<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
Current Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
August 1, 2000
Date of Report (Date of earliest event reported)
CHOICE ONE COMMUNICATIONS INC.
--------------------------
(Exact name of registrant as specified in its charter)
Delaware 0-29279 16-1550742
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(State of other jurisdiction of (Commission (IRS Employer
incorporation or organization) File No.) Identification No.)
100 Chestnut Street, Suite 700, Rochester, New York 14604
-------------------------------------------------
(Address of principal executive offices and zip code)
(716) 246-4231
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(Registrant's telephone number, including area code)
<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
Acquisition of US Xchange, Inc.
On August 1, 2000, Choice One Communications Inc. (the "Company")
consummated the merger pursuant to the Agreement and Plan of Merger (the "Merger
Agreement") (which was filed as Exhibit 99.2 to the Company's 8-K/A dated May
14, 2000) with US Xchange, Inc., a Delaware corporation ("US Xchange"), and the
stockholder of US Xchange, pursuant to which US Xchange merged with and into
Barter Acquisition Corporation, a wholly owned subsidiary of the Company (the
"Merger").
The Company issued approximately 6.74 million shares of its common stock
and paid approximately $303 million in net cash pursuant to the merger. The
Company granted registration rights to the holder of the shares of its common
stock issued in the Merger for the registration of such shares under the
Securities Act of 1933. The shareholder of US Xchange also received the right
to designate a representative to the Company's Board of Directors so long as he
continues to own at least 4.5 million shares of the Company's common stock,
pursuant to an amendment to the existing transaction agreement among the Company
and its principal management and institutional investors.
To finance the Merger, the Company entered into a $350 million Second
Amended and Restated Credit Agreement with First Union Investors Inc., as
Administrative Agent, General Electric Capital Corporation, as Syndication
Agent, and Morgan Stanley Senior Funding, Inc., as Documentation Agent,
approximately $145 million of which was used for the acquisition. In addition,
the Company issued to Morgan Stanley Dean Witter Capital Partners IV, L.P. and
related limited partnerships 200,000 shares of Series A Senior Cumulative
Preferred Stock, along with warrants to purchase 1,747,454 shares of common
stock of the Company at an exercise price of $.01 per share. The Company and
its principal management and institutional investors entered into an amendment
to their existing registration rights agreement in connection with the preferred
stock financing.
In addition, the Company entered into a $180 million Bridge Financing
Agreement with Morgan Stanley Senior Funding Inc. to finance additional market
expansion. As of August 1, 2000, the Company had not borrowed any money under
that facility.
Attached as Exhibit 99.1 is a press release issued by the Company dated
August 1, 2000 with respect to the Merger and related financings, which is
incorporated by reference herein.
Certain statements contained in this Current Report on Form 8-K are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, and the Company intends that such forward-looking
statements be subject to the safe harbors created thereby. The words
"believes", "expects", "estimates", "anticipates", "will be" and "plans" and
similar words or expressions identify forward-looking statements made by or on
behalf of the Company. These forward-looking statements are subject to many
uncertainties and factors that may cause the actual results of the Company to be
materially different from any future results expressed or implied by such
forward-looking statements. Examples of such uncertainties and factors include,
but are not limited to, availability of financing and regulatory approvals, the
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number of potential customers in a target market, the existence of strategic
alliances or relationships, technological, regulatory or other developments in
the Company's business, changes in the competitive climate in which the Company
operates and the emergence of future opportunities, all of which could cause
actual results and experiences of the Company to differ materially from
anticipated results and expectations expressed in the forward-looking statements
contained herein. These and other applicable risks are summarized under the
caption "Risk Factors" and elsewhere in the Company's Registration Statement on
Form S-1, Registration No. 333-91321, filed with the Securities and Exchange
Commission and declared effective on February 16, 2000.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
Page
----
(a) Unaudited financial statements of US Xchange, Inc. for the three 14
months ended March 31, 2000 and the Audited Financial Statements
of US Xchange, Inc. for each of the three years in the period ended
December 31, 1999
(b) Pro Forma Financial Information for the year ended December 31, 1999 5
and as of and for the six (6) months ended June 30, 2000
(c) Exhibits.
2.1 Agreement and Plan of Merger, dated as of May 14, 2000, among the
Company, US Xchange, Inc. and Barter Acquisition Corporation,
incorporated by reference to Exhibit 99.2 to the Company's Form 8-K/A
filed May 16, 2000.
3.1 Amended and Restated Certificate of Incorporation of the Company
incorporated by reference to Exhibit 3.1 of the Company's
Registration Statement on Form S-1, (Commission file number 333-
91321) and the Certificate of Designations for the Choice One
Communications Inc. Series A Senior Cumulative Preferred Stock
incorporated by reference to Exhibit 3.1 to the Company's Form 8-K
filed August 11, 2000.
10.1 Amendment No. 4 to the Registration Rights Agreement dated as of
August 1, 2000 to the Registration Rights Agreement dated as of July
8, 1998 among Choice One Communications Inc., the Investor Holders
and the Management Holders incorporated by reference to Exhibit 10.1
to the Company's Form 8-K filed August 11, 2000.
10.2 Amendment No. 7 to the Transaction Agreement dated as of August 1,
2000 to the Transaction Agreement dated as of July 8, 1998 among
Choice One Communications, L.L.C. and holders of Investor Equity and
Management Equity incorporated by reference to Exhibit 10.2 to the
company's Form 8-K filed August 11, 2000.
10.3 Bridge Financing Agreement dated as of August 1, 2000 among Choice
One Communications Inc., the lender parties hereto and Morgan Stanley
Senior Funding Inc., as Administrative Agent, Morgan Stanley Senior
Funding, Inc., as Arranger and Book Runner incorporated by reference
to Exhibit 10.3 to the Company's Form 8-K filed August 11, 2000.
10.4 Warrant No. 1 to purchase 1,570,907 shares of Common Stock of Choice
One Communications Inc. incorporated by reference to Exhibit 10.4 to
the Company's Form 8-K filed August 11, 2000.
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10.5 Warrant No. 2 to Purchase 133,670 shares of Common Stock of Choice
One Communications Inc. incorporated by reference to Exhibit 10.5 to
the Company's Form 8-K filed August 11, 2000.
10.6 Warrant No. 3 to Purchase 42,877 shares of Common Stock of Choice One
Communications Inc. incorporated by reference to Exhibit 10.6 to the
Company's Form 8-K filed August 11, 2000.
10.7 Securities Purchase Agreement dated as of August 1, 2000 among Morgan
Stanley Dean Witter Capital Partners IV, L.P., MSDW IV 892 Investors,
L.P., Morgan Stanley Dean Witter Capital Investors IV, and Choice One
Communications Inc. relating to the purchase and sale of securities
of Choice One Communications Inc. incorporated by reference to
Exhibit 10.7 to the company's Form 8-K filed August 11, 2000.
10.8 Second Amended and Restated Credit Agreement, dated as of August 1,
2000, by and among Choice One Communications Inc., a Delaware
corporation, as Guarantor, its Subsidiaries listed on the signature
pages hereto and any additional Subsidiaries joined hereto, as
Borrowers, the Lenders who are or may become a party to this
Agreement, First Union Investors Inc., as Administrative Agent,
General Electric Capital Corporation, as Syndication Agent and Morgan
Stanley Senior Funding, Inc., as Documentation Agent incorporated by
reference to Exhibit 10.8 to the Company's Form 8-K filed August 11,
2000.
10.9 Fiber Optic Agreement and Grant of IRU dated August 1, 2000, by and
between Choice One Communications Inc., and RVP Fiber Company, L.L.C.
incorporated by reference to Exhibit 10.9 to the Company's Form 8-K
filed August 11, 2000.
10.10 Form of Executive Employment Agreement between former executives of
US Xchange, Inc. and Choice One Communications Inc. incorporated by
reference to Exhibit 10.6 to the Company's Form 8-K filed August 11,
2000.
23.1 Consent of BDO Seidman, LLP, independent auditors.
99.1 Press Release, dated August 1, 2000, announcing the Company's
execution of a definitive agreement to acquire US Xchange
incorporated by reference to Exhibit 99.1 to the Company's Form 8-K
filed August 11, 2000.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
CHOICE ONE COMMUNICATIONS INC.
/s/ Ajay Sabherwal
Dated: September 15, 2000 By:_________________________________________
Name: Ajay Sabherwal
Title: Executive Vice President - Finance
Chief Financial Officer
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UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
The following unaudited pro forma condensed combined financial statements
combine the historical consolidated balance sheets and statements of operations
of the Company with those of US Xchange, including respective subsidiaries after
giving effect to the merger. The unaudited pro forma condensed combined balance
sheet as of June 30, 2000, gives effect to the merger as if it occurred on June
30, 2000. The unaudited pro forma condensed combined statement of operations for
the year ended December 31, 1999 gives effect to the merger with US Xchange as
well as the acquisition of Atlantic Connections, L.L.C. as if they occurred on
January 1, 1999. The unaudited pro forma condensed combined statement of
operations for the six months ended June 30, 2000 gives effect to the merger
with US Xchange as if it occurred on January 1, 1999. These statements are
prepared based on the merger being accounted for as a purchase and on the notes
to these unaudited pro forma condensed combined financial statements. In
November 1999, the Company acquired Atlantic Connections, L.L.C. The transaction
was accounted for as a purchase and is included in the Company's Consolidated
Statements of Operations since the date of acquisition. In connection with the
acquisition of Atlantic Connections, additional purchase price was payable if
specified performance criteria were met following that acquisition. Such
additional purchase price is to be paid in September 2000 in the amount of $1.5
million. The unaudited pro forma statements give effect to this additional
purchase price.
The following unaudited pro forma financial information has been prepared
based upon, and should be read in conjunction with, the audited historical
consolidated financial statements of the Company, US Xchange and Atlantic
Connections, L.L.C. The unaudited pro forma condensed combined financial
statements are not necessarily indicative of the financial position or operating
results that would have occurred had the merger been complete on June 30, 2000
or at the beginning of the period for which the merger is being given effect,
nor are they necessarily indicative of any future financial position or
operating results.
US Xchange transferred all of the fiber business to RVP Fiber Company,
L.L.C., an entity controlled by US Xchange's sole stockholder prior to the
consummation of the merger; provided, however, such entity will grant the
Company indefeasible rights of use (IRU) with respect to 8 fiber strands on each
route (except routes where 8 fiber strands exceed 50% of US Xchange's capacity,
in which case the Company will receive 4 strands). The pro forma condensed
combined statement of operations and the pro forma condensed combined balance
sheet reflect the transfer of the fiber business for the six months ended June
30, 2000. The operations of the fiber business for the year ended December 31,
1999 were not significant.
The unaudited pro forma statements are based upon currently available
information and upon certain assumptions that the Company believes are
reasonable under the circumstances.
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<PAGE>
Unaudited Pro Forma Condensed Combined Balance Sheet
(Amounts in thousands)
<TABLE>
<CAPTION>
June 30, 2000
---------------------------------------------------------------------
Choice One US Xchange Pro Forma Pro Forma
Historical Historical Adjustments Combined
---------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Assets:
Current assets:
Cash and cash equivalents...................... $ 8,095 $ 277 $ 38,117 /(1)/ $ 46,489
Restricted investments......................... -- 29,173 (29,173)/(1)/ --
Accounts receivable, net....................... 8,024 8,022 (74)/(2)/ 15,972
Note receivable................................ 5,357 -- (5,357)/(3)/ --
Prepaid expenses and other current assets...... 1,616 1,298 -- 2,914
--------- --------- ----------- ---------
Total current assets........................ 23,092 38,770 3,513 65,375
--------- --------- ----------- ---------
Property, plant and equipment, net............... 120,037 135,779 (39,120)/(2)/ 216,696
--------- --------- ----------- ---------
Total....................................... 120,037 135,779 (39,120) 216,696
--------- --------- ----------- ---------
Other assets:
Other assets................................... 21,243 14,667 383,342 /(3)/ 419,252
Restricted investments......................... -- 8,944 (8,944)/(1)/ --
--------- --------- ----------- ---------
Total other assets.......................... 21,243 23,611 374,398 416,752
--------- --------- ----------- ---------
Total Assets................................ $ 164,372 $ 198,160 $ 338,791 $ 701,323
========= ========= =========== =========
Liabilities and Stockholders' Equity:
Current liabilities:
Current portion of long-term debt.............. $ 2,430 $ 800 $ (800)/(4)/ $ 2,430
Note payable................................... -- 5,318 (5,318)/(4)/ --
Senior secured facility........................ -- 50,000 (50,000)/(4)/ --
Accounts payable............................... 939 10,451 (203)/(2)/ 11,187
Accrued expenses............................... 15,704 18,995 (375)/(5)/ 34,324
--------- --------- ----------- ---------
Total current liabilities................... 19,073 85,564 (56,696) 47,941
--------- --------- ----------- ---------
Long-term liabilities:........................... 1,655 243,530 (104,530)/(6)/ 140,655
--------- --------- ----------- ---------
Stockholders' Equity:
Preferred stock................................ -- -- 2 /(7)/ 2
Common stock and additional paid
in capital.................................. 343,827 60,000 323,834 /(7)/ 727,661
Deferred compensation.......................... (55,961) -- (14,753)/(7)/ (70,714)
Accumulated deficit............................ (144,222) (190,934) 190,934 /(7)/ (144,222)
--------- --------- ----------- ---------
Total stockholders' equity.................. 143,644 (130,934) 500,017 512,727
--------- --------- ----------- ---------
Total Liabilities and Stockholders' Equity....... $ 164,372 $ 198,160 $ 338,791 $ 701,323
========= ========= =========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
Notes to the Unaudited Pro Forma Condensed Combined Balance Sheet
1. Reflects the release of the restrictions on the current and non-
current restricted investments of US Xchange of $38.1 million.
2. Reflects the assets and liabilities related to the fiber network. The
net assets were transferred to RVP Fiber Company, L.L.C. which will retain
ownership and operation of the fiber network.
3. Reflects the estimated purchase accounting adjustments for the
acquisition based upon the historical book value of US Xchange's assets of June
30, 2000. For purchase accounting, US Xchange's assets have been recorded at
their estimated fair market value. The estimated amounts of the assets and
liabilities acquired from US Xchange are not expected to differ materially from
the final assigned values. Purchase accounting adjustments were reflected to
record the estimated fair value of the customer base acquired of $31.0 million,
the IRU of $42.0 million and the goodwill of $315.0 million and decrease the
long-term debt not assumed of $299.1 million (including accrued interest) as
well as the related asset of deferred financing costs of $6.6 million. The
estimated value attached to the common stock to be issued by the Company to US
Xchange was $27.56 per share which represents the closing price on August 1,
2000. The calculation of excess purchase cost over fair value of net assets
acquired is as follows:
(Amounts in thousands)
Cash paid............................................... $ 339,000
Common stock issued..................................... 171,083
Cash advance............................................ 5,357
Direct acquisition costs................................ 12,500
---------
Total purchase cost..................................... 527,940
Less: Net book value of US Xchange..................... (130,934)
Less: Adjustments in net assets to fair value.......... 270,413
---------
Excess of purchase costs over fair value of assets
acquired and liabilities assumed (goodwill)............. $ 388,461
=========
The pro forma adjustment also represents a decrease of $6.6 million for the
remaining net book value of the debt issuance costs existing on US Xchange's
balance sheet, and the $1.5 million additional purchase price for Atlantic
Connections, which represents the resolution of purchase price contingency, to
be paid in September 2000.
The pro forma adjustment also represents the elimination of the cash
advance to US Xchange for $5.4 million.
4. Reflects the elimination of debt of US Xchange that was not assumed in
the acquisition.
5. Reflects the liability for direct acquisition costs of $12.5 million,
issuance costs for the preferred stock financing of $2.0, liability for
additional purchase price for Atlantic Connections of $1.5 million less accrued
interest of $16.4 million related to the debt of US Xchange which was not
assumed in the acquisition.
6. Reflects the elimination of $231.9 million of debt of US Xchange that
was not assumed in the acquisition and debt related to the fiber business that
was not acquired of $11.6 million. Also reflects borrowings of $139.0 million of
the $350.0 million senior credit facility amended on August 1, 2000 and accrued
interest of $9.2 million at an effective interest rate on the amended senior
credit facility
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<PAGE>
of 13.15% per annum. The credit facility consists of a revolving credit
facility, term A loan and term B loan. The revolving credit facility is a $100
million eight-year revolver, of which $14 million was borrowed for the
acquisition. The term A loan is a $125 million eight-year multiple draw term
loan. All of the term A loan was available as of August 1, 2000. The term B loan
is a $125 million eight and one-half year loan of which all was borrowed for the
acquisition. Borrowings under the credit facility bear interest at the company's
option, at the higher of the lender's prime rate or the effective federal funds
rate, plus 1/2 of 1%, plus the applicable margin, or at the LIBOR rate for
deposits in US dollars for the relevant period, adjusted for the statutory
reserve rate, plus applicable margin.
7. Reflects issuance of $200.0 million of Series A Senior Cumulative
Preferred Stock less issuance costs and warrants exercisable to purchase shares
of the Company's common stock. The non-convertible preferred stock matures on
August 1, 2012, are redeemable by the Company beginning on the fifth anniversary
of issue date, and provides for annual dividends of 14% (which are payable in
kind for the first five years). The Company granted warrants to purchase
1,747,454 shares of common stock at an exercise price of $0.01 per share of
common stock.
Reflects issuance of 6.2 million common shares to Ronald H. VanderPol, sole
shareholder of US Xchange at $27.56 per share which represents the closing price
on August 1, 2000 and issuance of 535,296 common shares to employees of US
Xchange. The common shares of the employees vest 50% per annum over two years.
Deferred compensation has been recorded for $14.8 million related to the common
shares issued to employees. Also reflects issuance costs of $2.0 million
related to the Series A Preferred Stock and the elimination of the stockholder's
equity of US Xchange.
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<PAGE>
Unaudited Pro Forma Condensed Combined Statement of Operations
For the Six Months Ended June 30, 2000
(Amounts in thousands, except share and per share data)
<TABLE>
<CAPTION>
Choice One
Pro Forma US Xchange Pro Forma Pro Forma
Historical Historical Adjustments Combined
---------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Revenues..................................... $ 17,201 $ 20,526 $ 595 /(1)(2)/ $ 38,322
Operating expenses:
Network costs.............................. 16,701 22,629 (4,332)/(1)/ 34,998
Selling, general and administrative........ 99,087 15,857 8,711 /(3)/ 123,655
Depreciation and amortization.............. 6,979 8,892 19,514 /(2)(4)/ 35,385
----------- -------- ---------- -----------
Total operating expenses................... 122,767 47,378 23,893 194,038
----------- -------- ---------- -----------
Loss from operations......................... (105,566) (26,852) (23,298) (155,716)
Interest income (expense), net............... (1,108) (16,845) 7,689 /(5)/ (10,264)
----------- -------- ---------- -----------
Net loss..................................... (106,674) (43,697) (15,609) (165,980)
----------- -------- ---------- -----------
Accretion of preferred stock................. -- -- 3,911 /(6)/ 3,911
Accrued preferred stock dividends............ -- -- 16,346 /(6)/ 16,346
----------- -------- ---------- -----------
Net loss applicable to common stock.......... $ (106,674) $(43,697) $ (35,866) $ (186,237)
=========== ======== ========== ===========
Weighted average number of shares
outstanding, basic and diluted.............. 28,689,868 6,742,959 /(7)/ 35,432,827
Net loss per share, basic and diluted........ $ (3.72) $ (5.26)
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
Notes to the Unaudited Pro Forma Condensed Combined Statement of Operations for
the six months ended June 30, 2000
The unaudited 2000 condensed combined pro forma statement of operations
reflects the combination of the statement of operations of the Company for the
six months ended June 30, 2000 and the statement of operations of US Xchange for
the six months ended June 30, 2000.
1. Reflects the reclassification of the bad debt expense of $0.7 million
and switching and network operation center costs of $4.3 million related to cost
of communication to selling, general and administrative expenses in conformity
with the presentation of the Company.
2. Reflects the results of the fiber business for the six months ended
June 30, 2000. The impact to net loss is $(393). The fiber business was
transferred to RVP Fiber Company, L.L.C. prior to the acquisition of US Xchange.
3. Reflects deferred compensation of $3.7 million for issuance of common
shares to employees of US Xchange. The common shares vest 50% per annum over two
years.
4. Reflects an increase in amortization expense of $19.5 million related
to the amortization of the acquired goodwill, customer base and IRU. The value
of the acquired goodwill is based on estimates and will be adjusted based upon
the final allocation of the purchase price and is amortized using the straight-
line method with an estimated useful life of 10 years. The value of the acquired
customer base is $31.0 million, is based on estimates, and is amortized using
the straight-line method with an estimated useful life of 5 years. The value of
the IRU is $42.0 million, is based on estimates, and is amortized using the
straight-line method with an estimated useful life of twenty years. Also
reflects an increase in amortization expense related to the additional purchase
of $1.5 million for Atlantic Connections of $80,000.
5. Reflects a decrease in interest expense, net of $16.8 million related
to the debt of US Xchange not assumed as part of the acquisition, offset by an
increase in interest expense of $9.2 million related to the new debt incurred to
finance a portion of the acquisition. The weighted average interest rate on the
new debt was 13.15% per annum.
6. Reflects the accretion of preferred stock over a five year period (the
preferred stock becomes redeemable by the company on the fifth anniversary of
the issue date) and accrued preferred stock dividends issued in connection with
the financing of this transaction. The preferred stock provides for annual
dividends of 14% (which are payable in kind for the first five years).
7. Reflects 6.7 million common shares issued in connection with the
acquisition of US Xchange.
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Unaudited Pro Forma Condensed Combined Statement of Operations
For the Year Ended December 31, 1999
(Amounts in thousands, except share and per share data)
<TABLE>
<CAPTION>
Atlantic
Atlantic Connections US Xchange
Choice One Connections US Xchange Pro Forma Pro Forma Pro Forma
Historical Historical Historical Adjustments Adjustments Combined
----------- ------------ ---------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues.......................... $ 4,518 $ 7,140 $ 26,430 $ -- $ 698 /(3)/ $ 38,786
Operating expenses:
Network costs................... 6,979 5,427 37,740 -- (8,778)/(3)/ 41,368
Selling, general and
administrative................. 22,978 1,615 40,554 -- 16,852 /(3)(4)/ 81,999
Depreciation and amortization... 5,153 514 13,191 742 /(1)/ 39,846 /(5)/ 59,446
----------- ------------ ---------- ----------- ---------- -----------
Total operating expenses........ 35,110 7,556 91,485 742 47,920 182,813
----------- ------------ ---------- ----------- ---------- -----------
Loss from operations.............. (30,592) (416) (65,055) (742) (47,222) (144,027)
Interest income (expense), net.... (1,883) (283) (25,593) (463)/(2)/ 7,280 /(6)/ (20,942)
----------- ------------ ---------- ----------- ---------- -----------
Net loss.......................... (32,475) (699) (90,648) (1,205) (39,942) (164,969)
----------- ----------- ---------- ----------- ---------- -----------
Accretion of preferred stock...... -- -- -- -- 6,362 /(7)/ 6,362
Accrued preferred stock dividends. -- -- -- -- 29,505 /(7)/ 29,505
----------- ------------ ---------- ----------- ---------- -----------
Net loss applicable to common $ (32,475) $ (699) $ (90,648) $ (1,205) $ (75,809) $ (200,836)
stock............................ =========== ============ ========== =========== ========== ===========
Weighted average number of shares
outstanding, basic and diluted.. 22,022,256 6,742,959 /(8)/ 28,765,215
Net loss per share, basic and $ (1.47) $ (6.98)
diluted.......................... =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
Notes to the Unaudited Pro Forma Condensed Combined Statement of Operations for
the year ended December 31, 1999
The unaudited 1999 condensed combined pro forma statement of operations
reflects the combination of the statement of operations of the Company for the
year ended December 31, 1999 and the statement of operations of Atlantic
Connections for the ten months ended October 31, 1999.
1. Reflects an adjustment to depreciation expense related to the decrease
in net tangible assets of Atlantic Connections, based on the assumptions that
the acquisition had taken place on January 1, 1999. These assets have been
restated at their estimated fair market values and depreciated over the
remaining useful lives of the assets. The decrease in depreciation expense of
$76,000 as compared to that recorded by Atlantic Connections, was included in
operating expenses as indicated.
Reflects an increase in amortization expense of $657,000 related to the
amortization of the acquired goodwill and customer base, less the amortization
expense of intangible assets recorded in Atlantic Connection's historical
statement of operations. The values of the acquired goodwill and customer base
are based on estimated values and are amortized using the straight-line method
and estimated useful lives of 10 years and 5 years, respectively. Includes an
increase in amortization expense of $161,000 related to the additional purchase
price consideration of $1.5 million to be paid in September 2000.
2. Reflects the additional interest expense of $463,000 incurred on the
debt to finance the acquisition. The overall effective interest rate was 10.78%
per annum.
The unaudited 1999 condensed combined pro forma statement of operations
reflects the combination of the statement of operations of the Company for the
year ended December 31, 1999 and the statement of operations of US Xchange for
the year ended December 31, 1999.
3. Reflects the reclassification of bad debt expense of $0.7 million and
switching and network operations center costs of $8.8 million related to cost of
communication to selling, general and administrative expenses in conformity with
the presentation of the Company.
4. Reflects deferred compensation of $7.4 million for the issuance of
common shares to employees of US Xchange. The common shares vest 50% per annum
over two years.
5. Reflects an increase in amortization expense of $39.9 million related
to the amortization of the acquired goodwill, customer base and the IRU. The
value of the acquired goodwill is based on estimates and will be adjusted based
upon the final allocation of the purchase price and is amortized using the
straight-line method with an estimated useful life of 10 years. The value of the
acquired customer base is $31.0 million, is based on estimates, and is amortized
using the straight-line method with an estimated useful life of five years. The
value of the IRU is $42.0 million, is based on estimates, and is amortized using
the straight-line method with an estimated useful life of 20 years.
6. Reflects a decrease in interest expense of $25.6 million related to
the debt of US Xchange not assumed as part of the acquisition, offset by an
increase in interest expense of $18.3 million related to the new debt incurred
to finance a portion of the acquisition. The weighted average interest rate on
the new debt was 13.15% per annum.
7. Reflects the accretion of preferred stock and accrued preferred stock
dividends issued in connection with the financing of this transaction.
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<PAGE>
8. Reflects 6.7 million common shares issued in connection with the
acquisition of US Xchange.
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<PAGE>
(a) Interim Financial Statements:
US XCHANGE, L.L.C.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
------------- -------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and equivalents $ 1,419,902 $ 189,304
Restricted investments 28,550,368 28,795,226
Accounts receivable, less allowance
for doubtful accounts of $1,076,000 and $792,000 6,794,043 5,995,466
Other current assets 1,112,598 1,003,960
------------- -------------
TOTAL CURRENT ASSETS 37,876,911 35,983,956
------------- -------------
NETWORKS AND EQUIPMENT
Networks and networks
in process (cost to complete of $3,000,000 129,592,135 125,797,486
and $5,337,000)
Furniture and equipment 20,574,240 19,423,809
Leasehold improvements 7,740,850 7,451,545
------------- -------------
157,907,225 152,672,840
Less accumulated depreciation and amortization 20,936,107 16,566,408
------------- -------------
NET NETWORKS AND EQUIPMENT 136,971,118 136,106,432
------------- -------------
OTHER ASSETS
Restricted investments 14,704,268 28,873,973
Debt issuance costs, net 6,817,800 7,029,423
Miscellaneous 2,322,354 2,106,239
------------- -------------
TOTAL OTHER ASSETS 23,844,422 38,009,635
------------- -------------
TOTAL ASSETS $ 198,692,451 $ 210,100,023
============= =============
LIABILITIES AND MEMBER'S DEFICIT
CURRENT LIABILITIES
Accounts payable $ 10,066,442 $ 9,286,552
Accrued interest 7,663,064 15,191,526
Accrued other liabilities 2,603,126 2,105,387
Current maturities of long-term debt 800,000 800,000
Senior secured facility 50,000,000 50,000,000
------------- -------------
TOTAL CURRENT LIABILITIES 71,132,632 77,383,465
UNEARNED REVENUE 7,297,557 3,406,414
LONG-TERM DEBT, LESS CURRENT MATURITIES
15% Senior Notes 200,000,000 200,000,000
Notes payable 1,600,000 1,800,000
Member Subordinated Debt (including accrued interest) 27,666,962 14,746,750
------------- -------------
TOTAL LIABILITIES 307,697,151 297,336,629
MEMBER'S DEFICIT
Capital contributions 60,000,000 60,000,000
Accumulated deficit (169,004,700) (147,236,606)
------------- -------------
TOTAL MEMBER'S DEFICIT (109,004,700) (87,236,606)
------------- -------------
TOTAL LIABILITIES AND MEMBER'S DEFICIT $ 198,692,451 $ 210,100,023
============= =============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
-14-
<PAGE>
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------
2000 1999
------------ ------------
<S> <C> <C>
Revenues $ 9,720,601 $ 4,339,437
Costs and Expenses:
Cost of communication services 10,971,909 8,207,998
Selling, general and administrative 7,887,858 10,086,505
Depreciation and amortization 4,391,193 2,229,520
------------ ------------
Total costs and expenses 23,250,960 20,524,023
------------ ------------
Loss from operations (13,530,359) (16,184,586)
------------ ------------
Interest Expense (8,862,370) (5,933,845)
------------ ------------
Interest Income 624,635 1,310,186
------------ ------------
Net Loss $(21,768,094) $(20,808,245)
============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
-15-
<PAGE>
US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------
2000 1999
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(21,768,094) $(20,808,245)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 4,602,817 2,229,520
Provision for doubtful accounts 284,065 85,000
Interest earned on restricted investments (585,437) (957,295)
Accrued interest on Member Subordinated Debt 393,587 -
Increase in unearned revenue 3,891,143 -
Changes in assets and liabilities:
Accounts receivable (1,082,642) (993,245)
Other current assets (108,638) (243,971)
Accounts payable 779,890 (2,730,628)
Accrued liabilities (7,030,723) (6,390,363)
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (20,624,032) (29,809,227)
------------ ------------
INVESTING ACTIVITIES
Decrease in restricted investments 15,000,000 15,500,000
Purchase of networks and equipment (5,244,335) (14,503,515)
Increase in other assets (227,660) (259,395)
------------ ------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 9,528,005 737,090
------------ ------------
FINANCING ACTIVITIES
Proceeds from long-term debt 12,526,625 -
Repayment of long-term debt (200,000) (133,333)
Direct costs of financing - (349,825)
------------ ------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 12,326,625 (483,158)
------------ ------------
NET INCREASE (DECREASE)
IN CASH AND EQUIVALENTS 1,230,598 (29,555,295)
Cash and equivalents, beginning of period 189,304 40,018,552
------------ ------------
Cash and equivalents, end of period $ 1,419,902 $ 10,463,257
============ ============
Supplemental Disclosure of Cash Flow Information
Interest Paid (net of amounts capitalized) $ 15,409,781 $ 15,558,846
============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
-16-
<PAGE>
US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED
MARCH 31, 2000
(unaudited)
1. BASIS OF PRESENTATION
The consolidated balance sheet of US Xchange, L.L.C. (the "Company") at December
31, 1999 was obtained from the Company's audited balance sheet as of that date.
All other financial statements contained herein are unaudited and, in the
opinion of management, contain all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation. Operating results for
the three months ended March 31, 2000 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2000. The
Company's accounting policies and certain other disclosures are set forth in the
notes to the Company's audited consolidated financial statements as of and for
the year ended December 31, 1999.
2. RESTRICTED INVESTMENTS
Restricted investments consist of U.S. government securities and money market
funds plus accrued interest thereon purchased in connection with the 15% Senior
Notes (see Note 4) to secure the first three years' (six semi-annual) interest
payments on these notes, which payments the Company commenced on January 1,
1999. All these investments are classified as held-to-maturity securities. Such
investments are stated at cost, which approximates fair value, and are reported
in both current and long-term assets, based upon the maturity dates of the
individual securities.
3. UNEARNED REVENUES
Sales of indefeasible rights to use fiber or capacity ("IRU") are recorded as
unearned revenue at the earlier of the acceptance of the applicable portion of
the network by the customer or the receipt of cash. The revenue is recognized
over the life of the agreement as services are provided beginning on the date of
customer acceptance. IRU revenues of $32,000 and $0 were earned during the three
months ended March 31, 2000 and 1999, respectively.
4. LONG-TERM DEBT
In August 1999, the Company entered into a Line of Credit Agreement with its
sole member for up to $50 million in subordinated debt financing. Borrowings
under this arrangement totaled $27.0 million at March 31, 2000. Under this
subordinated line of credit, interest accrues on outstanding borrowings at a
floating rate equal to prime rate less 1.25% (effectively 7.75% at March 31,
2000), and borrowings are secured by all present and future assets of the
Company and are subordinated to the indebtedness under the Company's current and
any future secured credit facilities. Repayment of borrowings under this line of
credit and all accrued interest will
-17-
<PAGE>
commence upon the repayment of all obligations under the Company's current and
any future secured credit facilities.
On April 30, 1999, the Company obtained a $50 million senior secured credit
facility, pursuant to a Loan and Security Agreement among the Company's wholly-
owned subsidiary, US Xchange Finance Company, L.L.C., as borrower, the Company
and its operating subsidiaries, as guarantors, and General Electric Capital
Corporation ("GE Capital"), as Administrative Agent and lender. As of March 31,
2000 the full $50 million was outstanding. Issuance costs approximating $1
million are being ratably amortized over the term of the facility. Loans under
this facility bear interest at a floating rate equal to either a defined base
rate plus 3.0% or at LIBOR plus 4.0%, at the borrower's option. The effective
interest rate was 10.1% at March 31, 2000. Interest is payable at least on a
quarterly basis. During 1999, unused portions of this facility subject to a
commitment fee ranging between .75% and 1.25% of the unused amount. The
aggregate outstanding principal is repayable in quarterly installments,
commencing July 31, 2002 and continuing through April 30, 2007, based upon the
following annual debt reduction formula: 10%, 15%, 20%, 25% and 30%. Borrowings
are secured by all present and future real and personal property, assets and
revenues of the borrower and its subsidiaries. The Company and the subsidiaries
of the borrower have guaranteed the repayment of all indebtedness under this
facility.
The senior secured revolving credit facility contains financial performance
covenants regarding minimum quarterly revenues, maximum quarterly EBITDA losses
and maximum annual capital expenditures, with which the Company did not comply
for the quarters ended December 31, 1999 and March 31, 2000 and for the year
ended December 31, 1999. (EBITDA consists of earnings (loss) before net
interest, income taxes, depreciation and amortization.) GE Capital has agreed to
forbear from exercising any remedies against the Company as a result of the non-
compliance with these covenants through the earlier of a Termination Event, as
defined by GE Capital, or July 31, 2000 (the "forbearance period"). As a result,
the Company has classified the GE Capital senior secured credit facility as a
current liability since there is no assurance that GE Capital will not require
repayment of this credit facility after the forbearance period expires. However,
it is anticipated that this credit facility will be settled as a result of the
impending merger of the Company's new parent (see Note 7).
On June 25, 1998, the Company completed a sale of $200 million principal amount
of 15% Senior Notes, due 2008 (the "15% Senior Notes"). Of the total net
proceeds approximating $193.0 million, the Company placed approximately $82.5
million, representing funds, together with interest thereon, sufficient to pay
the first six semi-annual interest payments on the 15% Senior Notes, into an
escrow account for the benefit of the holders. Issuance costs approximating $7.0
million are being amortized ratably over the term of the debt. Interest on the
15% Senior Notes is payable semi-annually, on January 1 and July 1, commencing
January 1, 1999. The Company made interest payments of $15 million, $15.5
million and $15.0 million on January 1, 2000, July 1, 1999 and January 1, 1999,
respectively, to the holders of the 15% Senior Notes. The 15% Senior Notes are
non-callable and mature in full on July 1, 2008.
The 15% Senior Notes are unsubordinated, unsecured senior indebtedness of the
Company. The Company's subsidiaries have no obligation to pay amounts due on the
15% Senior Notes and do
-18-
<PAGE>
not guarantee the 15% Senior Notes. Therefore, the 15% Senior Notes are
effectively subordinated to all existing and future liabilities (including trade
payables) of the Company's subsidiaries. The 15% Senior Notes are subject to
certain covenants that, among other things, restrict the ability of the Company
and certain subsidiaries to incur additional indebtedness, pay dividends or make
distributions or redemptions in respect of membership interests.
On August 28, 1997, the Company entered into a credit facility agreement with a
local bank that provided for borrowings of up to $4 million for the acquisition
of office furniture, equipment and computer software and for construction costs
related to leasehold improvements of office and switch site locations. In March
1998, the credit facility was fully utilized and converted into a term note
payable in 60 equal monthly installments commencing April 1998. Amounts borrowed
bear interest at 1/2% under the bank's prime rate or 2% over the bank's cost of
funds, at the Company's option. The effective rate was 8.50% at March 31, 2000.
Specific assets and the guarantee of an affiliated company owned by the
Company's majority member secure all borrowings. The credit facility also
provides that the affiliated company maintains minimum debt to tangible net
worth and current ratio levels. At March 31, 2000, the affiliated company was in
compliance with the covenant requirements.
The aggregate principal repayments of long-term debt over the next five years
are as follows:
YEAR ENDING DECEMBER 31,
------------------------
2000 (9 months) 600,000
2001 800,000
2002 800,000
2003 200,000
5. RELATED PARTY TRANSACTIONS
Under an expense sharing agreement with an affiliated company, the Company
incurred $19,414 and $82,153 relating to management and administrative services
for the three months ended March 31, 2000 and 1999, respectively. In October
1999, the Company entered into a lease agreement with the affiliated company for
certain office furniture in its corporate administrative offices. Total lease
costs under this agreement for the three months ended March 31, 2000 was
$48,750.
The Company also leases its corporate administrative offices from two companies
each of which is 50% controlled by the same affiliated company. Rents paid under
these lease agreements were $394,207 and $134,757 for the three months ended
March 31, 2000 and 1999, respectively. The Company has a lease agreement with
another affiliated company owned by the majority member for aircraft
transportation services. Total costs incurred under this arrangement for the
three months ended March 31, 2000 and 1999 were $6,095 and $33,350,
respectively.
See also Note 4 regarding the Company's borrowings under the subordinated line
of credit from the Company's sole member.
-19-
<PAGE>
6. LEASES
The Company leases administrative and sales office facilities, operating sites
and certain equipment under noncancelable operating leases having initial or
remaining terms of more than one year. Certain of the Company's facility leases
include renewal options, and most leases include provisions for rent escalation
to reflect increased operating costs and/or require the Company to pay certain
maintenance and utility costs. Rental expense under these operating leases for
the three months ended March 31, 2000 and 1999 was $1,127,800 and $719,600
respectively.
Future minimum lease payments under noncancelable operating leases at March 31,
2000 were as follows:
Year Ending Operating Site
December 31, Office Facilities Facilities Equipment Total
----------------------------------------------------------------------------
2000 (9 months) $1,726,259 $474,310 $816,517 $3,017,085
2001 2,192,213 640,750 615,439 3,448,401
2002 1,980,657 634,812 307,200 2,922,669
2003 1,397,028 329,964 5,378 1,732,370
2004 580,073 237,739 -- 817,812
2005-2009 -- 865,822 -- 865,822
7. SUBSEQUENT EVENT
On May 14, 2000, the new parent of the Company, a corporation wholly-owned by
the Company's sole member, entered into a definitive merger agreement with
Choice One Communications, Inc. ("Choice One"), a publicly-held company. Under
terms of the agreement, Choice One will exchange 7 million shares of its common
stock and $311 million in net cash for all of the outstanding common stock of
the Company's parent. Based on the price of Choice One's common stock as of the
close of business on the day before the merger announcement, the merger is
valued at approximately $518 million. In addition, as a condition of the merger,
all of the holders of the 15% Senior Notes have agreed to a redemption price
equal to 109% of their principal amount plus accrued interest, if any, to the
closing date of the merger. The merger is subject to regulatory approvals and
other customary conditions.
-20-
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
US Xchange, L.L.C.
Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of US Xchange,
L.L.C. and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of operations, member's capital (deficit) and cash flows
for each of the years in the three-year period ended December 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of US Xchange, L.L.C.
and subsidiaries at December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1999, in conformity with generally accepted accounting
principles.
/s/ BDO SEIDMAN, LLP
Grand Rapids, Michigan
May 17, 2000
-21-
<PAGE>
US Xchange, L.L.C.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-----------------------------
1999 1998
-------------- -------------
<S> <C> <C>
ASSETS
Current assets
Cash and equivalents................................................ $ 189,304 $ 40,018,552
Restricted investments.............................................. 28,795,226 28,525,109
Accounts receivable, less allowance for doubtful
accounts of $792,000 and $174,000................................ 5,995,466 1,865,503
------------- -------------
Other............................................................... 1,003,960 700,411
------------- -------------
Total current assets............................................. 35,983,956 71,109,575
------------- -------------
Networks and equipment
Networks and networks in process (cost to complete
of $5,337,000)............................................... 125,797,486 85,821,872
Furniture and equipment............................................. 19,423,809 14,017,604
Leasehold improvements.............................................. 7,451,545 3,937,223
------------- -------------
152,672,840 103,776,699
Less accumulated depreciation and amortization...................... 16,566,408 3,432,193
------------- -------------
Net networks and equipment............................................ 136,106,432 100,344,506
------------- -------------
Other assets
Restricted investments.............................................. 28,873,973 56,206,738
Debt issuance costs, net............................................ 7,029,423 6,793,770
Miscellaneous....................................................... 2,106,239 261,328
------------- -------------
Total other assets............................................... 38,009,635 63,261,836
------------- -------------
Total assets $ 210,100,023 $ 234,715,917
============= =============
LIABILITIES AND MEMBER'S CAPITAL (DEFICIT)
Current liabilities
Accounts payable.................................................... $ 9,286,552 $ 11,264,241
Accrued interest.................................................... 15,191,526 15,521,634
Accrued other liabilities........................................... 2,105,387 1,185,820
Current maturities of long-term debt................................ 800,000 800,000
Senior secured facility............................................. 50,000,000 -
------------- -------------
Total current liabilities........................................ 77,383,465 28,771,695
Unearned revenues 3,406,414 -
Long-term debt, less current maturities:
15% Senior Notes.................................................... 200,000,000 200,000,000
Member subordinated debt (including accrued interest) 14,746,750 -
Notes payable....................................................... 1,800,000 2,533,333
------------- -------------
Total liabilities................................................ 297,336,629 231,305,028
------------- -------------
Member's capital (deficit)
Capital contributions............................................... 60,000,000 60,000,000
Accumulated deficit................................................. (147,236,606) (56,589,111)
------------- -------------
Total member's capital (deficit)................................. (87,236,606) 3,410,889
------------- -------------
Total liabilities and member's capital (deficit)...................... $ 210,100,023 $ 234,715,917
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
-22-
<PAGE>
US Xchange, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1999 1998 1997
------------ ------------ -----------
<S> <C> <C> <C>
REVENUES.................................................. $ 26,429,789 $ 7,015,310 $ 206,682
------------ ------------ -----------
Costs and expenses
Cost of communication services (excluding
depreciation and amortization, shown separately
below)................................................. 37,739,781 16,338,583 749,662
Selling, general and administrative..................... 40,554,373 28,679,670 5,065,589
Depreciation and amortization........................... 13,190,549 3,257,055 189,347
------------ ------------ -----------
Total costs and expenses............................. 91,484,703 48,275,308 6,004,598
------------ ------------ -----------
Loss from operations.................................... (65,054,914) (41,259,998) (5,797,916)
------------ ------------ -----------
Interest expense.......................................... (29,537,206) (13,838,996) (30,452)
------------ ------------ -----------
Interest income........................................... 3,944,625 4,476,061 -
------------ ------------ -----------
Net loss................................................ $(90,647,495) $(50,622,933) $(5,828,368)
============ ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
-23-
<PAGE>
US Xchange, L.L.C.
CONSOLIDATED STATEMENTS OF MEMBER'S CAPITAL (DEFICIT)
<TABLE>
<CAPTION>
Capital Accumulated
Contributions Deficit Total
------------- --------------- -------------
<S> <C> <C> <C>
Balance, January 1, 1997.................................... $ - $ (137,810) $ (137,810)
Member capital contributions........................... 5,000,000 - 5,000,000
Net loss for the year.................................. - (5,828,368) (5,828,368)
----------- ------------- ------------
Balance, December 31, 1997.................................. 5,000,000 (5,966,178) (966,178)
Member capital contributions........................... 55,000,000 - 55,000,000
Net loss for the year.................................. - (50,622,933) (50,622,933)
----------- ------------- ------------
Balance, December 31, 1998.................................. 60,000,000 (56,589,111) 3,410,889
Net loss for the year.................................. - (90,647,495) (90,647,495)
----------- ------------- ------------
Balance, December 31, 1999.................................. $60,000,000 $(147,236,606) $(87,236,606)
=========== ============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
-24-
<PAGE>
US Xchange, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1999 1998 1997
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss........................................... $(90,647,495) $ (50,622,933) $ (5,828,368)
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation and amortization.................... 13,988,549 3,609,055 189,347
Provision for uncollectible accounts............. 698,488 227,949 2,000
Increase in unearned revenues.................... 3,406,414 - -
Accrued interest on member subordinated debt..... 246,750 - -
Interest earned on restricted investments........ (3,437,351) (2,262,063) -
Changes in assets and liabilities:
Accounts receivable........................... (4,828,448) (1,948,217) (147,235)
Other current assets.......................... (303,550) (539,803) (134,933)
Accounts payable.............................. (1,977,689) 5,945,748 5,318,493
Accrued liabilities........................... 589,461 16,502,288 205,166
------------ ------------- ------------
Net cash used in operating activities......... (82,264,871) (29,087,976) (395,530)
------------ ------------- ------------
INVESTING ACTIVITIES
Purchase of restricted investments................. - (82,469,784) -
Decrease in restricted investments................. 30,500,000 - -
Purchase of networks and equipment................. (48,906,624) (75,619,611) (28,157,088)
Increase in other assets........................... (1,891,092) (375,770) (11,096)
------------ ------------- ------------
Net cash used in investing activities......... (20,297,716) (158,465,165) (28,168,184)
------------ ------------- ------------
FINANCING ACTIVITIES
Proceeds from long-term debt....................... 64,500,000 201,211,000 2,789,000
Direct costs of financing.......................... (1,033,327) (7,034,441) -
Repayment of long-term debt........................ (733,334) (666,667) -
Advances from affiliated company................... - 61,211 20,875,304
Member capital contributions....................... - 33,900,000 5,000,000
------------ ------------- ------------
Net cash provided by financing activities..... 62,733,339 227,471,103 28,664,304
------------ ------------- ------------
Net Increase (Decrease) in Cash and
Equivalents................................ (39,829,248) 39,917,962 100,590
Cash and equivalents, beginning of year............ 40,018,552 100,590 -
------------ ------------- ------------
Cash and equivalents, end of year.................. $ 189,304 $ 40,018,552 $ 100,590
============ ============= ============
Supplemental disclosure of cash flow information
Interest paid (net of amounts capitalized)....... $ 28,572,890 $ 279,209 $ 12,334
============ ============= ============
Supplemental disclosure of non-cash financing
activities
Conversion of advances to member's capital......... $ - $ 21,100,000 $ -
============ ============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
-25-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Business
US Xchange, L.L.C. and its wholly-owned subsidiaries (Company) provide
facilities-based competitive local telecommunications services in selected
cities of the north central area of the United States. The Company operates in
a single segment and its maximum duration is until December 2030. The Company
competes with incumbent local exchange carriers (ILECs) by offering business and
residential customers innovative and customized products, superior customer
service and lower costs through the use of an advanced telecommunications
systems network.
From its inception in August 1996 until June 30, 1997, the Company was in
the development stage. During that time, the Company's principal activities
included developing its business plan, hiring management and other key
personnel, designing the architecture for its network systems and negotiating an
interconnection agreement with an ILEC.
The Company's sole member and an affiliated company of the member provided
equity funding to the Company of $60 million. In August 1999, the member agreed
to provide up to $50 million in subordinated debt financing (see Note 3).
Principles of Consolidation
The consolidated financial statements include the accounts of US Xchange,
L.L.C. and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
Fair Value of Financial Instruments
The carrying amounts for cash, accounts receivable, accounts payable and
accrued liabilities approximate their fair value. The fair value of long-term
debt, including the senior secured facility, is estimated based on quoted market
rates for similar financial instruments.
<TABLE>
<CAPTION>
1999 1998
---------------------------------------- ------------------------------------------
Carrying Amount Fair Value Carrying Amount Fair Value
-------------------- ------------------ -------------------- --------------------
<S> <C> <C> <C> <C>
Long-term debt $267,346,750 $228,346,750 $203,333,333 $203,333,333
</TABLE>
Cash and Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
-26-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts receivables.
The risk is limited due to the large number of entities comprising the Company's
customer base and the dispersion of those entities across many different
industries and geographical areas. Credit is extended based on evaluation of
the customer's financial condition and generally collateral is not required.
Anticipated credit losses are provided for in the consolidated financial
statements and have been within management's expectations.
Networks and Equipment
Networks and equipment are stated at cost. Leasehold improvements are
amortized using the straight-line method over their useful life or lease term,
whichever is shorter. Depreciation is calculated using the straight-line method
over the estimated useful lives of the assets as follows:
Years
----------------
Telecommunications equipment..................... 5-8
Fiber optic cable................................ 20
Leasehold improvements........................... 10-15
Office furniture and equipment................... 3-7
Costs directly related to the construction of network systems and
facilities, including interest, are capitalized. Uncompleted portions of fiber
optic networks are reported as networks in progress. Upon completion, the
construction costs will be classified as fiber optic networks and depreciated
over their useful lives. Interest expense capitalized in connection with
construction projects amounted to approximately $4 million, $2.3 million and
$2,000 in 1999, 1998 and 1997, respectively. Repairs and maintenance costs are
expensed as incurred. The Company had firm commitments for capital expenditures
of approximately $3.8 million at December 31, 1999.
Long-Lived Assets
The Company periodically reviews long-lived assets for impairment by
comparing the carrying value of the assets to their estimated future
undiscounted cash flows. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
Revenue Recognition
Revenues are recognized as services are provided to customers. Sales of
indefeasible rights to use fiber or capacity (IRU) are recorded as unearned
revenue at the earlier of the acceptance of the applicable portion of the
network by the customer or the receipt of cash. The revenue is recognized over
the life of the agreement as services are provided beginning on the date of
customer acceptance. There were no IRU revenues in 1999, 1998 or 1997.
-27-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Advertising Costs
Costs for advertising, which were approximately $2.1 million, $2 million
and $180,000 for the years ended December 31, 1999 and 1998, and 1997
respectively, are expensed as incurred within the fiscal year
Income Taxes
The Company is treated as a partnership for U.S. federal income tax
purposes. Income and losses are reported on the respective tax returns of the
members, therefore, no provision for federal income taxes has been made in these
consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1999
presentation.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
requires companies to recognize all derivative contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. This
standard, as amended by SFAS 137 issued in June 1999, is effective for all
fiscal quarters of all fiscal years beginning after June 15, 2000.
Historically, the Company has not entered into derivative contracts and,
therefore, does not expect that adoption of this standard will have a material
impact on its consolidated financial statements.
2. Restricted Investments
Restricted investments consist of U.S. government securities and money
market funds plus accrued interest thereon purchased in connection with the 15%
Notes (see Note 3) to secure the first three years' interest payments on these
notes. Interest payments are made semi-annually and commenced on January 1,
1999. All these investments are classified as held-to-maturity securities. Such
investments are stated at cost, which approximates fair value, and are reported
in both current and long-term assets, based upon the maturity dates of the
individual securities.
-28-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Long-Term Debt
On August 26, 1999, the Company entered into a line of credit agreement
with its sole member for up to $50 million in subordinated debt financing.
Borrowings under this arrangement totaled $14.5 million at December 31, 1999.
Under this subordinated line of credit, interest accrues on outstanding
borrowings at a floating rate equal to prime rate less 1.25% (effectively 7.25%
at December 31, 1999), and borrowings are secured by all present and future
assets of the Company and are subordinated to the indebtedness under the
Company's current and any future secured credit facilities. Repayment of
borrowings under this line of credit and all accrued interest will commence upon
the repayment of all obligations under the Company's current and future secured
credit facilities.
On April 30, 1999, the Company obtained a $50 million senior secured credit
facility pursuant to a loan and security agreement among the Company's wholly-
owned subsidiary, US Xchange Finance Company, L.L.C., as borrower, the Company
and its operating subsidiaries, as guarantors, and General Electric Capital
Corporation (GE Capital), as Administrative Agent and lender. As of December 31,
1999 the full $50 million was outstanding. Issuance costs approximating $1
million are being ratably amortized over the term of the facility. Loans under
this facility bear interest at a floating rate equal to either a defined base
rate plus 3% or at LIBOR plus 4%, at the borrower's option. The effective
interest rate was 10.45 % at December 31, 1999. Interest is payable at least on
a quarterly basis. During 1999 unused portions of this facility were subject to
a commitment fee ranging between .75% and 1.25% of the unused amount. The
aggregate outstanding principal is repayable in quarterly installments,
commencing July 31, 2002 and continuing through April 30, 2007, based upon the
following annual debt reduction formula: 10%, 15%, 20%, 25% and 30%. Borrowings
are secured by all present and future real and personal property, assets and
revenues of the borrower and its subsidiaries. The Company and the subsidiaries
of the borrower have guaranteed the repayment of all indebtedness under this
facility.
The senior secured revolving credit facility contains financial performance
covenants regarding minimum quarterly revenues, maximum quarterly EBITDA losses
and maximum annual capital expenditures, with which the Company did not comply
for the quarter and the year ended December 31, 1999. (EBITDA consists of
earnings (losses) before net interest, income taxes, depreciation and
amortization.) GE Capital has agreed to forebear from exercising any remedies
against the Company as a result of the non-compliance with these covenants
through the earlier of a Termination Event, as defined in the forbearance
agreement, or July 31, 2000 (the "forbearance period"). As a result, the Company
has classified the GE Capital senior secured facility as a current liability
since there is no assurance that GE Capital will not require repayment of this
credit facility after the forbearance period expires. However, it is anticipated
that this credit facility will be settled as a result of the impending merger of
the Company's new parent (see footnote 8).
-29-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On June 25, 1998, the Company completed a sale of $200 million principal
amount of 15% Senior Notes due 2008 (15% Senior Notes). Of the total net
proceeds approximating $193 million, the Company placed approximately $82.5
million, representing funds, together with interest thereon, sufficient to pay
the first six semi-annual interest payments on the 15% Senior Notes, into an
escrow account for the benefit of the holders. Issuance costs approximating $7
million are being amortized ratably over the term of the debt. Interest on the
15% Senior Notes is payable semi-annually, on January 1 and July 1, commencing
January 1, 1999. The Company made interest payments of $15.5 million and $15
million on January 1, 1999 and July 1, 1999, respectively, to the holders of the
15% Senior Notes. The 15% Senior Notes are non-callable and mature in full on
July 1, 2008.
The 15% Senior Notes are unsubordinated, unsecured senior indebtedness of
the Company. The Company's subsidiaries have no obligation to pay amounts due
on the 15% Senior Notes and do not guarantee the 15% Senior Notes. Therefore,
the 15% Senior Notes are effectively subordinated to all existing and future
liabilities (including trade payables) of the Company's subsidiaries.
The 15% Senior Notes are subject to certain covenants that, among other
things, restrict the ability of the Company and certain subsidiaries to incur
additional indebtedness, pay dividends or make distributions or redemptions in
respect of membership interests.
On August 28, 1997, the Company entered into a credit facility agreement
with a local bank that provided for borrowings of up to $4 million for the
acquisition of office furniture, equipment and computer software and for
construction costs related to leasehold improvements of office and switch site
locations. In March 1998, the credit facility was fully utilized and converted
into a term note payable in 60 equal monthly installments commencing April 1998.
Amounts borrowed bear interest at 1/2% under the bank's prime rate or 2% over
the bank's cost of funds, at the Company's option. The effective rate was 8.0%
at December 31, 1999. Specific assets and the guarantee of an affiliated
company owned by the Company's sole member secure all borrowings. The credit
facility also provides that the affiliated company maintains minimum debt to
tangible net worth and current ratio levels. At December 31, 1999, the
affiliated company was in compliance with the covenant requirements.
The aggregate principal repayments of long-term debt over the next five
years is as follows:
Year Ending
December 31,
------------
2000................................................. $800,000
2001................................................. 800,000
2002................................................. 800,000
2003................................................. 200,000
-30-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Related Party Transactions
In connection with the Company's issuance of the 15% Senior Notes, advances
from an affiliated company owned by the Company's sole member of $21.1 million
were converted to member's capital as of March 31, 1998. Under an expense
sharing agreement with the affiliated company, the Company incurred $318,500,
$346,200 and $257,500 relating to management and administrative services for
1999, 1998 and 1997, respectively. In October 1999, the Company entered into a
lease agreement with the affiliated company for certain office furniture in its
corporate administrative offices. Total lease costs under this agreement for
1999 was $48,750.
The Company also leases its corporate administrative offices from two
companies each of which is 50% controlled by the same affiliated company owned
by the Company's sole member. Rents paid under these lease agreements during
1999 and 1998 were $822,200 and $198,600, respectively. There were no rents for
1997.
In June 1997, the Company entered into a lease agreement with another
affiliated company owned by the member for aircraft transportation services.
Total travel costs incurred under this arrangement for 1999, 1998 and 1997 was
$75,200, $101,200 and $69,100, respectively.
5. Employee Benefit Plan
In May 1997, the Company established a 401(k) plan that covers
substantially all employees. Employees who are 21 years of age or older are
eligible to participate in the 401(k) plan upon completion of three months of
service, at which time they may voluntarily contribute a percentage of
compensation. Participants are eligible to receive Company matching
contributions after completion of 12 months of service. The Company will match
50% of the participant's contribution up to a maximum of 3% of such
participant's eligible annual compensation. Matching contributions vest to the
participant over a five-year period. The cost of the plan in 1999 and 1998 was
approximately $267,000 and $51,000, respectively. The Company was not required
to make a contribution to the plan for 1997.
6. Leases
The Company leases administrative and sales office facilities, operating
sites and certain equipment under noncancelable operating leases having initial
or remaining terms of more than one year. Certain of the Company's facility
leases include renewal options, and most leases include provisions for rent
escalation to reflect increased operating costs and/or require the
-31-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company to pay certain maintenance and utility costs. Rental expense under
these operating leases was $3.4 million, $1.7 million and $83,500 for 1999, 1998
and 1997, respectively
Future minimum lease payments under noncancelable operating leases at
December 31, 1999, were as follows:
<TABLE>
<CAPTION>
Year Ending Office Operating site
December 31, facilities facilities Equipment Total
------------ ---------- ---------- --------- -----
<S> <C> <C> <C> <C>
2000................................. $2,210,557 $631,785 $1,095,945 $3,938,287
2001................................. 2,192,213 640,750 615,439 3,448,401
2002................................. 1,980,657 634,812 307,200 2,922,669
2003................................. 1,397,028 329,964 5,378 1,732,370
2004................................. 580,073 237,739 - 817,812
2005-2009............................ - 865,822 - 865,822
</TABLE>
7. Quarterly Financial Data (Unaudited)
<TABLE>
<CAPTION>
1999
---------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenues................... $ 4,339,438 $ 5,947,990 $ 7,480,351 $ 8,662,010
Operating loss............. (15,985,086) (16,429,878) (17,188,349) (15,451,601)
Net loss................... (20,808,244) (22,222,439) (24,386,946) (23,229,866)
<CAPTION>
1998
---------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenues................... $ 565,203 $ 1,419,200 $ 2,144,552 $ 2,886,355
Operating loss............. (5,260,764) (8,569,793) (12,969,746) (14,732,695)
Net loss................... (5,321,499) (8,927,589) (16,782,717) (19,591,128)
</TABLE>
At December 31, 1999, the Company reclassified amortization of debt
issuance costs to interest expense. These costs had previously been classified
as depreciation and amortization expense. This reclassification changed the
previously reported quarterly operating losses for 1999 and 1998 as follows:
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
1999
As previously reported..... $(16,184,586) $(16,629,378) $(17,387,849)
Reclassification........... 199,500 199,500 199,500
------------- -------------- -------------
$(15,985,086) $(16,429,878) $(17,188,349)
============= ============== =============
<CAPTION>
1998
<S> <C> <C> <C> <C>
As previously reported..... $ (5,260,764) $ (8,569,793) $(12,872,746) $(14,908,695)
Reclassification........... - - 176,000 176,000
------------- -------------- ------------- --------------
$ (5,260,764) $ (8,569,793) $(12,696,746) $(14,732,695)
============= ============== ============= ==============
</TABLE>
-32-
<PAGE>
US Xchange, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Subsequent Event.
On May 14, 2000, the new parent of the Company, a corporation wholly-owned
by the Company's sole member, entered into a definitive merger agreement with
Choice One Communications, Inc. (Choice One), a publicly-held company. Under
terms of the agreement, Choice One will exchange 7 million shares of its common
stock and $311 million in net cash for all of the outstanding common stock of
the Company's parent. In addition, as a condition of the merger, substantially
all of the holders of the 15% Senior Notes have agreed to a redemption price
equal to 109% of their principal amount plus accrued interest, if any, to the
closing date of the merger. Based on the price of Choice One's stock as of the
close of business on the day before the merger announcement, the merger is
valued at approximately $518 million. The merger is subject to regulatory
approvals and other customary conditions.
-33-
