10 to be issued upon the consummation of an initial public offering of the
common stock of InfoHighway (the "Offering"). The Company will terminate its
status as an S Corporation at the effective date of the offering. At that time,
the Company will be required to provide deferred income taxes for cumulative
temporary differences between financial statement and income tax bases of the
Company's assets and liabilities. At December 31, 1998 and June 30, 1999, an
accrual for distribution of $3,600,271 and $5,727,997 to the MTM stockholders
and a deferred tax liability of $660,475 and $542,196, respectively, have been
reflected in the pro forma balance sheets presented.
F-41
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--BASIS OF PRESENTATION, BUSINESS AND ORGANIZATION (CONTINUED)
The 1998 unaudited pro forma net income data reflect adjustments for income
taxes as if the Company had been subject to federal and state income taxes based
upon a pro forma effective tax rate of 34% applied to income before income taxes
(see Note 5).
PRO FORMA EARNINGS PER SHARE
Pro forma earnings per share is calculated in accordance with Statement of
Financial Accounting Standards No. 128 and, as such, is based on the weighted
average number of shares of Common Stock outstanding. Dilutive earnings per
share is equivalent to basic earnings per share for all periods presented as the
Company had no potentially dilutive securities in 1996, 1997 and 1998.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PROPERTY AND EQUIPMENT
Property and equipment, consisting primarily of computer equipment, office
furniture and fixtures, leasehold improvements, and automobiles, is carried at
cost less accumulated depreciation. Depreciation for financial reporting
purposes is provided by the straight-line method over the estimated useful lives
of three to seven years. The cost of repairs and maintenance is charged against
income as incurred.
Property and equipment is comprised of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1997 1998 1999
--------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Automobiles................................ $ 142,904 $ 142,904 $ --
Furniture, fixtures and equipment.......... 435,232 505,356 534,727
Leasehold improvements..................... 156,175 234,223 234,223
--------- --------- -----------
734,311 882,483 768,950
Accumulated depreciation and
amortization............................. (147,682) (344,318) (407,975)
--------- --------- -----------
Net property and equipment............. $ 586,629 $ 538,165 $ 360,975
--------- --------- -----------
--------- --------- -----------
</TABLE>
REVENUE RECOGNITION
Revenue is recognized in the month the Company's customers complete their
telephone call.
PRIZE AND AWARD COSTS
The Company records as expense the amounts of awards and prizes for sales
promotions and customer contests in the year when publicly declared.
INCOME TAXES
Effective January 1, 1998, the Company and its stockholders elected to be
taxed as a qualified subchapter S subsidiary ("QSSS") of MTM under the
provisions of Subchapter S of the United States Internal Revenue Code of 1986.
Under those provisions, the Company is treated as a division of its S
corporation parent, MTM, and the stockholders of MTM are liable for individual
Federal income taxes on the Company's taxable income. As a result, no provision
for United States income taxes has
F-42
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
been included in the accompanying statements of operations for 1998 other than
the reversal of the deferred tax liability at the date of election of QSSS
status.
For the years ending December 31, 1997 and 1996, Federal income taxes are
provided in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 109, "ACCOUNTING FOR INCOME TAXES", which requires the use of an asset and
liability approach for financial accounting and reporting for income taxes.
Deferred tax assets relate to the deferral of certain expenses for tax reporting
purposes. Deferred tax liabilities relate primarily to the excess of tax
depreciation over depreciation recorded for financial statement reporting
purposes, and the net effect of deferring revenues and expenses for filing the
Federal income tax return on a cash basis. Deferred tax balances are adjusted to
reflect the tax rates in effect when those amounts are expected to be payable or
refundable.
TERMINATION OF S CORPORATION ELECTION
Certain events, including the transaction with InfoHighway as described in
Note 10, will automatically terminate the Company's QSSS status, thereby
subjecting future income to Federal and state income taxes at the corporate
level. Due to temporary differences in recognition of revenue and expenses,
income for financial reporting purposes has exceeded income for income tax
purposes. Accordingly, the application of the provisions of SFAS No. 109,
"ACCOUNTING FOR INCOME TAXES", will result in the recognition of deferred tax
liabilities and a corresponding charge to expense in the period in which the
InfoHighway transaction occurs (see Note 5).
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
STATEMENT OF CASH FLOWS
For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents.
CONCENTRATION OF CREDIT RISK
The Company maintains its cash with a major domestic bank. The amounts held
in this bank exceed the insured limit of $100,000 from time to time. The terms
of these deposits are on demand to minimize risk. The Company has not incurred
losses related to these deposits.
Financial instruments that potentially subject the Company to concentrations
of credit risk are the Company's accounts receivable billed and collected by
SWBT and AOCs. The Company's accounts generally consist of a large number of
individually small amounts which reduces the risk of significant accounts
receivable losses from any individual account write-off. The Company
continuously monitors its bad debt experience in its areas of operations and
adjusts its marketing and credit policies as necessary.
The Company's allowance for doubtful accounts is provided based upon
industry standards and its actual bad debt experience. The allowance is withheld
and uncollectible amounts deducted from
F-43
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
customer remittances by SWBT and AOCs as revenues are generated. The allowance
for doubtful accounts is adjusted for actual bad debt experience on a periodic
basis. Bad debts and other uncollectible amounts of accounts receivable were
$3,473,567, $1,382,888 and $401,114 for 1998, 1997 and 1996, respectively. Bad
debts and other uncollectible amounts for the six month periods ending June 30,
1998 and 1999 were $1,792,547 and $2,221,492, respectively. (unaudited)
RECLASSIFICATION OF PRIOR YEAR AMOUNTS
Certain reclassifications of 1997 and 1996 amounts have been made to conform
to the 1998 financial statement presentation.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS",
requires that the Company disclose estimated fair values of its financial
instruments. Fair value estimates, methods and assumptions are set forth below.
The carrying amounts of cash, accounts receivable, receivables from related
parties and others, accounts payable and accrued expenses approximate fair value
at December 31, 1998 and 1997 due to the short-term nature of such accounts.
Management believes that the stated interest rates of notes payable
approximate market rates for instruments with similar credit risk. Accordingly,
the carrying value of notes payable is believed to approximate fair value.
NEW ACCOUNTING STANDARDS
For fiscal year ending December 31, 1999 the Company will adopt SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information,"
which established standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report information about operating segments in interim
financial reports. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company believes that it currently operates under one segment.
In November 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES", which
established accounting and reporting standards for derivative instruments and
hedging activities. It requires that entities recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The provisions of this statement, as amended by
SFAS No. 137, are effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000. In December 1998, the FASB issued SFAS 134,
"ACCOUNTING FOR MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF
MORTGAGE LOANS HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE", which amended
SFAS 65. This statement is effective for the first fiscal quarter beginning
after December 15, 1998. SFAS 134 will not apply to the Company. The FASB
recently issued SFAS 135, "RESCISSION OF FASB STATEMENT NO. 75 AND TECHNICAL
CORRECTIONS". SFAS 135 includes a long list of technical corrections that, among
other things, rescinds SFAS 75, "DEFERRAL OF THE EFFECTIVE DATE OF CERTAIN
ACCOUNTING REQUIREMENTS FOR PENSION PLANS OF STATE AND LOCAL GOVERNMENTAL
UNITS". The Statement is effective for financial statements issued for fiscal
F-44
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
years ending after February 15, 1999. The Company believes that these standards
will not have a material impact on their financial statements or disclosures
thereto.
In April 1998, the Accounting Standards Executive Committee initiated
Statement of position ("SOP") 98-5 "REPORTING ON THE COSTS OF START-UP
ACTIVITIES" requires all start-up and organizational costs to be expensed as
incurred. It also requires all remaining historically capitalized amounts of
these costs existing at the date of adoption to be expensed and reported as the
cumulative effect of a change in accounting principles. SOP 98-5 is effective
for all fiscal years beginning after December 31, 1998. The Company believes
that the adoption of SOP 98-5 will not have a material effect on its financial
statements.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The unaudited interim financial statements for the six month periods ended
June 30, 1998 and 1999 and as of June 30, 1999 have been prepared on the same
basis as the Company's audited financial statements as of and for the year ended
December 31, 1998. In the opinion of management, all adjustments, consisting of
normal, recurring accruals, necessary to present fairly the financial position
of the Company at June 30, 1999, and the results of operations and cash flows
for the six month periods ended June 30, 1998 and 1999 have been included. The
results of operations for such interim periods are not necessarily indicative of
the results expected for the full year ending December 31, 1999.
NOTE 3--ACCOUNTS RECEIVABLE
In 1997, the Company entered into a renewable accounts receivable sales
agreement with Receivables Funding Corporations ("RFC"). The agreement provides
for sale, without recourse, of selected accounts receivable generated through
the billing and collection agreements with SWBT and AOCs not to exceed an
aggregate outstanding balance of $3,000,000. This agreement was amended in April
1998 to increase the maximum aggregate outstanding balance to $5,500,000.
Advances by RFC are limited to 90% of the selected account balances and are
recorded as a reduction of accounts receivable. The related fees are expensed.
The monthly fees charged equal 1.17% of the aggregate outstanding balance of the
receivables sold. This agreement is accounted for as a sale of accounts
receivable in accordance with SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities."
F-45
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--NOTES PAYABLE AND LONG-TERM DEBT
NOTES PAYABLE
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1998 JUNE 30, 1999
---- ---------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Note payable to a third party lender, dated December 23, 1998, bearing interest
of $10,000, entire balance of principal and interest due January 8, 1999,
secured by accounts receivable................................................ $ -- $1,000,000 $ --
$700,000 bank line of credit, dated December 11, 1998, bearing interest at prime
plus 1% (8.75% as of December 31, 1998), entire balance of principal and
accrued interest due January 5, 1999, secured by brokerage accounts held by
the stockholders of MTM....................................................... $ -- 694,969 --
---- ---------- -----
$ -- $1,694,969 $ --
---- ---------- -----
---- ---------- -----
</TABLE>
These notes were paid in full in January 1999.
LONG-TERM DEBT
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998 JUNE 30, 1999
--------- --------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Term loan to a bank, dated December 8, 1997, due in 36
installments of $2,008 each including interest at
9.25%, commencing January 8, 1998 secured by
automotive equipment................................. $ 62,786 $ 38,693 $ --
Less current portion................................... 19,080 20,921 --
--------- --------- -----
$ 43,706 $ 17,772 $ --
--------- --------- -----
--------- --------- -----
</TABLE>
In February 1999, the Company entered into another term note agreement with
a bank due in 36 installments of $2,127 each including interest at 8% and
secured by automotive equipment.
Interest paid during 1996, 1997 and 1998 on long-term debt and short-term
borrowings amounted to $20,424, $28,529 and $271,504, respectively. Interest
paid during the six month periods ending June 30, 1998 and 1999 were $165,408
and $96,931, respectively. (unaudited)
F-46
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
Maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
-------------
<S> <C>
1999............................................................................... $ 20,921
2000............................................................................... 17,772
---------
$ 38,693
---------
---------
</TABLE>
Both term notes were paid in full in March 1999.
NOTE 5--INCOME TAXES
The reconciliation between the effective income tax rate and the U.S.
federal statutory rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------- -------------------------
1998 1998 1999
1996 1997 (PRO FORMA) (PRO FORMA) (PRO FORMA)
---------- ---------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
U.S. federal taxes at statutory rate............ $ 275,320 $ 818,336 $ 695,354 $ 1,192,731 $ 535,233
Increase (decrease):
Book/tax basis differences on disposed
equipment................................... -- (8,547) -- -- --
Nondeductible terms........................... 9,709 20,919 48,122 11,642 17,316
Other......................................... (6,745) 6,385 (6,406) (6,404) 6,156
---------- ---------- ----------- ------------ -----------
Income tax provision............................ $ 278,284 $ 837,093 $ 737,070 $ 1,197,969 $ 558,705
---------- ---------- ----------- ------------ -----------
---------- ---------- ----------- ------------ -----------
</TABLE>
Deferred income tax assets (liabilities) consist of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------ JUNE 30,
1998 1999
1997 1998 (PRO FORMA) (PRO FORMA)
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
CURRENT
Net receivables--cash basis................................. $ (72,715) $ (904,840) $(223,440) $(223,440)
---------- ----------- ----------- -----------
NONCURRENT
Depreciation and amortization............................... $ (20,670) $ (17,177) $ 15,210 $ 16,404
Net receivables--cash basis................................. 10,200 4,675 (452,245) (335,160)
---------- ----------- ----------- -----------
Net deferred tax liability.................................. $ (10,470) $ (12,502) $(437,035) $(318,756)
---------- ----------- ----------- -----------
---------- ----------- ----------- -----------
</TABLE>
Federal income taxes of $12,345, $267,590 and $684,000 were paid during the
years ended December 31, 1996, 1997 and 1998, respectively. The $684,000 paid
during 1998 is reflected as a receivable at December 31, 1998 since no federal
income taxes were due.
During 1998, the Company's 1996 federal income tax return was audited by the
Internal Revenue Service. The Company did not receive additional tax assessments
as a result of the audit.
F-47
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--INCOME TAXES (CONTINUED)
Upon termination of its S Corporation status (SEE NOTE 1), the Company will
be required to recognize deferred income taxes for cumulative temporary
differences between income for financial and tax reporting purposes. Had the
termination occurred at December 31, 1998, the deferred income tax liability,
calculated in accordance with Statement of Financial Accounting Standards No.
109, "ACCOUNTING FOR INCOME TAXES," would have approximated $660,475.
NOTE 6--REGULATORY APPROVAL
The Company is required to obtain statutory approval to sell long distance
traffic in the states in which the Company conducts business. The Company has
filed for and received approval of all necessary tariff applications in all
states in which it operated at December 31, 1996, 1997 and 1998.
NOTE 7--COMMITMENTS AND CONTINGENCIES
CONTRACTS WITH PROVIDERS
The Company's agreement with Coastal whereby Coastal provides long-haul
transmissions for the Company's traffic has an initial term of five years ending
in the year 2000 at which time the contract is cancelable upon 30 days notice
(SEE NOTE 1).
The Company's September 1996 agreement with Frontier has an initial term of
four years with automatic renewal options, unless terminated earlier by either
party. Commencing in June 1997 the agreement requires the Company to purchase
minimum services starting at $50,000 and escalating to $250,000 minimum monthly
usage in September 1998 and beyond, for a total minimum requirement of
$7,650,000 during the initial contract period. In the event the Company is in
breach of the agreement as defined, and Frontier elects to terminate the
agreement, the total minimum requirement is reduced to $6,000,000 for the
initial four-year term. Minimum purchase requirements were met for the years
ended December 31, 1997 and 1998. The Company was assessed $20,887, the minimum
charge called for under the agreement for the period ended June 30, 1999 as
purchased services did not meet the minimum purchase requirements.
Should the Company be unable to renew these agreements on favorable terms or
should either Coastal or Frontier be unable to provide services to the Company
at any time, the Company would be required to contract with similar providers
for these services in order to continue operations. The Company's management
believes that there are sufficient alternative providers from which similar
services could be timely acquired at competitive rates in order to avoid
interruptions of operations.
The Company also has a contract with SWBT to provide billing and account
collection services. The initial term of the contract is five years ending in
the year 2000 at which time the contract is cancelable upon ninety days notice,
or it is renewable for one year periods under amended terms. The contract calls
for guaranteed minimum purchases of services of $52,500 per year totaling
$262,500 over the five year term. The Company's management believes that there
are sufficient alternative sources, including the Company, to provide these
services without an interruption of operations should SWBT discontinue providing
them. Minimum purchase requirements were met for years ending December 31, 1997
and 1998.
LITIGATION
The Public Utility Commission of Texas ("PUC") and the Office of the
Attorney General for the state of Texas brought claims under the Texas Deceptive
Trade Practices Act alleging that the Company
F-48
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--COMMITMENTS AND CONTINGENCIES (CONTINUED)
engaged in the practice known as "slamming" which involves the unauthorized
change of a customer's long distance service. The Texas Attorney General sought
to restrain certain marketing practices and to assess damages. The case was
settled in June 1998 for $150,000 and while the settlement did not constitute an
admission of liability on the Company's part, the Company did agree to comply
with the rules promulgated by the PUC. The settlement agreement required a
payment of $50,000 on the date of the agreement and 12 payments of $8,333
beginning June 1, 1998. Unpaid settlement amounts are included in accrued
liabilities at December 31, 1997 and 1998.
Similar claims have been brought against the Company in early 1998 by the
Attorneys General for the states of Illinois, Oklahoma and Missouri. The Company
settled with the Illinois Attorney General in March 1999 for $50,000. The
settlement amount is included in accrued liabilities at December 31, 1998.
The remaining suits request, amongst other things, fines, restitution and
loss of ability to conduct business in these states. The Company believes these
claims are without merit, that it has meritorious defenses to them and intends
to vigorously defend itself against these claims.
In addition, the Company has been named a defendant in two suits seeking
class action certification. Both suits were filed in 1998 and are in the
discovery phase. Management of the Company believes that the claims asserted are
without merit and intends to vigorously contest them.
The Company is subject to other legal proceedings which have arisen in the
ordinary course of business and have not been fully adjudicated. Although there
can be no assurance as to the ultimate disposition of these matters and the
proceedings disclosed above, in the opinion of management, based upon
information available at this time, the cost of defense or settlement of these
actions, individually or in the aggregate, will not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company.
OPERATING LEASES
The Company leases office space, office furniture and fixtures and equipment
under noncancellable operating lease arrangements for various periods ranging up
to five years. Future minimum lease payments are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
-------------
<S> <C>
1999.............................................................................. $ 417,040
2000.............................................................................. 174,462
2001.............................................................................. 32,759
----------
Total future minimum lease payments........................................... $ 624,261
----------
----------
</TABLE>
Lease rental expenses were approximately $73,550, $151,341 and $361,646 for
the years ended December 31, 1996, 1997 and 1998, respectively. Lease rental
expenses approximated $119,373 and $156,817 for the six month periods ended June
30, 1998 and 1999, respectively.
NOTE 8--RELATED PARTY TRANSACTIONS
The notes receivable from certain stockholders of MTM at December 31, 1997
bear interest at 7% and are payable in annual installments of principal and
interest of $14,746 and $225,450 for years
F-49
<PAGE>
AXCES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--RELATED PARTY TRANSACTIONS (CONTINUED)
ending December 31, 1999 and 2000, respectively. These notes were included in
the stockholders compensation for 1998.
During the six month period ending June 30, 1999, the Company advanced the
stockholders of MTM $49,228 and $1,670,344, respectively. These amounts are
included in receivables from related parties at June 30, 1999.
The Company had the following transaction with a printing company under
common control of MTM:
In January 1998, the Company entered into a one-year agreement totaling
$500,000 with the printing company to provide management and consulting
service for the Company's advertising campaigns, public relations,
marketing, and strategic planning needs.
In November 1998, the Company loaned the printing company $200,000. The
note receivable bears interest at 7%, principal and accrued interest are
payable on March 31, 1999. Outstanding balance at December 31, 1998 is
included in receivables from related parties.
During 1998 and 1997, the Company purchased printing services totaling
$281,660 and $284,660, respectively, from the printing company. Amounts due
the printing company at December 31, 1997 and 1998 were $16,583 and $66,265,
respectively, and are included in accounts payable.
During 1998, the Company paid $20,475 of officers life insurance premiums on
behalf of MTM. This amount is included in receivables from related parties at
December 31, 1998. The Company paid $6,496 of officers' life insurance premiums
on behalf of MTM which are included in receivables from related parties at June
30, 1999. (unaudited)
NOTE 9--401(K) PLAN
The Company established a 401(k) Profit Sharing Plan (the "Plan") effective
January 1, 1998, covering all eligible Company employees. Contributions may be
made to the Plan by an employee at a percentage of salary, but not to exceed the
maximum allowed by the Internal Revenue Code and may be matched by a
discretionary Company contribution of 50% of the employer's contribution up to
3% of total employee compensation.
The Company's contributions to the Plan for the year ended December 31, 1998
totaled $29,886. The Company's contributions to the Plan for the six month
periods ended June 30, 1998 and 1999 were $18,682 and $16,717, respectively.
(unaudited)
NOTE 10--SUBSEQUENT EVENT
In April 1999, the Company and the stockholders of MTM signed a definitive
agreement with InfoHighway pursuant to which all shares of the Company will be
exchanged for the following consideration: (i) 700,000 shares of common stock,
and (ii) $9.0 million of Series B 8% Cumulative Convertible Preferred Stock. The
preferred stock is convertible into 600,000 shares of common stock at the
holder's option and is redeemable after 36 months out of a designated portion of
InfoHighway's cash flow. Additionally, the merger agreement provides for
distributions to MTM totaling $6.5 million representing (i) substantially all of
the undistributed earnings of AXCES, a QSSS under the Federal Income Tax Code of
1986, and (ii) up to $3.0 million in borrowings prior to the Offering. The
acquisition of AXCES is expected to occur during September 1999 upon the
consummation of an initial public offering of the common stock of InfoHighway.
F-50
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
InfoHighway International, Inc.:
We have audited the accompanying balance sheets of InfoHighway
International, Inc. as of December 31, 1997 and 1998 and the related statements
of operations, stockholders' equity (deficit) and cash flows for each of the
years in the three-year period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of InfoHighway International,
Inc. as of December 31, 1997 and 1998, and the results of its operations and its
cash flows for each of the years in the three-year period ended December 31,
1998, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note 2 to the
financial statements, the Company has suffered recurring losses and negative
cash flows from operations and has a working capital deficit and stockholders'
deficit that raise substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also described in
note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
KPMG LLP
April 9, 1999
Houston, Texas
F-51
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- JUNE 30,
1997 1998 1999
---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets
Cash................................................. $ 355 $ 250 $ 398
Accounts receivable, net of allowance for doubtful
accounts of $50,638, $82,904 and $116,194 at
December 31, 1997 and 1998 and June 30, 1999,
respectively....................................... 86,992 39,260 297,490
Other current assets................................. -- 1,250 32,000
---------- ---------- ----------
Total current assets............................... 87,347 40,760 329,888
Property and equipment, net............................ 407,779 323,050 782,810
Intangible assets, net................................. 92,393 71,382 391,070
Other assets........................................... 21,399 14,469 22,018
---------- ---------- ----------
Total assets....................................... $ 608,918 $ 449,661 $1,525,786
---------- ---------- ----------
---------- ---------- ----------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Notes payable........................................ $ -- $ -- $ 293,000
Note payable to related party........................ -- 475,650 669,250
Notes payable to shareholders........................ 199,900 418,942 418,942
Capital lease obligations............................ 142,477 48,896 34,255
Accounts payable..................................... 376,897 629,259 843,902
Deferred revenues.................................... 196,399 262,458 348,432
Accrued expenses..................................... -- 45,694 113,209
---------- ---------- ----------
Total current liabilities.......................... 915,673 1,880,899 2,720,990
Commitments and contingencies
Stockholders' deficit:
Common stock, no par value, authorized 20,000,000
shares; 6,236,620, 16,605,958 and 10,489,729 shares
issued and outstanding, respectively............... 1,692,778 1,836,015 2,600,788
Accumulated deficit.................................. (1,999,533) (3,267,253) (3,795,992)
---------- ---------- ----------
Total stockholders' deficit........................ (306,755) (1,431,238) (1,195,204)
---------- ---------- ----------
Total liabilities and stockholders' deficit........ $ 608,918 $ 449,661 $1,525,786
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See accompanying notes to financial statements.
F-52
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED ENDED DECEMBER 31, JUNE 30,
--------------------------------- --------------------
1996 1997 1998 1998 1999
--------- ---------- ---------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Access service revenues $ 425,561 $ 914,661 $1,384,563 $ 796,716 $1,100,091
Cost of services................... 217,086 647,172 995,524 509,349 591,696
--------- ---------- ---------- --------- ---------
Gross profit..................... 208,475 267,489 389,039 287,367 508,395
Selling, general and
administrative................... 639,204 1,481,366 1,338,859 600,344 713,206
Depreciation and amortization 52,336 175,217 260,816 141,990 260,726
--------- ---------- ---------- --------- ---------
Loss from operations............. (483,065) (1,389,094) (1,210,636) (454,967) (465,537)
Interest expense................... 4,034 28,135 57,084 28,826 63,202
--------- ---------- ---------- --------- ---------
Loss before income taxes......... (487,099) (1,417,229) (1,267,720) (483,793) (528,739)
Income taxes....................... -- -- -- -- --
--------- ---------- ---------- --------- ---------
Net loss $(487,099) $(1,417,229) $(1,267,720) $(483,793) $(528,739)
--------- ---------- ---------- --------- ---------
--------- ---------- ---------- --------- ---------
Basic and diluted loss per share:
Net loss $ (0.12) $ (0.27) $ (0.14) $ (0.07) $ (0.04)
--------- ---------- ---------- --------- ---------
--------- ---------- ---------- --------- ---------
Weighted-average common shares
outstanding 3,995,502 5,222,454 8,884,820 6,699,434 13,467,932
--------- ---------- ---------- --------- ---------
--------- ---------- ---------- --------- ---------
</TABLE>
See accompanying notes to financial statements.
F-53
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK STOCKHOLDERS'
-------------------------- ACCUMULATED EQUITY
SHARES AMOUNT DEFICIT (DEFICIT)
------------ ------------ ------------- --------------
<S> <C> <C> <C> <C>
Balances, December 31, 1995............................ 3,350,000 $ 113,670 $ (95,205) $ 18,465
Issuances of common stock for cash..................... 966,000 371,310 -- 371,310
Issuances of common stock for services performed....... 100,000 80,000 -- 80,000
Net loss............................................... -- -- (487,099) (487,099)
------------ ------------ ------------- --------------
Balances, December 31, 1996............................ 4,416,000 564,980 (582,304) (17,324)
Issuances of common stock for cash..................... 1,570,610 647,782 -- 647,782
Issuances of common stock for services performed....... 123,038 276,861 -- 276,861
Issuances of common stock for acquisition of intangible
assets............................................... 126,972 203,155 -- 203,155
Net loss............................................... -- -- (1,417,229) (1,417,229)
------------ ------------ ------------- --------------
Balances, December 31, 1997............................ 6,236,620 1,692,778 (1,999,533) (306,755)
Issuances of common stock for cash..................... 70,547 10,085 -- 10,085
Issuances of common stock for services performed....... 505,221 2,088 -- 2,088
Issuances of common stock for acquisition of intangible
assets............................................... 4,883 7,814 -- 7,814
Issuances of common stock in connection with unit
offering............................................. 308,125 123,250 -- 123,250
Issuances of common stock for consulting services
performed............................................ 7,182,244 -- -- --
Issuances of common stock in connection with note
payable to related party............................. 2,298,318 -- -- --
Net loss............................................... -- -- (1,267,720) (1,267,720)
------------ ------------ ------------- --------------
Balances, December 31, 1998............................ 16,605,958 1,836,015 (3,267,253) (1,431,238)
Issuance of common stock in satisfaction of notes
payable for acquisition.............................. 968,750 768,753 -- 768,753
Stock re-purchase...................................... (4,375) (7,000) -- (7,000)
Exercise of option..................................... 101,640 3,200 -- 3,200
Re-acquisition of shares issued for consulting
services............................................. (7,182,244) (180) -- (180)
Net loss (unaudited)................................... -- -- (528,739) (528,739)
------------ ------------ ------------- --------------
Balances, June 30, 1999 (unaudited).................... 10,489,729 $ 2,600,788 $ (3,795,992) $ (1,195,204)
------------ ------------ ------------- --------------
------------ ------------ ------------- --------------
</TABLE>
See accompanying notes to financial statements.
F-54
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------------- --------------------
1996 1997 1998 1998 1999
--------- ----------- ----------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.......................................... $(487,099) $(1,417,229) $(1,267,720) $(483,793) $(528,739)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................... 52,336 175,217 260,816 141,990 260,726
Issuances of common stock for services
performed..................................... 80,000 276,861 2,088 -- --
Changes in assets and liabilities:
Accounts receivable........................... (71,965) (15,027) 47,732 (52,675) (258,230)
Other current assets.......................... -- -- (1,250) (850) (30,750)
Other assets.................................. (4,782) (15,415) 6,930 (34,458) (7,549)
Accounts payable.............................. 77,485 299,412 252,362 246,715 214,643
Deferred revenues............................. 103,827 92,572 66,059 98,942 85,974
Accrued expenses.............................. -- -- 45,694 6,032 67,515
--------- ----------- ----------- --------- ---------
Net cash used in operating activities....... (250,198) (603,609) (587,289) (78,097) (196,410)
--------- ----------- ----------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment............... (121,184) (216,251) (130,825) (96,950) (80,282)
Acquisition of intangible assets.................. -- -- (16,437) (28,464) (41,318)
--------- ----------- ----------- --------- ---------
Net cash used in investing activities....... (121,184) (216,251) (147,262) (125,414) (121,600)
--------- ----------- ----------- --------- ---------
Cash flows from financing activities:
Proceeds from unit offering....................... -- -- 493,000 -- --
Proceeds from note payable to related party....... -- -- 475,650 -- 193,600
Proceeds from notes payable to shareholders....... -- 269,500 117,463 143,782 143,000
Payments of notes payable to shareholders......... (17,533) (97,067) (268,171) -- --
Payments of capital lease obligations............. -- -- (93,581) (46,521) (14,641)
Issuances of common stock for cash................ 371,310 647,782 10,085 106,250 (3,801)
--------- ----------- ----------- --------- ---------
Net cash provided by financing activities....... 353,777 820,215 734,446 203,511 318,158
--------- ----------- ----------- --------- ---------
Net increase (decrease) in cash................. (17,605) 355 (105) -- 148
Cash at beginning of period......................... 17,605 -- 355 355 250
--------- ----------- ----------- --------- ---------
Cash at end of period............................... $ -- $ 355 $ 250 $ 355 $ 398
--------- ----------- ----------- --------- ---------
--------- ----------- ----------- --------- ---------
Supplemental disclosure of cash flow
information--cash paid for interest............... $ 4,034 $ 28,228 $ 34,273 $ 11,988 $ 8,188
--------- ----------- ----------- --------- ---------
--------- ----------- ----------- --------- ---------
Supplemental disclosure of noncash activities:
Issuance of common stock for acquisition of
customer lists.................................. $ -- $ 203,155 $ 7,814 $ -- $ --
--------- ----------- ----------- --------- ---------
--------- ----------- ----------- --------- ---------
Equipment acquired under capital leases........... $ 100,369 $ 42,108 $ -- $ -- $ --
--------- ----------- ----------- --------- ---------
--------- ----------- ----------- --------- ---------
Issuance of notes payable for acquisition......... $ -- $ -- $ -- $ -- $ 918,573
--------- ----------- ----------- --------- ---------
--------- ----------- ----------- --------- ---------
Issuance of common stock in payment of notes
payable......................................... $ -- $ -- $ -- $ -- $ 768,753
--------- ----------- ----------- --------- ---------
--------- ----------- ----------- --------- ---------
</TABLE>
See accompanying notes to financial statements.
F-55
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
(1) BUSINESS AND ORGANIZATION
InfoHighway International, Inc. (the Company) is an Internet service
provider whose customers consist primarily of small to medium-sized businesses.
The Company was founded in 1994 and is based in Houston, Texas.
(2) LIQUIDITY
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. Since its inception, the Company has
suffered losses and negative cash flows from operations and has a working
capital deficit and stockholders' deficit that raise substantial doubt about its
ability to continue as a going concern. In addition, the Company's operations
are subject to certain risks and uncertainties including the following: (i)
risks associated with technology and regulatory trends; (ii) evolving industry
standards; (iii) dependence on its network infrastructure and suppliers; (iv)
growth and acquisitions; (v) actual and prospective competition by entities with
greater financial and other resources; and (vi) the development of the Internet
market. Inability to obtain additional financing or refinancing on acceptable
terms could necessitate changes in the Company's operating plans.
As discussed further in note 10, management has entered into a stock
purchase agreement with InfoHighway Communications Corporation (f/k/a OmniLynx
Communications Corporation, InfoHighway) whereby the Company will be acquired by
InfoHighway and included in the proposed initial public offering of InfoHighway.
Ultimately, the Company's ability to generate positive cash flows depends on
factors which may be beyond the Company's control. There can be no assurance
that the proposed initial public offering of InfoHighway will be successful.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) INTERIM FINANCIAL INFORMATION (UNAUDITED)
The unaudited financial statements as of June 30, 1999 and for the six-month
periods ended June 30, 1998 and 1999 have been prepared on the same basis as the
audited financial statements, and, in the opinion of management, include all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of the financial position and results of operations of such
interim periods in accordance with generally accepted accounting principles.
Results for the six months ended June 30, 1999 are not necessarily indicative of
results to be expected for the full year.
(B) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets of three to
five years. Leasehold improvements are amortized over the shorter of their
estimated useful lives or the remaining lease term.
The Company leases certain of its data communication and other equipment
under agreements accounted for as capital leases. The assets and liabilities
under capital leases are recorded at the lesser of the present value of
aggregate future minimum lease payments, including estimated bargain purchase
options, or the fair value of the assets under lease. Assets under capital lease
are depreciated over the shorter of their estimated useful lives or the related
lease term.
F-56
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(C) INTANGIBLE ASSETS
Intangible assets consist primarily of capitalized costs incurred for the
purchase of subscriber bases from other Internet service providers, and are
being amortized on a straight-line basis over the expected periods to be
benefitted of 3 to 4 years. Accumulated amortization on intangible assets
amounted to $39,946, $85,016 and $177,732 at December 31, 1997 and 1998, and
June 30, 1999 (unaudited), respectively. The Company assesses the recoverability
of intangible assets by determining whether the carrying value of the intangible
assets can be recovered through undiscounted future operating cash flows of the
purchased subscriber bases. The amount of impairment, if any, is measured based
on projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of intangible
assets will be impacted if estimated future operating cash flows are not
achieved.
(D) REVENUE RECOGNITION
Revenues derived from the providing of access services are recognized as the
services are provided. In some instances, the Company bills its subscribers in
advance for direct access to the Internet, but defers recognition of these
revenues until the services have been provided.
(E) SOURCE OF SUPPLIES
The Company relies on certain telecommunication companies to provide data
communications capacity. Although management believes alternative
telecommunications facilities could be found in a timely manner, any disruption
of these services could have an adverse effect on operating results.
The Company attempts to maintain multiple vendors for its modems, terminal
servers and high-performance routers, which are important components of its
network. If the suppliers are unable to meet the Company's needs as it expands
its network infrastructure, the Company may experience delays and increased
costs, which would adversely affect operating results.
(F) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(G) LOSS PER SHARE
Basic loss per share is computed by dividing loss available to common
stockholders by the weighted-average number of common shares outstanding for the
period, and excludes the effect of potentially dilutive securities (such as
options, warrants and convertible securities) which are convertible into common
stock. Dilutive loss per share is equivalent to basic loss per share for all
periods presented as the Company had no potentially dilutive securities
outstanding in 1996, 1997, 1998 or during the six months ended June 30, 1999.
F-57
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(H) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS, requires the disclosure of estimated fair values
for financial statement instruments. Fair value estimates are made at discrete
points in time based on relevant market information. These estimates may be
subjective in nature and involve uncertainties and matters of significant
judgment and therefore, cannot be determined with precision. The Company
believes that the carrying amounts of its financial instrument current assets
and current liabilities approximate the fair value of such items due to their
short-term nature. The carrying amounts of notes payable and capital lease
obligations approximate their fair value because the interest rates approximate
market.
(I) 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 reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(4) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ JUNE 30,
1997 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
(UNAUDITED)
Data communications equipment $ 556,499 $ 654,027 $ 1,132,174
Office equipment...................................... 42,608 69,113 213,225
Other................................................. 12,314 19,106 24,617
----------- ----------- ------------
611,421 742,246 1,370,016
Less accumulated depreciation and amortization........ (203,642) (419,196) (587,206)
----------- ----------- ------------
$ 407,779 $ 323,050 $ 782,810
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
(5) NOTE PAYABLE TO RELATED PARTY
In September 1998, the Company entered into a $500,000 loan agreement with
Trident III, L.L.C. (Trident III). Under the terms of the loan agreement, the
Company has borrowed $475,650 from Trident III. These borrowings incur interest
at 12% annually and are payable at the earlier of September 30, 1999, the
Company's receipt of $1,000,000 or more from one or more debt or equity
financings or the merger of the Company into a publicly-traded company. The
borrowings are secured by substantially all of the assets of the Company.
In connection with the borrowings, the Company issued a total of 2,298,318
shares of common stock to Trident III. These shares were issued with a
repurchase right that gave the Company the right to repurchase all of the shares
for total cash of $1 if the Company was not merged into or had become a
publicly-traded company by March 31, 1999. In connection with additional
borrowings granted to the Company and InfoHighway by Trident III subsequent to
March 31, 1999, the Company forfeited its
F-58
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(5) NOTE PAYABLE TO RELATED PARTY (CONTINUED)
right to repurchase these shares. Due to the nominal repurchase right, no value
was given to the issuance of these shares.
(6) UNIT OFFERING
In 1998 the Company sold units in a private placement offering for cash
proceeds of $493,000. Each unit was sold for $16,000 and consisted of a $12,000
note payable and 10,000 shares of the Company's common stock. The notes payable
bear interest at 10% and mature at the sooner of March 31, 2003 or within 90
days of the sale of the Company. In connection with the unit offering, the
Company issued 308,125 shares of common stock.
(7) ISSUANCES OF COMMON STOCK
During 1998 the Company sold 70,547 shares of common stock to various
investors for cash proceeds of $10,085. In addition, the Company issued 4,883
shares of common stock in connection with the purchases of subscriber bases from
other Internet service providers. The Company also issued 505,221 shares of
common stock to certain employees and consultants of the Company in exchange for
services performed. For the year ended December 31, 1998, the Company recorded
$2,088 in compensation expense related to the issuances of common stock to
certain employees and consultants based on management's estimate of the fair
value of the stock on the date of issuance.
Additionally during 1998, the Company issued 7,182,244 shares of common
stock to Benchmark Equity Group (Benchmark) in exchange for consulting and
advisory services provided in connection with the anticipated merger with
InfoHighway. These shares were issued with a repurchase right that gave the
Company the right to repurchase the shares for total cash of $1 if the Company
was not merged into or had become a publicly-traded company by March 31, 1999.
This repurchase right was exercised by the Company and the shares owned by
Benchmark were forfeited in 1999. Due to the nominal repurchase right, no value
was given to the issuance of these shares.
During 1997 the Company sold 1,570,610 shares of common stock to various
investors for cash proceeds of $647,782. In addition, the Company issued 126,972
shares of common stock in connection with the purchases of subscriber bases from
other Internet service providers. The Company also issued 123,038 shares of
common stock to certain employees and consultants of the Company in exchange for
services performed. For the year ended December 31, 1997, the Company recorded
$276,861 in compensation expense related to the issuances of common stock to
certain employees and consultants based on management's estimate of the fair
value of the stock on the date of issuance.
During 1996 the Company sold 966,000 shares of common stock to various
investors for cash proceeds of $371,310. The Company also issued 100,000 shares
of common stock to certain employees and consultants of the Company in exchange
for services performed. For the year ended December 31, 1996, the Company
recorded $80,000 in compensation expense related to the issuances of common
stock to certain employees and consultants based on management's estimate of the
fair value of the stock on the date of issuance.
F-59
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(8) INCOME TAXES
No income tax expense or benefit was recognized for the years ended December
31, 1996, 1997 or 1998. Income tax benefit attributable to losses from
operations differed from the amounts computed by applying the U.S. federal
income tax rate to pretax loss from operations as a result of the following:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Computed "expected" tax benefit........................ $ (165,614) $ (481,858) $ (431,025)
Increase in valuation allowance........................ 137,390 385,287 430,315
Nondeductible expenses................................. 28,224 96,571 710
----------- ----------- -----------
$ -- $ -- $ --
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets at December 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.................................. $ 550,074 $ 886,002
Accounts receivable............................................... -- 28,187
----------- -----------
Total deferred tax assets....................................... 550,074 914,189
Less valuation allowance.......................................... (550,074) (914,189)
----------- -----------
Net deferred tax asset.......................................... $ -- $ --
----------- -----------
----------- -----------
</TABLE>
At December 31, 1998, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $2,606,000 which are available to
offset future federal taxable income, if any, through 2018. These net operating
loss carryforwards are subject to limitations in the event of a change of
ownership of the Company.
(9) LEASES
The Company is obligated under various noncancellable operating and capital
leases, primarily for the lease of office space and data communications
equipment. Future minimum lease payments under noncancellable operating leases
(with initial or remaining lease terms in excess of one year) as of December 31,
1998 are:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING
DECEMBER 31, LEASES
- -------------------------------------------------------------------------------- ------------
<S> <C>
1999............................................................................ $ 100,365
2000............................................................................ 100,365
2001............................................................................ 105,027
2002............................................................................ 107,291
2003............................................................................ 42,485
------------
$ 455,533
------------
------------
</TABLE>
F-60
<PAGE>
INFOHIGHWAY INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(9) LEASES (CONTINUED)
Rent expense for the years ended December 31, 1996, 1997 and 1998 was
$51,000, $70,000 and $80,000, respectively.
(10) SUBSEQUENT EVENTS (UNAUDITED)
The Company has entered into a stock purchase agreement with InfoHighway. In
exchange for all of the issued and outstanding shares of the company,
shareholders of the Company will receive shares of InfoHighway on a pro rata
basis. Additional shares of InfoHighway will be issued to the shareholders of
the Company upon achievement of certain share price targets of InfoHighway
common stock.
During January 1999, the Company acquired certain assets, including customer
lists and property and equipment from an Internet service provider (the "Eden
Acquisition"). The purchase price consisted of $50,000 in cash; a $150,000 note,
accruing interest at 9% per annum, due March 15, 1999; and a $768,573 note
redeemable in 968,750 shares of the Company's common stock on March 15, 1999.
The Company and Eden extended the due date of the notes pending completion of
the Company's stock purchase agreement with InfoHighway. The note for $768,573
was redeemed in June, 1999 by issuance of 968,750 shares of common stock.
Payments totalling $107,000.00 had been paid on the $150,000 note as of June 30,
1999; the balance is to be paid with proceeds from the initial public offering
of InfoHighway. The purchase price was allocated $547,486 to property and
equipment and $421,087 to customer lists. The customer lists are being amortized
on a straight-line basis over 3 years.
(11) YEAR 2000 COMPLIANCE (UNAUDITED)
Many software applications, computer hardware and related equipment and
systems that use embedded technology, such as microprocessors, rely on two
digits rather than four digits to represent years in performing computations and
decision-making functions. These programs, hardware items and systems may fail
on January 1, 2000 or earlier because they misinterpret "00" as the year 1900
rather than 2000. These failures could have an adverse effect on the Company
because of its direct dependence on its own applications, equipment and systems
and its indirect dependence on those of third parties.
F-61
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
ARC Networks, Inc.
Hauppauge, New York
We have audited the accompanying consolidated balance sheets of ARC
Networks, Inc. and Subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of operations, capital deficit, and cash flows for each
of the three years in the period ended December 31, 1998. 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 consolidated financial position of
ARC Networks, Inc. and Subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As shown in the
consolidated financial statements and as discussed in Note 3 to the consolidated
financial statements, the Company has suffered recurring losses since its
inception in 1993, and has a deficit at December 31, 1998 of $6,425,265. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 3. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
MOORE STEPHENS, P.C.
Certified Public Accountants.
Cranford, New Jersey
February 16, 1999
F-62
<PAGE>
ARC NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
PREDECESSOR
------------------------
SUCCESSOR
DECEMBER 31, -----------
------------------------ JUNE 30,
1997 1998 1999
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and Equivalents.................................... $ 68,712 $ 192,992 $ 168,776
Accounts Receivable, net of Allowance for Doubtful
Accounts of $85,200, $443,196, and $355,470........... 2,386,072 2,991,554 3,763,919
Costs and Estimated Profits in Excess of Interim
Billings.............................................. 100,149 158,355 480,950
Prepaid Expenses and Other Current Assets............... 32,737 97,805 130,335
----------- ----------- -----------
Total Current Assets........................................ 2,587,670 3,440,706 4,543,980
Equipment - net............................................. 84,970 125,675 127,951
----------- ----------- -----------
Other Assets:
Deferred Financing Costs................................ 70,742 248,730 --
Customer list, net...................................... -- 53,125 --
Goodwill................................................ -- 239,566 10,451,145
Deposits................................................ 50,100 86,241 86,241
----------- ----------- -----------
Total Other Assets.......................................... 120,842 627,662 10,537,386
----------- ----------- -----------
Total Assets................................................ $ 2,793,482 $ 4,194,043 $15,209,317
----------- ----------- -----------
----------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current Maturities of Long Term Debt.................... $ 106,000 $ -- $ --
Current Maturities of Capitalized Leases................ 15,507 20,350 21,650
Current Maturities of Notes Payable..................... 650,000 250,000 800,000
Notes Payable--Related Parties.......................... 100,000 2,044,724 2,859,724
Loan Payable--Asset Based Lender........................ 231,064 -- --
Accounts Payable........................................ 3,098,480 3,817,657 5,173,296
Disputed Amounts Under Contract......................... -- 1,518,971 1,289,975
Deferred Salary--Officer................................ -- 52,336 --
Deferred Revenue........................................ 110,326 -- --
Interim Billings in Excess of Costs and Estimated
Profits............................................... 1,166,283 462,605 402,173
----------- ----------- -----------
Total Current Liabilities................................... 5,477,660 8,166,643 10,546,818
----------- ----------- -----------
Long-Term Liabilities:
Long Term Debt.......................................... 123,740 -- --
Capitalized Leases...................................... 33,777 15,319 5,141
Notes Payable........................................... -- 550,000 --
Notes Payable--Related Parties.......................... 1,155,095 1,171,674 1,146,674
----------- ----------- -----------
Total Long-Term Liabilities................................. 1,312,612 1,736,993 1,151,815
----------- ----------- -----------
Commitments and Contingencies...............................
Capital Deficit:
Common Stock - par value $.01, Authorized: 15,000,000
Shares; 3,000,000, 9,530,760 and 9,530,760 issued and
outstanding........................................... 30,000 95,307 95,307
Additional Paid-in Capital.............................. 489,750 620,365 3,415,377
Deficit................................................. (4,516,540) (6,425,265) --
----------- ----------- -----------
Total Capital Deficit....................................... (3,996,790) (5,709,593) 3,510,684
----------- ----------- -----------
Total Liabilities and Capital Deficit....................... $ 2,793,482 $ 4,194,043 $15,209,317
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements.
F-63
<PAGE>
ARC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PREDECESSOR
------------------------------------------------------------------------
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
-------------------------------------------- --------------------------
1996 1997 1998 1998 1999
------------- ------------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Sales.................................. $ 5,256,498 $ 9,110,364 $ 13,624,320 $ 6,353,291 $ 8,171,286
Sales - Related Parties................ 326,237 537,837 306,367 306,367 --
------------- ------------- -------------- ------------ ------------
Total Sales............................ 5,582,735 9,648,201 13,930,687 6,659,658 8,171,286
------------- ------------- -------------- ------------ ------------
Cost of Sales.......................... 4,773,279 8,410,293 11,374,867 5,398,770 6,694,203
Cost of Sales - Related Parties........ 300,138 484,810 276,159 291,890 --
------------- ------------- -------------- ------------ ------------
Total Cost of Sales.................... 5,073,417 8,895,103 11,651,026 5,690,660 6,694,203
------------- ------------- -------------- ------------ ------------
Gross Profit........................... 509,318 753,098 2,279,661 968,998 1,477,083
------------- ------------- -------------- ------------ ------------
Expenses:
Selling, General and Administrative
Expenses......................... 1,248,496 2,277,290 3,104,603 1,151,476 1,610,501
Provision for Bad Debts............ 109,989 36,179 345,500 55,141 200,600
Administrative Expenses - Related
Parties.......................... 80,119 28,579 14,066 11,664 16,813
Depreciation and Amortization...... 17,222 436,538 407,390 165,396 219,241
Loss on Impaired Asset............. -- 352,847 -- -- --
------------- ------------- -------------- ------------ ------------
Total Expenses......................... 1,455,826 3,131,433 3,871,559 1,383,677 2,047,155
------------- ------------- -------------- ------------ ------------
Loss from Operations................... (946,508) (2,378,335) (1,591,898) (414,679) (570,072)
------------- ------------- -------------- ------------ ------------
Other Expenses:
Interest Expense................... (59,903) (205,164) (134,732) (123,412) (113,754)
Interest Expense - Related
Parties.......................... (106,910) (120,912) (182,095) (59,089) (187,813)
------------- ------------- -------------- ------------ ------------
Total Other Expenses................... (166,813) (326,076) (316,827) (182,501) (301,567)
------------- ------------- -------------- ------------ ------------
Net Loss............................... $ (1,113,321) $ (2,704,411) $ (1,908,725) $ (597,180) $ (871,639)
------------- ------------- -------------- ------------ ------------
------------- ------------- -------------- ------------ ------------
BASIC EARNINGS PER SHARE:
Net Loss per Share................. $ (0.37) $ (0.90) $ (0.39) $ (0.20) $ (0.09)
------------- ------------- -------------- ------------ ------------
------------- ------------- -------------- ------------ ------------
Weighted Average Number of
Shares........................... 3,000,000 3,000,000 4,860,819 3,000,000 9,530,760
------------- ------------- -------------- ------------ ------------
------------- ------------- -------------- ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-64
<PAGE>
ARC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CAPITAL DEFICIT
<TABLE>
<CAPTION>
PREDECESSOR
-----------------------------------------------------------------
COMMON STOCK ADDITIONAL TOTAL
--------------------- PAID-IN CAPITAL
SHARES AMOUNT CAPITAL DEFICIT DEFICIT
---------- --------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995.................... 3,000,000 $ 30,000 $ (17,750) $ (698,808) $ (686,558)
Allocated related party administrative
expenses.................................... -- -- 18,000 -- 18,000
Net loss...................................... -- -- -- (1,113,321) (1,113,321)
---------- --------- ------------ ------------- -------------
Balance, December 31, 1996.................... 3,000,000 30,000 250 (1,812,129) (1,781,879)
Allocated related party administrative
expenses.................................... -- -- 4,500 -- 4,500
Issuance of warrants related to debt.......... -- -- 485,000 -- 485,000
Net loss...................................... -- -- -- (2,704,411) (2,704,411)
---------- --------- ------------ ------------- -------------
Balance, December 31, 1997.................... 3,000,000 30,000 489,750 (4,516,540) (3,996,790)
Issuance of shares related to refinancing..... 6,530,760 65,307 130,615 -- 195,922
Net loss...................................... -- -- -- (1,908,725) (1,908,725)
---------- --------- ------------ ------------- -------------
Balance, December 31, 1998.................... 9,530,760 95,307 620,365 (6,425,265) (5,709,593)
Net loss...................................... -- -- -- (871,639) (871,639)
---------- --------- ------------ ------------- -------------
Balance, June 30, 1999 (unaudited)............ 9,530,760 $ 95,307 $ 620,365 $ (7,296,904) $ (6,581,232)
-------------------------------------------------------------------------------------------
SUCCESSOR
-----------------------------------------------------------------
Eliminate predecessor retained deficit........ -- -- -- 7,296,904 7,296,904
Purchase price adjustment..................... -- -- 2,795,012 -- 2,795,012
---------- --------- ------------ ------------- -------------
Balance, June 30, 1999 (unaudited)............ 9,530,760 $ 95,307 $ 3,415,377 $ -- $ 3,510,684
---------- --------- ------------ ------------- -------------
---------- --------- ------------ ------------- -------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-65
<PAGE>
ARC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PREDECESSOR
--------------------------------------------------------
YEARS ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
---------------------------------- --------------------
1996 1997 1998 1998 1999
---------- ---------- ---------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss............................................ $(1,113,321) $(2,704,411) $(1,908,725) $(597,180) $(871,639)
Adjustments to reconcile net loss to net Cash used
in operating activities
Provision for doubtful accounts..................... 109,989 36,179 345,500 55,141 200,600
Depreciation........................................ 17,222 46,488 30,539 11,187 37,050
Amortization........................................ -- 390,050 376,850 154,208 182,192
Loss on impaired asset.............................. -- 352,847 -- -- --
Cost of shares issued in refinancing................ -- -- 195,923 -- --
(Increase) Decrease in assets:
Accounts receivable--trade.......................... (549,490) (1,329,865) (800,565) (767,772) (684,639)
Amounts charged to allowance for doubtful
accounts.......................................... -- (5,979) (150,417) (35,171) (288,326)
Costs and estimated profits in excess of interim
billings.......................................... 129,760 (94,411) (58,207) (85,038) (322,595)
Notes receivable--officer........................... -- 22,500 -- -- --
Prepaid expenses and other assets................... (11,264) (6,835) (65,068) (24,862) 12,035
Deposits............................................ (225) (49,875) (36,141) (22,741) --
Increase (Decrease) in Liabilities:
Accounts payable and accrued expenses............... 765,591 1,841,481 719,176 603,120 1,355,639
Deferred salary--officer............................ -- -- 52,336 -- (52,336)
Deferred revenue.................................... 6,115 104,211 (110,326) (110,326) --
Disputed amounts under contract..................... -- -- 1,518,971 -- (228,996)
Interim billings in excess of costs and earnings.... 221,520 918,588 (703,677) 1,211,748 (60,432)
---------- ---------- ---------- --------- ---------
Cash flows used in operating activities............. (424,103) (479,032) (593,831) 392,314 (721,447)
---------- ---------- ---------- --------- ---------
INVESTING ACTIVITIES:
Acquisition of long distance customer base.......... -- -- (413,266) (413,054) --
Capital expenditures................................ (416,466) (82,579) (71,243) (33,192) (39,326)
---------- ---------- ---------- --------- ---------
Cash flows used in investing activities............. (416,466) (82,579) (484,509) (446,246) (39,326)
---------- ---------- ---------- --------- ---------
FINANCING ACTIVITIES:
Net proceeds (repayment) asset based lender......... 79,742 151,322 (231,064) 106,235 --
Proceeds from notes payable, due April 1, 1998...... -- 495,000 -- -- --
Proceeds from demand notes.......................... -- 250,000 -- -- --
Note payable--parent................................ (67,496) (429,389) (106,277) -- --
Proceeds of notes payable--affiliate................ 427,126 223,692 67,855 47,565 400,000
Repayments of notes payable--affiliate.............. -- -- -- -- (10,000)
Proceeds of Line of Credit.......................... -- -- 1,999,724 -- 400,000
Proceeds of capitalized leases...................... 114,085 52,950 -- -- --
(Repayments) of capitalized leases.................. -- (3,666) (13,615) (7,438) (8,878)
Proceeds of note payable--equipment loan............ 350,000 -- -- -- --
(Repayment) of note payable--equipment loan......... -- (102,000) (229,740) (44,001) --
Deferred financing costs............................ -- (70,742) (284,263) (1,052) (44,565)
---------- ---------- ---------- --------- ---------
Cash flows provided by financing activities......... 903,457 567,167 1,202,620 101,309 736,557
---------- ---------- ---------- --------- ---------
Net increase in cash and equivalents................ 62,888 5,556 124,280 47,377 (24,216)
Cash and equivalents--beginning balance............. 268 63,156 68,712 68,712 192,992
---------- ---------- ---------- --------- ---------
Cash and equivalents--ending balance.................. $ 63,156 $ 68,712 $ 192,992 $ 116,089 $ 168,776
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
Supplemental disclosures:
Cash paid during the period for:
Interest.............................................. $ 27,536 $ 40,941 $ 233,748 $ 123,413 $ 120,757
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
Income taxes.......................................... $ -- $ -- $ -- $ -- $ --
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
</TABLE>
F-66
<PAGE>
ARC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the twelve months ended December 31, 1998, 1997 and 1996 the following
non-cash items occurred:
In February 1997, in connection with the issuance of $550,000 of notes, the
Company issued Series B Warrants to purchase 1,000,000 shares of common stock at
$1.00 per share and Series C Warrants to purchase 500,000 shares of common stock
at $5.00 per share. The Company has valued the Series B Warrants, using the
Black-Scholes method, at $485,000 and the Series C Warrants at $0. Such amount
is being amortized over the life of the notes which matured April 1, 1998.
Amortization recorded for the twelve month period ended December 31, 1998 and
1997 was $150,000 and $335,000.
In connection with the issuance of $550,000 interim notes payable, the
Company paid to the placement agent a fee of $55,000 which was amortized in
1997. In 1998, the Company arranged for the sale of these notes to a friendly
party. (See below)
In September 1998, the Company paid certain debts and refinanced others by
obtaining a $2,000,000 line of credit, secured by all assets of the Company,
with Consolidated Technology Group, Ltd. in exchange for the issuance of
4,500,760 shares of Common Stock valued at $135,000. In conjunction with the
refinancing, the Company renegotiated the employment contract of its President
and CEO and issued 1,280,000 shares valued at $38,400. In conjunction with the
refinancing of the $550,000 in notes referred to above, 750,000 shares of Common
Stock were issued to the new note holder valued at $22,500. The total cost of
the refinancing was deferred at September 1998 and is being amortized over 2
years. A summary of the deferral is presented below:
<TABLE>
<S> <C>
Cost of issuing shares............................................ $ 195,922
Origination fee................................................... 15,000
Legal costs....................................................... 73,341
---------
Total deferral.................................................... 284,263
Amortization...................................................... (35,533)
---------
Net deferral...................................................... $ 248,730
---------
---------
</TABLE>
The Note Receivable-Officer in the amount of $22,500 was forgiven and
recorded as additional compensation in 1997.
See Notes to Consolidated Financial Statements.
F-67
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
[1] PRINCIPLES OF ORGANIZATION AND BUSINESS
ARC Networks, Inc., a Delaware corporation (the "Company") was incorporated
in January 1997. The Company was formed for the purpose of acquiring all of the
outstanding stock of A.R.C. Networks, Inc., a New York corporation ("ARC-New
York"). On January 17, 1997, all of the stockholders of ARC-New York transferred
their stock to ARC Networks, Inc. for 100% ownership in the Company (the
"Recapitalization"). The accompanying consolidated financial statements reflect
the financial position and the results of operations and cash flows of the
Company and its subsidiary as if the Recapitalization occurred January 1, 1994.
The Company was a majority owned subsidiary of SIS Capital Corp. ("SISC")
through June 30, 1999. SISC is a wholly-owned subsidiary of Consolidated
Technology Group Ltd. ("CTG" and "Parent"), a public company. On June 30, 1999,
the Company was acquired by InfoHighway Communications Corporation
("InfoHighway"), formerly OmniLynx Communications Corporation "Successor
Company" See Note 23[A].
The Company offers local and long-distance telephone services to commercial
telephone users, and also provides data cable installation services primarily in
the New York metropolitan area.
[2] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include
the accounts of the Company and its subsidiary after elimination of intercompany
balances and transactions through June 30, 1999 (the "predecessor company"). The
consolidated balance sheet as of June 30, 1999 reflects the acquisition of ARC
(the "Successor Company") by InfoHighway. See Note 23[A].
UNAUDITED INTERIM FINANCIAL STATEMENTS--The financial statements as of June
30, 1998 and 1999 and for the six months ended June 30, 1998 and 1999 are
unaudited; however, in the opinion of management, all adjustments (consisting
solely of normal recurring adjustments) necessary to a fair presentation of the
financial statements for the interim periods have been made. The results of the
interim periods are not necessarily indicative of the results to be obtained for
a full fiscal year.
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 reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK--The Company extends credit to customers which
results in accounts receivable arising from its normal business activities. The
financial strength of the customers is routinely assessed and, based upon
factors surrounding the credit risk of the customers, the Company believes that
its receivable credit risk exposure is limited. Such estimate of the financial
strength of customers may be subject to change in the near term. At December 31,
1998, cash balances of $308,000 were held at a financial institution in excess
of the federally insured limits. The Company believes no significant
concentration of credit risk exists with respect to cash.
CASH AND EQUIVALENTS--The Company considers certain highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents. At December 31, 1998, the Company had no cash equivalents.
EQUIPMENT AND DEPRECIATION--Equipment is recorded at cost. Expenditures for
normal repairs and maintenance are charged to expense as incurred. When assets
are retired or otherwise disposed of,
F-68
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[2] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
their costs and related accumulated depreciation are removed from the accounts
and the resulting gains and losses are included in operations. Depreciation and
amortization are recorded using the straight-line method over the estimated
useful lives of the assets. The following sets forth the Company's depreciation
policy:
<TABLE>
<S> <C>
5-10
Telecommunications equipment..................................... years
Office equipment and computers................................... 5 years
</TABLE>
INTANGIBLES--Intangible assets consist primarily of capitalized costs
incurred for the purchase of a customer base and are amortized on a straight
line basis over the expected periods to be benefitted, twenty four months.
Management assesses the recoverability of the intangible assets by determining
whether the carrying value of the intangible assets can be recovered through
undiscounted future operating cash flows of the acquired customer base. The
amount of impairment, if any, is measured based on projected discounted future
operating cash flows using a discount rate reflecting the Company's average cost
of funds. The assessment of intangible assets will be impacted if estimated
future operating cash flows are not achieved.
REVENUE RECOGNITION--For local and long distance telephone service, the
Company recognizes revenue as service is provided to customers. For telephone
service provided through the sale of prepaid debit cards the Company invoices
the customer, principally distributors, at a discount from the face amount of
the debit card, when the debit cards are distributed. The Company records the
invoiced amount as deferred revenue and recognizes revenue as telephone usage is
provided.
The Company recognizes revenue from its data cable installation services
using the percentage of completion method, measured by the percentage of cost
incurred to date to the total estimated cost for each contract. Revisions in
cost estimates and recognition of losses, if any, on these contracts are
reflected in the accounting period in which the facts become known. Contract
terms provide for billing schedules that differ from revenue recognition and
give rise to costs and estimated profits in excess of interim billings, and
billings in excess of costs and estimated profits. It is reasonably possible
that the amount of costs and estimated profits in excess of billing and billings
in excess of costs and estimated profits may be subject to change in the near
term.
INCOME TAXES--The Company utilizes the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the period that includes the enactment date.
STOCK OPTIONS AND SIMILAR EQUITY INSTRUMENTS--On January 1, 1996, the
Company adopted the disclosure requirements, but not the fair value based method
of valuation, of Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation", for stock options and similar equity
instruments (collectively, "Options") issued to employees. The Company will
continue to apply the intrinsic value based method of accounting for Options
issued to employees prescribed by Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees." However, SFAS No. 123
applies to transactions in which an entity issues its equity
F-69
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[2] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
instruments to acquire goods or services from non-employees. Those transactions
are accounted for based on the fair value of the consideration received or the
fair value of the equity instruments issued, whichever is more reliably
measurable.
EARNINGS (LOSS) PER SHARE--Loss per share for the 1998 and 1999 periods is
based upon the weighted average shares outstanding for the period. Loss per
share for 1997 and 1996 are based on 3,000,000 shares issued in the
Recapitalization as if they were outstanding for both 1997 and 1996. Potential
common share equivalents are included in the calculation if they are dilutive.
Loss per share for all periods have been recalculated pursuant to SFAS No 128,
"Earnings per Share."
DEFERRED FINANCING COSTS--The Company accounts for the value of warrants
associated with the issuance of debt as a reduction of the principal balance and
amortizes such amounts over the life of the debt utilizing the straight line
method. Costs associated with the issuance of debt are deferred and amortized
over the term of the debt. Amounts paid or accrued for costs associated with an
anticipated public offering are deferred until the completion of the offering at
which time they are charged to paid in capital or are charged to expense if the
offering is not consummated.
[3] GOING CONCERN
The accompanying financial statements have been prepared on a going concern
basis which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company has sustained losses
since inception, and its accumulated deficit at December 31, 1998 and June 30,
1999 was $6,425,265 and $7,296,904, respectively. Its ability to continue as a
going concern is dependent upon the success of its marketing efforts, its
ability to produce sufficient margins to cover operating and overhead expenses
and its access to sufficient funding to enable it to continue operations. The
Company has been funded through December 31, 1998 by loans from its principal
stockholder and affiliated entities. The Company's plans for its transition to
profitability include obtaining financing, possibly through additional private
equity or through the merger of its operations with another entity in order to
provide the necessary working capital to expand its operations profitably and by
instituting stringent cost controls. While there can be no assurance that
additional equity capital can be raised or that its cost control efforts will be
successful, the Company recognizes that it must generate revenues at a level in
excess of its ongoing expenses or consider the prospect of reducing or ceasing
operations. Management also plans to increase revenues by marketing its services
and products to geographic markets throughout the United States and to increase
the products available to its customers.
[4] RECEIVABLES AND LOAN PAYABLE--ASSET-BASED LENDER (PREDECESSOR)
In 1994, the Company entered into an agreement with an asset-based lender to
finance its accounts receivable. The maximum availability of funds was
$3,000,000. The base interest rate was equal to 8.25% throughout 1998, 1997 and
1996, plus 2% and a commission of 0.3% of the receivables financed. The weighted
average interest rate for 1998 was 20.4%. The balance of the loan, $178,476, was
repaid in September 1998 from the proceeds of the Line of Credit received from
CTG (See Note 8). As of December 31, 1997 the balance of the loan was $231,064.
F-70
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[5] CONTRACTS IN PROGRESS
Costs, estimated profits, and billings on uncompleted contracts are
summarized as follows:
<TABLE>
<CAPTION>
PREDECESSOR
----------------------------
DECEMBER 31,
----------------------------
1997 1998
------------- ------------- SUCCESSOR
-------------
JUNE 30,
-------------
1999
-------------
(UNAUDITED)
<S> <C> <C> <C>
Costs Incurred....................................................... $ 1,368,827 $ 991,835 $ 1,197,841
Estimated Profits.................................................... 405,586 368,807 426,557
------------- ------------- -------------
Totals............................................................... 1,774,413 1,360,642 1,624,398
Billings to Date..................................................... (2,840,547) (1,664,892) (1,545,621)
------------- ------------- -------------
Net.............................................................. $ (1,066,134) $ (304,250) $ 78,777
------------- ------------- -------------
------------- ------------- -------------
Included in the accompanying balance sheet under the following
captions:
Costs and Estimated Profits in Excess of Interim Billings............ $ 100,149 $ 158,355 $ 480,950
Interim Billings in Excess of Costs and Estimated Profits............ (1,166,283) (462,605) (402,173)
------------- ------------- -------------
Net.................................................................. $ (1,066,134) $ (304,250) $ 78,777
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
At December 31, 1998 and June 30, 1999, the Company reclassified certain
contracts which are the subject of litigation in "Disputed Amounts Under
Contract" in the amounts of $1,518,971 and $1,289,975, respectively. See Notes
21 and 23.
At December 31, 1998, the Company had a backlog of firm orders for data
cabling and wiring services of approximately $2,000,000, of which substantially
all is expected to be completed during 1999.
[6] EQUIPMENT
Equipment consists of the following:
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
--------------------- -----------
DECEMBER 31, JUNE 30,
--------------------- -----------
1997 1998 1999
--------- ---------- -----------
<S> <C> <C> <C>
(UNAUDITED)
Telephone switching equipment............................ $ 33,558 $ 34,735 $ 35,935
Furniture and fixtures................................... 13,351 17,450 18,109
Computer equipment....................................... 43,136 109,104 146,571
--------- ---------- -----------
90,045 161,289 200,615
Less: Accumulated Depreciation........................... (5,075) (35,614) (72,664)
--------- ---------- -----------
Equipment--net........................................... $ 84,970 $ 125,675 $ 127,951
--------- ---------- -----------
--------- ---------- -----------
</TABLE>
Depreciation expense was $17,222, $46,488 and $30,539 for the years ended
December 31, 1996, 1997 and 1998, respectively, and $11,187 and $37,050 for the
six months ended June 30, 1998 and 1999, respectively.
F-71
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[7] INTANGIBLES (PREDECESSOR)
In June 1998, the Company purchased for cash a long distance customer base
for $413,266 of which $338,266 was allocated to goodwill and $75,000 was
allocated to customer lists. The total purchase price is being amortized over 24
months. Amortization amounted to $120,575 for the twelve months December 31,
1998 and $111,125 for the six months ended June 30, 1999.
[8] DEBT
[A] LONG TERM DEBT--EQUIPMENT LOAN (PREDECESSOR)
In September 1996, the Company entered into a term loan agreement with an
asset-based lender to borrow up to $350,000 for the purpose of purchasing
equipment. The loan agreement provided for weekly principal payments of $2,000.
Interest was charged monthly at a rate equal to the highest prime interest
charged in New York City plus 12%. The loan was collateralized by the Company's
accounts receivable and equipment.
The security interest granted to this lender was junior to the security
interest granted to the Company's other asset-based lender as to all assets,
except for the equipment being financed under this loan. SISC, CTG, and Lewis
Schiller, the Company's former Chairman and Chief Executive Officer, guaranteed
the Company's obligations under this agreement. The outstanding balance of this
loan, $189,156, was repaid in September 1998, plus a $12,500 prepayment penalty
from the proceeds of the Company's new $2,000,000 Line of Credit with CTG. As of
December 31, 1997 $106,000 was classified as Current Maturities of Long Term
Debt and the balance, $123,740 was shown as Long Term Debt. The weighted average
interest rate was 32.7% for 1998, including the prepayment penalty.
[B] NOTES PAYABLE--LISTED BELOW IS A SUMMARY OF NOTES PAYABLE
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
------------------------ ------------
DECEMBER 31, JUNE 30,
------------------------ ------------
1997 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
(UNAUDITED)
12% Demand Notes...................................... $ 250,000 $ 250,000 $ 250,000
8% Notes.............................................. 550,000 550,000 550,000
Less: Debt discount on 8% Notes....................... (150,000) -- --
----------- ----------- ------------
Sub-total........................................... 650,000 800,000 800,000
Less: Current Portion................................. (650,000) (250,000) (800,000)
----------- ----------- ------------
Total Long-Term Notes................................. $ -- $ 550,000 $ --
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
[I] 12% DEMAND NOTES (PREDECESSOR)
In September 1997, the Company borrowed $250,000 from two accredited
investors and issued its 12% Demand Notes. No fee was incurred in connection
with the issuance of such Demand Notes. The first interest payment is due
January 1, 1999 and the weighted average interest rate was 12% for 1998 and
1997. See Notes 21 and 23.
F-72
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[8] DEBT (CONTINUED)
[II] 8% NOTES PAYABLE (PREDECESSOR)
In February 1997, the Company issued 8% promissory notes in the principal
amount of $550,000, from which it received net proceeds of approximately
$495,000 after deducting a $55,000 commission paid to the placement agent, and,
in connection therewith, issued Series B Common Stock Purchase Warrants ("Series
B") to purchase an aggregate of 1,000,000 shares of Common Stock at $1.00 per
share and Series C Common Stock Purchase Warrants ("Series C") to purchase an
aggregate of 500,000 shares of Common Stock at $5.00 per share. The Company has
valued the Series B Warrants, using the Black-Scholes method, at $485,000. The
Series C Warrants were valued at $0. Amortization of $335,000 was recorded in
1997 and $150,000 in 1998. Such notes were originally due April 1, 1998.
In conjunction with the Line of Credit obtained from CTG in September 1998
(see below), the Company arranged for the sale of the $550,000 notes and
renegotiated the terms as follows. The Series B Warrants were cancelled and
400,000 of the 500,000 Series C Warrants were transferred to the new note
holder. The maturity date of the notes was extended to January 1, 2001, subject
to certain prepayment conditions should the Company raise in excess of $3
million or more in financings. All interest due under the note was forgiven and
the note became non-interest bearing. CTG guaranteed the note and the Company
issued 750,000 shares of its Common Stock to the new note holder, which was
valued at $22,500. (See Note 23).
[C] NOTES TO RELATED PARTIES
A summary of notes to related parties is summarized as follows:
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
--------------------------- -------------
DECEMBER 31, JUNE 30,
--------------------------- -------------
1997 1998 1999
------------ ------------- -------------
<S> <C> <C> <C>
(UNAUDITED)
Accounts payable--CTG............................. $ 106,277 $ -- $ --
Revolving Line of Credit--CTG..................... -- 1,999,724 2,399,724
Trans Global Services, Inc........................ 1,148,818 1,216,674 1,206,674
InfoHighway Communications Corporation............ -- -- 400,000
------------ ------------- -------------
Sub-total....................................... 1,255,095 3,216,398 4,006,398
Less: Current Maturities.......................... (100,000) (2,044,724) (2,859,724)
------------ ------------- -------------
Notes Payable--long term.......................... $ 1,155,095 $ 1,171,674 $ 1,146,674
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
[I] REVOLVING LINE OF CREDIT WITH CTG (PREDECESSOR)
In September 1998, the Company obtained a $2,000,000 line of credit from CTG
in exchange for the issuance of 4,500,760 shares of its Common Stock, valued at
$135,000. The terms of this line of credit allow the Company to borrow up to 85%
of eligible receivables as defined in the agreement and is collateralized by all
assets of the Company. Interest on the outstanding balance is prime plus 2% and
a monthly maintenance fee of $1,500. The weighted average interest rate was
15.9% for 1998. (See Notes 14 and 22)
The proceeds of the CTG Line of Credit were used, in part, to repay the Loan
Payable--Asset Based Lender, in the amount of $178,476, and the Equipment Loan
in the amount of $189,156. The
F-73
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[8] DEBT (CONTINUED)
balance was used for working capital. At December 31, 1998 and June 30, 1999,
the outstanding balances under the line were $1,999,724 and $2,399,724,
respectively.
[II] DEFERRED FINANCING COSTS (PREDECESSOR)
As a condition to receiving the Line of Credit in September 1998, the
Company paid at closing to CTG a $15,000 origination fee and the attorney's fees
for both the Company and CTG in the amount of $73,341. In addition, the Company
renegotiated the employment contract with its President and CEO and issued to
him 1,280,000 shares of Common Stock valued at $38,400 (See Note 16). All such
amounts have been deferred and are being amortized over 24 months. A summary of
the 1998 activity regarding this deferral is presented below:
<TABLE>
<CAPTION>
PREDECESSOR
----------------------
SHARES AMOUNT
---------- ----------
<S> <C> <C>
Cost of share issuance:
CTG Line of Credit................................................... 4,500,760 $ 135,022
Employment Contract.................................................. 1,280,000 38,400
Shares in lieu of interest--$550,000 Notes........................... 750,000 22,500
---------- ----------
Sub-total........................................................ 6,530,760 195,922
Origination Fee to CTG............................................... 15,000
Legal Costs.......................................................... 73,341
----------
Gross Deferral....................................................... 284,263
Amortization......................................................... (35,533)
----------
Deferred Financing Costs............................................. $ 248,730
----------
----------
</TABLE>
For the six months ended June 30, 1999 amortization totaled $71,066.
[III] NOTES PAYABLE AND TRANSACTIONS--AFFILIATED COMPANY (PREDECESSOR)
During 1996, 1997 and 1998, Trans Global Services, Inc. ("Trans Global"), an
affiliate through common ownership by CTG, made loans and advances to the
Company. Interest is charged at 10% annually on amounts owed to Trans Global.
Such amounts were $78,167, $104,968, and $119,935 for the years ended December
31, 1996, 1997 and 1998, respectively. In addition, Trans Global allocated
certain amounts for shared expenses such as certain payroll, payroll taxes,
employee benefits, professional fees and rents. Such amounts allocated totaled
$38,966, $21,245 and $0 for the years ended December 31, 1996, 1997 and 1998,
respectively, and bear interest at 10% per annum. Offsetting these items, the
Company provided to Trans Global phone services during 1997 totaling $24,918. As
of December 31, 1996 and 1997, respectively, such loans amounted to $973,411 and
$1,148,818, including interest. On September 30, 1997, the Company issued its
10% promissory note to Trans Global in the principal amount of $1,139,000,
representing the amount due to Trans Global on such date, including accrued
interest. In September 1998, the Company renegotiated this note in the amount of
$1,216,674, including all previously deferred interest. Interest on the new note
is payable monthly and, beginning in April 1999, monthly principal payments of
$5,000 are due until August 31, 2003, when a balloon payment for the balance is
due. The note is subject to certain prepayment conditions in the event the
F-74
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[8] DEBT (CONTINUED)
Company raises additional financings of at least $5,000,000, or, in the event of
a sale of the Company or a change of control occurs, as defined in the
agreement. See Note 23[A].
Scheduled payments related to this note for the next five years are as
follows:
<TABLE>
<S> <C>
1999............................................................ $ 45,000
2000............................................................ 60,000
2001............................................................ 60,000
2002............................................................ 60,000
2003............................................................ 991,674
---------
Total........................................................... $1,216,674
---------
---------
</TABLE>
[9] CAPITAL LEASES
During 1997, the Company purchased certain equipment with a value of $52,950
through the issuance of four capitalized leases. Accumulated depreciation
through December 31, 1997, 1998 and June 30, 1999 was $3,005, $10,445 and
$24,610, respectively. Depreciation expense on equipment under capitalized
leases is included in depreciation expense. Interest rates on the leases range
from approximately 16% to 18%. Future minimum lease payments for the remaining
years of the leases as of December 31, 1998 and June 30, 1999 are as follows:
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
------------ -----------
DECEMBER 31, JUNE 30,
1998 1999
------------ -----------
<S> <C> <C>
(UNAUDITED)
1999.............................................................. $ 25,243 $ 22,023
2000.............................................................. 16,478 6,120
------------ -----------
Total minimum payments............................................ 41,721 28,143
Less: amounts representing interest............................... (6,052) (1,352)
------------ -----------
Net present value of lease payments............................... $ 35,669 $ 26,791
------------ -----------
------------ -----------
</TABLE>
[10] INCOME TAXES
The tax effects of significant items comprising the Company's net deferred
tax asset as of December 31, 1997 and 1998 and June 30, 1999 are as follows:
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
---------------------------- -------------
DECEMBER 31, JUNE 30,
---------------------------- -------------
1997 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
(UNAUDITED)
Deferred Tax Asset:
Loss Carryforwards............................. $ 1,800,000 $ 2,500,000 $ 2,900,000
Less: Valuation Allowance...................... (1,800,000) (2,500,000) (2,900,000)
------------- ------------- -------------
Net Deferred Tax Asset......................... $ -- $ -- $ --
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The Valuation Allowance increased by approximately $1,120,000 in 1997,
$700,000 in 1998, and $200,000 and $400,000 for the six months ended June 30,
1998 and 1999, respectively. The provision for
F-75
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[10] INCOME TAXES (CONTINUED)
income taxes varies from the amount computed by applying statutory rates for the
reasons summarized below for all periods presented:
<TABLE>
<CAPTION>
PREDECESSOR
--------------------------------
DECEMBER 31, JUNE 30,
------------------ -----------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Provision based on statutory rates.......................... (34)% (34)% (34)% (34)% (34)%
State taxes, net of federal tax benefit..................... (6) (6) (6) (6) (6)
Losses for which there is no current tax benefit............ 40 40 40 40 40
---- ---- ---- ---- ----
Total....................................................... --% --% --% --% --%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
</TABLE>
For financial reporting purposes, at December 31, 1998 and June 30, 1999,
the Company had net operating loss carryforwards of approximately $6,400,000 and
$6,800,000, respectively, expiring in 2013 and 2014. Pursuant to Section 382 of
the Internal Revenue Code of 1986, as amended, utilization of these losses may
be limited in the event of a substantial change in the Company's ownership.
Based on this and the operating losses generated through December 31, 1998 and
June 30, 1999, the deferred tax asset of approximately $2,500,000 and $2,900,000
is offset by an allowance of $2,500,000 and $2,900,000, respectively.
The expiration dates of net operating loss carryforwards are as follows:
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
------------ ------------
DECEMBER 31, JUNE 30,
1998 1999
------------ ------------
<S> <C> <C>
(UNAUDITED)
2009............................................................. $ 125,000 $ 125,000
2010............................................................. 525,000 525,000
2011............................................................. 1,050,000 1,050,000
2012............................................................. 2,800,000 2,800,000
2018............................................................. 1,900,000 1,900,000
2019............................................................. -- 400,000
------------ ------------
$6,400,000 $ 6,800,000
------------ ------------
------------ ------------
</TABLE>
[11] STOCK OPTIONS (PREDECESSOR)
In January 1997, the Company, by action of the Board of Directors and
shareholders, adopted the 1997 Stock Option Plan (the "1997 Plan"). The 1997
Plan provides for the awards of stock options, non-qualified options, stock
appreciation rights, restricted stock, deferred stock, stock purchase rights and
other stock based awards to purchase up to 500,000 shares of Common Stock of the
Company. If shares subject to an option under the 1997 Plan cease to be subject
to such option, or if shares awarded are later forfeited or otherwise terminated
without a payment being made to the participant in the form of stock, such
shares will again be available for future issuance under the 1997 Plan. Awards
under the 1997 Plan may be made to key employees, including officers of and
consultants to the Company, its subsidiaries and affiliates, but may not be
granted to any director unless the director is also an employee of or consultant
to the Company or any subsidiaries or affiliates. The 1997 Plan
F-76
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[11] STOCK OPTIONS (PREDECESSOR) (CONTINUED)
imposes no limit on the number of officers and other key employees to whom
awards may be made. The exercise price of each option is equal to the market
price of the Company's stock on the date of grant.
In January 1997, the Company granted options to purchase 200,000 shares of
Common Stock at $5.00 per share, which was in excess of the fair market value of
the Common Stock on the date of grant, to the Company's President. Such options
are immediately exercisable as to 20,000 shares and become exercisable
cumulatively as to an additional 20,000 shares on January 1st of each year from
1998 through 2006. All other options, when granted, become cumulatively
exercisable as to 50% of shares granted, one year from the date of grant and an
additional 25% on the second and third anniversaries of the date of grant. All
options have a term of ten years from the date of grant. Based on current
vesting requirements, the Company estimates that 100% of the options granted to
date will eventually vest. A summary of activity in the 1997 option plan is as
follows:
<TABLE>
<CAPTION>
PREDECESSOR
----------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- -----------------
<S> <C> <C>
Outstanding, December 31, 1996................................... -- --
Granted.......................................................... 200,000 $ 5.00
Exercised........................................................ -- --
Expired/Forfeited................................................ -- --
--------- -----
Outstanding at December 31, 1997................................. 200,000 $ 5.00
Granted.......................................................... -- --
Exercised........................................................ -- --
Expired/Forfeited................................................ -- --
--------- -----
Outstanding, December 31, 1998................................... 200,000 $ 5.00
Granted.......................................................... -- --
Exercised........................................................ -- --
Expired/Forfeited................................................ -- --
--------- -----
Outstanding, June 30, 1999 (unaudited)........................... 200,000 $ 5.00
--------- -----
--------- -----
Exercisable at December 31, 1998................................. 40,000 $ 5.00
--------- -----
--------- -----
Exercisable at June 30, 1999 (unaudited)......................... 60,000 $ 5.00
--------- -----
--------- -----
</TABLE>
The following table summarizes option information as of December 31, 1998
and 1997, and June 30, 1999:
<TABLE>
<CAPTION>
PREDECESSOR
--------------------------------------------------------------------------------------
OUTSTANDING OPTIONS
---------------------------------------------------------- EXERCISABLE OPTIONS
RANGE OF WEIGHTED AVG --------------------------
EXERCISE REMAINING WEIGHTED AVG WEIGHTED AVG
DATE PRICES SHARES CONTRACTUAL LIFE EXERCISE PRICE SHARES EXERCISE PRICE
- ------------------------------------ ----------- --------- ----------------- --------------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1997................... $ 5.00 200,000 9 yrs. $ 5.00 20,000 $ 5.00
December 31, 1998................... $ 5.00 200,000 8 yrs. $ 5.00 40,000 $ 5.00
June 30, 1999 (unaudited)........... $ 5.00 200,000 7 yrs. $ 5.00 60,000 $ 5.00
</TABLE>
F-77
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[11] STOCK OPTIONS (PREDECESSOR) (CONTINUED)
The Company applies APB Opinion 25 in accounting for its stock option plan.
No compensation has been recognized for the plan in 1997, 1998 or 1999. If the
Company had accounted for the issuance of options pursuant to the fair value
method of SFAS No. 123, the Company would have recorded additional compensation
expense in 1997 of $596,400 and the Company's net loss and net loss per share
would have been:
<TABLE>
<CAPTION>
PREDECESSOR
-------------
DECEMBER 31,
1997
-------------
<S> <C>
Net loss, as reported.......................................................... $ (2,704,411)
-------------
-------------
Net loss, as adjusted.......................................................... $ (3,300,811)
-------------
-------------
Net loss per share, as reported................................................ $ (.90)
-------------
-------------
Net loss per share, as adjusted................................................ $ (1.10)
-------------
-------------
</TABLE>
The per share weighted average fair value of options granted during 1997 was
$2.98, which was estimated on the grant date using the Black-Scholes method. The
following assumptions were made in estimating the fair value:
<TABLE>
<CAPTION>
PREDECESSOR
-----------
1997
-----------
<S> <C>
Dividend yield................................................................... --%
Risk free interest rate.......................................................... 5.50%
Expected life.................................................................... 10 yrs
Expected volatility.............................................................. 37.85%
</TABLE>
[12] WARRANTS (PREDECESSOR)
In February 1997, the Company issued 8% promissory notes in the principal
amount of $550,000, from which it received net proceeds of approximately
$495,000 after deducting a $55,000 commission paid to the placement agent, and,
in connection therewith, issued Series B Common Stock Purchase Warrants to
purchase an aggregate of 1,000,000 shares of Common Stock at $1.00 per share and
Series C Common Stock Purchase Warrants to purchase an aggregate of 500,000
shares of Common Stock at $5.00 per share. The Company valued the Series B
Warrants, using the Black-Scholes method, at $485,000 and valued the Series C
Warrants at $0. Amortization of $335,000 was recorded in 1997 and $150,000 in
1998. Such notes were originally due April 1, 1998.
In conjunction with the Line of Credit obtained from CTG in September 1998,
the Company arranged for the sale of the $550,000 notes and renegotiated the
terms as follows. The Series B Warrants were cancelled and 400,000 of the
500,000 Series C Warrants were sold to a new note holder. The maturity date of
the notes was extended to January 1, 2001, subject to certain prepayment
conditions should the Company raise in excess of $3 million or more in
financings. All interest due under the note was forgiven and the note is now
non-interest bearing. CTG guaranteed the note and
F-78
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[12] WARRANTS (PREDECESSOR) (CONTINUED)
the Company issued 750,000 shares of its Common Stock to the new note holder,
which was valued at $22,500 (See Note 8). A summary of activity for all warrants
is as follows:
<TABLE>
<CAPTION>
PREDECESSOR
----------------------------
WEIGHTED AVG
WARRANTS EXERCISE PRICE
----------- ---------------
<S> <C> <C>
Outstanding, December 31, 1996................................... -- --
Granted.......................................................... 1,500,000 $ 2.33
Exercised........................................................ -- --
Expired/Cancelled................................................ -- --
----------- -----
Outstanding, December 31, 1997................................... 1,500,000 $ 2.33
Granted.......................................................... -- --
Exercised........................................................ -- --
Expired/Cancelled................................................ (1,000,000) $ 1.00
----------- -----
Outstanding, December 31, 1998................................... 500,000 $ 5.00
Granted.......................................................... -- --
Exercised........................................................ -- --
Expired/Cancelled................................................ -- --
----------- -----
Outstanding, June 30, 1999 (unaudited)........................... 500,000 $ 5.00
----------- -----
----------- -----
</TABLE>
The following table summarizes warrant information as of December 31, 1997
and 1998 and June 30, 1999:
<TABLE>
<CAPTION>
PREDECESSOR
--------------------------------------------------------------------------------------
OUTSTANDING WARRANTS
---------------------------------------------------------
WEIGHTED AVG EXERCISABLE WARRANTS
RANGE OF REMAINING ---------------------------
EXERCISE CONTRACTUAL WEIGHTED AVG WEIGHTED AVG
DATE PRICES SHARES LIFE EXERCISE PRICE SHARES EXERCISE PRICE
- ----------------------------------- ----------- ---------- --------------- --------------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1997.................. $ 5.00 500,000 10 yrs $ 5.00 500,000 $ 5.00
$ 1.00 1,000,000 10 yrs $ 1.00 1,000,000 $ 1.00
December 31, 1998.................. $ 5.00 500,000 9 yrs $ 5.00 500,000 $ 5.00
June 30, 1999 (unaudited).......... $ 5.00 500,000 8 yrs $ 5.00 500,000 $ 1.00
</TABLE>
The Company accounted for the issuance of warrants and recorded compensation
pursuant to the fair value method of SFAS No. 123, which produced additional
compensation expense of $485,000, of which $150,000 and $335,000 was amortized
in 1998 and 1997, respectively. See Note 11 for the assumptions made in
estimating the fair value of warrants.
[13] ECONOMIC DEPENDENCY
For the six months ended June 30, 1999, one customer accounted for
$1,785,000, or 22% of total revenues and $803,200 in accounts receivable. For
the six months ended June 30, 1998, one customer accounted for $1,890,000, or
28% of total revenues. No customer accounted for more than 10% of accounts
receivable. For the twelve months ended December 31, 1998, no customer accounted
for more than 10% of total revenues, however, one customer accounted for 12% of
accounts receivable.
F-79
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[13] ECONOMIC DEPENDENCY (CONTINUED)
Revenues from two customers in 1996 and 1997, respectively, amounted to
$1,046,238 and $1,835,382, or 11% and 19%, and $710,097 and $869,195, or 13% and
16% of total revenues, respectively. Accounts receivable for these two customers
was $224,904 and $241,393 at December 31, 1996 and 1997, respectively. At
December 31, 1998, the Company had a backlog of firm orders for data cabling and
wiring services of approximately $2,000,000, of which substantially all is
expected to be completed during 1999. There is no backlog for telephone
services.
[14] TRANSACTIONS WITH RELATED PARTIES (PREDECESSOR)
[A] NOTES PAYABLE--PARENT (CTG) AND TELEVEND
During the years ended December 31, 1995 and 1996, the Company received
loans from SISC. Interest expense on the outstanding notes amounted to $28,743,
$34,033 and $62,160 for the years ended December 31, 1996, 1997 and 1998,
respectively. Such loans accrued interest at 10% per annum. As of December 31,
1996, 1997 and 1998, such loans, exclusive of the Line of Credit received in
September 1998 from CTG, were $466,117, $534,902 and $0, respectively. See Note
8 regarding the Company's Accounts Receivable Line of Credit.
During the years ended December 31, 1996 and 1997, the Company sold prepaid
debit calling cards to Televend, a wholly owned subsidiary of CTG, in the
amounts of $326,237 and $537,837, respectively. Sales to Televend were at a rate
no lower than that provided to the Company's best customers. At December 31,
1996 and 1997, Televend owed to the Company $49,236 and $428,625, respectively.
Such amounts were offset against the Company's payable to CTG at the respective
dates according to a directive issued by CTG. During 1998, Televend purchased an
additional $306,367 of prepaid debit cards from the Company and paid to the
Company $116,085, which resulted in Televend owing to the Company $618,906.
On March 31, 1998, Lewis Schiller ("Schiller"), the Company's former CEO and
CTG's and Televend's former President, CEO and Chairman, and certain other
officers and directors of the Company and CTG, agreed to terminate their
employment agreements and resign as officers and directors of the Company and
CTG, subject to certain terms and conditions, in return for a lump sum payment
by CTG of $4,000,000. As part of this agreement, CTG agreed to transfer certain
subsidiaries of CTG with a zero or negative net worth to Schiller for a nominal
consideration. Televend was one of the subsidiaries transferred to Schiller. At
this point, the Company had a receivable from a company who no longer was an
affiliate. In May 1998, with the consent of CTG, the Company reclassified the
$618,906 Televend owed to the Company against its payable to CTG, leaving a
balance of $84,004 owed to CTG by the Company.
[B] RELATED PARTY TRANSACTIONS--PARENT (PREDECESSOR)
The Company occupies space leased by CTG in New York City. There is no
formal lease agreement between CTG and the Company. Rent is charged by CTG to
the Company which amounted to $23,153, $27,752 and $14,066 for the years ended
December 31, 1996, 1997 and 1998, respectively. For the six months ended June
30, 1998 and 1999, rent charged was $11,664 and $16,813, respectively.
During 1996 and 1997, certain administrative services were performed for the
Company by CTG and its subsidiaries. The fair value of such services,
approximately $18,000 and $4,500, respectively, was charged to general and
administrative expenses and credited to additional paid-in capital since CTG
will not be reimbursed for such charges.
F-80
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[15] FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes the financial instruments by individual
balance sheet account as of December 31, 1998 and 1997 and June 30, 1999. The
fair value of the financial instruments disclosed therein is not necessarily
representative of the amount that could be realized or settled, nor does the
fair value amount consider the tax consequences of realization or settlement.
<TABLE>
<CAPTION>
CARRYING AMOUNT FAIR VALUE
---------------------------------------- ----------------------------------------
DECEMBER 31, JUNE 30, DECEMBER 31, JUNE 30,
-------------------------- ------------ -------------------------- ------------
1997 1998 1999 1997 1998 1999
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
PREDECESSOR SUCCESSOR PREDECESSOR SUCCESSOR
Debt Maturing Within One
Year....................... $ 987,064 $ 250,000 $ 800,000 $ 1,137,064 $ 250,000 $ 800,000
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
Notes payable--Parent &
Affiliates................. $ 1,255,095 $ 3,216,398 $ 4,006,398 $ 1,683,720 $ 3,216,398 $ 4,006,398
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
Long-Term Debt............... $ 123,740 $ 550,000 $ -- $ 123,740 $ 550,000 $ --
------------ ------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------ ------------
</TABLE>
For certain financial instruments, including cash, trade receivables and
payables, and short-term debt, the carrying amount approximated fair value
because of the near term maturities of such obligations. The fair value of the
notes payable to the parent company, and affiliates, is based on current rates
at which the Company could borrow funds with similar remaining maturities and
approximates fair value. The fair value of long-term debt to non-affiliates is
based on current rates at which the Company could borrow funds with similar
terms and maturities.
[16] COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company occupies space at two locations for use in its data cable
installation services business and to support its telephone customer service
center and corporate offices. Both leases contain renewal options and escalation
clauses. Rent expense for the twelve months ended December 31, 1996, 1997 and
1998 was $29,122, $47,345 and $82,712, respectively. Rent expense for the six
months ended June, 1998 and 1999 was $32,183 and $43,279, respectively.
Future minimum rental payments under non-cancelable operating leases having
remaining terms in excess of one year as of December 31, 1998 for each of the
next five years and in the aggregate are:
<TABLE>
<CAPTION>
SUCCESSOR
----------
<S> <C>
1999.............................................................................. $ 103,861
2000.............................................................................. 106,978
2001.............................................................................. 102,823
2002.............................................................................. 95,617
2003.............................................................................. 56,767
----------
Total............................................................................. $ 466,046
----------
----------
</TABLE>
F-81
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[16] COMMITMENTS AND CONTINGENCIES (CONTINUED)
EMPLOYMENT CONTRACT--OFFICER (PREDECESSOR)
In September 1998, the Company revised and entered into a new five-year
employment agreement with its President and Chief Operating Officer (the
"Officer"). The agreement provides for annual compensation, as of September 30,
1998, of $204,000, subject to cost of living increases and bonuses beginning in
1999, provided the Company meets certain earnings goals. From October 1996
through 1998, the Officer deferred $52,336 of salary. During the twelve months
ended December 31, 1998 such amount was charged to expense.
MINIMUM PURCHASE COMMITMENTS
The Company has entered into agreements with local and long-distance
carriers (the "Carriers") from which it purchases telephone service. Such
agreements include minimum purchase obligations which require monthly payments
based on minimum service usage to the Carriers even if the minimum service is
not used. The minimums are stated in both dollar amounts and usage based on
minutes. Actual purchases made under unconditional purchase obligations for the
years ended December 31, 1996, 1997 and 1998 were $2,525,000, $5,583,000 and
$5,140,000, and for the six months ended June 30, 1998 and 1999 were $2,678,000
and $3,287,000, respectively. For the twelve months ended December 31, 1998, the
minimum purchase commitment with one of the Company's telephone carriers,
Frontier Communications, was not met and as a result, the Company was obligated
to record as additional expense $155,700. Estimated minimum future payments due
under the agreements in the aggregate are as follows:
<TABLE>
<CAPTION>
SUCCESSOR
-------------
YEAR ENDED
DECEMBER 31,
-------------
<S> <C>
1999........................................................................... $ 4,531,000
2000........................................................................... 6,171,000
2001........................................................................... 6,171,000
2002........................................................................... 1,671,000
2003........................................................................... 43,000
-------------
$ 18,587,000
-------------
-------------
</TABLE>
[17] LOSS ON IMPAIRED ASSET (PREDECESSOR)
In December 1997, the Company provided for the impairment of its debit card
platform due to the continuing losses and outlook for future profitability. The
platform was purchased in 1996 for $411,560. As of December 31, 1996 and 1997,
the Company had recorded depreciation of $17,301 and $41,412. The Company
accounted for debit card operations as part of Telephone Services. In October
1998, the Company began outsourcing the call processing for its debit card
operation as a means of improving its margins in this business.
F-82
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[18] INITIAL PUBLIC OFFERING (PREDECESSOR)
In 1997, the Company incurred $70,742 of costs in connection with the
anticipated initial public offering with an underwriter, which it deferred until
July 1998 when the offering was terminated. Such costs were charged to income.
In 1996, the Company had incurred $162,282 of costs associated with an
offering, which were expensed in 1997 as a result of the Company's decision to
proceed with an offering through another underwriter.
[19] SEGMENT INFORMATION
The Company's reportable segments are strategic businesses that, although
complimentary, offer different products and services. They are managed
separately because each business requires different technology and marketing
strategies. See Note 1 for descriptive information about the Company's business
segments and Note 13 for information on certain significant customers. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on results of operations before income taxes, interest and unusual items.
The Company derives 100% of its revenue from customers within the domestic
United States.
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------------------------ --------------------------
1996 1997 1998 1998 1999
------------ ------------- ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales:
Telephone Services..................... $ 4,083,343 $ 6,646,784 $ 9,516,110 $ 4,377,886 $ 6,176,528
Telephone Sales to
Related Party........................ 326,237 537,837 306,367 306,367 --
Data Cable Installation Services....... 1,173,155 2,463,580 4,108,210 1,975,405 1,994,758
------------ ------------- ------------- ------------ ------------
Totals............................... $ 5,582,735 $ 9,648,201 $ 13,930,687 $ 6,659,658 $ 8,171,286
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
Operating Loss:
Telephone Services..................... $ (951,893) $ (2,520,288) $ (2,174,694) $ (961,630) $ (957,688)
Data Cable Installation Services....... 5,385 141,953 582,796 546,951 387,616
------------ ------------- ------------- ------------ ------------
Totals............................... $ (946,508) $ (2,378,335) $ (1,591,898) $ (414,679) $ (570,072)
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
<CAPTION>
PREDECESSOR SUCCESSOR
-------------------------------------------------------- ------------
<S> <C> <C> <C> <C> <C>
Assets:
Telephone Services..................... $ 1,430,260 $ 2,303,476 $ 2,921,795 $ 3,058,927 $ 3,547,764
Data Cable Installation Services....... 136,040 343,649 804,471 620,828 1,149,819
Corporate.............................. 88,640 146,357 467,777 278,593 419,818
------------ ------------- ------------- ------------ ------------
Totals............................... $ 1,654,940 $ 2,793,482 $ 4,194,043 $ 3,958,348 $ 5,117,401
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
</TABLE>
F-83
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[19] SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------------------------ --------------------------
1996 1997 1998 1998 1999
------------ ------------- ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Depreciation:
Telephone Services..................... $ 17,222 $ 46,488 $ 30,539 $ 11,187 $ 37,050
Data Cable Installation Services....... -- -- -- -- --
------------ ------------- ------------- ------------ ------------
Totals............................... $ 17,222 $ 46,488 $ 30,539 $ 11,187 $ 37,050
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
Additions to Equipment:
Telephone Services..................... $ 416,466 $ 82,579 $ 71,243 $ 33,192 $ 39,326
Data Cable Installation Services....... -- -- -- -- --
------------ ------------- ------------- ------------ ------------
Totals............................... $ 416,466 $ 82,579 $ 71,243 $ 33,192 $ 39,326
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
Amortization of Intangibles:
Telephone Services..................... $ -- $ 390,050 $ 376,850 $ 154,209 $ 182,191
Data Cable Installation Services....... -- -- -- -- --
------------ ------------- ------------- ------------ ------------
Totals............................... $ -- $ 390,050 $ 376,850 $ 154,209 $ 182,191
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
Acquisition of Customer Base:
Telephone Services..................... $ -- $ -- $ 413,266 $ 413,054 $ --
Data Cable Installation Services....... -- -- -- -- --
------------ ------------- ------------- ------------ ------------
Totals............................... $ -- $ -- $ 413,266 $ 413,054 $ --
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
</TABLE>
[20] NEW AUTHORITATIVE PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) has issued SFAS No 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. SFAS No 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The accounting for changes
in the fair value of a derivative depends on the intended use of the derivative
and how it is designated. For example, gains or loses related to changes in the
fair value of a derivative not designated as a hedging instrument are recognized
in earnings in the period of the change, while certain types of hedges may be
initially reported as a component of other comprehensive income (outside
earnings) until the consummation of the underlying transaction.
SFAS No 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application of SFAS No 133 should be as of the
beginning of a fiscal quarter; on that date, hedging relationships must be
designated anew and documented pursuant to the provisions of SFAS No 133.
Earlier application of all of the provisions of SFAS No 133 is encouraged, but
it is not permitted only as of the beginning of any fiscal quarter. SFAS No 133
is not to be applied retroactively to financial statements of prior periods. The
Company will evaluate the new standard to determine any required new disclosures
or accounting.
F-84
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[21] SUBSEQUENT EVENTS (PREDECESSOR)
LITIGATION
On January 8, 1999, the Company was served with a summons from the State
Supreme Court of New York, County of New York, by Mitel Telecommunications
Systems, Inc., ("Mitel") for a breach of contract claim in the amount of
$1,715,000 relating to cabling and installation services for which the Company
has been paid in full. The Company believes the action is without merit and
filed a motion to dismiss the action based on numerous defenses available to it
and that it continues to perform all requested services under the contract from
Mitel. As of December 31, 1998, the Company believes the maximum exposure
resulting from this claim will be $1,518,971 and has recorded a liability for
such amount, however, it is at least reasonably possible that a change in the
estimate may occur in the near term. See Note 23 [B].
[22] DEFAULTS (PREDECESSOR)
LINE OF CREDIT--CTG
In January 1999, the Company received an additional $250,000 advance from
CTG pursuant to Amendment #1 of the agreement. As of March 12, 1999, the Company
was in default of certain provisions of the agreement relating to $249,724 of
ineligible accounts receivable and $18,327 of interest which remained unpaid to
CTG.
DEMAND NOTES
In January 1999, the Company was obligated to make interest payments for the
period September 1997 through December 31, 1998 amounting to $38,750. Through
February 15, 1999, the Company paid $10,000.
[23] SUBSEQUENT EVENTS AFTER FEBRUARY 16, 1999--UNAUDITED (PREDECESSOR)
[A] CHANGE OF CONTROL--On June 30, 1999, InfoHighway acquired all of the
outstanding capital stock of the Company. The acquisition consideration received
by the stockholders of the Company consists of 390,076 shares of common stock of
InfoHighway valued at $3,510,684 and 152,672 shares of contingent common stock
of InfoHighway. Issuance of the contingent common stock is conditional upon
achievement of certain share price targets of InfoHighway after an initial
public offering expected to be completed in 1999. Additionally, InfoHighway
assumed all outstanding debt of the Company, with the exception of the note
payable to Trans Global in the amount of $1.2 million, which, it is anticipated,
will be exchanged for Series A 10% Convertible Redeemable Preferred Stock of
InfoHighway valued at $1.2 million upon completion of an initial public offering
by InfoHighway. The preferred stock is redeemable by the holder at $1.00 per
share in the event InfoHighway's common stock declines to less than 33% of the
initial public offering price.
[B] BASIS OF PRESENTATION--ARC was acquired by InfoHighway on June 30, 1999.
The acquisition has been accounted for as a purchase utilizing push-down
accounting. This push-down adjustment has also been reflected in stockholder's
equity of ARC. Accordingly, Successor has recorded the assets and liabilities of
the Predecessor at estimated fair values. The excess of estimated fair market
value of net assets acquired over the purchase price was allocated to noncurrent
assets. Because of these adjustments, the accompanying consolidated financial
statements of Successor are not directly comparable to those of Predecessor. The
values assigned by Successor to Predecessor net assets are
F-85
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[23] SUBSEQUENT EVENTS AFTER FEBRUARY 16, 1999--UNAUDITED (PREDECESSOR)
(CONTINUED)
based upon preliminary estimates and may be revised in the future, as additional
information is obtained.
The following table compares Predecessor and Successor June 30, 1999 balance
sheets. The changes reflect the revaluations and changes in stockholders equity
described above.
<TABLE>
<CAPTION>
ADJUSTMENT TO
HISTORICAL FAIR VALUE FAIR VALUE
------------- ------------- -------------
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents......................................... $ 168,776 $ $ 168,776
Accounts receivable, net.......................................... 3,763,919 3,763,919
Costs and estimated earnings in excess of billings on uncompleted
contracts....................................................... 480,950 480,950
Prepaid expenses and other current assets......................... 130,335 -- 130,335
------------- ------------- -------------
Total Current Assets............................................ 4,543,980 -- 4,543,980
Equipment, net.................................................... 127,951 127,951
Deferred financing costs.......................................... 177,664 (177,664) --
Customer list, net................................................ 32,600 (32,600) --
Goodwill.......................................................... 148,965 10,302,180 10,451,145
Deposits.......................................................... 86,241 -- 86,241
------------- ------------- -------------
Total Assets.................................................... $ 5,117,401 $ 10,091,916 $ 15,209,317
------------- ------------- -------------
------------- ------------- -------------
LIABILITIES
Current Liabilities:
Current portion of capitalized lease obligations.................. $ 21,650 $ $ 21,650
Notes payable to related parties.................................. 800,000 800,000
Notes payable--related parties.................................... 2,859,724 2,859,724
Accounts payable.................................................. 5,173,296 5,173,296
Interim billings in excess of costs and estimated profits......... 402,173 402,173
Disputed amounts under contract................................... 1,289,975 -- 1,289,975
------------- ------------- -------------
Total Current Liabilities....................................... 10,546,818 -- 10,546,818
Capitalized leases................................................ 5,141 5,141
Note payable to related parties................................... 1,146,674 -- 1,146,674
------------- ------------- -------------
Total Liabilities............................................... 11,698,633 -- 11,698,633
Capital Deficit:
Common stock...................................................... 95,307 95,307
Additional paid in capital........................................ 620,365 2,795,012 3,415,377
Retained deficit.................................................. (7,296,904) 7,296,904 --
------------- ------------- -------------
Total Capital Deficit........................................... (6,581,232) 10,091,916 3,510,684
------------- ------------- -------------
Total Liabilities and Capital Deficit........................... $ 5,117,401 $ 10,091,916 $ 15,209,317
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
F-86
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[23] SUBSEQUENT EVENTS AFTER FEBRUARY 16, 1999--UNAUDITED (PREDECESSOR)
(CONTINUED)
LINE OF CREDIT--CTG
Pursuant to Amendment #3 to the Note Agreement dated September 18, 1998, as
amended, CTG will be repaid, (i) $750,000 of principal on the earlier of (a)
October 19, 1999, or (b) the receipt by InfoHighway of at least $10,000,000 in
gross proceeds from an initial public offering of debt or equity securities, or
(c) any earlier date on which ARC repays to CTG the then outstanding aggregate
amount of the note; (ii) $450,000 of principal on the earlier of (a) January 31,
2000, or (b) the date, if any, on which CTG delivers the note to ARC for
conversion into ARC or InfoHighway common stock at $8.00 per share, or (c) the
events set forth in clause (i)(c) above. Simultaneously with the execution of
Amendment #3, InfoHighway issued a warrant to purchase 90,000 shares of
InfoHighway common stock at an exercise price of $8.00 per share, subject to
adjustment as provided in the warrant agreement. InfoHighway has guaranteed
payment on behalf of ARC to CTG. In July 1999, ARC paid $50,000 towards accrued
but unpaid interest and agreed to pay the balance of all accrued and unpaid
interest through July 31, 1999 on or before August 5, 1999. As of June 17, 1999
the interest rate was changed from prime plus 2% to 14%.
NOTE PAYABLE--INFOHIGHWAY
In April and June 1999, the Company received $150,000 and $250,000,
respectively, from InfoHighway pursuant to a 12% note payable. The note and
accrued interest are both due on or before October 31, 1999.
[B] LITIGATION
[I] MITEL--As of June 30, 1999, the Company estimates that its maximum
exposure resulting from this claim will be $1,289,975. This represents a
decrease of $228,996 from the estimated December 31, 1998 liability and results
from the Company completing work on other jobs granted to the Company by Mitel
used to offset the contracts under dispute.
[II] On March 26, 1999, the Company was served with a summons from the State
Supreme Court of New York, County of Orange, by an employee of a customer of the
Company located in Thiells, N.Y., for $1,000,000 resulting from a December 1996
fall over wiring claimed to be negligently installed by the Company. The Company
has a liability insurance policy which provides sufficient coverage in the event
the plaintiff's claim is successful. The Company believes the action is without
merit and filed a motion to dismiss the action based on numerous defenses
available to it.
[C] DEFAULTS
[I] LINE OF CREDIT--CTG--Pursuant to Amendments 1, 2 and 3, CTG advanced an
additional $400,000. As of August 1, 1999, the Company was in default of certain
provisions of the agreement relating to approximately $4,300 of rent and $50,000
of interest owed to CTG.
[II] DEMAND NOTES--In June 1999, the Company received a demand for repayment
of the 8% $550,000 Note Payable. The Company is negotiating with the note holder
to amend the terms of the note which may include extending the maturity date and
agreeing to pay interest in the future. Towards that end, the Company accrued
approximately $54,000 as interest expense in June 1999 and paid $10,000 of such
amount in July 1999.
F-87
<PAGE>
ARC NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[23] SUBSEQUENT EVENTS AFTER FEBRUARY 16, 1999--UNAUDITED (PREDECESSOR)
(CONTINUED)
In June 1999, the Company also received a demand for repayment of the two
Demand Notes for $125,000 each. As of June 30, 1999, the Company was in default
related to interest to the two note holders in the amount of $43,750 and paid
$20,000 of such amount in July 1999. The Company is negotiating with the note
holders to amend the terms of the note which may include extending the maturity
date and agreeing to pay additional interest in the future.
[D] INITIAL PUBLIC OFFERING
In the first six months of 1999, the Company deferred $44,565 of legal costs
in anticipation of an initial public offering by InfoHighway in mid 1999.
F-88
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT, AND THE UNDERWRITERS HAVE NOT, AUTHORIZED ANY OTHER PERSON TO PROVIDE
YOU WITH DIFFERENT INFORMATION. IF ANYONE PROVIDES YOU WITH DIFFERENT OR
INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. WE ARE NOT, AND THE
UNDERWRITERS ARE NOT, MAKING AN OFFER TO SELL THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THAT
THE INFORMATION APPEARING IN THIS PROSPECTUS IS ACCURATE AS OF THE DATE ON THE
FRONT COVER OF THIS PROSPECTUS ONLY. OUR BUSINESS, FINANCIAL CONDITION, RESULTS
OF OPERATIONS AND PROSPECTUS MAY HAVE CHANGED SINCE THAT DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 8
Use of Proceeds........................................................... 23
Dividend Policy........................................................... 24
Capitalization............................................................ 25
Dilution.................................................................. 27
Selected Financial Data................................................... 29
Management's Discussion and Analysis of Pro Forma Financial Condition and
Results of Operations................................................... 32
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Combined and Founding Companies............................. 51
Business.................................................................. 65
Management................................................................ 95
Certain Relationships and Related Transactions............................ 107
Principal Stockholders.................................................... 116
Description of Capital Stock.............................................. 120
Shares Eligible for Future Sale........................................... 127
Underwriting.............................................................. 131
Legal Matters............................................................. 134
Experts................................................................... 134
Where You Can Find More Information....................................... 134
Index to Financial Statements............................................. F-1
</TABLE>
UNTIL , 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, 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.
1,600,000 SHARES
INFOHIGHWAY
COMMUNICATIONS
CORPORATION
COMMON STOCK
---------------------
PROSPECTUS
---------------------
WEATHERLY
SECURITIES
CORPORATION
WESTPORT
RESOURCES
INVESTMENT
SERVICES, INC.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 3. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the expenses (other than underwriting
discounts and commissions) in connection with the offering described in this
Registration Statement, all of which shall be paid by us. All of such amounts
(except the SEC Registration Fee, the NASD Filing Fee and the New York Stock
Exchange Listing Fee) are estimated.
<TABLE>
<S> <C>
SEC Registration Fee.............................................. $ 5,627
NASD Filing Fee................................................... 6,000
American Stock Exchange Listing Fee............................... 35,000
Printing and Mailing Costs........................................ 100,000
Legal Fees and Expenses........................................... 400,000
Accounting Fees and Expenses...................................... 200,000
Transfer Agent and Registrar Fees and Expenses.................... 10,000
Miscellaneous..................................................... 67,373
---------
Total......................................................... $ 824,000
---------
---------
</TABLE>
- ------------------------
* To be provided by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the Delaware General Corporation Law permits a corporation to
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative or investigative, by reason of the fact that he
is or was a director, officer, employee or agent of the corporation or is or was
serving at the request of the corporation as a director, officer, employee or
agent of another corporation, partnership, joint venture, trust or other
enterprise against expenses, judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action. In an
action brought to obtain a judgment in the corporation's favor, whether by the
corporation itself or derivatively by a stockholder, the corporation may only
indemnify for expenses, including attorney's fees, actually and reasonably
incurred in connection with the defense or settlement of such action, and the
corporation may not indemnify for amounts paid in satisfaction of a judgment or
in settlement of the claim. In any such action, no indemnification may be paid
in respect of any claim, issue or matter as to which such person shall have been
adjudged liable to the corporation except as otherwise approved by the Delaware
Court of Chancery or the court in which the claim was brought. In any other type
of proceeding, the indemnification may extend to judgments, fines and amounts
paid in settlement, actually and reasonably incurred in connection with such
other proceeding, as well as to expenses.
The statute does not permit indemnification unless the person seeking
indemnification has acted in good faith and in a manner be reasonably believed
to be in, or not opposed to, the best interests of the corporation and, in the
case of criminal actions or proceedings, the person had no reasonable cause to
believe his conduct was unlawful. The statute contains additional limitations
applicable to criminal actions and to actions brought by or in the name of the
corporation. The determination as to whether a person seeking indemnification
has met the required standard of conduct is to be made (1) by a majority vote of
a quorum of disinterested members of the board of directors, (2) by independent
legal counsel in a written opinion, if such a quorum does not exist or if the
disinterested directors so direct, or (3) by the stockholders.
II-1
<PAGE>
Our Certificate of Incorporation and Bylaws require us to indemnify our
directors to the fullest extent permitted under Delaware law. Pursuant to
employment agreements entered into by us with our executive officers and certain
other key employees, we must indemnify such officers and employees in the same
manner and to the same extent that we are required to indemnify our directors
under our Bylaws. The Certificate of Incorporation limits the personal liability
of a director to us or our stockholders to damages for breach of the director's
fiduciary duty.
We maintain officers' and directors' indemnity insurance against expenses of
defending claims or payment of amounts arising out of good-faith conduct
believed by the officer or director to be in or not opposed to our best
interest.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since our inception, we have issued and sold the following unregistered
securities:
- - In March and in April 1999, we underwent successive recapitalizations which
included both a forward and a reverse stock split. As adjusted for the
recapitalization, we have issued and sold an aggregate of 939,000 shares of
common stock to our founders, directors and consultants at a purchase price
of $.0001 per share. In addition in June 1999, we issued certain contingent
common stock issue rights to certain of these shareholders. Sales of our
common stock and related issue rights were as follows:
<TABLE>
<CAPTION>
NUMBER CONTINGENT
OF COMMON STOCK
SHAREHOLDER SHARES ISSUE RIGHTS
- -------------------------------------------------------------------------- ------------ --------------
<S> <C> <C>
Benchmark Equity Group.................................................... 579,886 158,363
Emerging Ventures, L.L.C.................................................. 97,260 38,067
Pound Capital............................................................. 52,371 20,497
Christopher H. Efird...................................................... 115,429 67,243
Constantin J. Trezos...................................................... 40,614 23,660
Jeffrey W. Tomz........................................................... 23,514 13,699
Gary Panno................................................................ 14,963 8,716
Don Moorehead............................................................. 14,963 8,716
------------ -------
Total Common Shares................................................... 939,000 338,961
------------ -------
------------ -------
</TABLE>
The contingent common stock issue rights entitle the holder to receive
shares of our common stock based upon its market performance beginning 90
days after the closing of this offering. Approximately one-half of the
shares are issuable when the common stock reaches a 10-day average of $16.00
per share. The remaining one-half are issuable when the common stock reaches
a 10-day average of $21.00 per share. The rights expire after three years.
- - From April through June 1999, we issued a total of 573,333 warrants to
purchase common stock in connection with certain bridge loans to accredited
investors which will be repaid out of the proceeds of the offering. The
warrants are exercisable at $8.00 per share for a period of five years after
their issuance.
- - We acquired ARC in on June 30, 1999. We will acquire InfoHighway
International and AXCES simultaneously, with and as a condition of this
offering. In connection with the acquisition, we
II-2
<PAGE>
issued the shares of common stock, contingent common stock issue rights and
preferred stock to accredited investors and a limited number of unaccredited
investors:
<TABLE>
<CAPTION>
CONTINGENT COMMON
COMMON STOCK STOCK ISSUE RIGHTS(1) PREFERRED STOCK
--------------------- ---------------------- ---------------------
VALUE OF VALUE OF VALUE OF
ACQUISITION SHARES SHARES SHARES SHARES SHARES SHARES
- ---------------------------- --------- ---------- --------- ----------- --------- ----------
AXCES....................... 700,000 $6,300,000 -- $ -- 60,000(2) $9,000,000
<S> <C> <C> <C> <C> <C> <C>
InfoHighway International... 958,166 8,623,494 235,878 -- -- --
ARC(3)...................... 390,076 3,510,684 152,672 -- 1,206,673(4) 1,206,673
--------- ---------- --------- ----- --------- ----------
Total....................... 2,048,242 $18,434,178 388,550 $ -- 1,266,673 $10,206,673
--------- ---------- --------- ----- --------- ----------
--------- ---------- --------- ----- --------- ----------
- ------------------------
</TABLE>
(1) The contingent common stock issue rights entitle the holder to receive
shares of our common stock based upon its market performance beginning 90
days after the closing of this offering. Approximately one-half of the
shares are issuable when the common stock reaches a 10-day average of
$16.00 per share. The remaining one-half are issuable when the common
stock reaches a 10-day average of $21.00 per share. The rights expire
after three years.
(2) Shares of Series B 8% Cumulative Convertible Preferred Stock. Each share
of the series B preferred stock is convertible into 10 shares of common
stock at any time at the option of the holder. If our common stock trades
for an average of $20.00 per share or more for a period of 10 consecutive
days, we may force a conversion of the series B preferred stock into
common stock.
(3) We also issued convertible promissory notes for a total of $1.65 million
to a former debt holder of ARC. The notes are convertible at $8.00 per
share for a total of 206,250. The holder of this note also received
warrants to purchase a total of 90,000 shares of common stock at an
exercise price of $8.00 per share. In addition, certain former warrant
holders of ARC received warrants to purchase a total of 20,464 shares of
common stock at an exercise price of $122.17 per share.
(4) Shares of Series A 10% Convertible Preferred Stock. The series A
preferred stock is convertible into common stock at the option of the
holder at any time after 90 days from the closing of this offering or
earlier with the consent of both us and the representative of the
underwriters with respect to this offering. The number of shares of
common stock issuable upon conversion of the series A preferred is
determined by multiplying the number of shares being converted by the
conversion rate as defined in the statement of designation. The
conversion rate is calculated by dividing $1.00 by the lesser of the
offering price or the five-day average closing price ending on the
trading day prior to any such conversion date.
- - In connection with this offering, the underwriters will receive warrants to
purchase a total of 160,000 shares of common stock of an exercise price of
$16.50 per share. If the underwriters exercise their over-allotment option
in full, the amount of shares of common stock issuable will be increased to
184,000.
- - From February until June 1999, we issued warrants to purchase a total of
36,185 shares of common stock at $5.71 per share to John Vanderhider, our
former Chief Financial Officer, for consulting work performed prior to his
election as an officer. In April 1999, we also issued 300,000 options to
purchase common stock to each of Joseph Gregori and Peter Parrinello, our
Chief Executive Officer and President, respectively, at an exercise price of
$8.00 per share. In addition we intend to issue options to purchase an
additional 900,000 shares of common stock to these and other officers,
directors and employees upon the closing of this offering at exercise prices
of $5.00 and $10.00 per share.
II-3
<PAGE>
The sales of the securities described in paragraphs (1) through (5) were
deemed to be exempt from registration under the Securities Act in reliance upon
Section 4(2) of the Securities Act, or Regulation D promulgated thereunder, as
transactions by an issuer not involving a public offering. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates and other instruments issued in such transactions. All recipients
either receive adequate information about InfoHighway or had access, through
employment or other relationships, to such information.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -----------------------------------------------------------------------------------------------
<C> <C> <S>
*1.1 -- Form of Underwriting Agreement dated , 1999 by and between InfoHighway (f/k/a
OmniLynx and Gemini II) and Weatherly Securities Corporation.
+2.1 -- Agreement and Plan of Reorganization dated as of June 30, 1999 by and among InfoHighway, ARC
Acquisition, Inc., ARC Networks, Inc. and its Stockholders Named Therein.
+2.2 -- Agreement and Plan of Reorganization dated as of June 24, 1999 by and among InfoHighway, AXCES
Acquisition, Inc, AXCES, Inc., MTM Holdings Corporation and its Shareholders Named Therein.
+2.3 -- Agreement and Plan of Reorganization dated as of June 30, 1999 by and among InfoHighway, Info
Acquisition,Inc., InfoHighway International, Inc. and its Stockholders Named Therein.
+3.1 -- Amended and Restated Certificate of Incorporation of InfoHighway, including the Designation,
Preferences, Rights and Limitations of Series A 10% Convertible Preferred Stock as filed on
June 24, 1999.
+3.2 -- Form of Certificate of Designation, Preferences, Rights and Limitations of Series B 8%
Cumulative Convertible Preferred Stock.
+3.3 -- Amended and Restated Bylaws of InfoHighway.
+3.4 -- Amendment to the Certificate of Incorporation of InfoHighway as filed on September 3, 1999.
*4.1 -- Form of Certificate representing common stock.
*4.2 -- Form of Certificate representing Series A 10% Convertible Preferred Stock.
*4.3 -- Form of Certificate representing Series B 8% Cumulative Convertible Preferred Stock.
*4.4 -- Form of Underwriters' Warrant Agreement.
+4.5 -- Warrant issued to John Vanderhider.
+4.6 -- Form of 13% Promissory Note issued by InfoHighway during March through June 1999 in connection
with the Bridge Loans.
+4.7 -- Form of Agreement of Purchase and Sale entered into during March through June 1999 in
connection with the Bridge Loans.
+4.8 -- Form of Warrants to Purchase Common Stock of InfoHighway entered into during March through June
1999 in connection with the Bridge Loans.
+4.9 -- Form of Registration Rights Agreement entered into during March through June 1999 in connection
with the Bridge Loans.
</TABLE>
II-4
<PAGE>
<TABLE>
<C> <C> <S>
+4.10 -- Form of Registration Rights Agreements entered into between InfoHighway and each of the
shareholders of AXCES, ARC and InfoHighway International in connection with the acquisitions.
*4.11 -- Registration Rights Agreement to be entered into between InfoHighway and the Representative of
the Underwriter concerning the shares underlying the Underwriter Representative Warrants.
+4.12 -- Agreement by and among Trans Global Services, Inc., ARC Networks, Inc., Consolidated Technology
Group Ltd., Technology Acquisitions Ltd. and InfoHighway dated March 23, 1999.
+4.13 -- Registration Rights Agreement between InfoHighway and Consolidated Technology Group, Ltd. dated
May 19, 1999.
+4.14 -- Form of Certificate of Contingent Interest in Common Stock.
+4.15 -- Secured Promissory Note issued by ARC Networks, Inc. and A.R.C. Networks, Inc. to Consolidated
Technology Group Ltd. dated May 19, 1999.
+4.16 -- Warrant to Purchase Common Stock of InfoHighway issued to Consolidated Technology Group, Ltd.
dated May 19, 1999.
+4.17 -- Form of Series C Common Stock Purchase Warrants of ARC Networks, Inc. issued in February 1997.
*5.1 -- Opinion of Porter & Hedges, L.L.P.
+10.1 -- 1999 Stock Incentive Plan
*10.2 -- Form of Indemnification Agreement between InfoHighway and each of its directors and officers.
+10.3 -- Employment Agreement by and between InfoHighway and Joseph A. Gregori dated June 30, 1999.
+10.4 -- Employment Agreement by and between InfoHighway and Peter Parrinello dated June 30, 1999.
+10.5 -- Employment Agreement by and between InfoHighway and Tony Howlett dated June 30, 1999.
+10.6 -- Employment Agreement by and between InfoHighway and Glenn Kramer dated June 30, 1999.
+10.7 -- Employment Agreement by and between AXCES and Michael Avignon dated as of June 24, 1999.
+10.8 -- Employment Agreement by and between AXCES and Timothy Till dated as of June 24, 1999.
+10.9 -- Consulting Agreement by and between AXCES and MTM Holdings dated as of June 24, 1999.
+10.10 -- Consulting Agreement by and between InfoHighway and Benchmark dated as of September 1, 1998, as
amended on June 1, 1999, and June 24, 1999.
+10.11 -- M&A Letter Agreement by and between InfoHighway and Benchmark dated September 1, 1998, as
amended on June 1, 1999, and June 24, 1999.
+10.12 -- Agreement of Lease between FGP Islandia, Inc. and ARC Networks, Inc. dated June 1998.
+10.13 -- Employment Agreement by and between InfoHighway and Charles N. Garber dated July 19, 1999.
+10.14 -- Employment Agreement by and between InfoHighway and Peter Karoczkai dated July 7, 1999.
</TABLE>
II-5
<PAGE>
<TABLE>
<C> <C> <S>
+10.15 -- Agreement for Billing and Collection Services between AXCES, Inc., Ameritech Long Distance
Industry Services, Ameritech Illinois, Ameritech Indiana, Ameritech Michigan and Wisconsin
Bell, Inc., d/b/a Ameritech Wisconsin effective June 26, 1996.
+10.16 -- Wholesale Service Agreement by and between Frontier Communications of the West, Inc. and AXCES,
Inc. executed September 7, 1999.
+10.17 -- Telecommunications Services Agreement by and between Coastal Telephone Services Limited Company
and AXCES, Inc. dated September 7, 1995.
+10.18 -- Agreement for the Provision of Billing and Collection Services between Southwestern Bell
Telephone Company and AXCES, Inc. dated November 21, 1997.
+10.19 -- Resale Agreement by and between Teleport Communications Group, Inc. and ARC Networks, Inc.
dated March 18, 1993.
+10.20 -- Switchless Wholesale Service Agreement between Frontier Communications of the West, Inc. and
ARC Networks, Inc. executed January 22, 1997, as amended August 14, 1997, October 21, 1997,
November 25, 1997, February 26, 1998, April 8, 1998, June 8, 1998 and June 18, 1998.
+10.21 -- Form of Incentive Stock Option Agreement for Employees under 1999 Stock Incentive Plan.
+10.22 -- Form of Nonstatutory Stock Option for Employees under 1999 Stock Incentive Plan.
+10.23 -- Form of Nonstatutory Stock Option for Non-Employee Director under 1999 Stock Incentive Plan.
+10.24 -- Amendment No. 3 to Loan Agreement dated September 18, 1998, as amended by and among
Consolidated Technology Group Ltd, ARC Networks, Inc., and A.R.C. Networks, Inc. dated as of
May 19, 1999.
+21.1 -- Subsidiaries of InfoHighway.
**23.1 -- Consent of BDO Seidman, LLP.
**23.2 -- Consent of Pannell Kerr Forster of Texas, P.C.
**23.3 -- Consent of KPMG LLP.
**23.4 -- Consent of Moore Stephens, P.C.
*23.5 -- Consent of Porter & Hedges, L.L.P. (contained in Exhibit 5.1)
+23.6 -- Consent of Harry Bennett as nominee for director
+23.7 -- Consent of Glenn Kramer as nominee for director.
+23.8 -- Consent of Michael Macaluso as nominee for director.
+23.9 -- Consent of Peter Parrinello as nominee for director.
*23.10 -- Consent of [Weatherly nominee] as nominee for director.
+24.1 -- Power of Attorney (included on the signature page of this Registration Statement).
+27.1 -- Financial Data Schedule.
</TABLE>
- ------------------------
* To be filed by amendment.
** Filed herewith.
+ Previously filed.
(b) Financial Statement Schedules. All schedules are omitted because they
are not applicable or because the required information is contained in the
Financial Statements or Notes thereto.
II-6
<PAGE>
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes to provide to the underwriters,
at the closing specified in the underwriting agreement, certificates
representing the shares of common stock offered hereby in such denominations and
registered in such names as required by the underwriters to permit prompt
delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned registrant hereby undertakes that:
(1) For the purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as a
part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed
to be part of this registration statement as of the time it was declared
effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-7
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment no. 3 to this registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Houston, State of Texas, on September 22, 1999.
INFOHIGHWAY COMMUNICATIONS CORPORATION
By: /s/ JOSEPH A. GREGORI
-----------------------------------------
Joseph A. Gregori,
CHIEF EXECUTIVE OFFICER AND DIRECTOR
Pursuant to the requirements of the Securities Act of 1933, this amendment
no. 3 to this registration statement has been signed by the following persons in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY IN WHICH SIGNED DATE
- --------------------------------------------- ------------------------------------------ ----------------------
<C> <S> <C>
/s/ JOSEPH A. GREGORI
------------------------------------ Chief Executive Officer (Principal September 22, 1999
Joseph A. Gregori Executive Officer), and Director
*
------------------------------------ Chief Financial Officer (Principal September 22, 1999
Charles Garber Financial and Accounting Officer)
*
------------------------------------ Director September 22, 1999
Christopher H. Efird
</TABLE>
<TABLE>
<S> <C>
*By: /s/ JOSEPH A. GREGORI
-------------------------
Joseph A. Gregori
CHIEF EXECUTIVE OFFICER
AND DIRECTOR AND AS
ATTORNEY-IN-FACT
</TABLE>
II-8
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
InfoHighway Communications Corporation
Houston, Texas
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement on Amendment No. 3 to Form S-1 No. 333-82151 of our
report dated May 3, 1999, relating to the financial statements of InfoHighway
Communications Corporation, formerly known as OmniLynx Communications
Corporation, which is contained in the Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Houston, Texas
September 22, 1999
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the inclusion in the registration statement of InfoHighway
Communications Corporation, Amendment No. 3 to Form S-1, of our report dated
April 13, 1999, on our examination of the December 31, 1998 financial
statements of AXCES, Inc. We also consent to the reference to our firm under
the caption "Experts".
/s/ Pannell Kerr Forster of Texas, P.C.
PANNELL KERR FORSTER OF TEXAS, P.C.
Houston, Texas
September 22, 1999
<PAGE>
Exhibit 23.3
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
InfoHighway International, Inc.
We consent to the use of our report dated April 9, 1999, related to the
financial statements of InfoHighway International, Inc. as of December 31,
1997 and 1998, and for each of the years in the three year period ended
December 31, 1998, included herein and the reference to our firm under the
heading "Experts" in the Prospectus.
/s/ KPMG LLP
Houston, Texas
September 22, 1999
<PAGE>
Exhibit 23.4
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the use in this Registration Statement on Form S-1 of our
report dated February 16, 1999, accompanying the financial statements of ARC
Networks, Inc., which report includes an explanatory paragraph relating to
the ability of ARC Networks, Inc. to continue as a going concern, and to the
use of our name, and the statements with respect to us as appearing under the
heading "Experts" in the Prospectus.
/s/ Moore Stephens, P.C.
----------------------------
MOORE STEPHENS, P.C.
Certified Public Accountants
Cranford, New Jersey
September 22, 1999
