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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission file number 1-10726
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WINSTAR COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
DELAWARE 13-3585278
(State of (I.R.S. Employer
Incorporation) Identification No.)
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230 PARK AVENUE
NEW YORK, NEW YORK 10169
(212) 687-7577
(Address, including zip code, and telephone number, including area code,
of registrant's executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes /X/ No/ /
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-K is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. /X/
Registrant's revenues for its most recent fiscal year: $68,000,000
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days: As of March 25, 1997, the aggregate market value of such stock was
approximately $336.6 million.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of March 25,
1997, the number of shares of Common Stock outstanding was 32,766,706.
DOCUMENTS INCORPORATED BY REFERENCE
The information required in Part III by Items 10, 11, 12 and 13 is
incorporated by reference to the Registrant's proxy statement in connection with
the annual meeting of stockholders scheduled to be held on June 30, 1997, which
will be filed by the Registrant within 120 days after the close of its fiscal
year.
EXHIBIT INDEX -- Page 35
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ITEM 1. BUSINESS
GENERAL
WinStar Communications, Inc. (the "Company") provides a full range of
telecommunications services, including local, long distance and Internet access
services, as a competitive local exchange carrier ("CLEC"). By exploiting its
fiber-quality digital capacity in the 38 GHz portion of the radio spectrum
("Wireless Fiber-TM-") and a switch-based infrastructure, the Company seeks to
distinguish itself as a facilities-based, value-added provider of high-capacity
telecommunications services to small and medium-sized businesses and an
attractive alternative to established providers, such as the regional Bell
operating companies ("RBOCs"). In October 1996, the Company began offering
switch-based local exchange services to end users in New York City and is
currently offering or introducing local exchange services on a resale basis in
11 additional major metropolitan areas. During the next several years, the
Company intends to introduce its local exchange services in each of the other
major metropolitan areas where it is licensed to provide 38 GHz services over
four or more 100 MHz channels. Over time, the Company intends to carry a
substantial majority of its local telecommunications services traffic over
Wireless Fiber and its own switched networks, unlike most fiber-based CLECs,
which typically do not carry the majority of their customer traffic over their
own networks. The Company also offers a variety of facilities-based broadband,
high-capacity local access and digital network services ("Carrier Services") to
other telecommunications services providers on a wholesale basis. As of March
25, 1997, the Company had 40 carrier customers, including, among others,
Ameritech Cellular Services, MCI Communications, Pacific Bell and Teleport
Communications.
The Company is the holder of the largest amount of 38 GHz spectrum in the
United States and is utilizing this asset to build local telephone networks for
the transmission of voice, data and video traffic in the major metropolitan
areas covered by the Company's 38 GHz licenses (the "Wireless Licenses"). The
Wireless Licenses, including the 88 licenses acquired by the Company in its
January 1997 acquisition of Milliwave Limited Partnership (the "Milliwave
Acquisition"), cover an aggregate of more than 100 cities with populations
exceeding 100,000 each, and encompass an aggregate population of approximately
172 million. The Wireless Licenses allow the Company to provide Wireless Fiber
services in 48 of the 50 most populated Metropolitan Statistical Areas ("MSAs")
in the United States. The Company has agreed to acquire an aggregate of 47
additional 38 GHz licenses in a series of transactions, subject to approval by
the Federal Communications Commission ("FCC"). Upon completion of these
acquisitions, the Company's Wireless Licenses will enable the Company to provide
services in the 50 most populated MSAs and will cover cities encompassing an
aggregate population of 180 million. Many of the Company's Wireless Licenses
allow for the provision of Wireless Fiber services over four or more channels in
a single market. The Company believes that the utilization of multiple 38 GHz
channels in a single licensed area provides it with advantages over 38 GHz
service providers that possess fewer channels, by allowing it to build out city-
wide networks of broadband capacity.
The Company has four operating units conducting business primarily through
the following wholly owned subsidiaries:
- WinStar Telecommunications, Inc. ("WinStar Telecom") is a CLEC providing
competitive local telephone service as an alternative to local telephone
companies.
- WinStar Wireless, Inc. ("WinStar Wireless") delivers the Company's Carrier
Services to long distance carriers, other competitive access providers
("CAPs"), mobile communications companies, local telephone companies,
cable television operators, Internet access providers, end users, and
other customers with broadband local telecommunications needs.
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- WinStar New Media Company, Inc. ("New Media") acquires rights to, and
distributes information services and entertainment content as a complement
to the Company's telecommunications activities.
- WinStar Global Products, Inc. ("Global Products") is a nonstrategic,
merchandising subsidiary acquired prior to the Company's entry into the
telecommunications industry , which distributes consumer products through
more than 20,000 individual retail outlets.
The Company was incorporated under the laws of the State of Delaware in
September 1990 and its principal offices are located at 230 Park Avenue, New
York, New York 10169. The Company's phone number is (212) 687-7577. Each of the
Company's principal subsidiaries is incorporated under the laws of the State of
Delaware.
TELECOMMUNICATIONS INDUSTRY OVERVIEW
The telecommunications industry is being reshaped by the deregulation of
telecommunications markets, growing demand for high-speed, high-capacity digital
telecommunications services and rapid advances in wireless technologies,
including 38 GHz-based technology. The long distance market has been opened to
competition for more than a decade and current deregulation is now allowing new
competitors to enter into the local telecommunications markets to compete with
the incumbent local exchange carriers ("LECs") in all aspects of local
telecommunications services and to offer integrated (I.E., bundled local, long
distance and other) telecommunications services. The accelerating growth of
local area networks ("LANs"), wide area networks ("WANs"), Internet services and
video teleconferencing and the ongoing revolution in microprocessor power are
significantly increasing the volume of broadband telecommunications traffic. The
convergence of these factors is creating significant opportunities for
competitive telecommunications services providers such as the Company.
GENERAL
The present structure of the telecommunications marketplace was shaped
principally by the court-directed divestiture ("Divestiture") of the Bell System
in 1984. In connection with the Divestiture, the United States was divided into
194 local access transportation areas ("LATAs") and the Bell System was
separated into a long distance carrier, AT&T, to provide long distance services
between LATAs, and seven RBOCs, including, for example, Bell Atlantic and NYNEX,
to provide local telecommunications services.
While the Divestiture facilitated competition in the long distance segment
of the telecommunications market, each LEC initially continued to enjoy a
monopoly in the provision of local telecommunications services in its respective
geographic service area. The Telecommunications Act of 1996 (the
"Telecommunications Act"), however, opens the local exchange services market to
competition on a nationwide basis. The Telecommunications Act provides for the
removal of legal barriers to competition in the local exchange market and will
permit CLECs, such as the Company, to offer, in addition to long distance and
other services, a full range of local exchange services, including local dial
tone, custom calling features and intraLATA toll services, to both business and
residential customers. It requires LECs to allow alternate carriers, such as the
Company, to interconnect with their networks and establishes additional
procompetitive obligations upon the incumbent LECs. These obligations include
allowing unbundled access to the incumbent LECs' networks, resale of local
exchange services, number portability, dialing parity, access to rights-of-way
and mutual compensation for the termination of switched local traffic. In
addition, the legislation codifies the LECs' equal access and nondiscrimination
obligations and preempts inconsistent state regulation. The Telecommunications
Act also contains certain provisions that ultimately will eliminate the
restrictions that currently prohibit the RBOCs from providing interLATA
services.
The full extent of the effects of the Telecommunications Act and certain of
the FCC's rules thereunder (the "Interconnection Order") on the Company and
other telecommunications companies is as yet unknown. The Telecommunications Act
and the Interconnection Order contain many provisions that
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require enabling regulations, many of which have not yet been promulgated, are
not yet final, or are still subject to reconsideration or appeal or both.
However, the Company believes that both competition and opportunity in the
telecommunications industry will be increased by the Telecommunications Act, as
telecommunications providers seek to enter into newly-opened markets quickly.
The Company believes that such opportunity is amplified by: (i) growing consumer
interest, especially among business users, in alternatives to their existing
carriers for improved customer service, and for more capacity in the form of
broader digital bandwidth channels to customer premises, better pricing terms
and route diversity; (ii) long distance carriers' desire to connect their long
distance networks to local origination and termination points at rates lower
than available from the incumbent LECs; (iii) a monopoly position and pricing
structure in the local exchange services market which historically has provided
little economic incentive for the incumbent LECs to upgrade their existing
networks or to provide specialized services; (iv) technological advances in data
and video services and products requiring greater transmission capacity and
reliability; (v) the rapid growth of the Internet and the corresponding increase
in demand for local access broadband circuits; and (vi) ongoing regulatory
initiatives to allow other providers of local telecommunications services to
interconnect their networks with those owned by the incumbent LECs.
38 GHZ TECHNOLOGY
An aggregate of fourteen 100 MHz channels in the 38 GHz portion of the radio
spectrum are currently allocated by the FCC in each licensed area, with certain
additional 100 MHz channels available for future licensing. Although FCC rules
specify that 38 GHz be used for point-to-point transmissions, it has not
mandated any particular commercial services for such frequency. Prior to 1993,
the 38 GHz portion of the radio spectrum remained largely unassigned for
commercial use in the United States due to, among other factors, the lack of
available technology to efficiently utilize 38 GHz for commercial purposes. In
the early 1990s, however, technology became available which allowed for the
commercial provision of wireless telecommunications links between two fixed
points. The 38 GHz portion of the radio spectrum was first used on a commercial
basis in Europe by providers of personal communications services ("PCS") for the
interconnection of their cell sites.
By early 1994, technological advances combined with growing use in Europe
led to increasing awareness of and interest in the potential uses of 38 GHz
technology in the United States. After Avant-Garde Telecommunications, Inc.
(which was acquired by the Company in July 1995 and was the original recipient
of many of the Wireless Licenses) received its initial 30 multiple-channel 38
GHz licenses in September 1993 (each license providing for four channels for an
aggregate of 400 MHz of bandwidth capacity), other entities, including several
large telecommunications companies such as Pacific Telesis, GTE and MCI
Communications, sought similar multiple-channel 38 GHz licenses for the
provision of wireless local telecommunications services. However, in September
1994, the FCC began to follow new procedures with respect to the granting of 38
GHz licenses, including limiting bandwidth capacity to a single 100 MHz channel
per licensee in a particular licensed geographic area and, in November 1995,
established a freeze on the issuance of new licenses in this spectrum pending
the outcome of a rulemaking proceeding. See "Government Regulation of
Telecommunications Operations" elsewhere in this Item 1.
Point-to-point wireless local telecommunications services can be offered in
many portions of the radio spectrum. However, 38 GHz has characteristics well
suited for the provision of local telecommunications services, including:
RAPID DEPLOYMENT OF ALTERNATIVE LOCAL INFRASTRUCTURE. 38 GHz technology
generally can be deployed considerably more rapidly than wireline (because of
permit procedures and construction time required for wireline buildout) and many
other wireless technologies (because of their infrastructure requirements and,
in many instances, the need to follow FCC frequency coordination procedures in
connection with wireless facilities).
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BROAD BANDWIDTH. The total amount of bandwidth for each 38 GHz channel is
100 MHz, which supports full broadband capability. For example, one 38 GHz DS-3
channel at 45 Mbps can transfer data at a rate which is over 1,500 times the
rate of the fastest dial-up modem currently in general use (28.8 Kbps) and over
350 times the rate of the fastest ISDN line currently in general use (128 Kbps).
Data transfer rates of a 38 GHz DS-3 channel even exceed the data transfer rates
of cable modems (30 Mbps). The broadband capacity of 38 GHz provides improved
speed and quality in transmissions, as compared to transmissions that are
carried over a "last mile" consisting of copper wire. In addition to
accommodating standard voice and data requirements, 45 Mbps data transmission
rates allow end users to receive full motion video and 3-D graphics and to
utilize highly interactive applications on the Internet and other networks.
EASE OF INSTALLATION. The equipment used for point-to-point applications in
38 GHz (i.e., antennae, transceivers and digital interface units) is typically
smaller, less obtrusive and less expensive, and uses less power than equipment
used for similar applications at lower frequencies. These characteristics make
it relatively easier to obtain the necessary rights ("Roof Rights") required to
install 38 GHz transceivers on rooftops and towers and less costly to initiate
38 GHz-based services as compared to most other wireless services.
EFFICIENT CHANNEL REUSE. Certain characteristics of 38 GHz, including the
small amount of dispersion (I.E., scattering) of the radio beam as compared to
the more dispersed radio beams produced at lower frequencies, allow for the
reuse of bandwidth capacity in a licensed area. The ability to reuse capacity
allows the 38 GHz license holder to densely deploy its 38 GHz services in a
given geographic area, provide services to multiple customers over the same 38
GHz channel, and conserve bandwidth capacity, thereby enhancing the types of
services that can be provided and increasing the number of customers to which
such services can be provided. Due to the limited dispersion characteristics of
38 GHz, numerous T-1 circuits and/or DS-3 circuits can be placed in close
proximity without interfering with each other. The Company believes that the use
of multiple 100 MHz channels allows, and in many instances is required, for
reuse where multiple DS-3 paths are being densely deployed in a given area. The
Company currently utilizes one 100 MHz channel to provide either four T-1
circuits, eight T-1 circuits or one DS-3 circuit depending on the specific radio
equipment utilized and its configuration. The specific equipment and capacity
deployed are determined by the capacity needed on each link.
38 GHz licenses have been granted by the FCC on a geographic basis and cover
areas originally defined by the applicant, allowing the license holder to
install and operate as many transmission links as can be engineered in the
entire licensed area without obtaining further approval from the FCC. This is a
significant difference from the licensing provisions applicable to most other
comparable portions of the radio spectrum (I.E., those that are used for most
other commercial point-to-point applications), many of which are licensed on a
link-by-link basis following frequency coordination. Frequency coordination is
often time consuming and problematic at frequencies lower than 38 GHz because
such frequencies are widely used and signals at such frequencies are more
dispersed. The exclusive right to use a particular channel or channels within a
broad geographic area gives the licensee much greater control and flexibility
over its network design. A 38 GHz licensee can save costs, ensure
interference-free operations and increase quality and reliability by designing
efficient 38 GHz networks in advance of their deployment.
TELECOMMUNICATIONS OPERATIONS
The Company believes that in order to effectively compete with incumbent
LECs and other telecommunications services providers in its target markets, it
must develop a core group of assets, capabilities and resources. The Company has
made substantial progress in acquiring and developing these core assets, which
include:
TRANSMISSION AND SWITCHING FACILITIES. In October 1996, the Company
initiated local switched services in New York City, utilizing its first 5ESS
switch, purchased from Lucent Technologies ("Lucent"), and
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facilities leased from NYNEX. During the next three years, the Company intends
to install Lucent switches to serve most of its major markets. The Company has
acquired the necessary Roof Rights to install its Wireless Fiber transmission
facilities on approximately 900 buildings nationally and is acquiring Roof
Rights to an additional 50 to 75 buildings per month. The Company also has
developed monitoring and management systems that will ensure the efficient use
of its networks and provide network reliability and transmission quality
equivalent to that provided by fiber-optic networks. The Company recently
completed construction of a network operating center ("NOC"), which is operating
24 hours a day, 7 days a week, and is currently building a national field
service force.
STATE AUTHORIZATIONS. The Company has obtained authorization to operate as
a CLEC in 19 states and is in the process of seeking authorization to operate as
a CLEC in a number of additional jurisdictions. The Company is authorized to
provide its local access and other Carrier Services as a CAP in 31 states and
has applications pending for such authorizations in a number of additional
jurisdictions.
SALES AND CUSTOMER SUPPORT ORGANIZATIONS. The Company is expending a
significant amount of time and capital to build a dedicated, responsive sales
and customer support organization in order to ensure that the people and systems
necessary to achieve customer satisfaction keep pace with a growing customer
base. The Company has a direct sales organization for its CLEC services,
currently consisting of more than 240 people located in 12 major cities, and a
Carrier Services sales group, currently consisting of more than 70 people.
INFORMATION SYSTEMS. The Company is investing significant capital
developing state-of-the-art information systems platforms directed toward the
accurate and flexible handling of the billing and customer satisfaction
requirements of a diverse customer base purchasing a variety of
telecommunications services. The Company believes that its information systems
allow it to provide customers with a level of service and responsiveness that
many other telecommunications services providers do not offer and that such
level of service will become a key factor in customers' choice of
telecommunications services providers as the market matures.
EXPERIENCED MANAGEMENT AND OPERATING PERSONNEL. The Company has assembled a
management team and hired operating personnel experienced in all areas of
telecommunications operations, including more than 200 former officers and
employees of MCI Communications and more than 50 former officers and employees
of Sprint Corporation, as well as officers and employees from other established
telecommunications companies. The Company plans to hire additional experienced
telecommunications marketing and operations personnel as appropriate.
STRATEGY FOR TELECOMMUNICATIONS BUSINESS GROWTH
The Company's objective is to become the full-service telecommunications
provider of choice to small and medium-sized business customers and a provider
of high-quality alternative and broadband facilities to its Carrier Services
customers. Key elements of the Company's strategy are to:
EXPAND NETWORK INFRASTRUCTURE. The Company is creating an infrastructure on
a city-by-city basis using its Wireless Fiber capabilities, switches acquired by
the Company from equipment vendors and facilities leased from other carriers to
originate and terminate traffic. Pursuant to its building-centric network plan,
the Company is identifying strategically located sites in each metropolitan area
to serve as hubs for its network. These hub sites will be connected via Wireless
Fiber links to end users. The Company believes that a limited number of hub
sites (generally less than a dozen) in each metropolitan area will allow it to
address more than 70% of its targeted customers' buildings and to carry the
majority of its customers' traffic on its own network instead of the higher cost
facilities of other carriers.
EXPLOIT FIRST-TO-MARKET ADVANTAGES. The Company seeks to capitalize on the
significant opportunities emerging in the industry as a result of the
Telecommunications Act by exploiting a "first-to-market"
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advantage as one of the few holders of 38 GHz licenses with an established
operating and management infrastructure. The Company believes that its early
entrance into its markets provides it with advantages over many potential
competitors by allowing it to: (i) establish a customer base prior to widespread
competition from other CLECs; (ii) develop a proven, reliable network
infrastructure using its own switching capacity ahead of many other CLECs; (iii)
develop pioneering expertise in the utilization of 38 GHz for the delivery of
telecommunications services and the design and management of 38 GHz-based
networks; and (iv) acquire Roof Rights to place its 38 GHz antennae on a large
number of buildings on favorable terms and in advance of other wireless service
providers.
FOCUS ON SMALL AND MEDIUM-SIZED BUSINESS CUSTOMERS. The Company believes
there exists a substantial opportunity to attract a base of small and
medium-sized business customers by providing superior customer service and sales
support. The customer base initially targeted by the Company consists of
businesses typically located in buildings that have more than 100,000 square
feet of commercial space and which, in many instances, are not served by CLECs
or CAPs. The Company estimates that there are more than 8,000 buildings in this
target group, populated by approximately 9.7 million workers using more than 2.1
million phone lines. Over time, the Company intends to expand its target
customer base to include the majority of small and medium-sized businesses in
the metropolitan areas covered by the Wireless Licenses, which the Company
estimates contain approximately 60% of all such businesses in the United States
and represent a market opportunity in excess of $30 billion per year.
MARKET WIRELESS FIBER TO OTHER CARRIERS. The Company markets its Carrier
Services to other carriers such as the RBOCs and other LECs, interexchange
carriers ("IXCs"), other CAPs and CLECs, providers of PCS and cellular and
specialized mobile radio services ("CMRS") providers. The Company believes that
its Carrier Services present an attractive, economical method for
telecommunications services providers to add a high-capacity extension to their
own networks and service territories, especially as they seek to rapidly
penetrate new markets opening as a result of the Telecommunications Act. The
Company's Carrier Services can also provide cost-efficient route diversity where
network reliability concerns require multiple telecommunications paths.
Since the commercial introduction of the Company's Carrier Services in
October 1995, the number of carrier customers has increased significantly. Such
customers include Ameritech Cellular Services, AT&T Wireless, Bell
Atlantic/NYNEX Mobile, Brooks Fiber, Cellular One, PrimeCo Personal
Communications, Siemens Stromberg-Carlson, Teleport Communications and Western
Wireless. In addition, the Company has entered into multi-year master service
agreements with American Communications Services, Electric Lightwave, IntelCom,
MCI Communications and Pacific Bell. These agreements establish the framework
under which such companies may effect the integration of Wireless Fiber services
into their own telecommunications networks. The Company is in the process of
negotiating additional master service agreements with other large
telecommunications providers, including AT&T.
MARKET WIRELESS FIBER SERVICES AS A SOLUTION TO GROWING CAPACITY
SHORTAGES. The Company believes that demand for its Wireless Fiber-based CLEC
and Carrier Services will grow because of the expanding volume of data
communications traffic resulting from increasing Internet usage and other
high-volume data transmission requirements. This type of traffic increasingly
requires high-capacity, end-to-end networks that are often difficult to provide
economically with older RBOC and LEC infrastructure.
PROVIDE INFORMATION AND CONTENT SERVICES. The Company believes that the
ability to deliver information and other content will become an increasingly
important factor in the choice of a telecommunications provider by businesses as
competition increases and the markets covered by the Wireless Licenses mature.
Accordingly, the Company actively seeks opportunities to utilize its information
and content services to enhance the marketability of the Company's
telecommunications services.
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TELECOMMUNICATIONS SERVICES
The Company commenced marketing its local exchange services in New York City
in April 1996 on a resale basis and began providing switch-based services in New
York City in October 1996. The Company is currently introducing its CLEC
services on a resale basis in eleven additional cities: Atlanta, Boston,
Chicago, the District of Columbia, Hartford, Los Angeles, Milwaukee,
Philadelphia, San Diego, San Francisco and Stamford. Since late 1994, the
Company also has focused on the development and marketing of its Wireless
Fiber-based Carrier Services. After an initial market-education phase, in which
the Company demonstrated the efficacy and reliability of its Wireless Fiber
services, principally through the use of field demonstrations and the
installation of Wireless Fiber links on a trial basis, the Company began
receiving orders for its Carrier Services in 1995.
WIRELESS FIBER
The Company utilizes its Wireless Fiber capacity in connection with its
Carrier Services and as an integral component of its CLEC facilities for the
origination and termination of local traffic and hubbing of switch sites and
other facilities accessed by the Company.
WIRELESS FIBER LINKS. Each Wireless Fiber link currently provides up to
eight T-1s of capacity (equivalent to 192 voice lines) or one DS-3 of capacity
(equivalent to 672 voice lines). The Company believes that with future
developments in 38 GHz technology there will be substantial increases in the
capacity of each Wireless Fiber link. The Company's Wireless Fiber links meet or
exceed general telephone industry standards, provide transmission quality
equivalent to that produced by fiber optic-based facilities, and address the
growing demand for high-speed, high-capacity, digital telecommunications
services for voice, data and video applications, including traditional local
access, Internet access and network interconnection services.
Each Wireless Fiber path consists of transmission links, which are paired
digital millimeter wave radio transceivers placed at a distance of up to five
miles from one another within a direct, unobstructed line of sight. The
transceivers are typically installed on rooftops or towers or in windows. The
transceivers currently used by the Company are primarily the Tel-Link 38 Radio
Systems supplied by P-Com, Inc. ("P-Com") pursuant to a four-year nonexclusive
supply agreement ("Tel-Link Agreement") executed in November 1994, which may be
terminated by the Company upon 90 days' notice to P-Com (subject to certain
liquidated damages provisions if certain purchase minimums are not met). The
Tel-Link Agreement includes provisions whereby the Company pays a higher price
per link at the beginning of the contract period, with the excess recoverable by
the Company in the form of significantly discounted links once certain volume
levels have been achieved. The contract also stipulates certain minimum annual
volume levels which must be met in order to maintain the agreed upon pricing
structure. The Company has entered into an amendment to the Tel-Link Agreement
with P-Com, pursuant to which the requirements for volume discount pricing were
revised. The Company has not yet qualified for significant volume discounts. The
amendment also added another year to such term, reduced the purchase commitment
provisions upon termination, and revised the type of Tel-Links to be provided by
P-Com such that a greater proportion of higher capacity transceivers (including
DS-3 capable transceivers) will be delivered under the agreement.
Significant features of the Company's Wireless Fiber services include: (i)
38 GHz digital millimeter wave transmissions having narrow beam width, reducing
the potential for channel interference; (ii) 100 MHz bandwidth in each channel,
allowing for high subdivision of voice and data traffic; (iii) a range of up to
five miles between transmission links; (iv) performance engineered to provide up
to 99.999% reliability, as tested; (v) transmission accuracy engineered to
provide bit error rates of 10 (unfaded); (vi) 24-hour network monitoring by the
Company's and Lucent's NOCs; (vii) optional safeguards from link outages by
installation of hot standbys that remain powered up and switch "on-line" if the
primary link fails;
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(viii) optional forward error correction ensuring the integrity of transmitted
data over Wireless Fiber paths; and (ix) relatively low cost (installed) for
each pair of transceivers comprising a transmission link.
In August 1995, the Company entered into a three-year service contract with
Lucent, pursuant to which Lucent has agreed to provide site survey,
installation, maintenance and network management services for the Company's
Wireless Fiber services 24 hours a day, 7 days a week, as required. The Company
also is in the process of expanding its own installation, maintenance and
network management capabilities, which expansion includes the hiring of
qualified personnel, the development of management and operating systems, and
the recently completed construction of a modern, state-of-the-art NOC, which is
operating 24 hours a day, 7 days a week. Transmission links in the Company's
Wireless Fiber paths are connected via dial-up modems to the NOCs. The NOCs
provide the Company with points of contact for network monitoring,
troubleshooting and dispatching repair personnel in each MSA. The NOCs provide a
wide range of network surveillance functions for each Wireless Fiber path,
providing the Company with the ability to remotely receive data regarding the
diagnostics, status and performance of its transmission links.
In order to provide quality transmission, Wireless Fiber services require an
unobstructed line of sight between two transceivers comprising a link, with a
maximum distance between any two corresponding transceivers of up to five miles
(or shorter distances in certain areas; as weather conditions may necessitate
distances as short as 1.1 miles between transceivers to maintain desired
transmission quality). The areas in which such shorter distances are required
are those where rainfall intensity and the size of the raindrops adversely
impact transmission quality at longer distances. Other weather conditions, such
as snow, electrical storms and high winds, have not, in the Company's
experience, affected Wireless Fiber services. The establishment of Wireless
Fiber may require additional transceivers to triangulate around obstacles (such
as buildings). Similarly, to establish Wireless Fiber services covering a
distance in excess of five miles or to establish a system of interconnected hub
sites, additional transceivers are required to establish a chain whose links are
no more than five miles apart at any given point. The cost of additional
transceivers where required by weather, physical obstacles or distance may
render the provision of Wireless Fiber services uneconomical in certain
instances.
The Company must obtain Roof Rights for each building where a transceiver
will be placed. The Company's prequalification activities often require the
payment of option fees for the buildings that are being prequalified. In
connection with the development of its Wireless Fiber capacity for both its
Carrier Services and CLEC businesses, the Company has been following a plan
pursuant to which it seeks to negotiate, prior to receipt of actual service
orders, Roof Rights for the installation of Wireless Fiber links on buildings
specifically identified by existing and potential customers in the metropolitan
areas covered by the Wireless Licenses, including buildings that can provide
interconnection access to IXCs' points of presence ("POPs"), switch locations
and local access nodes. As part of the Company's acquisition ("Locate
Acquisition") in 1996 of Local Area Telecommunications, Inc. ("Locate"), the
Company gained roof access to a number of buildings, including the World Trade
Center and other key sites in New York City, which the Company anticipates using
in its Carrier Services and CLEC operations.
WIRELESS LICENSES. The Company recently completed the acquisition of the
Milliwave Limited Partnership. As a result of the Milliwave Acquisition, the
Company obtained 88 channels of 38 GHz capacity, each providing for 100 MHz of
bandwidth ("Milliwave Licenses"). The Milliwave Licenses allow for the provision
of service in more than 80 major markets. The cities covered by the Milliwave
Licenses include many that were already serviceable by the Company under its
existing Wireless Licenses, such as Boston, Chicago, Dallas, Los Angeles and New
York, thus increasing the Company's aggregate bandwidth capacity in each such
city. The Milliwave Licenses also cover many cities that were not previously
serviceable by the Company under its existing Wireless Licenses, such as
Honolulu, Nashville, Orlando, Raleigh/Durham and Rochester (New York). In 1996,
the Company also consummated the Locate Acquisition, acquiring the assets
comprising Locate's business as a CAP providing microwave-based local access
services to corporations and long distance and other common carriers. Among
Locate's key assets are two 38 GHz licenses, each providing 100 MHz of
bandwidth, for the New York City metropolitan area, including Long Island
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and Northern New Jersey. As part of the Locate Acquisition, the Company also
acquired from Locate certain licenses for the provision of point-to-point
services in other portions of the radio spectrum, including, among others, 10,
12, 16 and 18 GHz.
The Wireless Licenses allow the Company to provide Wireless Fiber services
in the 47 of the 50 most populated MSAs in the United States, which include more
than 100 cities with populations exceeding 100,000 each and encompass an
aggregate population of almost 172 million people. The Company has the largest
aggregate amount of 38 GHz bandwidth capacity in the United States. The Wireless
Licenses (including those acquired in the Milliwave and Locate Acquisitions)
allow for the provision of Wireless Fiber services over four or more channels in
the following cities:
<TABLE>
<S> <C> <C>
New York--Manhattan Boston Milwaukee
New York--West (NJ) Atlanta Cincinnati
New York--Long Island Houston Pittsburgh
Los Angeles Miami St. Louis
Chicago Cleveland Kansas City
Philadelphia Minneapolis-St.Paul Buffalo
Dallas Baltimore Spokane
San Francisco Seattle San Diego
Detroit Phoenix Tampa
Washington Denver Tacoma
</TABLE>
The Wireless Licenses also allow for the provision of Wireless Fiber
services over multiple channels in ten additional cities and a single channel in
53 additional cities.
The Wireless Licenses have been granted or acquired since September 1993.
The FCC's current policy is to align the expiration dates of all outstanding 38
GHz licenses such that all such licenses mature concurrently and then to renew
all such licenses for a matching period. The initial term of all currently
outstanding 38 GHz licenses, including the Wireless Licenses, expires in
February 2001. While the Company believes that all of its Wireless Licenses will
be renewed, based upon FCC custom and practice establishing a presumption in
favor of licensees that have complied with their regulatory obligations during
the initial license period, there can be no assurance that any Wireless License
will be renewed upon expiration of its initial term.
The Company has signed agreements with a number of licensees to acquire an
aggregate of 47 additional 38 GHz licenses and associated business operations,
including 15 channels in the 50 most populated MSAs in the United States. Upon
completion of the acquisitions, which are subject to approval by the FCC, the
Company's total population coverage will grow to approximately 180 million, its
total channel pops will grow to approximately 650 million, and the Company will
have Wireless Licenses in 49 of the 50 most populated MSAs in United States
markets. The total purchase price for the licenses will be approximately $16.0
million, payable in shares of the Company's Common Stock, priced at the time of
each closing or in cash at the Company's option, if the market price of the
Common Stock is less than $16 per share.
CLEC AND LONG DISTANCE SERVICES
An integral part of the Company's telecommunications business strategy is
the creation of a Wireless Fiber-based infrastructure on a city-by-city basis
that will allow the Company to provide a broad range of communications services
within cities covered by the Wireless Licenses. The Company believes that its
Wireless Fiber capabilities will provide it with a critical economic advantage
over many other service providers because of the high costs such service
providers encounter in connecting fiber-optic lines to end users.
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CLEC SERVICES. In October 1996, the Company initiated local switched
services in New York City, utilizing its first 5ESS switch, purchased from
Lucent, and facilities leased from NYNEX. The Company currently intends to
install, during the next three years, switches provided by Lucent to service
most of its major markets. In July 1996, the Company entered into a three-year
agreement with Lucent providing for the purchase of the switching systems and
related equipment and software the Company will need to build its CLEC
infrastructure. Switches will be provided to the Company at discounted prices so
long as the Company purchases a minimum number of switches during each year of
the agreement.
The Company has commenced a program designed to obtain, by the end of 1999,
authorization to operate as a CLEC in virtually every state where the Company
has Wireless Licenses, which will allow the Company to file tariffs and provide
local exchange services in such states once authorization is granted. The
Company currently is authorized through state-specific subsidiaries as a CLEC in
California, Colorado, Connecticut, the District of Columbia, Florida, Georgia,
Illinois, Maryland, Massachusetts, Michigan, Minnesota, New Jersey, New York,
Ohio, Pennsylvania, Tennessee, Texas, Utah, Virginia, Washington and Wisconsin,
is in the process of seeking authorization to operate as a CLEC in several
additional states, and intends to seek such authorization in a number of
additional states. The Company has never had an application for CLEC
authorization denied. The Company has entered into a number of interconnection
agreements with carriers in states that encompass various cities covered by the
Wireless Licenses. These agreements are with carriers such as Ameritech Corp.
for Illinois and Michigan, Pacific Bell for California, Southwestern Bell for
Texas, GTE for California and Tampa, Florida, NYNEX for New York and
Massachusetts, Bell South for Florida, Georgia and Tennessee and Bell Atlantic
for Pennsylvania, Maryland, the District of Columbia, New Jersey and Virginia
and Southern New England Telephone for Connecticut. It also is in the process of
negotiating additional interconnection agreements with various local exchange
service providers, including incumbent LECs.
In connection with the plan to build its CLEC networks on a city-by-city
basis, the Company is hiring numerous engineering, installation, maintenance,
customer service and marketing and sales personnel in order to create a direct
sales organization which will provide a high level of service to the small and
medium-sized business and multiple-dwelling residential market. A sales force
has been deployed in New York and in eleven other cities, and the Company
currently plans to have a sales force in all metropolitan areas covered by the
Wireless Licenses by the end of 1999. The Company also is developing joint
marketing, reselling and agency relationships. For example, pursuant to an
agreement ("Digex Agreement") with Digex, Inc., a provider of Internet access
services to businesses ("Digex"), the Company will purchase from Digex, during
the next six years, a minimum of $5 million of Internet services with the right
to purchase additional amounts on a discounted basis. The Company will resell
these Internet services under the Company's own brand name, including through
the bundling of such services with the Company's other telecommunications
services.
The Company seeks to make its CLEC business an attractive choice for
potential customers by (i) offering a broad range of telecommunications services
that specifically address its target customers' needs, while providing levels of
customer satisfaction that exceed those provided by larger competitors and (ii)
exploiting the Company's Wireless Fiber service whenever feasible for
cost-effective origination and termination of customer traffic, thereby allowing
for attractive pricing of services.
LONG DISTANCE SERVICES. As a complement to its CLEC services, the Company
offers its business customers long distance services on a resale basis through
agreements with major long distance carriers (MCI Communications and U.S. Long
Distance) which allow it to utilize their networks. In addition to providing
basic long distance service, the Company is able to provide toll-free services,
international call-back, prepaid phone cards and certain enhanced services.
The Company's agreements with certain major long distance carriers are for
one- to four-year terms and provide the Company with access to long distance
carriers' networks at rates which are typically discounted, varying with monthly
traffic generated by the Company through each carrier. Generally, the
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Company is obligated to generate certain minimum monthly usage through each
network and, if such traffic is less than the minimum monthly usage commitment,
may be required to pay an underutilization fee in addition to its monthly bill
equal to a certain percentage of the difference between such minimum commitments
and the traffic actually generated by the Company. The Company has never paid or
been required to pay any underutilization charges. During 1995, the Company
established a reserve for possible underutilization charges.
The Company continues to provide long distance services to its existing
residential customers, though it no longer actively markets such services to
that segment of the market, except through certain established affinity
programs. As a result of this change in focus, the Company's residential long
distance customer base has and will continue to decrease due to attrition.
CARRIER SERVICES
The Company markets and provides wireless broadband, high-capacity local
access and other network services primarily to other carriers. Utilizing its
Wireless Licenses, the Company offers numerous wireless telecommunications
services to support a wide range of local access and dedicated service needs
with a high degree of reliability. The technology and service applications in
this field are evolving rapidly, and the Company believes that its Wireless
Fiber service offerings will expand over time to include a broad range of voice,
data and video applications. The Company currently offers its Carrier Services
for the following applications, among others:
LOCAL BY-PASS FOR LONG DISTANCE CARRIERS. Long distance carriers can
utilize the Company's Wireless Fiber services to connect certain call
termination or origination points in a particular licensed area to such
carriers' POPs in the licensed area at more economical rates than those
generally charged by LECs and to connect two or more of their respective POPs in
a single licensed area. Long distance carriers using Wireless Fiber services may
benefit from both the lower cost afforded by such services and the wide-band
capacity compared to LEC facilities, which, in many instances, are based in part
on copper infrastructure and are, therefore, narrow-band. By utilizing the
Company's Wireless Fiber services, long distance carriers can avoid the capacity
barrier inherent in copper wire connections that typically has prevented them
from providing their customers with end-to-end, full digital service available
under a fiber-optic or wireless-based system. Wireless Fiber services also may
be utilized to provide such carriers with viable, cost-efficient paths to serve
as physically diverse routes (redundant and back-up capacity) for traffic in
situations where primary routes are incapacitated and/or network reliability
concerns demand alternate telecommunications paths.
WIRELESS COMPLEMENT TO CAP AND LEC NETWORKS. CAPs typically compete with
LECs by utilizing their own fiber-optic cable rings and leasing the other
facilities necessary to complete their networks from the LECs. Due to the large
capital investment required to construct such networks, CAPs generally build
their networks in limited, densely populated areas and offer services primarily
to large customers such as long distance carriers, medium-sized and large
businesses, government agencies and institutions. CAPs can utilize Wireless
Fiber services to bypass facilities typically leased by them from the LECs. CAPs
also can utilize the Company's Wireless Fiber services to facilitate the
buildout and enhance the reliability of their own local telecommunications
networks and expand their marketing opportunities. The Company believes that the
relative ease and low cost of installation of Wireless Fiber services in
comparison to fiber-optic facilities can provide CAPs with the ability to expand
their networks to reach some customers in areas where demand levels are
insufficient to justify the cost and time involved in constructing fiber-optic
capacity. CAPs, as well as LECs, also can use the Company's Wireless Fiber
services to extend their own networks to provide services to areas within a
licensed area to which it is not cost-efficient to run fiber-optic cable or to
which such cable simply has not yet been run. CAPs and LECs also may utilize the
Company's Wireless Fiber services to provide redundant and back-up capacity to
their own existing networks.
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BACKBONE INTERCONNECTION AND REDUNDANCY FOR CMRS PROVIDERS. Wireless Fiber
services can be utilized by providers of mobile telecommunications services,
such as PCS, cellular and specialized mobile radio carriers, for interconnecting
traffic (backbone network traffic) between and among cell sites, repeaters and
the wired local networks. The Company also anticipates that entities that
acquired licenses in the PCS auctions or which will acquire licenses in
subsequent PCS auctions conducted by the FCC also will find Wireless Fiber
services attractive to carry their backbone network traffic. By utilizing
Wireless Fiber services for their backbone network needs, CMRS carriers can
maintain greater control over their systems by monitoring traffic carried over
the Wireless Fiber services component of their systems, reduce costs of
construction of their networks, increase the flexibility of their services and
reduce the lead time involved in the provision of services in their respective
licensed areas. Wireless Fiber services also can be used by CMRS carriers to
provide redundant and back-up capacity for the fiber-optic and/or copper wire
portions of their backbone networks.
DEDICATED PRIVATE NETWORK SERVICES. The Company also markets its Wireless
Fiber services to businesses, government agencies and institutions with multiple
locations within the Company's licensed areas and which generate heavy
telecommunications traffic between such locations. These entities can utilize
Wireless Fiber services to establish their own independent telecommunications
systems for dedicated private network services. Wireless Fiber services present
entities with: (i) a method for providing telecommunications connections between
their buildings on a cost-effective basis; (ii) a viable alternative to the
LECs' networks that frequently use low-capacity copper wire for "last mile"
delivery, generally allowing for faster, more reliable data transmissions; (iii)
greater control over their local telecommunications traffic and costs; and (iv)
greater security because of the private line nature of the Company's Wireless
Fiber services.
NETWORK AND INTERNET ACCESS. The ability to access and distribute
information quickly has become critical to business and government end users.
Data traffic is becoming an increasing portion of overall telecommunications
traffic because of the proliferation of LANs, WANs, Internet services and video
teleconferencing. The Company's Wireless Fiber capacity enables it to provide
high-speed data transmission services to end users.
WAN SERVICES. The Company recently introduced dedicated WAN services. The
Company's high-speed data telecommunications services permit businesses to
transport data between buildings and between personal computers or workstations.
These dedicated services allow personal computers and workstations on one LAN to
communicate with personal computers and workstations on another LAN at the same
speed at which these LANs operate. The Company's WAN services are offered at a
variety of capacities to allow customers to choose the level which meets their
needs.
INTERNET SERVICES. The expanding demand for Internet access and the growing
importance of audio, video and graphic Internet applications to both businesses
and consumers also has created a growing market opportunity for the Company. The
Company can offer Internet service providers timely, reliable and affordable
access at high-speed data rates. The Company can provide wireless broadband
links between customers and their Internet service providers and between
Internet service providers' POPs and the Internet backbone. In June 1996, the
Company entered into an agreement ("Digex Agreement") with Digex, Inc., a
provider of Internet access services to businesses ("Digex"), pursuant to which
the Company will purchase Internet services on a discounted basis from Digex
during the next six years. The Company will resell these Internet services under
the Company's own brand name, including through the bundling of such services
with the Company's other telecommunications services. The Company is actively
pursuing relationships with other Internet service providers. Pursuant to the
Digex Agreement, the Company also has the right of first refusal to provide
Digex's local access and/or customer interconnection requirements.
POTENTIAL INTERACTIVE VIDEO APPLICATIONS. The inherent qualities of 38 GHz
also may offer substantial opportunities for broadband interactive video
applications appropriate for highly customized commercial demands. While the
specific service offerings using 38 GHz technology for video applications are
still in
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development, the ability to commercially utilize certain aspects of this
technology appears to be possible. The narrow-beam characteristics of 38 GHz
technology, allowing for frequency reuse within a small area, coupled with its
broadband capacity and multichannel capabilities may offer a significant market
opportunity in the future as the appropriate technologies emerge, although there
can be no assurance of the consumer acceptance or commercial viability of such
video services. In June 1996, the Company entered into an agreement with Source
Media, Inc. ("Source Media") a provider of interactive technology and
programming. Pursuant to this agreement, the Company has the exclusive right, in
the 38 GHz spectrum, to use Source Media's technology and programming in
connection with entertainment and information services the Company may offer.
ADVERTISING AND MARKETING OF TELECOMMUNICATIONS SERVICES
CLEC AND LONG DISTANCE SERVICES
Over the next three years, the Company intends to market its
telecommunications services in substantially all markets covered by its Wireless
Licenses through direct sales, alternative sales channels television, print and
other media. The Company introduced its first series of television commercials
and print advertising in the New York City market in November 1996 and intends
to utilize media advertising campaigns in each market in which it commences
offering its CLEC services, including broadcast media in specific major markets.
The Company is targeting small and medium-sized businesses, especially those
in buildings in which the Company's Wireless Fiber capacity can be utilized, for
economic competitive advantage, to originate and/or terminate customers' local
telecommunications traffic.
The Company also intends to market its services to residences in
multiple-dwelling units, such as apartment buildings to enter into the
residential segment of the local exchange services market primarily by entering
into partnerships and agency arrangements with shared tenant services providers
and possibly partnerships or alliances with other telecommunications services
providers.
Consistent with its telecommunications marketing strategy of emphasizing
small and medium-sized business customers, the Company has, among other things,
introduced products and services readily marketable to business long distance
customers, including prepaid phone card services and a broad array of toll-free
services, including services which allow toll-free calls to be originated
nationwide. The Company also offers business customers several flexible billing
services such as master account billing (which enables customers to aggregate
billing for several locations for management and accounting purposes and to
qualify for volume discounts), project accounting codes (which reflect
accounting codes of the customer on the billing statement) and computerized call
detail reports (which provide call detail to customers on computer disks or tape
for direct input into the customer's computer for accounting or rebilling).
CARRIER SERVICES
The Company began marketing its Wireless Fiber services in December 1994.
Wireless Fiber services currently are marketed by the Company primarily to long
distance carriers, CAPs, CMRS providers and LECs, as well as businesses,
government agencies and institutions. The Company also recently began to provide
Wireless Fiber services to The City of New York as a back-up disaster recovery
system for certain of its facilities, providing the city with redundancy in the
event that its land-based telecommunications service fails for any reason.
The Company currently markets or intends to market its Carrier Services: (i)
by performing field demonstrations and testing of Wireless Fiber services; (ii)
by providing potential customers with Wireless Fiber services at reduced rates,
in order to educate such customers about the efficacy and reliability of such
services; (iii) by appearing at trade shows and advertising in trade
publications; (iv) through national sales
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agents and direct sales; and (v) directly to existing and potential customers of
the Company's other telecommunications services.
COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY
LOCAL TELECOMMUNICATIONS MARKET
The local telecommunications market is intensely competitive for newer
entrants and currently is dominated by the RBOCs and LECs. The Company has been
marketing local access and other Carrier Services only since December 1994 and
local exchange services as a CLEC only since April 1996, and the Company has not
obtained significant market share in any of the areas where it offers such
services, nor does it expect to do so given the size of the local
telecommunications services market, the intense competition and the diversity of
customer requirements. In each area covered by the Wireless Licenses, the
services offered by the Company compete with those offered by the LECs, such as
the RBOCs, which currently dominate the provision of local services in their
markets. The LECs have long-standing relationships with their customers, have
the potential to subsidize competitive services with revenues from a variety of
business services and benefit from existing state and federal regulations that
currently favor the LECs over the Company in certain respects. While legislative
and regulatory changes have provided increased business opportunities for
competitive telecommunications providers such as the Company, these same
decisions have given the LECs increased flexibility in their pricing of
services. This may allow the LECs to offer special discounts to the Company's
and other CLECs' customers and potential customers. Further, as competition
increases in the local telecommunications market, general pricing competition
and pressures will increase significantly. As LECs lower their rates, other
telecommunications providers will be forced by market conditions to charge less
for their services in order to compete.
In addition to competition from the LECs, the Company also faces competition
from a growing number of new market entrants, such as other CAPs and CLECs,
competitors offering wireless telecommunications services, including leading
telecommunications companies, such as AT&T Wireless, future satellite-based
providers such as Iridium and Teledesic, and other entities that hold or have
applied for 38 GHz licenses or which may acquire such licenses or other wireless
licenses, including those in comparable bands such as 28 GHz and 18 GHz, from
others or from the FCC. There is at least one other CAP and/or CLEC in each
metropolitan area covered by the Company's Wireless Licenses, including, in many
such areas, companies such as IntelCom, MCI Communications, MFS Communications,
Teleport Communications and Time Warner. Many of these entities (and the LECs)
already have existing infrastructure which allows them to provide local
telecommunications services at potentially lower marginal costs than the Company
currently can attain and which could allow them to exert significant pricing
pressure in the markets where the Company provides or seeks to provide
telecommunications services. In addition, many CAPs and CLECs have acquired or
plan to acquire switches so that they can offer a broad range of local
telecommunications services.
The Company currently also faces competition from other entities which
offer, or are licensed to offer, 38 GHz services, such as Advanced Radio
Telecommunications ("ART"), and BizTel, Inc. The Company also could face
competition in certain aspects of its existing and proposed businesses from a
number of competitors providing wireless services in other portions of the radio
spectrum, such as CellularVision USA, a provider of wireless television services
which, in the future, also may provide wireless Internet access and other local
telecommunications services, and Associated Communications, a potential provider
of wireless CAP and other services. In many instances, these service providers
hold 38 GHz licenses or licenses for other frequencies (such as 2, 18 and 28
GHz) in geographic areas which encompass or overlap the Company's market areas.
Additionally, some of these entities enjoy the substantial backing of, or
include among their stockholders, major telecommunications entities, such as
Ameritech with respect to ART and Teleport Communications with respect to
BizTel. Due to the relative ease and speed of deployment of 38 GHz and some
other wireless-based technologies, the Company could face intense price
competition from these and other wireless-based service providers. Furthermore,
the
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Notice of Proposed Rulemaking ("NPRM") issued by the FCC contemplates an auction
of the lower 16 channels in the 38 GHz spectrum band, which have not been
previously available for commercial use. The grant of additional licenses by the
FCC in the 38 GHz band, or other portions of the spectrum with similar
characteristics (such as 2, 18 and 28 GHz), as well as the development of new
technologies, could result in increased competition. The Company believes that,
assuming the adoption of the NPRM as currently proposed, additional entities
having greater resources than the Company could acquire licenses to provide 38
GHz services or comparable services utilizing other bands such as 28 GHz and 18
GHz. In March 1997, the FCC released an order pursuant to which it stated its
intention to license up to 1.3 GHz of spectrum in the 28 GHz band in each of 492
separate markets throughout the United States. The Company anticipates that, in
the absence of litigation to stay this order, these licenses will be issued
pursuant to auctions which may occur as early as the second half of 1997.
The Company also may face competition from cable companies, electric
utilities, LECs operating outside their current local service areas and long
distance carriers in the provision of local telecommunications services. The
great majority of these entities provide transmission services primarily over
fiber-optic, copper-based and/or microwave networks, which, unlike the Company's
Wireless Fiber services, enjoy proven market acceptance for the carriage of
telecommunications traffic. Moreover, the consolidation of telecommunications
companies and the formation of strategic alliances within the telecommunications
industry, which are expected to accelerate as a result of the passage of the
Telecommunications Act, could give rise to significant new or stronger
competitors to the Company. There can be no assurance that the Company will be
able to compete effectively in any of its markets.
The Company's Internet services also are likely to face significant
competition from other Internet service providers as well as from cable
television operators deploying cable modems, which provide high-speed data
capability over installed coaxial cable television networks. Although cable
modems currently are not widely available and do not provide for data transfer
rates that are as rapid as those which can be provided by Wireless Fiber
services, the Company believes that the cable industry may support the
deployment of cable modems to residential cable customers through methods such
as price subsidies. Notwithstanding the cable industry's interest in rapid
deployment of cable modems, the Company believes that in order to provide
broadband capacity to a significant number of business and government users,
cable operators will be required to spend significant time and capital in order
to upgrade their existing networks to a more advanced hybrid fiber coaxial
network architecture. However, there can be no assurance that cable modems will
not emerge as a source of competition to the Company's Internet business.
Further, Internet access services based on existing technologies such as ISDN
and, in the future, on such technologies as ADSL and HDSL will likely provide
additional sources of competition to the Company's Internet access services.
Additionally, the Company believes that many LECs and CLECs already are
promoting other Internet access services.
LONG DISTANCE MARKET
The long distance market has relatively insignificant barriers to entry,
numerous entities competing for the same customers and a high (and increasing)
average churn rate as customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. The Company competes with major carriers such as AT&T, MCI
Communications and Sprint, as well as other national and regional long distance
carriers and resellers, many of whom own substantially all of their own
facilities and are able to provide services at costs lower than the Company's
current costs since the Company generally leases its access facilities. The
Company believes that the RBOCs also will become significant competitors in the
long distance telecommunications industry for certain types of services and that
Internet service providers also will compete in this market. The Company
believes that the principal competitive factors affecting its market share are
pricing, customer service, accurate billing, clear pricing policies and, to a
lesser extent, variety of services. The ability of the Company to compete
effectively will depend upon its ability to maintain high-quality, market-driven
services at prices generally perceived to be
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equal to or below those charged by its competitors. To maintain its competitive
posture, the Company believes that it must be in a position to reduce its prices
in order to meet reductions in rates, if any, by others. Any such reductions
could adversely affect the Company. In addition, LECs have been obtaining
additional pricing flexibility. This may enable LECs to grant volume discounts
to larger long distance companies, which also would put the Company's long
distance business at a disadvantage in competing with larger providers.
GOVERNMENT REGULATION OF TELECOMMUNICATIONS OPERATIONS
The Company's telecommunications services are subject to varying degrees of
federal, state and local regulation. Generally, the FCC exercises jurisdiction
over all telecommunications services providers to the extent such services
involve the provision of jurisdictionally interstate or international
telecommunications, including the resale of long distance services, the
provision of local access services necessary to connect callers to long distance
carriers, and the use of electromagnetic spectrum (I.E., wireless services).
With the passage of the Telecommunications Act, the FCC's jurisdiction has been
extended to include certain interconnection and related issues that
traditionally have been considered subject primarily to state regulation. The
state regulatory commissions retain nonexclusive jurisdiction over the provision
of telecommunications services to the extent such services involve the provision
of jurisdictionally intrastate telecommunications. Municipalities also may
regulate limited aspects of the Company's business by, for example, imposing
zoning requirements or permit right-of-way procedures, and certain taxes or
franchise fees.
The Telecommunications Act is intended to remove the formal barriers between
the long distance and local telecommunications services markets, allowing
service providers from each market (as well as providers of cable television and
other services) to compete in all communications markets. The Telecommunications
Act will permit the RBOCs to compete in the provision of interLATA long distance
services. Additionally, the FCC must promulgate new regulations over the next
several years to address mandates contained in the Telecommunications Act, which
may change the regulatory environment significantly. The Telecommunications Act
generally requires LECs to provide competitors with interconnection and
nondiscriminatory access to the LEC network on more favorable terms than have
been available in the past. However, such interconnection and the terms thereof
are subject to negotiations with each LEC, which may involve considerable
delays, and may not necessarily be obtained on terms and conditions that are
acceptable to the Company. In such instances, although the Company may petition
the proper regulatory agency to arbitrate disputed issues, there can be no
assurance that the Company will be able to obtain acceptable interconnection
agreements.
The Company is unable to predict what effect the Telecommunications Act will
have on the telecommunications industry in general and on the Company in
particular. No assurance can be given that any regulation will broaden the
opportunities available to the Company or will not have a material adverse
effect on the Company and its operations. Further, there can be no assurance
that the Company will be able to comply with additional applicable laws,
regulations and licensing requirements or have sufficient resources to take
advantage of the opportunities which may arise from this dynamic regulatory
environment.
As required by the Telecommunications Act, in August 1996 the FCC adopted
the Interconnection Order. These rules constitute a procompetitive, deregulatory
national policy framework designed to remove or minimize the regulatory,
economic and operational impediments to full competition for local services,
including switched local exchange service. Although setting minimum uniform
national rules, the Interconnection Order also relies heavily on states to apply
these rules and to exercise their own discretion in implementing a
procompetitive regime in their local telephone markets. Among other things, the
Interconnection Order: establishes rules requiring incumbent LECs to
interconnect with new entrants such as the Company at specified network points;
requires incumbent LECs to provide carriers nondiscriminatory access to network
elements on an unbundled basis at any technically feasible point at rates that
are
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just, reasonable and nondiscriminatory; establishes rules requiring incumbent
LECs to allow interconnection via physical and virtual co-location; requires the
states to set prices for interconnection, unbundled elements, and termination of
local calls that are nondiscriminatory and cost-based (using a forward-looking
methodology which excludes embedded costs but allows a reasonable
cost-of-capital profit); requires incumbent LECs to offer for resale any
telecommunications services that the carrier provides at retail to end users at
prices to be established by the states but which generally are at retail prices
minus reasonably avoided costs; and requires LECs and utilities to provide new
entrants with nondiscriminatory access to poles, ducts, conduit and
rights-of-way owned or controlled by LECs or utilities. Exemptions to some of
these rules are available to LECs which qualify as rural LECs under the
Telecommunications Act. The Interconnection Order also requires that: intraLATA
presubscription (pursuant to which LECs must allow customers to choose different
carriers for intraLATA toll service without having to dial extra digits) be
implemented no later than February 1999; LECs provide new entrants with
nondiscriminatory access to directory assistance services, directory listings,
telephone numbers, and operator services; and LECs comply with certain network
disclosure rules designed to ensure the interoperability of multiple local
switched networks. There can be no prediction as to the manner in which the
Interconnection Order will be implemented or enforced or as to what effect such
implementation or enforcement will have on competition within the
telecommunications industry generally or on the competitive position of the
Company specifically. A number of LECs, as well as the National Association of
Regulatory Utility Consumers and others, have filed in Federal court seeking to
appeal aspects of the Interconnection Order and to stay some or all of the rules
adopted therein. In October 1996, the United States Court of Appeals for the
Eighth Circuit granted a stay of effectiveness of certain provisions of the
Interconnection Order, including the pricing provisions and the
"pick-and-choose" rule, pending court review of the merits of the case. Oral
argument on this appeal of the Interconnection Order was held in January 1997.
The Company believes that the stay will not adversely affect its CLEC operations
and that such stay may positively affect the operations of the Carrier Services
business.
The allocation of jurisdiction between federal and state regulators over
dedicated circuits that carry both interstate and intrastate traffic (including
private line and special access services) poses jurisdictional questions.
Although the FCC does not generally rule on the jurisdictional nature of a
carrier's traffic, under current FCC practice, non-switched telecommunications
services are considered jurisdictionally interstate (subject to FCC
jurisdiction) unless more than 90% of the traffic is intrastate in nature.
Currently, the Company's dedicated service offerings are primarily
jurisdictionally interstate in nature. The Company believes that these services
include virtually all service between a long distance carrier's POP and another
POP of that long distance carrier or another long distance carrier, and between
an end user and a long distance carrier's POP.
The Company currently is not subject to price-cap or rate-of-return
regulation and it may install and operate non-radio facilities for the
transmission of interstate communications without prior FCC authorization.
In addition, the Company has filed tariffs with the FCC as required with
respect to its provision of interstate service. However, pursuant to authority
granted to it under the Telecommunications Act, in October 1996 the FCC ruled
that non-dominant inter-exchange carriers such as the Company may no longer file
tariffs with the FCC and existing tariffs must be withdrawn by September 22,
1997 (although this requirement has recently been stayed by court order). The
Company through state-specific subsidiaries also has received certification or
other appropriate regulatory authority to provide intrastate non-switched
service in 31 states and has applied for authority in a number of additional
states.
Some of the Company's services may be classified as intrastate and therefore
currently subject primarily to state regulation. In all states where the Company
is offering jurisdictionally intrastate Carrier Services or CLEC service, the
Company (through its state-specific operating subsidiaries) is certified or
otherwise operating with appropriate state authorization. The Company provides
intrastate long distance service pursuant to certification, registration or
(where appropriate) on a deregulated basis in more than
17
<PAGE>
40 states and is currently seeking intrastate authority in the remaining
continental states. The Company expects that as its business and product lines
expand and as more procompetitive regulation of the local telecommunications
industry is implemented, it will offer additional intrastate service. The
Company is seeking to expand the scope of its intrastate service in various
jurisdictions, a process which depends upon regulatory action and, in some
cases, legislative action in the individual states. Interstate and intrastate
regulatory requirements are changing rapidly and will continue to change.
Although the Company believes that it is in substantial compliance with all
material laws, rules and regulations governing its operations and has obtained,
or is in the process of obtaining, all licenses and approvals necessary and
appropriate to conduct its operations, changes in existing laws and regulations,
including those relating to the provision of wireless local telecommunications
services via 38 GHz and/or the future granting of 38 GHz licenses, or any
failure or significant delay in obtaining necessary regulatory approvals, could
have a material adverse effect on the Company. On November 13, 1995, the FCC
released an order freezing the acceptance for filing of new applications for 38
GHz frequency licenses. On December 15, 1995, the FCC announced the issuance of
an NPRM, pursuant to which it proposed to amend its current rules relating to 38
GHz, including, among other items, the imposition of minimum construction and
usage requirements and an auction procedure for issuance of licenses in the
37-40 GHz band where mutually exclusive applications have been filed. In
addition, the FCC ordered that those applications that are subject to mutual
exclusivity with other applicants or that were placed on public notice by the
FCC after September 13, 1995 would be held in abeyance and not processed by the
FCC pending the outcome of the proceeding initiated by the NPRM. Final rules
with respect to the changes proposed by the NPRM have not been adopted and the
changes proposed by the NPRM have been, and are expected to continue to be, the
subject of numerous comments by members of the telecommunications industry, the
satellite industry, various government agencies and others. Consequently, there
can be no assurance that the NPRM will result in the issuance of rules
consistent with the rules initially proposed in the NPRM, or that any rules will
be adopted. Until final rules are adopted, the rules currently in existence
remain in effect with respect to outstanding licenses.
Pursuant to an international treaty to which the United States is a
signatory, the 38.6-40.0 GHz band
is allocated on a co-primary basis to the Fixed Satellite System ("FSS") and the
37.5-40.5 GHz band is allocated on a co-primary basis to the Mobile Satellite
System. The FCC has not proposed rules to implement the treaty provisions,
although comments and a petition for rulemaking recently have been filed with
the FCC by Motorola requesting that such rules be considered and, in particular,
that power flux density limits be adopted. On May 21, 1996, the FCC placed on
public notice for comment the petition to allocate the 37.5-38.6 GHz bands to
the FSS and to establish Technical Rules for the 37.5-38.6 GHz band. In
addition, Motorola requested the FCC to adopt the power flux density limitations
of the ITU Radio Regulations for the 37.5-40.5 GHz band in order to allow FSS
systems and terrestrial microwave operators to co-exist on a co-primary basis.
In September 1996, Motorola filed an application at the FCC to offer broadband
satellite services using a portion of the radio spectrum that includes the
38.6-40.0 GHz band where the Company holds its Wireless Licenses. If the FCC
were to allow transmissions from space to earth as proposed by Motorola, such
transmissions could adversely affect the Company's existing or future operations
by creating interference or causing the FCC to institute power and other
limitations upon the Company's transmissions. If adopted as proposed, the
Motorola application would likely require changes in the FCC's rules, although
it would likely be a number of years before Motorola's satellite system could be
launched. The extent of the adverse impact upon the Company's operations if
Motorola's application were to be granted in its current form is unknown, but
there can be no assurance that the Company's operations would not be adversely
affected.
In connection with the rulemaking proceedings required under the
Telecommunications Act, the FCC will consider reform of the existing access
charge mechanisms, including possibly substantial reductions in the rates
charged by LECs to long distance service providers for local "access" (I.E., the
transmission of a long distance call from the caller's location to the long
distance provider's POP and from the terminating
18
<PAGE>
POP to the recipient of the call). CAPs, such as the Company's Carrier Services
operations, provide local access at rates that are discounted from the rates
charged by LECs. If the FCC were to mandate reductions in LECs' local access
charges, CAPs might be forced to substantially reduce the rates they charge long
distance providers, resulting in lower gross margins (which, in the case of the
Company, are currently negative). The FCC currently is considering comments
filed in response to its NPRM on universal service and access charge reform.
Additionally, providers of long distance services, including the major IXCs
as well as resellers, such as the Company, are coming under intensified
regulatory scrutiny for marketing activities by them or their agents that result
in alleged unauthorized switching of customers from one long distance service
provider to another. The FCC and a number of state authorities are seeking to
introduce more stringent regulations or take other actions to curtail the
intentional or erroneous switching of customers, which could include, among
other things, the imposition of fines, penalties and possible operating
restrictions on entities which engage or have engaged in unauthorized switching
activities. In addition, the Telecommunications Act requires the FCC to
prescribe regulations imposing procedures for verifying the switching of
customers and additional remedies on behalf of carriers for unauthorized
switching of their customers. The effect, if any, of the adoption of any such
proposed regulations or other actions on the long distance industry and the
manner of doing business therein, cannot be anticipated. Statutes and
regulations which are or may become applicable to the Company as it expands
could require the Company to alter methods of operations, at costs which could
be substantial, or otherwise limit the types of services offered by the Company.
See Item 3, "Legal Proceedings."
NEW MEDIA BUSINESS
The Company believes that the ability to deliver entertainment and
information content to consumers will play an increasingly important role in
consumers' choice of a telecommunications provider. The Company actively seeks
opportunities to acquire the rights or means to market and distribute
information and entertainment content and services that are marketable to
traditional markets and which also can enhance the marketability of the
Company's telecommunications services. The Company believes that, in the future,
it will be able to bundle content that it controls with various
telecommunications services it offers to provide higher-margin products and
services.
In December 1994, the Company consummated the acquisition of Non Fiction
Films, Inc. ("NFF"), a producer of documentary programming. NFF's productions to
date include ten hours of programming for the Arts & Entertainment Network's
award winning Biography-Registered Trademark- series and "Divine Magic-TM-: The
World of the Supernatural," a ten-part series about ancient beliefs, miracles
and mysticism.
In April 1996, NFF acquired an 80% equity interest in Fox/Lorber Associates,
Inc. ("Fox/Lorber"), an independent distributor of films, entertainment series
and documentaries. Fox/Lorber distributes its content to television and home
video markets domestically and abroad. Its home video division emphasizes the
distribution of foreign and art films and has a home video library of over 100
titles. Its television division emphasizes the distribution of educational and
entertainment program series, sports-related programs and documentaries to
broadcast and cable stations abroad and in the United States and Canada. Under
the terms of an agreement between NFF and the holder of the remaining 20% equity
interest in Fox/Lorber, NFF has the right to require such holder to sell, and
such holder has the right to require NFF to purchase, the remaining 20% equity
interest based upon certain criteria.
From April 1994 through April 1996, the Company acquired an 80% equity
interest in The Winning Line, Inc. ("TWL"). The Company has the right to require
the stockholders of TWL who own the remaining 20% equity interest in TWL to sell
the remaining 20% equity interest based upon certain criteria. TWL operates
SportsFan, a multimedia sports programming and production company that provides
live sports programming to more than 200 sports and talk format radio stations
across the United States, up to 24 hours a day, including stations in 90 of the
top 100 United States markets. In addition to its
19
<PAGE>
radio programming, SportsFan has developing interests in television and on-line
distribution channels. In addition, in October 1996, TWL acquired certain assets
of Major Sports, a producer of sports radio programming, including such programs
as "Costas Coast to Coast," "John Madden Sports Quiz" and "Pat O'Brien's Sports
Flashback."
In June 1996, the Company entered into an agreement with Source Media, Inc.,
a provider of interactive technology and programming. Pursuant to this
agreement, the Company has the exclusive right, in the 38 GHz spectrum, to use
Source Media's technology and programming in connection with entertainment and
information services the Company may offer.
In September 1996 and November 1996, respectively, the Company acquired an
80% equity interest in Millennium Marketing, Inc. (which does business as
WinStar Interactive Media Sales ("WIMS")) and 100% of Global Media Sales, Inc.
("GMS"). The Company has the right to require the stockholders of WIMS who own
the remaining 20% equity interest in WIMS to sell, and such stockholders have
the right to require the Company to purchase, the remaining 20% equity interest
based upon certain criteria. WIMS is a full-service agency to media sellers,
with a focus on the provision of advertising sales representation and/or related
consulting services for content-driven interactive media properties. GMS is a
seller of advertising for radio content media companies.
The industry in which the Company's new media operation competes consists of
a very large number of entities producing, owning or controlling news, sports,
entertainment, educational and informational content and services, including
telecommunications companies, television broadcast companies, sports franchises,
film and television studios, record companies, newspaper and magazine publishing
companies, universities and on-line computer services. Competition is intense
for timely and highly marketable or usable information and entertainment
content. Almost all of the entities with which the Company's new media operation
competes have significantly greater presence in the various media markets and
greater resources than the Company, including existing content libraries,
financial resources, personnel and existing distribution channels. There can be
no assurance that the Company will be able to successfully compete in the
emerging new media industry.
CONSUMER PRODUCTS
The Company's consumer products business is operated through its subsidiary,
Global Products. Global Products designs, markets and distributes personal care
products, including hair brushes and certain hair accessories, and bath
products, including gels, lotions and bath oils, and home fragrance products,
including potpourri and candles. The Company considers this to be a nonstrategic
business operation.
MARKETING AND DISTRIBUTION
Global Products' customers are primarily large retailers, including mass
merchandisers, discount stores, department stores, national and regional drug
store chains and other regional chains. Global Products' customers sell through
more than 20,000 individual retail outlets. Its current customer list includes
the following national and regional chain stores: WalMart, Revco Drug Stores,
CVS, Mervyn's, Target, Ames, Marshalls, Eckerd Drug, Family Dollar Stores, Sally
Beauty Supply, Fay Drug, Arbor Drug and American Drug Stores.
A significant portion of Global Products' sales is made by its in-house
sales force. The remainder of Global Products' sales typically are made by
independent sales representatives who receive a commission from Global Products
on all orders generated by them. Independent sales representatives generally
carry the product lines of several noncompeting manufacturers and distributors,
many of whom are much larger than Global Products.
20
<PAGE>
SOURCING
Global Products currently utilizes a combination of domestic and foreign
suppliers and contract manufacturers and internal assembling for its consumer
product lines. Global Products generally purchases its hair brushes and combs
from foreign manufacturers, and packages these products in its Fairfield, New
Jersey facility. Global Products purchases components for its bath and body
product line from both foreign and domestic sources, and assembles and packages
products in its Fairfield, New Jersey facility. Global Products does not have
any binding agreements with any of its manufacturers or suppliers. Therefore,
any of such entities can terminate their relationship with Global Products at
any time. Global Products does not believe that the termination of any such
relationship or relationships would have a material adverse impact on its
operations since management believes it would have alternative sources for its
products and components at comparable prices. There can be no assurance of this,
however, or that, in the event that Global Products were to experience
difficulties with its present manufacturers, suppliers and subassemblers, it
would not experience a temporary delay in obtaining the products or components
it needs elsewhere.
COMPETITION
The consumer products industry is subject to changes in styles and consumer
tastes. An unanticipated change in consumer preferences inconsistent with Global
Products' merchandise lines could have a serious and adverse effect upon its
operations. Global Products' product lines are subject to intense competition
with numerous manufacturers and distributors of hair, beauty and bath products.
Mass merchandisers, drug store chains, and other mass volume retailers typically
utilize freestanding pegboard fixtures or pegboard wall fixtures, as well as
in-line shelving and end-cap displays, to display their products. Competition
for shelf and wall space for product placement is intense, as many companies
seek to have their products strategically placed within the store. Competition
also exists with respect to product name recognition and pricing, since
retailers and consumers often choose products on the basis of name brand, cost
and value. Many of Global Products' competitors have greater product and name
recognition than it does, as well as much larger and more sophisticated sales
forces, product development, marketing and advertising programs and facilities.
Global Products generally competes by attempting to offer quality service and
products to its customers at reasonable prices.
EMPLOYEES
As of March 25, 1997 the Company had approximately 1,000 employees. The
Company is not a party to any collective bargaining agreements and never has
experienced a strike or work stoppage. The Company considers its relations with
its employees to be good.
ITEM 2. PROPERTIES
The Company's corporate headquarters are located at 230 Park Avenue, New
York, New York 10169. These headquarters are situated in approximately 11,500
square feet of space which the Company subleases for an average rent of
approximately $304,000 per annum. The Company has executed leases for additional
office space of approximately 6,000 square feet and 18,000 square feet, each at
230 Park Avenue, for rent of approximately $188,000 per annum and approximately
$576,000 per annum, respectively. Each of the above-described leases expires in
November 2006. The Company maintains leases on other properties used in the
operations of its subsidiaries. The Company believes that its insurance coverage
on its properties is adequate and that the Company, and each of its
subsidiaries, as the case may be, is in compliance with the related leases.
21
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
Gateway, the Company's residential long distance subsidiary, receives
inquiries from state authorities with respect to consumer complaints concerning
the provision of telecommunications services, including allegations of
unauthorized switching of long distance carriers and misleading marketing. The
Company believes such inquiries are common in the long distance industry and
addresses such inquiries in the ordinary course of business. During 1996,
Gateway experienced an increased level of consumer and regulatory complaints, a
substantial majority of which arose from the activities of a limited number of
independent marketing agents. On May 10, 1996, Gateway adopted a policy of
mandatory independent verification for 100% of customer orders received from
these agents' programs, and effective June 10, 1996, no longer accepts customer
orders from these programs. In December 1996, the FCC and Gateway entered into a
consent decree which terminated an inquiry by the FCC into any alleged
violations of unauthorized carrier conversions through the use of box programs
by some of Gateway's agents. The FCC cited Gateway's efforts in identifying the
problems caused by these agents and its proactive response in implementing
remedial actions on its own as significant factors leading to the consent decree
in lieu of initiating a formal investigation. The Company does not believe that
resolution of these issues will have a material adverse effect on the Company,
its financial condition or its results of operations.
In June 1996 the Company, as plaintiff, commenced an action for declaratory
judgment against Nelson Thibodeaux, a former officer of Gateway, in the Federal
District Court for the Southern District of New York, seeking a declaration that
the Company has no obligation to Mr. Thibodeaux under stock option agreements
granted to him during his employment with Gateway. Further, because the Company
believes that any and all claims that may be advanced by Mr. Thibodeaux with
regard to his stock option agreements would be frivolous, the Company has
notified Mr. Thibodeaux and his counsel of its intention to seek sanctions and
such other remedies as may be available against Mr. Thibodeaux and his counsel
in the event that Mr. Thibodeaux and his counsel seek to assert any defense to
the Company's action. Additionally, the Company seeks monetary damages arising
from an alleged breach by Mr. Thibodeaux of the noncompetition and related
provisions contained in his employment agreement with the Company. Mr.
Thibodeaux answered the Company's complaint in August 1996, denying all of the
Company's assertions. The Company intends to diligently proceed with this
action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
None.
22
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS
MATTERS
MARKET PRICE OF THE COMPANY'S COMMON STOCK
The Company's Common Stock has been quoted on the Nasdaq National Market
since June 1994 under the symbol "WCII."
The following table sets forth, for the fiscal periods indicated, the high
and low last sale prices of the Common Stock as reported on the Nasdaq National
Market. The quotes represent "inter-dealer" prices without adjustment or
mark-ups, mark-downs or commissions and may not necessarily represent actual
transactions.
<TABLE>
<CAPTION>
COMMON STOCK
--------------------
PRICE
PERIOD ENDED HIGH LOW
- --------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
February 28, 1995.......................................................... $9 1/8 $5 1/32
May 31, 1995............................................................... 7 1/32 6
August 31, 1995............................................................ 13 3/8 5
November 30, 1995.......................................................... 21 13/16 13 1/2
December 31, 1995 (commencing December 1,1995)............................. 17 3/8 14
March 31, 1996............................................................. 18 1/2 13 3/8
June 30, 1996.............................................................. 32 1/4 16
September 30, 1996......................................................... 29 15 3/4
December 31, 1996.......................................................... 23 7/8 16 1/2
</TABLE>
The last sale price of the Common Stock on March 25, 1997 was $11-3/4 per
share. As of March 25, 1997, the Company had 32,766,706 shares of Common Stock
outstanding held by more than 1,000 beneficial holders.
23
<PAGE>
RECENT SALES OF UNREGISTERED SECURITIES
(a) The following table sets forth certain information with respect to
issuances of securities by the Company (other than stock options granted to its
employees and others) during the year ended December 31, 1996, without
registration of such securities under the Securities Act:
<TABLE>
<CAPTION>
CONSIDERATION
RECEIVED AND
DESCRIPTION OF
UNDERWRITING OR
NUMBER OTHER DISCOUNTS EXEMPTION
OF TO MARKET PRICE FROM
DATE OF SECURITIES AFFORDED TO REGISTRATION
SALE TITLE OF SECURITY SOLD PURCHASERS CLAIMED
- --------- --------------------------------------- ----------- ------------------- ---------------
<S> <C> <C> <C> <C>
4/30/96 Common Stock........................... 8,643 (1) 4(2)
4/30/96 Common Stock........................... 58,800 (1) 4(2)
11/30/96 Common Stock........................... 13,172 (2) 4(2)
</TABLE>
- ------------------------
(1) Issued by the Company in connection with the acquisition of Fox/Lorber
Associates, Inc. by a subsidiary of the Company.
(2) Issued by the Company in connection with the acquisition of Global Media The
Sales And Marketing Company, Inc. by a subsidiary of the Company.
(b) The following table sets forth certain information with respect to
grants by the Company of stock options to its employees and others during the
year ended December 31, 1996, without registration of such securities under the
Securities Act:
<TABLE>
<CAPTION>
CONSIDERATION
RECEIVED AND
DESCRIPTION OF
UNDERWRITING OR IF OPTION, WARRANT
OTHER DISCOUNTS EXEMPTION OR CONVERTIBLE
NUMBER TO MARKET PRICE FROM SECURITY, TERMS OF
DATE OF TITLE OF OF OPTIONS AFFORDED TO REGISTRATION EXERCISE OR
SALE SECURITY GRANTED PURCHASERS CLAIMED CONVERSION
- ----------- ------------- ----------- ------------------- --------------- -------------------
<S> <C> <C> <C> <C> <C>
1/96--12/96 options to 4,057,000 options granted-- 4(2) exercisable for
purchase no consideration periods of five or
common stock received by the ten years from
granted to Company until grant at exercise
employees exercise prices ranging from
$13.75 to $31.13
</TABLE>
24
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below for the years ended February 28,
1993, 1994 and 1995, the ten months ended December 31, 1995 and as of and for
the year ended December 31, 1996 have been derived from the Company's audited
Consolidated Financial Statements included elsewhere in this Report. The
selected financial data for the year ended December 31, 1995 has been derived
from unaudited consolidated financial statements of the Company. In the opinion
of management, the unaudited consolidated financial statement has been prepared
on the same basis as the audited Consolidated Financial Statements and includes
all adjustments, which consist only of normal recurring adjustments, necessary
for a fair presentation of the results of operations for the period. This data
presented below should be read in conjunction with Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's Consolidated Financial Statements, including the notes thereto,
appearing elsewhere in this Report.
<TABLE>
<CAPTION>
YEAR ENDED
YEAR ENDED FEBRUARY 28, TEN MONTHS ENDED DECEMBER 31,
------------------------------- DECEMBER 31, ----------------------
1993 1994 1995 1995 1995 1996
--------- --------- --------- ----------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA:
<CAPTION>
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Net Sales:
Telecommunications (1)....................... $ -- $ 8,505 $ 14,909 $ 13,137 $ 14,626 $ 33,969
Information services......................... -- -- 473 2,648 2,928 14,650
Other........................................ 11,289 7,120 10,183 13,986 15,746 19,429
--------- --------- --------- -------- ---------- ----------
Total net sales.......................... 11,289 15,625 25,565 29,771 33,300 68,048
Operating income (loss):
Telecommunications........................... -- (814) (4,984) (7,288) (8,437) (43,698)
Information services......................... -- -- (157) 217 322 (1,409)
Other........................................ (3,582) 159 216 681 644 (42)
General corporate............................ (663) (1,536) (944) (3,861) (4,761) (11,373)
--------- --------- --------- -------- ---------- ----------
Total operating loss..................... (4,245) (2,191) (5,869) (10,251) (12,232) (56,522)
Interest expense............................... (534) (744) (637) (7,630) (7,712) (37,476)
Interest income................................ 75 109 385 2,890 2,935 10,275
Other expenses, net (2)........................ -- (5,369) (1,109) (866) (1,211) --
--------- --------- --------- -------- ---------- ----------
Net loss....................................... $ (4,704) $ (8,195) $ (7,230) $ (15,857) $ (18,220) $ (83,723)
--------- --------- --------- -------- ---------- ----------
--------- --------- --------- -------- ---------- ----------
Net loss per common share outstanding.......... $ (0.93) $ (1.06) $ (0.42) $ (0.70) $ (0.82) $ (3.00)
Weighted average common shares outstanding..... 5,066 7,719 17,122 22,770 22,287 27,911
Other Financial Data:
EBITDA (3)..................................... $ (2,955) $ (1,845) $ (5,179) $ (8,952) $ (10,723) $ (49,597)
Capital expenditures........................... 84 307 1,816 8,652 9,003 47,961
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
FEBRUARY 28, DECEMBER 31,
------------------------------- ----------------------
1993 1994 1995 1995 1996
--------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
Cash, cash equivalents and short-term investments................. $ 631 $ 719 $ 3,156 $ 211,701 $ 122,487
Property and equipment, net....................................... 394 1,301 2,663 15,898 63,287
Total assets...................................................... 8,943 14,610 29,509 285,363 290,223
Current portion of long-term debt and capital lease obligations... 3,858 2,851 332 9,643 23,036
Long-term debt and capital lease obligations, less current portion
and discount.................................................... 1,206 3,084 5,165 240,455 284,339
Common and preferred stock and additional paid-in capital(4)...... 11,410 22,665 43,518 104,823 75,726
Stockholders' equity (deficit).................................... 1,747 4,719 18,280 21,752 (49,671)
</TABLE>
- ------------------------
(1) The Company has generated minimal revenues from its Wireless Fiber services.
(2) For the year ended February 28, 1994, principally represents noncash expense
of $5.3 million consisting of the difference between the exercise prices of
certain options granted in connection with the Company's initial public
offering in April 1991 and the market value of the underlying shares of
Common Stock on the date such options became exercisable.
(3) EBITDA consists of loss before interest, income taxes, depreciation and
amortization and other income and expense. EBITDA is a measure commonly used
in the telecommunications industry and is presented to enhance an
understanding of the Company's operating results and ability to service its
debt. It is not intended to represent cash flow or results of operations in
accordance with generally accepted accounting principles for the periods
indicated. See Item 8, "Financial Statements and Supplementary Data."
(4) The Company did not declare or pay any dividends on its Common Stock during
the periods covered hereby.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
COMPANY OVERVIEW
The Company provides a full range of telecommunications services as a CLEC,
including local, long distance and Internet access services, to small and
medium-sized businesses in major metropolitan areas in the United States. By
exploiting its Wireless Fiber services and a switch-based infrastructure, the
Company seeks to distinguish itself as a facilities-based, value-added provider
of high-capacity telecommunications services and an attractive alternative to
established providers, such as the RBOCs. The Company also utilizes its Wireless
Fiber capacity to provide its Carrier Services, a variety of facilities-based
broadband, high-capacity local access and digital network services, to other
telecommunications services providers. As a complement to its telecommunications
operations, the Company produces and distributes information and entertainment
content. The Company also operates a nonstrategic consumer products company.
During the third quarter of 1996, the Company launched its CLEC offering in
New York City and has since introduced its local telecommunications services in
11 additional markets. The Company intends to introduce its local exchange
services in all of the other major metropolitan areas where it is licensed to
provide 38 GHz services over four or more 100 MHz channels during the next
several years. The Company
26
<PAGE>
is creating an infrastructure on a city-by-city basis using its Wireless Fiber
capabilities, switches acquired by the Company from equipment vendors and
facilities leased from other carriers to originate and terminate traffic.
The Company also provides wholesale Carrier Services that enable other
carriers to expand their networks or meet end user demand via the Company's
digital wireless capacity in the 38 GHz portion of the radio spectrum. The
Company is in the process of expanding its Carrier Services business and
currently markets these services in its licensed areas to RBOCs and other LECs,
IXCs, CAPs and CLECs, PCS and CMRS providers, cable companies, Internet service
providers, value-added resellers and systems integrators. Additionally, the
Company has signed multi-year master service agreements with a number of large
industry customers, including Pacific Bell and Ameritech Cellular Services, each
of which has forecasted demand for several thousand circuits, including T-1
circuits (equivalent capacity of 24 voice-grade circuits) and DS-3 circuits
(equivalent capacity of 28 T-1 circuits). The Company's wholesale Carrier
Services business also will serve a significant portion of the local access
needs of the Company's CLEC business, including backbone interconnections of
hub, main switch and local node sites, and the origination and termination of
local traffic for the Company's local exchange customers.
In connection with the Company's rollout of its local telecommunications
services, the Company is developing its business information services. One of
the Company's goals in this area is to market an Internet-delivered group of
targeted services to small to medium-sized business customers. It is currently
anticipated that these services will be sold through the Company's direct sales
force and will be structured as tiered-channels of licensed and customized
information, which will serve as a one-stop, easy-to-use desktop information
resource for the Company's business customers.
The Company has significantly expanded its spectrum holdings during the past
year with the completion of the Milliwave Acquisition and the Locate
Acquisition. The Company also has entered into certain agreements to purchase an
aggregate of 47 additional 38 GHz licenses. Currently, the Wireless Licenses
allow the Company to provide Wireless Fiber services in 47 of the 50 most
populated MSAs in the United States. The Wireless Licenses currently cover more
than 100 cities with populations exceeding 100,000 each, encompass an aggregate
population of approximately 172 million people and address approximately 600
million channels pops (population coverage multiplied by the number of 100 MHz
channels). Upon completion of all pending acquisitions, which are subject to FCC
consent, the Company's total population coverage will increase to approximately
180 million, its total channel pops will grow to approximately 650 million and
the Wireless Licenses will allow the Company to provide services in 49 of the 50
most populated MSAs in the United States. See Item 1,
"Business--Telecommunications Services-- Wireless Licenses."
REVENUES
Revenues generated by the operations of the Company's telecommunications
businesses will represent an increasing percentage of the Company's consolidated
revenues as the Company expands into the local telecommunications services
market. Factors driving the mix of revenues are as follows:
CLEC AND LONG DISTANCE SERVICES. CLEC revenues are driven primarily by the
number of local exchange circuits installed and in service. The Company had
installed more than 5,600 CLEC customer lines as of February 28, 1997. Customers
generally are billed a flat monthly fee plus a per-minute usage charge or
fraction thereof. Revenue growth depends on the introduction of local exchange
services in new cities, the purchase and installation of switches to service
those areas, and the addition of new customers. Additionally, as bundled
services, such as long distance, Internet access and Internet-related services,
are purchased by the Company's customers, revenue per circuit would be expected
to increase.
The Company intends to develop other anticipated sources of revenue
including resale agreements for CMRS, advanced data, broadband data transmission
and video conferencing services. The Company believes that as its local exchange
services business grows, such business will become the most significant
27
<PAGE>
component of the Company's revenues. Revenues from this segment were $502,000 in
the fourth quarter of 1996, versus $84,000 in the third quarter of 1996, with
approximately half of such revenues generated in the month of December. The
Company currently sets prices at a discount to those charged by LECs and
anticipates ongoing price reductions for provision of local exchange services.
The Company is first rolling out its local services on a resale basis in
each city and plans to follow initial sales with the installation of Lucent 5ESS
switches. The first switch went into service in New York City in October 1996,
and four additional switches are now under construction in Boston, Chicago, Los
Angeles and San Diego. The Company began connecting customers to the New York
switch via Wireless Fiber links in January 1997.
Long distance telecommunications services revenues are driven principally by
the size and type of the customer base, with the largest percentage of the
Company's long distance telecommunications services revenues currently derived
from residential customers. Customers are billed on the basis of minutes or
fractions thereof. The Company is focusing on the sale of long distance services
to small and medium-sized business customers as part of its CLEC business and is
not currently marketing long distance services to residential customers on an
active basis, except through established affinity group and other targeted
programs. As a result, the Company is allowing its revenues from residential
long distance service to decline through attrition, as it focuses on its core
small to medium-sized business market.
CARRIER SERVICES. Carrier Services revenues are driven primarily by the
number and capacity (I.E., T-1s or DS-3s) of Wireless Fiber links in service. A
key measure of progress for the Company is its installed and available Wireless
Fiber capacity. The Company had more than 90,000 voice-grade equivalent circuits
in place as of February 28, 1997. Customers generally are billed at a fixed
monthly rate per unit of capacity. Since the Company's local access customers
have been, and will likely continue to be, predominantly telecommunications
services providers, the addition or loss of several major customers would have a
material impact on this business. Another key measure of progress is the number
of buildings for which the Company has secured Roof Rights. The Company's Roof
Rights have been increasing in number and declining in average cost. As of
February 28, 1997, the Company has secured Roof Rights on approximately 900
buildings and is acquiring Roof Rights to an additional 50 to 75 buildings per
month.
INFORMATION AND CONTENT. Information and content revenues are generated
principally by: (i) sales of content and related services, such as
documentaries, sports programming and foreign films, to traditional content
customers, such as cable networks and radio stations; (ii) sales of content to
new media distribution channels, such as on-line services; (iii) sales of
advertising; and (iv) the bundling of content with the Company's
telecommunications services. Revenues also are driven by the size and quality of
the Company's programming library and the release of new programs, which affects
quarter to quarter comparability.
CONSUMER PRODUCTS. Consumer products revenues are generated by a
nonstrategic subsidiary and are driven principally by the number of national
retailers in the Company's customer base. The Company obtains shelf space
through such large retailers, and the addition or loss of several large
retailers can have a significant effect on the revenues of the Company's
consumer products business. Product sell-through and new product introductions
also play an important role in the Company's relationships with its customers.
COSTS
Factors relating to costs are as follows:
CLEC AND LONG DISTANCE SERVICES. Costs associated with the Company's CLEC
business include significant up-front capital expenditures for development of
the infrastructure required to provide the Company's own local exchange
services, including expenditures relating to interconnection (I.E., the use of
LEC facilities to terminate calls), purchases and installation of switching
equipment, 38 GHz radios and
28
<PAGE>
related equipment, site acquisition fees and expenses (including option fees for
the prequalification of buildings for Roof Rights) and strategic preplacement of
a limited number of radios and related equipment in connection with the
Company's building-centric network plan (I.E., hubbing). In addition, the
Company is incurring start-up costs related to its CLEC business that will not
be capitalized, including costs of engineering, sales office and service
personnel, marketing, administrative and other personnel, who will be needed in
advance of related revenues. When the Company commences operations in a city, it
will initially resell the local exchange services of LECs or other CLECs. The
Company will carry more of its traffic on its own facilities as it develops and
installs the switches, radios and interconnections required to provide services
in a particular city. However, the Company will always carry significant amounts
of its traffic over leased facilities at lower margins. The resale of local
exchange services typically will result in greater operating costs than the
provision of services over the Company's own facilities and such costs will
therefore decrease as a percentage of total CLEC operating costs as the Company
begins to provide more services over its own facilities. Additionally, site
acquisition and switch costs will become a lower percentage of cost per minute
of service as more buildings are connected and as the Company increases the
number of customers and lines per building. The up front capital costs of
establishing the initial infrastructure required for the Company to provide its
own local exchange services are substantial and much greater than those relating
to the Company's Carrier Services business.
Costs associated with the Company's long distance business include expenses
related to minutes purchased from major carriers for resale, and accordingly
fluctuate with revenue. Typically, reductions of such costs are achieved through
negotiated volume rebates and competitive contract pricing. Generally, the
Company is obligated to generate certain minimum monthly usage with its long
distance carriers and may be required to pay, in addition to its monthly bill,
an underutilization fee equal to a certain percentage of the difference between
such minimum commitments and the traffic actually generated by the Company. The
Company has never paid or been required to pay any underutilization charges. The
Company expects that such costs will be reduced as it installs its own switches.
CARRIER SERVICES. Costs associated with the Company's Carrier Services
business include site acquisition (including option fees for the
prequalification of buildings for Roof Rights) and equipment related fees and
expenses, including costs incurred in connection with the acquisition of Roof
Rights and the purchase of 38 GHz radios. In addition, the Company will continue
to incur substantial start-up costs related to its Carrier Services business
that will not be capitalized, including costs of engineering, sales office and
service personnel, and marketing, administrative and other personnel, who will
be needed in advance of related revenues. The Company anticipates that the cost
per Wireless Fiber link will be reduced as increased traffic is generated in
buildings in which the Company already has established service and as the
Company qualifies for volume discounts from its principal equipment vendors. The
Company also expects that equipment costs will continue to drop as a result of
technological improvements and increased competition in the microwave equipment
manufacturing industry.
INFORMATION AND CONTENT. The Company's information and content businesses
have production, distribution and administrative costs. Film production costs
include those related to producing original products and licensing third-party
products and are capitalized as incurred and are expensed as productions are
completed and distributed. Overhead costs in the production division are also
capitalized and allocated to films in progress, and are subsequently expensed as
such films are completed and distributed. Other media production costs are
expensed as incurred. The distribution and advertising divisions incur royalty
costs payable to third-party producers and selling costs, both of which vary
directly with sales of acquired product, as well as administrative costs and
personnel-related costs, which are primarily fixed in nature and which are
expensed as incurred.
CONSUMER PRODUCTS. Costs associated with the Company's consumer products
business fluctuate with material and labor component pricing. A large percentage
of material components are sourced overseas,
29
<PAGE>
and are purchased in United States dollars. The Company seeks to lower product
costs through improved material sourcing.
RESULTS OF OPERATIONS
Revenues of the Company's operating segments are as follows (in millions):
<TABLE>
<CAPTION>
TEN MONTHS
YEAR ENDED ENDED DECEMBER 31*, YEAR ENDED
FEBRUARY 28, DECEMBER 31,
-------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
1994 1995 1994 1995 1995 1996
--------- --------- --------- --------- --------- ---------
Telecommunications Services:
Carrier Services............................................. $ -- $ 0.1 $ -- $ 0.1 $ 0.1 $ 3.9
Local Exchange............................................... -- -- -- -- -- 0.6
Residential Long Distance.................................... 8.5 14.8 13.4 13.0 14.5 29.5
--------- --------- --------- --------- --------- ---------
8.5 14.9 13.4 13.1 14.6 34.0
Information and Content........................................ -- 0.5 0.2 2.6 2.9 14.7
Consumer Products.............................................. 7.1 10.2 8.4 14.0 15.8 19.4
--------- --------- --------- --------- --------- ---------
Total Revenues........................................... $ 15.6 $ 25.6 $ 22.0 $ 29.7 $ 33.3 $ 68.1
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
- ------------------------
* The Company changed its fiscal year to December 31 from February 28
effective January 1, 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenues increased by $34.8 million, or 104.5%, for the year ended December
31, 1996, to $68.1 million, from $33.3 million from the year ended December 31,
1995. This increase was primarily attributable to increased revenues generated
by the Company's telecommunications and information services segments.
The Company's telecommunications services revenues increased by $19.4
million, or 132.9%, for the year ended December 31, 1996, to $34.0 million, from
$14.6 million for the year ended December 31, 1995, principally resulting from
an increase in revenues from residential long distance telephone services.
Revenues from the information and entertainment services segment increased by
$11.8 million, or 406.9%, for the year ended December 31, 1996, to $14.7
million, from $2.9 million for the year ended December 31, 1995, due to
continued growth of this segment internally and through acquisitions. The
revenue increase in 1996 was generated primarily from increased production and
distribution of entertainment content, including documentaries, foreign films
and multimedia sports programming. Consumer products revenues increased by 22.8%
in 1996 resulting from growth of the bath and body products line.
Cost of services and products increased by $27.4 million, or 110.9%, for the
year ended December 31, 1996, to $52.1 million, from $24.7 million for the year
ended December 31, 1995. As a percentage of sales, cost of services and products
in 1996 was 76.5%, compared with 74.2% in 1995, due in part to increased
start-up costs for facilities in connection with the rollout of the Company's
telecommunications network, in addition to lower profit margins in the consumer
products segment.
Selling, general and administrative expense increased by $48.1 million to
$67.7 million for the year ended December 31, 1996, or 99.4% of revenues, from
$19.6 million, or 58.9% of revenues, for the year ended December 31, 1995.
Selling, general and administrative expense increased predominantly in the
telecommunications segment as the Company continued to hire sales, marketing and
related support personnel in connection with the accelerated roll out of its
CLEC operations, and increased spending on related advertising and marketing of
services in new and existing cities where the Company offered its services.
30
<PAGE>
For the reasons noted above, the operating loss for the year ended December
31, 1996, was $56.5 million, compared to an operating loss of $12.2 million for
the year ended December 31, 1995.
Depreciation and amortization expense increased by $3.5 million or 291.7%,
for the year ended December 31, 1996, to $4.7 million, from $1.2 million for the
year ended December 31, 1995, principally resulting from the Company's
acquisition of switches, radios and other telecommunications equipment.
Interest expense increased by $29.8 million, or 387.0%, for the year ended
December 31, 1996, to $37.5 million, from $7.7 million for the year ended
December 31, 1995. The increase was primarily attributable to $33.5 million in
interest accrued on the Old Notes issued in the 1995 Debt Placement, which is
not payable in cash until after 1999.
Interest income increased by $7.4 million, or 255.2%, for the year ended
December 31, 1996, to $10.3 million, from $2.9 million for the year ended
December 31, 1995. The increase is attributable to short-term investment
earnings on the proceeds of the 1995 Debt Placement.
For the reasons noted above, the Company reported a net loss of $83.7
million for the year ended December 31, 1996, compared to a net loss of $18.2
million for the year ended December 31, 1995.
TEN MONTHS ENDED DECEMBER 31, 1995 COMPARED TO THE TEN MONTHS ENDED DECEMBER 31,
1994
Revenues for the ten months ended December 31, 1995 increased by $7.8
million, or 35.5%, to $29.8 million, from $22.0 million in the comparable period
of the prior year. This increase was attributable to increased revenues in the
Company's information and entertainment and consumer products merchandising
segments. During the ten months ended December 31, 1995, the Carrier Services
business had only nominal revenues. The information and entertainment segment,
which reported nominal revenues in the prior year, had revenues of approximately
$2.6 million for the ten months ended December 31, 1995, related primarily to
the completion of certain documentary television products. The consumer products
segment also experienced an increase in revenue of approximately $5.6 million,
primarily due to the growth in sales volume of its bath and body product line.
Cost of services and products for the ten months ended December 31, 1995
increased by $5.8 million, to $20.9 million, from $15.1 million for the ten
months ended December 31, 1994. The increase was principally attributable to the
growth in the Company's information and entertainment services and consumer
products segments, along with initial expenses in connection with the Company's
telecommunications network.
Selling, general and administrative expenses increased by $7.7 million to
$17.9 million, or 60.1% of revenues, for the ten months ended December 31, 1995,
from $10.2 million, or 46.4% of revenues, in the comparable period of the prior
year. The acquisition of Avant-Garde, the original holder of many of the
Wireless Licenses) and the consolidation of that entity's results of operations
into the Company's financial statements from July 17, 1995 onward, as well as
the growth in the administrative infrastructure in the Carrier Services business
accounted for approximately 32.7% of the total increase. In particular, expenses
were incurred to develop operating systems, to market services to targeted
customers and to prepare for future growth in the wireless business. Corporate
general and administrative expenses accounted for approximately 28.1% of the
total increase because of the hiring of additional personnel and the expansion
of the Company's infrastructure to manage future growth in the
telecommunications business. Selling and marketing expenses incurred by the
consumer products segment to service increased revenues accounted for
approximately 26.4% of the total increase.
For the reasons noted above, the operating loss for the ten months ended
December 31, 1995, was $10.3 million, compared to an operating loss of $3.6
million in the comparable period of the prior year.
31
<PAGE>
Interest expense increased by $7.1 million to $7.6 million for the ten
months ended December 31, 1995, from $0.5 million for the ten months ended
December 31, 1994, reflecting principally the noncash accretion of interest on
the Old Notes.
Interest income for the ten months ended December 31, 1995 increased by $2.6
million, to $2.9 million, compared with $0.3 million for the same period during
the prior year. The increase was attributable to earnings on the 1995 Debt
Placement, which raised net proceeds of $214.5 million.
For the reasons noted above, the Company reported a net loss of $15.9
million for the ten months ended December 31, 1995, compared to a net loss of
$4.6 million in the comparable period of the prior year.
YEAR ENDED FEBRUARY 28, 1995 COMPARED TO YEAR ENDED FEBRUARY 28, 1994
Revenues for the year ended February 28, 1995, were $25.6 million, up 64.1%
from the prior year's revenues of $15.6 million. During the year ended February
28, 1995, the telecommunications segment reported revenues of $14.9 million,
compared to revenues of $8.5 million in the year ended February 28, 1994, an
increase of 75.3%. Telecommunications revenues consisted almost entirely of
revenues generated through the Company's resale of long distance services, and
revenue growth resulted primarily from growth in the Company's customer base.
The consumer products segment also experienced substantial revenue growth, from
$7.1 million in the year ended February 28, 1994, to $10.2 million in the year
ended February 28, 1995, an increase of 43.7%. This increase was attributable to
approximately $3.6 million in additional revenues from the bath and body product
line acquired in the year ended February 28, 1994, as well as growth in the
personal care products line. These revenue increases were offset by a reduction
of approximately $1.2 million in revenues from discontinued business lines. The
information and entertainment segment generated $0.5 million in revenues in the
year ended February 28, 1995, its first year of operation.
Cost of services and products for the year ended February 28, 1995 increased
by $8.4 million, or 78.5%, to $19.1 million, from $10.7 million for the year
ended February 28, 1994. The increase is principally attributable to the growth
in the Company's long distance telephone and consumer products businesses.
Selling, general and administrative expenses increased by $5.2 million to
$11.9 million, or 46.5% of revenues, for the year ended February 28, 1995, from
$6.7 million, or 42.9% of revenues, for the prior year. The increase was
attributable to increased operating expenses related to the growth of the
Company's telecommunications revenues and the consumer products segment, the
development of the corporate infrastructure needed to identify, acquire and
manage opportunities for the Company's continued telecommunications growth, and
start-up expenses associated with the Carrier Services business, offset by a
reduction of expenses related to discontinued business lines. The Company also
recorded a restructuring charge of $0.6 million and other nonrecurring charges
of $0.5 million in the year ended February 28, 1995, related to its
telecommunications operations. These charges include termination costs for
previous executive, management, and staff personnel as well as other charges
taken in connection with sales programs and other initiatives implemented by
previous management. For the reasons noted above, the operating loss for the
year ended February 28, 1995, was $5.9 million, compared to an operating loss of
$2.1 million in the prior year.
Interest expense decreased to $0.6 million in the year ended February 28,
1995 from $0.7 million in the prior year. This improvement was due to the use of
approximately $2.0 million in promissory notes by the holders thereof for the
payment of the exercise price of certain warrants.
For the reasons noted above, the Company reported a net loss of $7.2 million
for the year ended February 28, 1995, compared to a net loss of $8.2 million for
the year ended February 28, 1994.
32
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating and net losses, due in large
part to the development of its telecommunications services business, and
anticipates that such losses will increase over the near term as the Company
accelerates its growth strategy. Historically, the Company has funded its
operating losses and capital expenditures through public and private offerings
of debt and equity securities and from credit and lease facilities, and expects
to continue funding its growth strategy, as necessary, through a combination of
these financing vehicles. Cash used to fund negative EBITDA during the year
ended December 31, 1996 was $49.6 million, and purchases of property and
equipment were $48.0 million. At December 31, 1996 and 1995, working capital was
$75.6 million and $214.9 million, respectively, including cash, cash equivalents
and short-term investments of $87.6 million and $211.7 million, respectively
(giving effect to the Milliwave Acquisition). As of December 31, 1996, after
giving pro forma effect to the Milliwave Acquisition and the Preferred Stock
Placement (as defined below), cash, cash equivalents and short-term investments
were $183.6 million. As adjusted, giving effect to the 1997 Debt Placement (as
defined below) (including the application of $17.8 million of the proceeds
therefrom to repay promissory notes of the Company issued in connection with the
Locate Acquisition (the "Locate Notes")) cash, cash equivalents and short-term
investments were $456.2 million as of December 31, 1996.
The passage of the Telecommunications Act in February 1996 resulted in
opportunities that motivated the Company to accelerate the development and
expansion of its telecommunications businesses through increased capital
expenditures. Capital expenditures for the years ended December 31, 1996 and
1995 were $48.0 million and $9.0 million, respectively. As a result of the
acceleration of the development and expansion of the Company's
telecommunications business, the Company's current plans are for capital
expenditures of an average of approximately $170 million per year over the next
three years. The amount of capital required to execute this plan is a function
of the speed at which the plan is executed. The Company may elect to slow the
speed or narrow the focus of this expansion in the event that it is unable to
raise sufficient amounts of capital on acceptable terms.
A significant portion of the Company's increased capital requirements will
result from the rollout of the Company's CLEC business. The Company is building
a direct sales force, has opened sales offices in eleven major cities and is in
the process of expanding into other metropolitan areas. Additionally, the
Company is in the process of ordering and installing switching and other network
equipment to be placed in its key markets.
The Company has commitments during 1997 to purchase $26.4 million of
telecommunications capital equipment and, prior to April 8, 1997, to repay the
Locate Notes aggregating approximately $17.8 million.
In February 1997 the Company sold 4,000,000 shares of its 6% Series A
Cumulative Preferred Stock and warrants to purchase 1,600,000 shares of Common
Stock, pursuant to which the Company and one of its subsidiaries realized net
proceeds of approximately $96 million (the "Preferred Stock Placement"). In
addition, in March 1997, the Company and one of its subsidiaries sold an
aggregate of $300 million principal amount of notes, pursuant to which they
realized net proceeds of approximately $290 million (the "1997 Debt Placement").
Management anticipates, based on current plans and assumptions relating to
its operations, that the proceeds of the 1997 Debt Placement, together with the
Company's existing financial resources and additional equipment financing
arrangements which the Company intends to seek, will be sufficient to fund the
Company's growth and operations for approximately 24 to 30 months from the date
of this Report. In order to provide additional future liquidity to the Company,
the Company has obtained a commitment for a $150 million facility from
affiliates of the initial purchasers of the notes sold in the 1997 Debt
Placement, which, subject to the Company satisfying various operating and
financial criteria, may be drawn by the Company on March 31, 1999. In the event
the Company's plans or assumptions change or prove to be inaccurate, or if the
Company consummates any acquisitions of businesses or assets (including
additional
33
<PAGE>
spectrum licenses, by auction or otherwise), the Company may be required to seek
additional sources of capital sooner than currently anticipated.
The Company's subsidiaries have two asset-based working capital facilities
with a total of $9.8 million outstanding thereunder as of December 31, 1996,
with terms expiring in 1998 and 1999. Remaining availability under these lines
as of December 31, 1996 was approximately $1.7 million. In addition, the
Company's subsidiaries have entered into, and will continue to seek, financing
arrangements with respect to equipment, including telecommunications switches,
38 GHz radios and other related equipment. The Company's subsidiary, WinStar
Telecom, consummated a $3.1 million sale/leaseback of its New York City switch
in December 1996, and borrowed approximately $3.3 million from a third party
lender in connection with WinStar Telecom's purchase of its Chicago switch from
Lucent in March 1997.
FORWARD-LOOKING STATEMENTS
When used in this and in future filings by the Company with the SEC, in the
Company's press releases and in oral statements made with the approval of an
authorized executive officer of the Company, the words or phrases "will likely
result," expects," "plans," "will continue," "is anticipated," "estimated,"
"project" or "outlook" or similar expressions (including confirmations by an
authorized executive officer of the Company of any such expressions made by a
third party with respect to the Company) are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, each of which speak
only as of the date made. Such statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. Factors that
may cause actual results to differ materially from those contemplated by such
forward-looking statements include, among others, the following: (a) the
Company's ability to service its debt or to obtain financing for the buildout of
its telecommunications network; (b) the Company's ability to attract and retain
a sufficient revenue-generating customer base; (c) competitive pressures in the
telecommunications industry; and (d) general economic conditions. The Company
has no obligation to publicly release the result of any revisions which may be
made to any forward-looking statements to reflect anticipated or unanticipated
events or circumstances occurring after the date of such statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by Item 8(a) are included in this Report
beginning on Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
34
<PAGE>
PART III
The information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated herein by reference to the Company's Proxy Statement for the Annual
Meeting of Stockholders anticipated to be held on June 30, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
(1) Financial Statements
See Index to Financial Statements and Financial Statement Schedules
appearing on page F-1
(2) Financial Statement Schedules
See Index to Financial Statements and Financial Statement Schedules
appearing on page F-1
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------
<C> <S>
2.1 Agreement by and among the Company, New Media, TWL, and the principals of TWL relating to certain
financing provided by the Company to TWL and related matters (Incorporated by reference from Exhibit
2.3 to the Company's Annual Report for the Fiscal Year Ended February 28, 1994)
2.2 First Amendment to Agreement by and among the Company, New Media, TWL and the principals of TWL
(Incorporated by reference from Exhibit 2.2 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1995)
2.3 Second Amendment to Agreement by and among the Company, New Media, TWL and the principals of TWL
(Incorporated by reference from Exhibit 2.2 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1995)
3.1 Restated Certificate of Incorporation of the Company (Incorporated by reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-18 (No. 33-37024))
3.2 Amendment to Certificate of Incorporation of the Company effecting name change from "Robern Apparel,
Inc." to "Robern Industries, Inc." (Incorporated by reference to Exhibit 3.1(b) to the Company's
Registration Statement on Form S-4 (No. 33-52716))
3.3 Second Amendment to Certificate of Incorporation of the Company effecting name change from "Robern
Industries, Inc." to "WinStar Communications, Inc." (Incorporated by reference to Exhibit 3.1(b) to
the Company's Registration Statement on Form S-1 (No. 33-43915))
3.4 Certificate of Elimination of Series A, B, C, D and E Preferred Stock of the Company (Incorporated by
reference to Exhibit 3.6 to the Company's Current Report on Form 8-K dated February 14, 1997)
3.5 Certificate of Designations, Preferences and Rights of 6% Series A Cumulative Convertible Preferred
Stock (Incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K dated
February 14, 1997)
3.6 By-Laws of the Company (Incorporated by reference to Exhibit 3.2 to the Company's Registration
Statement on Form S-18 (No. 33-37024))
3.6(a) Amendments to the By-Laws of the Company (Incorporated by reference to Exhibit 3.6(a) to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996)
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------
<C> <S>
3.7 Certificate of Incorporation of WinStar Wireless (Incorporated by reference from Exhibit 7 to the
Company's Current Report on Form 8-K, dated February 11, 1994)
3.8 By-Laws of WinStar Wireless (Incorporated by reference from Exhibit 8 to the Company's Current Report
on Form 8-K, dated February 11, 1994)
3.9 Certificate of Incorporation of Gateway (Incorporated by reference to Exhibit 3.5 to the Company's
Annual Report on From 10-K for the Fiscal Year Ended February 28, 1993)
3.10 Amendment to Certificate of Incorporation of Gateway effecting name change from "Communications
Gateway Network, Inc." to "WinStar Gateway Network, Inc." (Incorporated by reference from Exhibit 3.11
to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)
3.11 By-Laws of Gateway (Incorporated by reference to Exhibit 3.6 to the Company's Annual Report on From
10-K for the Fiscal Year Ended February 28, 1993)
3.12 Certificate of Incorporation of New Media (Incorporated by reference to Exhibit 3.9 to the Company's
Annual Report on From 10-KSB for the Fiscal Year Ended February 28, 1994)
3.13 Amendment to Certificate of Incorporation of New Media effecting name change from "WinStar Interactive
Media Company, Inc." to "WinStar New Media Company, Inc." (Incorporated by reference from Exhibit 3.14
to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)
3.14 By-Laws of New Media (Incorporated by reference to Exhibit 3.10 to the Company's Annual Report on Form
10-KSB for the fiscal year ended February 28, 1994)
3.15 Certificate of Incorporation of WinStar Wireless Fiber Corp. ("Wireless Fiber Corp.") (Incorporated by
reference to Exhibit 3.16 to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1995)
3.16 Amendment to Certificate of Incorporation of Wireless Fiber Corp. effecting name change from "WinCom
Corp." to "WinStar Wireless Fiber Corp." (Incorporated by reference to Exhibit 3.17 the Company's
Registration Statement on Form S-3 (No. 33-95242))
3.17 Certificate of Merger effecting merger of Avant-Garde into Wireless Fiber Corp. (Incorporated by
reference to Exhibit 3.18 the Company's Registration Statement on Form S-3 (No. 33-95242))
3.18 By-Laws of Wireless Fiber Corp. (Incorporated by reference to Exhibit 3.17 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended February 28, 1995)
3.19 Certificate of Incorporation of Global Products (Incorporated by reference to Exhibit 3.3 to the
Registration Statement on Form S-18 of Global Products (No. 33-12549))
3.20 Amendment to Certificate of Incorporation of Global Products to change its name from "Beauty Labs,
Inc." to "WinStar Global Products, Inc." (Incorporated by reference from Exhibit 3.19 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)
3.21 By-Laws of Global Products (Incorporated by reference to Exhibit 3.4 to the Registration Statement on
Form S-18 of Global Products (No. 33-12549))
3.22 Certificate of Incorporation of WinStar NFF Inc. ("WinStar NFF") (Incorporated by reference from
Exhibit 3.21 to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28,
1995)
3.23 By-laws of WinStar NFF (Incorporated by reference from Exhibit 3.22 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended February 28, 1995)
3.24 Certificate of Merger of NFF with and into WinStar NFF, with WinStar NFF as the merger's surviving
entity (Incorporated by reference from Exhibit 3.23 to the Company's Annual Report on Form 10-KSB for
the fiscal year ended February 28, 1995)
</TABLE>
36
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------
<C> <S>
3.25 Amendment to Certificate of Incorporation of WinStar NFF changing its name from "WinStar NFF Inc." to
"Non Fiction Films Inc." (Incorporated by reference from Exhibit 3.24 to the Company's Annual Report
on Form 10-KSB for the fiscal year ended February 28, 1995)
3.26 Certificate of Incorporation of WinStar Telecom (Incorporated by reference from Exhibit 3.24 to the
Company's Transition Report on Form 10-KSB for the ten months ended December 31, 1995)
3.27 By-laws of WinStar Telecom (Incorporated by reference from Exhibit 3.24 to the Company's Transition
Report on Form 10-KSB for the ten months ended February 28, 1995)
4.1 Specimen of Common Stock Certificate (Incorporated by reference from Exhibit 4.3 to the Registration
Statement of Company on From S-18 (No. 33-37024))
4.2 Specimen of 6% Series A Preferred Stock Certificate (Incorporated by reference to Exhibit 3 to the
Company's Current Report on Form 8-K, dated February 14, 1997)
4.3 EC-A Warrants issued to Everest Capital Fund, L.P. ("Fund") for 130,500 shares of Common Stock and to
Everest Capital International, L.P. ("Capital") for 169,500 shares of Common Stock (Incorporated by
reference to Exhibit 4.6 to the Company's Registration Statement on Form S-3 (No. 33-95242))
4.4 EC-B Warrants issued to Fund for 43,500 shares of Common Stock and to Capital for 56,500 shares of
Common Stock (Incorporated by reference to Exhibit 4.7 to the Company's Registration Statement on Form
S-3 (No. 33-95242))
4.5 EC-C Warrants issued to Fund for 65,250 shares of Common Stock and to Capital for 84,750 shares of
Common Stock (Incorporated by reference to Exhibit 4.8 to the Company's Registration Statement on Form
S-3 (No. 33-95242))
4.6 Form of Warrants issued to purchasers in the Preferred Stock Placement (Incorporated by reference to
Exhibit 4.10 to the Company's Current Report on Form 8-K, dated February 14, 1997)
10.1 Agreement between the Company and ITC Group (Incorporated by reference from Exhibit 10.9 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)
10.2 Lease for 230 Park Avenue, New York, New York facilities (Incorporated by reference from Exhibit 10.10
to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)
10.3 Lease for additional space at 230 Park Avenue, New York, New York 10169 (Incorporated by reference
from Exhibit 10.2(a) to the Company's Transition Report on Form 10-KSB for the ten months ended
December 31, 1995)
10.4 Lease for 144 Fairfield Road, Fairfield, New Jersey facilities (Incorporated by reference from Exhibit
10.12 to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)
10.5 Lease for 7799 Leesburg Pike, Tysons Corner, Virginia facilities (Incorporated by reference from
Exhibit 10.15 to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28,
1995)
10.5(a) Amendment to Leesburg Pike Lease (Incorporated by reference from Exhibit 10.7(a) to the Company's
Transition Report on Form 10-KSB for the ten months ended December 31, 1995)
10.6 1992 Performance Equity Plan (Incorporated by reference to Exhibit 10.53 to the Company's Registration
Statement on Form S-18 (No. 33-37024)*
10.7 Loan and Security Agreement between Gateway and The CIT Group/Credit Finance, Inc. ("CIT")
(Incorporated by reference from Exhibit 10.22 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1995)
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------
<C> <S>
10.8 Guaranty and Surety Agreement between the Company and CIT in connection with Exhibit 10.12 above
(Incorporated by reference from Exhibit 10.25 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1995)
10.9 Subordination Agreement between the Company and CIT in connection with Exhibit 10.12 above
(Incorporated by reference from Exhibit 10.26 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1995)
10.10 Keepwell Agreement between the Company and CIT in connection with Exhibit 10.12 above (Incorporated by
reference from Exhibit 10.27 to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1995)
10.11 Agreement between CIT and Zero Plus Dialing, Inc. regarding Escrow and Disbursing Agreement with Texas
Commerce Bank and Assignment of Outstanding Accounts Receivable in connection with Exhibit 10.22 above
(Incorporated by reference from Exhibit 10.28 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1995)
10.12 Limited Guaranty of the Company in connection with Exhibit 10.19 above (Incorporated by reference from
Exhibit 10.38 to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28,
1995)
10.13 Executive Incentive Compensation Program (Incorporated by reference from Exhibit 10.40 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)*
10.14 Lease for 12 Gardner Road, Fairfield, New Jersey facilities (Incorporated by reference to Exhibit
10.52 to the Company's Registration Statement on Form S-3 (No. 33-95242))
10.15 Agreement between the Company, WinStar Wireless and P-Com, Inc. (Incorporated by reference from
Exhibit 10.11 to the Registration Statement on Form S-1 of P-Com, Inc. (No. 33-88492) on file with the
Commission)
10.16 Employment Agreement between the Company and Nathan Kantor, together with voting stipulation given by
William J. Rouhana, Jr. to Mr. Kantor (Incorporated by reference to Exhibit 10.54 to the Company's
Registration Statement on Form S-3 (No. 33-95242))*
10.17 Form of Stock Option Agreement between the Company and Nathan Kantor for the purchase of 350,000
shares of Common Stock (Incorporated by reference to Exhibit 10.55 to the Company's Registration
Statement on Form S-3 (No. 33-95242))*
10.18 Form of Stock Option Agreement between the Company and Nathan Kantor for the purchase of 350,000
additional shares of Common Stock (Incorporated by reference to Exhibit 10.56 to the Company's
Registration Statement on Form S-3 (No. 33-95242))*
10.19 Employment Agreement between the Company and William J. Rouhana, Jr. (Incorporated by reference to
Exhibit 10.57 to the Company's Registration Statement on Form S-3 (No. 33-95242))*
10.20 Employment Agreement between the Company and Fredric E. von Stange (Incorporated by reference to
Exhibit 10.58 to the Company's Registration Statement on Form S-3 (No. 33-95242))*
10.21 Facility Agreement between ML Investors Services, Inc. ("ML") and WinStar Wireless (Incorporated by
reference to Exhibit 10.59 to the Company's Registration Statement on Form S-3 (No. 33-95242))
10.22 Master Lease Agreement between ML and WinStar Wireless (Incorporated by reference to Exhibit 10.60 to
the Company's Registration Statement on Form S-3 (No. 33-95242))
10.23 Form of Stock Option Agreement between the Company and ML (Incorporated by reference to Exhibit 10.61
to the Company's Registration Statement on Form S-3 (No. 33-95242))
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------
<C> <S>
10.24 Lease Guaranty between the Company and ML (Incorporated by reference to Exhibit 10.62 to the Company's
Registration Statement on Form S-3 (No. 33-95242))
10.25 Service Agreement between WinStar Wireless and AT&T (Incorporated by reference to Exhibit 10.63 to the
Company's Registration Statement on Form S-3 (No. 33-95242)) (confidentiality granted under Rule 406
promulgated under the Act; accordingly, certain information has been omitted from this exhibit and
filed separately with the Commission)
10.26 Senior Notes Indenture, including form of Restricted Global Senior Note, entered into in connection
with the Company's private placement of notes in October 1995 (the "1995 Debt Placement")
(Incorporated by reference from Exhibit 2 to the Current Report on Form 8-K, dated October 23, 1995)
10.27 Convertible Notes Indenture, including form of Restricted Global Convertible Notes, entered into in
connection with the 1995 Debt Placement (Incorporated by reference from Exhibit 3 to the Current
Report on Form 8-K, dated October 23, 1995)
10.28 Employment Agreement between WinStar Wireless and Leo I. George (Incorporated by reference from
Exhibit 10.4 to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28,
1995)*
10.29 Employment Agreement between NFF and Stuart B. Rekant (Incorporated by reference from Exhibit 10.5 to
the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)*
10.30 Employment Agreement between New Media and Stuart B. Rekant (Incorporated by reference from Exhibit
10.6 to the Company's Annual Report on Form 10-KSB for the fiscal year ended February 28, 1995)*
10.31 Registration Rights Agreement among the Company and the former stockholders of the partners of
Milliwave entered into in connection with the Milliwave Acquisition (Incorporated by reference to the
Company's Current Report on Form 8-K dated February 17, 1997)
10.32 Amended and Restated Credit Agreement among WinStar Global Products, Inc., IBJ Schroder Bank Trust
Company, as lender, and IBJ Schroder Bank & Trust Company, as agent (Incorporated by reference to
Exhibit 10.79 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996)
10.33 Pledge Agreement by WinStar Global Products, Inc. in favor of IBJ Schroder Banker & Trust Company, as
agent (Incorporated by reference to Exhibit 10.80 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1996)
10.34 Subordination Agreement between WinStar Communications, Inc., and IBJ Schroder Bank & rust Company, as
agent (Incorporated by reference to Exhibit 10.81 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1996)
10.35 Amended and Restated Guaranty between WinStar Communications, Inc. and IBJ Schroder Bank & Trust
Company, as agent agent (Incorporated by reference to Exhibit 10.82 to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996)
10.36 First Supplemental Indenture (Old Senior Notes) between WinStar Communications, Inc. and United States
Trust Company of New York, as trustee (Incorporated by reference to Exhibit 10.83 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996)
10.37 First Supplemental Indenture (Convertible Notes) between WinStar Communications, Inc. and United
States Trust Company of New York, as trustee (Incorporated by reference to Exhibit 10.84 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996)
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------
<C> <S>
10.38 Senior Notes Indenture, including form of New Senior Note, entered into in connection with the
issuance of the New Senior Notes in the 1997 Debt Placement (Incorporated by reference from Exhibit
10.2 to the Company's Current Report on Form 8-K, dated March 27, 1997)
10.39 Guaranteed Senior Secured Notes Indenture, including form of WEC Note, entered into in connection with
the issuance of the WEC Notes in the 1997 Debt Placement (Incorporated by reference from Exhibit 10.3
to the Company's Current Report on Form 8-K, dated March 27, 1995)
10.40 Purchase Agreement with respect to the New Senior Notes and the WEC Notes entered into by the Company,
WEC and the purchasers thereunder in connection with the 1997 Debt Placement (Incorporated by
reference from Exhibit 10.1 to the Company's Current Report on Form 8-K, dated March 27, 1995)
10.41 Registration Rights Agreement entered into by the Company, WEC and the initial holders of the Notes in
connection with the 1997 Debt Placement (Incorporated by reference from Exhibit 10.4 to the Company's
Current Report on Form 8-K, dated March 27, 1995)
10.42 Security Agreement entered into by WEC and the Trustee in connection with the 1997 Debt Placement
(Incorporated by reference from Exhibit 10.5 to the Company's Current Report on Form 8-K, dated March
27, 1995)
10.43 Securities Purchase Agreement entered into in connection with the Preferred Stock Placement
(Incorporated by reference to Exhibit 2.7 to the Company's Current Report on Form 8-K dated February
14, 1997)
10.44 Registration Rights Agreement entered into in connection with the Preferred Stock Placement
(Incorporated by reference to Exhibit 10.85 to the Company's Current Report on Form 8-K dated February
14, 1997)
21.1 Schedule of Company's Subsidiaries (filed herewith)
23.1 Consent of Grant Thornton LLP, Independent Accountants of the Company
27.1 Financial Data Schedule
</TABLE>
- ------------------------
* Indicates management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
1. Current Report on Form 8-K with respect to the acquisition by the
Company of certain assets and business comprising the Microwave Division of
Local Area Telecommunications, Inc. on October 8, 1996, including the
following audited (except as otherwise indicated) financial statements of
the acquired business: Balance sheets as of June 30, 1996 and 1995;
Statements of Operations for the year ended December 31, 1995 and the six
months ended June 30, 1996 and 1995 (unaudited); Statements of Divisional
(Deficit) Surplus as of and for the six months ended June 30, 1996
(unaudited) and for the years ended December 31, 1995 and 1994; and
Statements of Cash Flows for the year ended December 31, 1995 and the six
months ended June 30, 1996 and 1995 (unaudited)
Copies of the exhibits listed above will be made available by the Company to
any stockholder upon written request of the stockholder addressed to WinStar
Communications, Inc., 230 Park Avenue, Suite 3126, New York, New York 10169,
Attention: Investor Relations. Any stockholder requesting a copy of any such
exhibit will be charged a copying fee of $.25 per page.
40
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized, on the 31st day of March, 1997.
WINSTAR COMMUNICATIONS, INC.
By: /s/ WILLIAM J. ROUHANA, JR.
-----------------------------------
William J. Rouhana, Jr.
Chairman of the Board
and Chief Executive Officer
In accordance with Section 13 or 15(d) of the Exchange Act, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------- ------------------------------------------------------ -----------------
<S> <C> <C>
/s/ WILLIAM J. ROUHANA, JR. Chairman of the Board, Chief Executive Officer
- ------------------------------- (principal executive officer) and Director
William J. Rouhana, Jr. March 31, 1997
/s/ STEVEN G. CHRUST
- ------------------------------- Vice Chairman and Director
Steven G. Chrust March 31, 1997
/s/ NATHAN KANTOR
- ------------------------------- President, Chief Operating Officer and Director
Nathan Kantor March 31, 1997
/s/ FREDRIC E. VON STANGE Executive Vice President, Chief Financial Officer
- ------------------------------- (principal accounting officer) and Director
Fredric E. von Stange March 31, 1997
/s/ WILLIAM HARVEY
- ------------------------------- Director
William Harvey March 31, 1997
/s/ STEVEN MAGYAR
- ------------------------------- Director
Steven Magyar March 31, 1997
/s/ WILLIAM J.VANDEN HEUVEL
- ------------------------------- Director
William J. vanden Heuvel March 31, 1997
/s/ BERT WASSERMAN
- ------------------------------- Director
Bert Wasserman March 31, 1997
- ------------------------------- Director
Dennis R. Patrick
/s/ JAMES I. CASH
- ------------------------------- Director
James I. Cash March 31, 1997
</TABLE>
41
<PAGE>
WINSTAR COMMUNICATIONS, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
PAGE NUMBER
---------------
<S> <C>
Report of Independent Certified Public Accountants.................................................. F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996........................................ F-3
Consolidated Statements of Operations, Year Ended February 28, 1995, Ten Months ended December 31,
1994 (unaudited), Ten Months ended December 31, 1995 and the Year Ended December 31, 1996......... F-4
Consolidated Statements of Stockholders' Equity (Deficit), Year Ended February 28, 1995, Ten Months
ended December 31, 1995 and the Year Ended December 31, 1996...................................... F-5
Consolidated Statements of Cash Flows, Year Ended February 28, 1995, Ten Months ended December 31,
1995 and the Year Ended December 31, 1996......................................................... F-8
Notes to Consolidated Financial Statements.......................................................... F-9
Report of Independent Certified Public Accountants on Schedules..................................... F-31
Schedule II--Valuation and Qualifying Accounts, Year Ended February 28, 1995, Ten Months Ended
December 31, 1995 and the Year Ended December 31, 1996............................................ F-32
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
WinStar Communications, Inc.
We have audited the accompanying consolidated balance sheets of WinStar
Communications, Inc. and Subsidiaries as of December 31, 1995 and 1996, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for the year ended February 28, 1995, the ten months ended
December 31, 1995 and the year ended December 31, 1996. 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 consolidated financial position of WinStar
Communications, Inc. and Subsidiaries as of December 31, 1995 and 1996, and the
consolidated results of their operations and their consolidated cash flows for
the year ended February 28, 1995, the ten months ended December 31, 1995 and the
year ended December 31, 1996, in conformity with generally accepted accounting
principles.
GRANT THORNTON LLP
New York, New York
January 24, 1997
F-2
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, 1996
DECEMBER 31, -----------------------------
1995 HISTORICAL PRO FORMA
------------ --------- ------------------
<S> <C> <C> <C>
(UNAUDITED, NOTE
2)
ASSETS
Current assets
Cash and cash equivalents......................................... $ 138,106 $ 95,490 $ 60,573
Short-term investments............................................ 73,595 26,997 26,997
------------ --------- --------
Cash, cash equivalents and short-term investments............... 211,701 122,487 87,570
Investments in equity securities.................................. 6,515 688 688
Accounts receivable, net of allowance for doubtful accounts of
$800 and $1,002 respectively.................................... 8,684 17,649 17,655
Inventories....................................................... 7,392 13,615 13,615
Prepaid expenses and other current assets......................... 3,768 16,726 11,726
------------ --------- --------
Total current assets............................................ 238,060 171,165 131,254
Property and equipment, net......................................... 15,898 63,287 64,678
Licenses, net....................................................... 12,556 27,434 167,569
Intangible assets, net.............................................. 3,034 13,404 13,404
Deferred financing costs............................................ 10,525 10,535 10,535
Other assets........................................................ 5,290 4,398 4,398
------------ --------- --------
Total assets................................................ $ 285,363 $ 290,223 $ 391,838
------------ --------- --------
------------ --------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Current portion of long-term debt................................. $ 8,288 $ 19,901 $ 19,901
Accounts payable and accrued expenses............................. 13,513 32,519 32,630
Current portion of capitalized lease obligations.................. 1,355 3,135 3,135
------------ --------- --------
Total current liabilities....................................... 23,156 55,555 55,666
Capitalized lease obligations, less current portion................. 6,081 10,849 10,849
Long-term debt, less current portion................................ 234,374 273,490 273,490
Deferred income taxes............................................... -- -- 26,500
------------ --------- --------
Total liabilities............................................... 263,611 339,894 366,505
------------ --------- --------
Commitments and contingencies
Stockholders' equity (deficit)
Preferred stock................................................... 689 -- --
Common stock, par value $.01; authorized 75,000 shares, issued
29,708 and 28,989, outstanding 27,201 and 28,989, respectively,
and pro forma issued and outstanding 32,583 shares.............. 297 290 326
Additional paid-in capital........................................ 103,837 75,436 150,404
Accumulated deficit............................................... (41,311) (125,034) (125,034)
------------ --------- --------
63,512 (49,308) 25,696
Treasury stock.................................................... (39,678) -- --
Deferred compensation............................................. (1,100) -- --
Unrealized loss on marketable equity securities................... (982) (363) (363)
------------ --------- --------
Total stockholders' equity (deficit)............................ 21,752 (49,671) 25,333
------------ --------- --------
Total liabilities and stockholders' equity (deficit)........ $ 285,363 $ 290,223 $ 391,838
------------ --------- --------
------------ --------- --------
</TABLE>
See Notes to Consolidated Financial Statements
F-3
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED FOR THE TEN MONTHS FOR THE
FEBRUARY ENDED DECEMBER 31, YEAR ENDED
28, ------------------------ DECEMBER 31,
1995 1994 1995 1996
----------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
(UNAUDITED)
Operating revenues
Telecommunications services............................... $ 14,909 $ 13,420 $ 13,137 $ 33,969
Information services...................................... 473 193 2,648 14,650
Other..................................................... 10,183 8,405 13,986 19,429
----------- ------------ ---------- ------------
Total operating revenues.................................... 25,565 22,018 29,771 68,048
----------- ------------ ---------- ------------
Operating expenses
Cost of services and products............................. 19,137 15,147 20,906 52,136
Selling, general and administrative expenses.............. 11,895 10,196 17,906 67,688
Depreciation and amortization............................. 402 319 1,210 4,746
----------- ------------ ---------- ------------
Total operating expenses.................................... 31,434 25,662 40,022 124,570
----------- ------------ ---------- ------------
Operating loss.............................................. (5,869) (3,644) (10,251) (56,522)
Other income (expense)
Interest expense.......................................... (637) (505) (7,630) (37,476)
Interest income........................................... 385 297 2,890 10,275
Equity in loss of AGT..................................... (1,109) (766) (866) --
----------- ------------ ---------- ------------
Net loss.................................................... $ (7,230) $ (4,618) $ (15,857) $ (83,723)
----------- ------------ ---------- ------------
----------- ------------ ---------- ------------
Net loss per share.......................................... $ (0.42) $ (0.28) $ (0.70) $ (3.00)
----------- ------------ ---------- ------------
----------- ------------ ---------- ------------
Weighted average shares outstanding......................... 17,122 16,609 22,770 27,911
----------- ------------ ---------- ------------
----------- ------------ ---------- ------------
</TABLE>
See Notes to Consolidated Financial Statements
F-4
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED FEBRUARY 28, 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREFERRED STOCK
-------------------------------------------------------------
B C D
---------------------- ------------------------ -----------
SHARES AMOUNT SHARES AMOUNT SHARES
----------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCES AT FEBRUARY 28, 1994.............................. 1.20 $ 1,204 0.17 $ 173 225
Issuances of common stock..................................
Exercise of warrants.......................................
Conversion of preferred stock.............................. (0.53) (533) (0.17) (173) (225)
Preferred stock dividend................................... 0.06 62
Other, net.................................................
Net loss...................................................
----- --------- ----- ----- ---
BALANCES AT FEBRUARY 28, 1995.............................. 0.73 $ 733 -- $ -- --
----- --------- ----- ----- ---
----- --------- ----- ----- ---
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN ACCUMULATED
AMOUNT SHARES AMOUNT CAPITAL DEFICIT
----------- --------- ----------- ----------- ------------
<S> <C>
BALANCES AT FEBRUARY 28, 1994.............................. $ 900 9,843 $ 98 $ 20,290 $ (17,946)
Issuances of common stock.................................. 3,714 37 7,967
Exercise of warrants....................................... 6,105 61 12,738
Conversion of preferred stock.............................. (900) 485 5 1,601
Preferred stock dividend................................... (62)
Other, net................................................. (13)
Net loss................................................... (7,230)
----- --------- ----- ----------- ------------
BALANCES AT FEBRUARY 28, 1995.............................. $ -- 20,147 $ 201 $ 42,583 $ (25,238)
----- --------- ----- ----------- ------------
----- --------- ----- ----------- ------------
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
------------
BALANCES AT FEBRUARY 28, 1994.............................. $ 4,719
Issuances of common stock.................................. 8,004
Exercise of warrants....................................... 12,799
Conversion of preferred stock.............................. --
Preferred stock dividend................................... --
Other, net................................................. (13)
Net loss................................................... (7,230)
------------
BALANCES AT FEBRUARY 28, 1995.............................. $ 18,279
------------
------------
</TABLE>
See Notes to Consolidated Financial Statements
F-5
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE TEN MONTHS ENDED DECEMBER 31, 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREFERRED STOCK
------------------------------------------------
B E COMMON STOCK ADDITIONAL
---------------------- ------------------------ ---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
--------- ----------- ----------- ----------- --------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT FEBRUARY 28,
1995......................... 0.73 $ 733 -- $ -- 20,147 $ 201 $ 42,583 $ (25,238)
Issuances of common stock...... 4,447 45 10,639
Issuance of preferred stock.... 932 6,000 (360)
Conversions of preferred
stock........................ (0.15) (147) (932) (6,000) 684 7 6,140
Warrants and common stock
equivalents issued in
connection with long-term
debt and lease financing..... 981
Conversion of long-term debt... 539 5 3,410
Preferred stock dividends...... 0.11 103 (216)
Issuance of restricted stock... 150 2 1,236
Amortization of deferred
compensation.................
WinStar Private Exchange
Transaction.................. 3,741 37 39,641
Unrealized loss on investments
in marketable equity
securities...................
Other, net..................... (433)
Net loss....................... (15,857)
--------- ----------- ----------- ----------- --------- ----- ----------- ------------
BALANCES AT DECEMBER 31,
1995......................... 0.69 $ 689 -- $ -- 29,708 $ 297 $ 103,837 $ (41,311)
--------- ----------- ----------- ----------- --------- ----- ----------- ------------
--------- ----------- ----------- ----------- --------- ----- ----------- ------------
<CAPTION>
TREASURY STOCK
--------------------------------------------------
UNREALIZED LOSS
COMMON STOCK PREFERRED STOCK B ON INVESTMENTS
---------------------- -------------------------- DEFERRED IN MARKETABLE
SHARES AMOUNT SHARES AMOUNT COMPENSATION EQUITY SECURITIES
----------- --------- ------------- ----------- --------------- -------------------
<S> <C>
BALANCES AT FEBRUARY 28,
1995......................... -- $ -- -- $ -- $ -- $ --
Issuances of common stock......
Issuance of preferred stock....
Conversions of preferred
stock........................
Warrants and common stock
equivalents issued in
connection with long-term
debt and lease financing.....
Conversion of long-term debt...
Preferred stock dividends......
Issuance of restricted stock... (1,238)
Amortization of deferred
compensation................. 138
WinStar Private Exchange
Transaction.................. (2,507) (36,348) (0.69) (3,330)
Unrealized loss on investments
in marketable equity
securities................... (982)
Other, net.....................
Net loss.......................
----------- --------- ----- ----------- ------- -----
BALANCES AT DECEMBER 31,
1995......................... (2,507) $ (36,348) (0.69) $ (3,330) $ (1,100) $ (982)
----------- --------- ----- ----------- ------- -----
----------- --------- ----- ----------- ------- -----
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
BALANCES AT FEBRUARY 28,
1995......................... $ 18,279
Issuances of common stock...... 10,684
Issuance of preferred stock.... 5,640
Conversions of preferred
stock........................ --
Warrants and common stock
equivalents issued in
connection with long-term
debt and lease financing..... 981
Conversion of long-term debt... 3,415
Preferred stock dividends...... (113)
Issuance of restricted stock... --
Amortization of deferred
compensation................. 138
WinStar Private Exchange
Transaction.................. --
Unrealized loss on investments
in marketable equity
securities................... (982)
Other, net..................... (433)
Net loss....................... (15,857)
-------------
BALANCES AT DECEMBER 31,
1995......................... $ 21,752
-------------
-------------
</TABLE>
See Notes to Consolidated Financial Statements
F-6
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
TREASURY
STOCK
---------
COMMON
PREFERRED STOCK B COMMON STOCK ADDITIONAL STOCK
-------------------- ---------------------- PAID-IN ACCUMULATED ---------
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT SHARES
--------- --------- --------- ----------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1995......... 0.69 $ 689 29,708 $ 297 $ 103,837 $ (41,311) (2,507)
Issuances of common stock............. 1,383 14 9,619
Acquisition of treasury shares........ (150)
Retirement of treasury shares......... (0.69) (689) (2,657) (27) (42,018) 2,657
Amortization of deferred
compensation........................
Conversion of long-term debt.......... 555 6 3,878
Fair value of stock options granted to
nonemployees and other, net......... 120
Unrealized gain on investments in
marketable equity securities........
Net loss.............................. (83,723)
--------- --------- --------- ----- ----------- ------------ ---------
BALANCES AT DECEMBER 31, 1996......... -- $ -- 28,989 $ 290 $ 75,436 $ (125,034) --
--------- --------- --------- ----- ----------- ------------ ---------
--------- --------- --------- ----- ----------- ------------ ---------
<CAPTION>
UNREALIZED
GAIN/ (LOSS) TOTAL
PREFERRED STOCK B ON INVESTMENTS STOCKHOLDERS'
---------------------- DEFERRED IN MARKETABLE EQUITY
AMOUNT SHARES AMOUNT COMPENSATION EQUITY SECURITIES (DEFICIT)
--------- ----------- --------- ------------- ----------------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1995......... $ (36,348) (0.69) $ (3,330) $ (1,100) $ (982) $ 21,752
Issuances of common stock............. 9,633
Acquisition of treasury shares........ (3,056) (3,056)
Retirement of treasury shares......... 39,404 0.69 3,330 --
Amortization of deferred
compensation........................ 1,100 1,100
Conversion of long-term debt.......... 3,884
Fair value of stock options granted to
nonemployees and other, net......... 120
Unrealized gain on investments in
marketable equity securities........ 619 619
Net loss.............................. (83,723)
--------- ----- --------- ------------- ----- ------------
BALANCES AT DECEMBER 31, 1996......... $ -- -- $ -- $ -- $ (363) $ (49,671)
--------- ----- --------- ------------- ----- ------------
--------- ----- --------- ------------- ----- ------------
</TABLE>
See Notes to Consolidated Financial Statements
F-7
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
TEN MONTHS
YEAR ENDED ENDED YEAR ENDED
FEBRUARY 28, DECEMBER 31, DECEMBER 31,
1995 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities
Net loss............................................................. $ (7,230) $ (15,857) $ (83,723)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization...................................... 658 1,300 6,307
Provision for doubtful accounts.................................... 894 887 1,562
Equity in unconsolidated results of AGT............................ 1,109 866 --
Noncash interest expense........................................... -- 6,151 35,040
Decrease in operating assets:
Accounts receivable.............................................. (1,410) (5,527) (5,464)
Inventories...................................................... (1,729) (3,159) (5,056)
Prepaid expenses and other current assets........................ (440) (2,479) (14,167)
Other assets..................................................... (91) (269) (1,566)
Increase in accounts payable and accrued expenses.................. 1,635 6,306 10,187
Other, net......................................................... 78 179 186
------------ ------------ ------------
Net cash used in operating activities.................................. (6,526) (11,602) (56,694)
------------ ------------ ------------
Cash flows from investing activities:
Investments in and advances to AGT................................... (7,129) (5,704) --
Decrease (increase) in short-term investments, net................... -- (73,594) 46,597
Decrease (increase) in other investments, net........................ -- (7,497) 6,447
Purchase of property and equipment, net.............................. (1,055) (8,608) (47,961)
Acquisitions, net.................................................... (679) -- (2,121)
Other, net........................................................... (1,925) (499) (1,619)
------------ ------------ ------------
Net cash provided by (used in) investing activities.................... (10,788) (95,902) 1,343
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from long-term debt, net.................................... 1,264 225,796 1,213
Payment of dividends................................................. -- (113) --
Net proceeds from equity transactions................................ 19,067 11,259 6,295
Proceeds from equipment lease financing.............................. -- 6,998 8,345
Payment of capital lease obligations................................. (251) (701) (2,108)
Other, net........................................................... (329) (785) (1,010)
------------ ------------ ------------
Net cash provided by financing activities.............................. 19,751 242,454 12,735
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents................... 2,437 134,950 (42,616)
Cash and cash equivalents at beginning of period....................... 719 3,156 138,106
------------ ------------ ------------
Cash and cash equivalents at end of period............................. 3,156 138,106 95,490
Short-term investments at end of period................................ -- 73,595 26,997
------------ ------------ ------------
Cash, cash equivalents and short-term investments at end of period..... $ 3,156 $ 211,701 $ 122,487
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements
F-8
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of WinStar
Communications, Inc. ("WCI") and its subsidiaries (the "Company"). All material
intercompany transactions and accounts have been eliminated in consolidation.
NATURE OF BUSINESS
The Company is the holder of the largest amount of 38 GHz licenses in the
United States and utilizes this position to provide facilities-based
telecommunications services. The Company plans to offer a full range of
telecommunications services as a Competitive Local Exchange Carrier ("CLEC"),
including local, long distance and Internet access services, to small and
medium-sized businesses in major metropolitan areas in the United States. The
Company also offers a variety of broadband, high-capacity local access and
digital network services to telecommunications service providers on a wholesale
basis. As a complement to its telecommunications services offerings, the Company
produces and distributes information and entertainment content. The Company also
operates a nonstrategic consumer products company. The Company's
telecommunications services are subject to varying degrees of federal, state and
local regulation.
To capitalize on opportunities in the telecommunications industry, the
Company is pursuing a rapid expansion of its telecommunications services, which
will require significant amounts of capital to finance capital expenditures and
anticipated operating losses. The Company may elect to slow the speed or narrow
the scope of this expansion in the event that it is unable to raise sufficient
amounts of capital on acceptable terms.
FISCAL YEAR
The Company changed its fiscal year end from February 28 to December 31,
effective January 1, 1996. Accordingly, these financial statements present the
year ended February 28, 1995, the ten-month transition period ended December 31,
1995, and the year ended December 31, 1996.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Cash
equivalents consist of money market fund investments, short-term certificates of
deposit, and commercial paper. Exclusive of cash in banks, cash equivalents at
December 31, 1995 and 1996 were $137.4 million and $84.5 million, respectively,
and approximate fair value.
SHORT-TERM INVESTMENTS
Short-term investments are widely diversified and principally consist of
certificates of deposit and money market deposits, U.S. government or government
agency securities, commercial paper rated "A-1/P-1" or higher, and municipal
securities rated "A" or higher with an original maturity of greater than three
months and less than six months. Short-term investments are considered
held-to-maturity and are stated at amortized cost which approximates fair value.
As of December 31, 1995 and 1996, cash, cash equivalents and short-term
investments totaled $211.7 million and $122.5 million, respectively.
F-9
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventories in the merchandising division are valued at the lower of cost or
market, principally using the first-in, first-out method.
Film inventories include direct and indirect production costs, which are
amortized to expense in the proportion that revenue recognized during the year
for each film bears to the estimated total revenue to be received from all
sources under the individual film forecast method. Management's estimate of
forecasted revenues exceeds the unamortized costs on an individual program
basis. Such forecasted revenue is subject to revision in future periods if
warranted by changing market conditions.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation and amortization are
generally computed using the straight-line method over the estimated useful
lives of the related assets.
CAPITALIZED INTEREST
The Company follows the policy of capitalizing interest expense as a
component of the cost of its telecommunications equipment constructed for its
own use.
LICENSES AND INTANGIBLE ASSETS
Licenses and intangible assets are being amortized by the straight-line
method over their estimated useful lives.
Goodwill represents the excess of cost over the fair value of assets
acquired. The Company's policy is to measure goodwill impairment by considering
a number of factors as of each balance sheet date including (i) current
operating results of the applicable business, (ii) projected future operating
results of the applicable business, (iii) the occurrence of any significant
regulatory changes which may have an impact on the continuity of the business,
and (iv) any other material factors that affect the continuity of the applicable
business. The amortization period for goodwill is determined on a case-by-case
basis for each acquisition from which goodwill arises based on a review of the
nature of the business acquired as well as the factors cited above (see Note 6).
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"). Pursuant to SFAS 109, deferred income taxes are recognized for temporary
differences between financial statement and income tax bases of assets and
liabilities, loss carryforwards and tax credit carryforwards for which income
tax benefits are expected to be realized in future years. A valuation allowance
is established to reduce deferred tax assets if it is more likely than not that
all, or some portion, of such deferred tax assets will not be realized. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date.
F-10
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
In the telecommunications segment, revenues are recorded upon placing of
calls or rendering of other related services. In the information services
segment, revenues from film productions are recognized when a program is
accepted by the licensee and is available for broadcast. Revenues from the
licensing of film productions are recognized when the license period begins and
the film is available for broadcast. Revenues from advertising sales are
recognized when the related advertising is broadcast. In the merchandising
segment, revenues are recorded upon shipment of merchandise and are presented in
the accompanying consolidated statement of operations net of merchandise
returns. The Company provides for future estimated returns of merchandise at the
time of sale.
NET LOSS PER COMMON SHARE
Net loss per common share is calculated by dividing the net loss by the
weighted average number of shares of common stock outstanding. Stock options,
warrants and other convertible securities have not been included in the
calculation as their inclusion would be antidilutive.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration
of credit risk consist principally of trade receivables. Concentration of credit
risk with respect to these receivables is generally diversified due to the large
number of entities comprising the Company's customer base and their dispersion
across geographic areas. The Company routinely addresses the financial strength
of its customers and, as a consequence, believes that its receivable credit risk
exposure is limited.
The Company places its cash and investments with relatively few high credit
quality financial institutions with approximately $60 million at one
institution. As a result, substantially all of the cash, cash equivalents and
short-term investments at December 31, 1996 are uninsured.
USE OF ESTIMATES IN PREPARING FINANCIAL STATEMENTS
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
UNAUDITED FINANCIAL STATEMENTS
The unaudited consolidated statement of operations for the ten months ended
December 31, 1994 is a condensed financial statement in accordance with the
rules and regulations of the Securities and Exchange Commission. Accordingly,
the statement omits certain information included in complete financial
statements and should be read in conjunction with the information for the year
ended February 28, 1995, the ten months ended December 31, 1995 and the year
ended December 31, 1996. In the opinion of the Company, the accompanying
unaudited consolidated financial statement includes all adjustments (consisting
only of normal recurring adjustments) necessary to present fairly the results of
operations for the ten months ended December 31, 1994.
F-11
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the
current period presentation.
NOTE 2--ACQUISITIONS
ACQUISITION OF MILLIWAVE LIMITED PARTNERSHIP AND PRO FORMA BALANCE SHEET
On January 2, 1997, a subsidiary of the Company merged with the corporate
shareholders of Milliwave Limited Partnership ("Milliwave"), a large holder of
38 GHz licenses in the United States, covering 160 million people in more than
80 major markets. The merger consideration paid by the Company to the
shareholders of the corporate partners of Milliwave was $116 million ($40.7
million in cash and 3.6 million shares of the Company's common stock, which had
an aggregate market value of $75 million). Pursuant to a registration rights
agreement, the Company agreed to register such shares of common stock for resale
prior to January 1, 1998. The merger was treated as a "purchase" for accounting
purposes with the purchase price principally allocated to licenses. In addition,
approximately $26.5 million of deferred tax liabilities were recorded in
connection with the acquisition, with a corresponding allocation to licenses,
which will be amortized on a straight-line basis over 40 years. Milliwave had
minimal operations prior to its merger into the Company.
The unaudited pro forma balance sheet has been prepared as if the Milliwave
acquisition had been consummated at December 31, 1996. The pro forma financial
information should be read in conjunction with the related historical
information and is not necessarily indicative of the results that would have
been attained had the transaction actually taken place.
Unaudited pro forma results of operations, which reflect the combined
operations of the Company and Milliwave as if the merger occurred as of the
January 1, 1996, is as follows:
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED
DECEMBER 31, 1996
-----------------
<S> <C>
Net Sales.................................................................. $ 66,560
Net Loss................................................................... (91,898)
Net Loss Per Share......................................................... (2.92)
</TABLE>
ACQUISITION OF LOCAL AREA TELECOMMUNICATIONS, INC.
In October 1996, a subsidiary of the Company acquired certain assets of
Local Area Telecommunications, Inc. ("Locate"), comprising its business as a
competitive access provider of local digital microwave distribution services and
facilities to large corporations and to interexchange and other common carriers.
The assets acquired included multiple 38 GHz licenses in the New York
metropolitan area. The purchase price for such assets was $17.5 million, which
was paid in the form of promissory notes (see Note 7). The acquisition has been
accounted for as a "purchase" for accounting purposes, with the majority of the
purchase price allocated to licenses, which will be amortized on a straight-line
basis over 40 years. The accounts of Locate have been consolidated into the
Company's financial statements as of the date of the acquisition.
F-12
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--ACQUISITIONS (CONTINUED)
ACQUISITION OF AVANT-GARDE
Avant-Garde Telecommunications, Inc. ("Avant-Garde" or "AGT") was a
privately held company which held 38 GHz radio licenses granted by the FCC in
September 1993. Through July 17, 1995, the Company owned 49% of Avant-Garde,
which it acquired for $4.9 million, and accounted for its investment in
Avant-Garde under the equity method. For the period from March 1, 1995 to July
17, 1995, and the year ended February 28, 1995, Avant-Garde had net losses of
$1.8 million and $2.3 million, respectively. On July 17, 1995, pursuant to the
terms of a merger agreement, the Company exchanged 1,275,000 restricted shares
of its common stock valued at $5.1 million for the 51% of Avant-Garde that it
did not already own. The acquisition of Avant-Garde has been treated as a
"purchase" for accounting purposes, with $12.6 million allocated to the licenses
acquired, which are being amortized on a straight-line basis over 40 years. The
accounts of Avant-Garde have been consolidated into the Company's financial
statements as of the date of the acquisition.
OTHER ACQUISITIONS
During the year ended February 28, 1995, a subsidiary of the Company
purchased Non Fiction Films, Inc. ("NFF"), a producer of non-fiction programming
for cable television and other media, for $476,000, consisting of $200,000 in
cash and 28,572 restricted shares of the Company's common stock. The transaction
was treated as a "purchase" for accounting purposes, with the purchase price
allocated based on the fair value of the assets acquired and liabilities
assumed. The excess of the purchase price over the fair value of the net assets
acquired, aggregating $495,000, has been recorded as goodwill. The accounts of
NFF have been consolidated into the Company's financial statements as of the
date of the acquisition.
During 1996, a subsidiary of the Company acquired 100% ownership or a
controlling interest in a number of companies engaged in the production and
distribution of entertainment content. These acquisitions were treated as
"purchases" for accounting purposes. The aggregate consideration for the
acquisitions was approximately $6.4 million, consisting of $4.1 million in cash,
$800,000 in notes payable and 100,605 shares of the Company's common stock or
share equivalents, valued at $1.5 million. In connection with these purchases,
the Company has made commitments to provide, under certain conditions, up to
$2.0 million in working capital and is obligated to pay contingent
consideration, up to a maximum of $3.5 million, if certain earnings targets are
met over the five-year period subsequent to the acquisition. The accounts of the
acquired companies have been consolidated with the Company's financial
statements as of the date of acquisitions.
Unaudited results of operations for acquisitions other than Milliwave have
not been included because they are not material to the consolidated statement of
operations of the Company.
NOTE 3--INVESTMENTS IN MARKETABLE EQUITY SECURITIES
The Company treats its investments in marketable securities as available for
sale securities. As such, they are carried at market value, with the difference
between the historical cost (which is determined on a FIFO basis) and the market
value reflected in unrealized gains or losses on marketable equity securities, a
component of stockholders' equity. During the year ended December 31, 1996,
proceeds of $6.4 million were realized on the sale of marketable securities,
which were sold at carrying value. At December 31, 1995 and 1996, unrealized
losses of $982,000 and $363,000, respectively, were carried in stockholders'
equity. The unrealized loss at December 31, 1996 is considered temporary.
F-13
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--INVENTORIES
Components of inventories are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Finished goods................................................... $ 1,433 $ 1,514
Raw materials.................................................... 4,018 7,092
Film inventories................................................. 1,941 5,009
------ ------------
$ 7,392 $ 13,615
------ ------------
------ ------------
</TABLE>
NOTE 5--PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, ESTIMATED
1995 1996 USEFUL LIFE
------------ ------------ ------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Telecommunications equipment and software....................... $ 15,355 $ 58,788 5 to 10 years
Furniture, fixtures and other................................... 1,581 4,577 4 to 5 years
Leasehold improvements.......................................... 540 4,979 Life of the lease
------------ ------------
17,476 68,344
Less accumulated depreciation and amortization.................. (1,578) (5,057)
------------ ------------
$ 15,898 $ 63,287
------------ ------------
------------ ------------
</TABLE>
NOTE 6--INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, ESTIMATED
1995 1996 USEFUL LIFE
------------- ------------ ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Goodwill............................................................ $ 2,953 $ 13,904 5 to 20 years
Covenants not to compete and other.................................. 708 708 5 to 10 years
------ ------------
3,661 14,612
Less accumulated amortization....................................... (627) (1,208)
------ ------------
$ 3,034 $ 13,404
------ ------------
------ ------------
</TABLE>
Licenses are amortized over a 40-year period, in accordance with industry
practice. As of December 31, 1995 and 1996, the value of licenses was $12.6
million and $27.4 million, net of accumulated amortization of $256,000 and
$820,000, respectively.
F-14
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Senior Notes Payable (a)......................................... $ 153,972 $ 176,328
Convertible Notes Payable (a).................................... 76,986 88,164
Other Notes Payable (b).......................................... 11,704 28,899
------------ ------------
Total............................................................ 242,662 293,391
Less Current Portion............................................. 8,288 19,901
------------ ------------
$ 234,374 $ 273,490
------------ ------------
------------ ------------
</TABLE>
a) In October 1995, the Company completed a $225 million private placement
of debt securities with institutional investors (the "Debt Placement"). The
transaction was structured as a units offering with two components, $150 million
of Senior Discount Notes due in 2005 (the "Senior Notes"), and $75 million of
Convertible Senior Subordinated Discount Notes due in 2005 (the "Convertible
Notes"), convertible at $20.625, a 10% premium over the closing price on October
18, 1995, the day of pricing. Both securities accrue interest at 14% per annum,
with no interest payable during the first five years, and principal payable only
at maturity in October 2005. After five years, both securities require the
payment of interest only, in cash, until maturity. In addition, the Convertible
Notes, including accretion thereon, will be automatically converted during the
initial five-year period if the market price of the Company's common stock
exceeds certain levels for thirty consecutive trading days, ranging from $37.50
per share in the first year to $44.00 per share in the fifth year.
Under the terms of the Debt Placement, the Company was obligated to
consummate an exchange offer with respect to the Senior Notes by April 23, 1996,
whereby these notes would be exchanged for new notes (the "New Notes") which
would be identical in every respect to the original Senior Notes except that the
New Notes would be registered under the Securities Act of 1933. Pursuant to such
obligation, the Company filed an offer to exchange the Senior Notes for the New
Notes on January 31, 1996, upon which all Senior Notes were subsequently
exchanged. The Company was also obligated to, and did, cause to be declared
effective a registration statement registering the issuance or resale of the
shares underlying the Convertible Notes (the "Conversion Shares") by October 23,
1996. The terms of the Debt Placement also place certain restrictions on the
ability of the Company to pay dividends or make other restricted payments, incur
additional indebtedness, issue guarantees, sell assets, or enter into certain
other specified transactions.
b) Two of the Company's subsidiaries have collateralized asset-based lending
agreements with separate financial institutions aggregating $17 million.
Borrowings are limited to varying percentages of accounts receivable and
inventory, as defined, and bear interest at rates of .75% to 3%, respectively,
in excess of the financial institutions' respective prime lending rates. The
terms of such agreements expire in 1999 and 1998, respectively. Such loans are
guaranteed by substantially all the assets of the respective subsidiaries, and
additionally contain certain limited guarantees of WCI aggregating $5.2 million.
At December 31, 1995 and 1996, the aggregate outstanding balances under these
agreements were $7.4 million and $9.8 million, respectively.
F-15
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--LONG-TERM DEBT (CONTINUED)
On October 8, 1996, in connection with the purchase of Locate (see Note 2),
the Company issued two promissory notes in the aggregate principal amount of
$17.5 million (the "Locate Notes") bearing interest at an annual rate of 8%.
Interest on the Locate Notes is payable on a quarterly basis. The Notes are due
on the earlier of April 8, 1997, or the day after the date on which the shares
into which the Notes may be converted have been registered pursuant to an
effective registration statement. The Company may convert the Locate Notes, in
whole but not in part, at its election, into that number of shares of the
Company's common stock equal to (a) the principal amount and all accrued and
unpaid interest on the Locate Notes divided by (b) the average of the closing
prices of the Company's common stock for the five days ending on the date on
which the Company gives written notice of its decision to convert the Locate
Notes. Locate has no rights of conversion. The Company has granted certain
registration rights to Locate with respect to such shares of its common stock in
the event that the Company elects such conversion. The Company may convert the
Locate Notes, and accordingly, in December 1996, the Company filed a
registration statement to register such underlying shares. At December 31, 1996,
the aggregate amount of the Locate Notes, including accrued interest thereon,
was $17.8 million.
In May 1995, a subsidiary of the Company issued $7.5 million of five year
collateralized convertible notes (the "Notes") bearing interest at a rate of 7%,
payable semiannually, with all principal due and payable on May 24, 2000. On
December 28, 1995, the note holders converted $3.75 million of the convertible
notes and accrued interest thereon into 539,255 shares of common stock of the
Company, and on November 24, 1996, converted the remaining outstanding Notes of
$3.75 million principal amount plus accrued interest thereon into 554,880 shares
of common stock of the Company.
Following are maturities of long-term debt for each of the next five years
ending December 31,
<TABLE>
<CAPTION>
(IN
THOUSANDS)
-------------
<S> <C>
1997........................................................................... $ 19,901
1998........................................................................... 246
1999........................................................................... 8,561
2000........................................................................... 191
-------------
$ 28,899
-------------
-------------
</TABLE>
NOTE 8--FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's financial instruments classified as current
assets or liabilities, including cash and cash equivalents, short-term
investments, accounts and notes receivable, and accounts payable and accrued
expenses approximate carrying value, principally because of the short maturity
of these items. Marketable equity securities are stated at quoted market value.
The carrying amounts of the long-term debt payable to financial institutions
issued pursuant to two of the Company's subsidiaries' asset-based lending
agreements approximate fair value because the interest rates on these agreements
change with market interest rates.
The fair values of capitalized lease obligations approximate carrying value
based on their effective interest rates compared to current market rates.
F-16
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Estimated fair values of the Company's Senior Notes Payable and Convertible
Notes Payable are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
---------------- ---------- ---------------- ----------
(IN THOUSANDS)
Senior Notes Payable................................. $ 153,972 $ 153,972 $ 176,328 $ 179,455
Convertible Notes Payable............................ 76,986 76,986 88,164 94,141
</TABLE>
NOTE 9--CAPITAL LEASE OBLIGATIONS
The Company leases telecommunications and other equipment through various
equipment lease financing facilities. Such leases have been accounted for as
capital leases in accordance with Statement of Financial Accounting Standards
No. 13, "Accounting for Leases."
Future minimum lease payments on these capital leases are as follows:
<TABLE>
<CAPTION>
(IN
YEAR ENDING DECEMBER 31, THOUSANDS)
- ------------------------------------------------------------------------------- -------------
<S> <C>
1997........................................................................... $ 4,727
1998........................................................................... 4,485
1999........................................................................... 4,074
2000........................................................................... 3,065
2001........................................................................... 1,203
-------------
17,554
Less amount representing interest.............................................. (3,570)
-------------
Present value of minimum lease payments........................................ $ 13,984
-------------
-------------
</TABLE>
The carrying value of assets under capital leases was $8.1 million and $15.9
million at December 31, 1995 and 1996, respectively, and is included in property
and equipment. Amortization of these assets is included in depreciation expense.
NOTE 10--COMMITMENTS AND CONTINGENCIES
A. OPERATING LEASES
The Company's offices, manufacturing and warehousing facilities, along with
various equipment and roof access rights, are leased under operating leases
expiring in 1997 through 2006. Certain leases contain escalation clauses based
upon increases in the consumer price index.
F-17
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum lease payments on noncancellable operating leases are as
follows:
<TABLE>
<CAPTION>
(IN
YEAR ENDING DECEMBER 31, THOUSANDS)
- ------------------------------------------------------------------------------- -------------
<S> <C>
1997........................................................................... $ 6,405
1998........................................................................... 5,516
1999........................................................................... 5,201
2000........................................................................... 4,713
2001........................................................................... 4,128
Thereafter..................................................................... 34,903
-------------
$ 60,866
-------------
-------------
</TABLE>
Rent expense for the year ended February 28, 1995, the ten month period
ended December 31, 1995 and the year ended December 31, 1996 was $500,000, $1
million and $4.4 million, respectively.
B. EMPLOYMENT CONTRACTS
Amounts due under employment contracts are as follows:
<TABLE>
<CAPTION>
(IN
YEAR ENDING DECEMBER 31, THOUSANDS)
- ------------------------------------------------------------------------------- -------------
<S> <C>
1997........................................................................... $ 3,135
1998........................................................................... 2,026
1999........................................................................... 1,430
2000........................................................................... 305
------
$ 6,896
------
------
</TABLE>
C. LITIGATION
The Company occasionally receives inquiries from state authorities arising
with respect to consumer complaints concerning the provision of
telecommunications services, including allegations of unauthorized switching of
long distance carriers and misleading marketing. The Company believes such
inquiries are common in the long distance industry and addresses such inquiries
in the ordinary course of business. In December 1996, the Federal Communications
Commission ("FCC") and WinStar Gateway Network, Inc. ("WGN") entered into a
consent decree which terminated an inquiry by the FCC into any alleged
violations of unauthorized carrier conversions through the use of contest
programs by certain of WGN's agents. The FCC commended WGN's efforts in
identifying the problems caused by these agents and cited its proactive response
in implementing self-directed remedial actions as a significant factor leading
to the consent decree.
In June 1996, the Company commenced an action for declaratory judgment
against a former officer of WGN, who had notified the Company of his belief that
he was entitled to the issuance of certain shares of common stock of the Company
(or payment of the cash value thereof) having an aggregate market value in
excess of $27 million under the terms of stock options granted to him during his
employment with WGN. He has based his beliefs on standard antidilution language
contained in his stock option agreement. Such language was designed and intended
to adjust the number of shares purchasable thereunder in the event of a merger,
capital restructuring or other similar event of the Company. As the Company has
never been subject to a merger or capital restructuring, the former officer was
immediately notified of the Company's
F-18
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--COMMITMENTS AND CONTINGENCIES (CONTINUED)
belief that his claim was without merit in law or fact. To expedite resolution
of these issues, the Company currently is seeking declaratory judgment that it
has no obligation to the former officer.
The Company is also involved in miscellaneous claims, inquiries and
litigation arising in the ordinary course of business. The Company believes that
these matters, taken individually or in the aggregate, would not have a material
adverse impact on the Company's financial position or results of operations.
D. OTHER
In connection with the purchase of telecommunications equipment including
switches and radios, the Company enters into agreements with the suppliers of
such equipment. As of December 31, 1996, the Company's noncancellable purchase
commitments under these agreements were approximately $26.4 million.
In connection with the purchase of three 38 GHz licenses, covering certain
geographic areas in the metropolitan areas which include Dallas, Baltimore and
Philadelphia, the Company has entered into commitments to pay $498,000 during
the year ended December 31, 1997, subject to approval by the FCC of the purchase
of the licenses.
NOTE 11--INCOME TAXES
SFAS No. 109 requires the use of the liability method in accounting for
income taxes. Temporary differences and carryforwards that give rise to deferred
tax assets and liabilities at are as follows:
<TABLE>
<CAPTION>
PRO FORMA
WITH
MILLIWAVE
(NOTE 2)
(UNAUDITED)
------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1996
------------ ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred Tax Assets:
Net Operating Loss Carryforward.................................... $ 14,700 $ 48,218 $ 48,218
Deferred Interest Expense.......................................... 1,562 10,417 10,417
Allowance for Doubtful Accounts.................................... 1,025 433 433
Other.............................................................. 1,015 961 961
------------ ------------- ------------
Gross Deferred Tax Assets.......................................... 18,302 60,029 60,029
Valuation Allowance................................................ (18,000) (58,586) (28,087)
------------ ------------- ------------
Deferred Tax Asset Net of Allowance................................ 302 1,443 31,942
------------ ------------- ------------
Deferred Tax Liabilities:
Depreciation....................................................... (302) (1,354) (1,354)
Amortization....................................................... -- (89) (57,088)
------------ ------------- ------------
Gross Deferred Tax Liabilities..................................... (302) (1,443) (58,442)
------------ ------------- ------------
Net Deferred Tax Liability........................................... $ -- $ -- ($ 26,500)
------------ ------------- ------------
------------ ------------- ------------
</TABLE>
The federal net operating loss carryforward at December 31, 1996 is
approximately $127 million. If not utilized, the net operating loss carryforward
will expire in various amounts through the year 2011.
F-19
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--INCOME TAXES (CONTINUED)
Some, if not all, of these losses are subject to a utilization limitation under
Section 382 of the Internal Revenue Code. However, the Company believes that
substantially all of such losses will be available to offset future income.
SFAS No. 109 requires a valuation allowance against deferred tax assets if,
based on the weight of available evidence, it is more likely than not that some
or all of the deferred tax assets may not be realized. The valuation allowance
at December 31, 1995 and December 31, 1996, primarily pertains to uncertainties
with respect to future utilization of net operating loss carryforwards.
The pro forma net deferred tax liability of $26.5 million was recorded in
connection with the acquisition of Milliwave (see Note 2). This deferred tax
liability results from the temporary difference between the book and tax basis
of the acquired licenses, and relates to the scheduled reversal of the temporary
differences through amortization in years 2018 through 2036 that cannot be
offset by deferred tax assets existing at January 2, 1997, the date of the
Milliwave acquisition.
NOTE 12--STOCKHOLDERS' EQUITY
COMMON STOCK
The authorized capital stock of WCI includes 75 million shares of common
stock, $.01 par value. The holders of common stock of WCI are entitled to one
vote for each share held of record on all matters submitted to a vote of
stockholders. Although the Company has no present intention of paying any
dividends, holders of its common stock are entitled to receive ratably such
dividends as may be declared by the Board of Directors out of funds legally
available therefor. In the event of a liquidation or dissolution of WCI, holders
of its common stock are entitled to share ratably in all assets remaining after
payment of liabilities and the liquidation preference of preferred shares.
Holders of WCI's common stock have no preemptive rights and have no rights to
convert their common stock into any other securities. There are no redemption or
sinking fund provisions applicable to the common stock of WCI.
PREFERRED STOCK
The authorized capital stock of the Company includes 15 million shares of
preferred stock, $.01 par value, which may be issued from time to time in one or
more series upon authorization by the Company's Board of Directors. As of
December 31, 1996, there are no shares of preferred stock outstanding. The Board
of Directors, without further approval of the stockholders, is authorized to fix
the rights and terms, conversion rights, voting rights, redemption rights and
terms, liquidation preferences and any other rights, preferences, privileges and
restrictions applicable to each series of preferred stock.
In April 1995, the Company completed a private placement of 932,040 shares
of Series E Convertible Preferred Stock ("Preferred Stock E") at a price of
$6.4375 per share, for gross proceeds of $6 million. Preferred Stock E holders
were entitled to dividends at the rate of 9% per annum, payable quarterly
beginning on June 30, 1995. During the ten month period ended December 31, 1995,
the entire 932,040 shares of Preferred Stock E were converted into 634,228
shares of common stock.
F-20
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--STOCKHOLDERS' EQUITY (CONTINUED)
TREASURY STOCK
Included in treasury stock at cost at December 31, 1995 were 2,506,763
shares of common stock and 689 shares of Preferred Stock B which were acquired
in the Private Exchange transaction and retired during 1996 (see Note 14).
NOTE 13--STOCK OPTIONS AND STOCK PURCHASE WARRANTS
In 1990, the Board of Directors adopted a non-qualified common stock
incentive plan, as amended, pursuant to which options to purchase an aggregate
of 150,000 shares of common stock may be granted to key employees of the Company
as selected by the Board of Directors. The exercise price for shares covered by
options granted pursuant to this plan will not be less than the fair market
value of the shares on the date of the grant. In 1992, the Board of Directors
adopted and stockholders approved the 1992 Performance Equity Plan ("1992
Plan"), which authorizes the granting of awards up to 1 million shares of common
stock to the Company's key employees, officers, directors and consultants. In
1996, the Board of Directors adopted and the stockholders approved an increase
in the number of shares available for grant under this plan to 1.5 million.
Awards consist of stock options (both non-qualified options and options intended
to qualify as "incentive" stock options under the Internal Revenue Code),
restricted stock awards, deferred stock awards, stock appreciation rights and
other stock-based awards. The plan provides for automatic issuance of 10,000
stock options annually to each director on January 13, at the fair market value
at that date, subject to availability. In June 1995, the Board of Directors
adopted the 1995 Performance Equity Plan ("1995 Plan") which was approved by the
stockholders of the Company at the Annual Meeting of Stockholders in September
1995. The 1995 Plan authorizes the granting of awards of up to 1.5 million
shares of the Company's common stock to the Company's key employees, officers,
directors and consultants. The 1995 Plan is similar to the 1992 Plan, except
that the 1995 Plan does not allow for annual automatic annual director grants.
In 1996, the Board of Directors and the stockholders approved an increase in the
number of shares available for grant to 3.5 million. In addition to these three
plans, the Company has granted options to certain individuals not under any
plan. The options are exercisable over a period ranging from immediately to four
years, depending on option terms.
F-21
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--STOCK OPTIONS AND STOCK PURCHASE WARRANTS (CONTINUED)
The following table summarizes option activity for the year ended December
31, 1996, the ten-month period ended December 31, 1995, and the year ended
February 28, 1995.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE PRICE
NUMBER OF OPTIONS -----------------
-------------------
(IN THOUSANDS)
<S> <C> <C>
Balance, February 28, 1994.................................................. 5,018 $ 2.08
Granted................................................................... 2,851 5.76
Exercised................................................................. (1,390) 2.36
Canceled.................................................................. (330) 6.06
------
Balance, February 28, 1995.................................................. 6,149 3.85
Granted................................................................... 3,896 9.13
Exercised................................................................. (2,092) 2.35
Canceled.................................................................. (708) 3.21
------
Balance, December 31, 1995.................................................. 7,245 6.90
Granted................................................................... 4,057 18.55
Exercised................................................................. (921) 6.00
Canceled.................................................................. (669) 12.72
------
Balance, December 31, 1996.................................................. 9,712 $ 11.43
------
------
</TABLE>
As of December 31, 1996, options outstanding for 3.8 million shares were
exercisable at prices ranging from $1.50 to $31.13, and the weighted remaining
contractual life was 4.6 years.
The following table summarizes option data as of December 31, 1996:
<TABLE>
<CAPTION>
NUMBER WEIGHTED
WEIGHTED AVERAGE EXERCISEABLE AS AVERAGE
REMAINING WEIGHTED AVERAGE OF 12/31/96 EXERCISE
RANGE OF EXERCISE PRICES CONTRACTUAL LIFE EXERCISE PRICE --------------- PRICE
- ------------------------------------------ NUMBER --------------------- ----------------- (IN THOUSANDS) -----------
OUTSTANDING AS
OF 12/31/96
---------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
$1.50 - $6.00............................. 3,260 3.5 $ 4.20 2,766 $ 3.97
$6.06 - $15.88............................ 3,255 4.5 10.59 1,031 9.21
$16.00 - $31.13........................... 3,197 5.4 19.66 466 18.69
----- -----
$1.50 - $31.13............................ 9,712 4.5 $ 11.43 4,263 $ 6.85
----- -----
----- -----
</TABLE>
Compensation cost charged to operations, which the Company records for
options granted to non-employees, was $150,000 and $0 in the year ended December
31, 1996 and the ten months ended December 31, 1995, respectively.
The Company measures compensation in accordance with the provisions of APB
Opinion No. 25 in accounting for its stock compensation plans. Accordingly, no
compensation cost has been recorded for options granted to employees or
directors in the year ended December 31, 1996 or the ten months ended
F-22
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--STOCK OPTIONS AND STOCK PURCHASE WARRANTS (CONTINUED)
December 31, 1995. The fair value of each option granted has been estimated on
the grant date using the Black-Scholes Option Valuation Model. The following
assumptions were made in estimating fair value:
<TABLE>
<S> <C>
Dividend Yield................................................... 0%
Risk-Free Interest Rate.......................................... 6.0%
Expected Life after Vesting Period
- Directors and Officers....................................... 2.0 Years
- Others....................................................... 0.5 Years
Expected Volatility.............................................. 66.88%
</TABLE>
Had compensation cost been determined under FASB Statement No. 123, net loss
and loss per share would have been increased as follows:
<TABLE>
<CAPTION>
TEN MONTHS ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1995 1996
----------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Net Loss
As reported............................................... $ (15,857) $ (83,723)
Pro forma for FASB No. 123................................ (21,795) (98,765)
Loss Per Share
As reported............................................... (0.70) (3.00)
Pro forma for FASB No. 123................................ $ (0.96) $ (3.54)
</TABLE>
The weighted average fair value of options granted during 1996 was $18.78
per share.
During the initial phase-in period of FASB Statement No. 123, such
compensation expense may not be representative of the future effects of applying
this statement.
F-23
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--STOCK OPTIONS AND STOCK PURCHASE WARRANTS (CONTINUED)
Warrants to purchase the Company's common stock were issued as follows
(warrants in thousands):
<TABLE>
<CAPTION>
YEAR ENDED 10 MONTHS ENDED YEAR ENDED
FEBRUARY 28, 1994 DECEMBER 31, 1995 DECEMBER 31, 1996
-------------------------- ------------------------------ ------------------------------
WARRANTS PRICE/SHARE WARRANTS PRICE/SHARE WARRANTS PRICE/SHARE
----------- ------------- ------------- --------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Beginning Balance....................... 5,836 $ 0.67-$3.75 -- -- 400 $ 12.00-$13.00
Warrants Issued......................... 1,041 $ 2.24-$3.75 400 $ 12.00-$13.00 -- --
Warrants Exercised...................... (6,568) $ 0.67-$3.75 -- -- -- --
Warrants Expired........................ (309) $ 3.00-$3.75 -- -- -- --
----------- --- ---
Ending Balance.......................... -- 400 $ 12.00-$13.00 400 $ 12.00-$13.00
----------- --- ---
----------- --- ---
</TABLE>
NOTE 14--RELATED PARTY TRANSACTIONS
SERVICES AGREEMENTS
In connection with the Company's merger with Milliwave, the Company entered
into a Services Agreement with Milliwave in June 1996. Under the Services
Agreement, a subsidiary of the Company installed radio links and managed
Milliwave's communications network. Total fees under the Services Agreement and
equipment sales paid by Milliwave to the Company were $1.5 million through
December 31, 1996.
In connection with the Company's purchase of certain assets of Locate, the
Company entered into a Services Agreement with Locate in April 1996. Under the
Agreement, the Company provided consulting services to Locate regarding the
operation of Locate's business. During the year ended December 31, 1996, Locate
paid the Company approximately $352,000 under the Services Agreement.
MANAGEMENT AGREEMENT
The Company and WinStar Services, a wholly owned subsidiary of WinStar
Companies, a corporation of which two of the Company's directors are principal
officers and stockholders, were parties to a five-year management agreement
which provided, as amended, that WinStar Services would render financial,
advisory and management services in connection with the capital, acquisition and
planning needs of the Company. During the year ended February 28, 1995, an
aggregate of $254,560 was paid to WinStar Services by the Company as management
fees and reimbursement of expenses. Additionally, the Company paid $481,039 in
cash and issued notes amounting to $481,038 in payment of contingent performance
fees to WinStar Services during the year ended February 28, 1995. These
contingent performance fees related to specific debt and equity financing and
investment transactions in excess of $33.6 million. During the year ended
February 28, 1995, all such notes were satisfied when they were used to pay for
the exercise of warrants and stock options held by WinStar Services and its
affiliates. See "Private Exchange Transaction" below.
The management agreement was terminated as of February 28, 1995.
F-24
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--RELATED PARTY TRANSACTIONS (CONTINUED)
PRIVATE EXCHANGE TRANSACTION
On November 29, 1995, the Company acquired, in exchange for the issuance of
3,741,224 shares of its common stock ("Private Exchange"), substantially all of
the assets of WinStar Companies, whose assets consisted of (i) all the
outstanding capital stock of WinStar Services and WinStar Venture, two wholly
owned subsidiaries of WinStar Companies, and (ii) 389,580 shares of the
Company's common stock owned by WinStar Companies. The sole assets of WinStar
Services and WinStar Venture were 2,117,183 shares of the Company's common stock
and other securities of the Company that were exercisable or convertible into
1,429,633 shares of the Company's common stock. Accordingly, the Company issued
3,741,224 shares of the Company's common stock and, in exchange, acquired
3,936,396 shares of common stock and common stock equivalents. All of the
Company's common stock and certain of the common stock equivalents received in
the Private Exchange were included in Treasury Stock at December 31, 1995 and
were retired in 1996. WinStar Companies, WinStar Services and WinStar Venture
had no liabilities at the time of the closing of the Private Exchange other than
a liability previously assumed by the Company or liabilities for which the
Company is being indemnified. No claims for any liabilities have been received
by the Company.
The new shares of the Company's common stock issued in the Private Exchange
represented that number of shares which had an aggregate market value based upon
the average of the closing sale price of the Company's common stock on the 30
trading days preceding November 15, 1995, the date as of which the exchange
agreement regarding the above-described transaction was executed, equal to the
market value of the Company's common stock (i) transferred by WinStar Companies
to the Company, (ii) owned by WinStar Services and WinStar Venture and (iii)
underlying certain other securities of the Company owned by WinStar Services and
WinStar Venture which were convertible into or exercisable for shares of the
Company's common stock, less the aggregate exercise price of such latter
securities.
The stockholders of WinStar Companies included several of the Company's
current executive officers and directors. Simultaneously with the Private
Exchange, WinStar Companies was dissolved and the new shares issued in the
Private Exchange were issued directly to the stockholders of WinStar Companies
in proportion to their equity ownership of WinStar Companies.
The Private Exchange was considered and approved by a special committee of
independent and disinterested directors of the Company and an opinion from an
independent investment banking firm that the Private Exchange was fair to the
Company and its stockholders was obtained in connection with the Private
Exchange.
SGC CONSULTING AGREEMENT
In November 1993 and as subsequently amended, the Company entered into a
consulting agreement with SGC Services ("SGC"), a telecommunications consulting
firm pursuant to which SGC received a monthly fee of $17,500 and options to
purchase 175,000 shares of the Company's common stock. The President and
Director of SGC is currently a Director and employee of the Company. Under this
consulting agreement, SGC was entitled to receive a cash fee equal to 5% of the
consideration paid in connection with certain transactions introduced to the
Company by SGC.
In connection with investments by the Company in Avant-Garde and The Winning
Line, Inc. ("TWL"), a producer of sports-related radio programming, both of
which businesses were introduced to the Company by SGC, SGC was paid fees by
Avant-Garde and by TWL. Additionally, in connection with
F-25
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--RELATED PARTY TRANSACTIONS (CONTINUED)
the Company's acquisition of its equity interest in Avant-Garde, such Director
was paid a fee by the principal of Avant-Garde equal to 4.0% of the total
consideration received by such principal from the Company in connection with the
acquisition. The Company paid no fees to SGC in connection with such
transactions, but the fees received by SGC and such Director from Avant-Garde
and TWL were credited against the monthly fees payable to SGC by the Company.
Fees and expenses paid to SGC during the year ended February 28, 1995 were
$119,000. The consulting agreement was terminated in January 1995 in connection
with the execution of such Director's employment agreement with the Company.
AGREEMENT WITH ITC GROUP, INC.
In May 1994, the Company, WinStar Wireless, Inc. ("WWI") and ITC Group, Inc.
("ITC"), a telecommunications consulting firm, entered into a two-year agreement
pursuant to which ITC advised the Company on the operations of its
telecommunications business. ITC, together with the management and employees of
WWI, developed and implemented a two-year operating plan for the Company's
wireless telecommunications business. Pursuant to the terms of the consulting
agreement, ITC made its consultants available to the Company and its
subsidiaries. The Company paid ITC an annual base consulting fee of $700,000 for
the services of a core management team, as well as supplemental fees at agreed
upon rates for additional consulting services rendered by ITC as necessary from
time to time. Under the terms of the agreement, ITC provided up to 12
consultants at any given time. During the year ended February 28, 1995 and
through September 1995, ITC was paid $1.5 million and $1 million, respectively,
in fees and expenses in connection with the consulting agreement, the Company
granted options to purchase an aggregate of 500,000 shares of its common stock
for $4.41 per share to certain consultants of ITC.
Effective September 5, 1995, ITC's President became President and Chief
Operating Officer of the Company and certain core management personnel
previously provided by ITC also became employees. Concurrently, ITC ceased
providing services to the Company under the consulting agreement, and the
Company's obligation to pay any future compensation to ITC under such agreement
was terminated.
NOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest during the year ended February 28, 1995, the ten
months ended December 31, 1995, and the year ended December 31, 1996 was
$621,000, $1.3 million and $2.1 million, respectively. During the year ended
December 31, 1996, the Company capitalized $300,000 of interest incurred in
connection with the buildout of its telecommunications network. No interest was
capitalized in the ten months ended December 31, 1995 or the year ended February
28, 1995.
During the year ended February 28, 1995, the Company completed the following
material noncash transactions: (i) the conversion of the Series D and Series E
Warrants through the assignment of notes payable and accrued interest; (ii) the
satisfaction of approximately $600,000 in notes payable through the exercise of
stock options; (iii) conversions of Preferred Stock Series B, C, and D; (iv) the
acquisition of approximately $740,000 in property and equipment through various
capitalized leases; and (v) the issuance of 28,572 shares of its common stock
valued at $200,000, in connection with an acquisition.
During the ten months ended December 31, 1995, the Company completed the
following material noncash transactions: (i) the conversion of $3.75 million of
convertible notes plus accrued interest thereon; (ii) the conversion of
Preferred Stock Series E; (iii) the acquisition of approximately $7.5 million in
F-26
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED)
property and equipment through various capitalized leases; (iv) the Private
Exchange transaction (see Note 14); (v) the settlement of the Company's
placement expenses from the gross proceeds of the Debt Placement; and (vi) the
acquisition of Avant-Garde.
During the year ended December 31, 1996, the Company completed the following
material noncash transactions: (i) the conversion of $3.75 million of
convertible notes plus accrued interest; (ii) the acquisition of $8.6 million in
property and equipment through various capitalized leases; (iii) the issuance of
100,605 shares and share equivalents, with a value of $1.5 million, and $800,000
in notes payable in connection with certain acquisitions (see Note 2); (iv) the
issuance of $17.5 million in notes payable for the acquisition of Locate; and
(v) the acceptance of 150,000 shares of the Company's common stock for payment
of stock options exercised. Depreciation and amortization includes amortization
of deferred compensation.
NOTE 16--ADVERTISING COSTS
Advertising costs are charged to operations when the advertising first takes
place. Advertising expense for the year ended February 28, 1995, the ten months
ended December 31, 1995, and the year ended December 31, 1996 was approximately
$200,000, $500,000 and $4.3 million, respectively.
F-27
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 17--BUSINESS SEGMENTS
The Company's business segments are telecommunications, information
services, and merchandising. The following table is a summary of these segments
for the year ended February 28, 1995, the ten months ended December 31, 1995 and
the year ended December 31, 1996:
<TABLE>
<CAPTION>
TOTAL
TELECOMMUNI- INFORMATION BUSINESS GENERAL
CATIONS SERVICES MERCHANDISING SEGMENTS CORPORATE CONSOLIDATED
------------- ----------- -------------- ------------- ---------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
For the year ended February 28, 1995
Net sales........................... $ 14,909 $ 473 $ 10,183 $ 25,565 $ -- $ 25,565
Operating income (loss)............. (4,984) (157) 216 (4,925) (944) (5,869)
EBITDA.............................. (4,560) (150) 461 (4,249) (930) (5,179)
Depreciation and amortization....... 392 7 245 644 14 658
Capital expenditures................ 1,329 4 287 1,620 196 1,816
Identifiable assets at February 28,
1995.............................. $ 14,594 $ 4,219 $ 6,911 $ 25,724 $ 3,785 $ 29,509
For the ten months ended December
31, 1995
Net sales........................... $ 13,137 $ 2,648 $ 13,986 $ 29,771 $ -- $ 29,771
Operating income (loss)............. (7,288) 217 681 (6,390) (3,861) (10,251)
EBITDA.............................. (6,358) 241 923 (5,194) (3,758) (8,952)
Depreciation and amortization....... 930 24 242 1,196 104 1,300
Capital expenditures................ 7,458 14 529 8,001 651 8,652
Identifiable assets at December 31,
1995.............................. $ 36,998 $ 20,195 $ 10,459 $ 67,652 $ 217,711 $ 285,363
For the year ended December 31, 1996
Net sales........................... $ 33,969 $ 14,650 $ 19,429 $ 68,048 $ -- $ 68,048
Operating loss...................... (43,698) (1,409) (42) (45,149) (11,373) (56,522)
EBITDA.............................. (39,206) (890) 294 (39,802) (9,796) (49,598)
Depreciation and amortization....... 3,831 469 330 4,630 202 4,832
Capital expenditures................ 46,632 701 119 47,452 509 47,961
Identifiable assets at December 31,
1996.............................. $ 101,380 $ 30,133 $ 15,248 $ 146,761 $ 143,462 $ 290,223
</TABLE>
- ------------------------
EBITDA represents operating income (loss) plus interest, taxes, depreciation and
amortization.
F-28
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 18--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly financial data for 1996 for the Company is as
follows:
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------
<S> <C> <C> <C> <C>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------- ---------- ------------ ------------
(IN THOUSANDS)
Operating revenues
Telecommunications services................................ $ 10,217 $ 10,356 $ 7,384 $ 6,012
Information services....................................... 771 2,652 4,056 7,171
Other...................................................... 3,521 3,166 5,857 6,885
---------- ---------- ------------ ------------
Total operating revenues................................. 14,509 16,174 17,297 20,068
---------- ---------- ------------ ------------
Operating expenses
Cost of services and products.............................. 9,052 11,304 13,280 18,500
Selling, general and administrative expenses............... 9,853 15,659 17,297 24,879
Depreciation and amortization.............................. 558 745 1,215 2,230
---------- ---------- ------------ ------------
Total operating expenses................................. 19,461 27,708 31,792 45,609
---------- ---------- ------------ ------------
Operating loss............................................... (4,952) (11,534) (14,495) (25,541)
Other expense
Interest expense........................................... 8,803 9,183 9,233 10,257
Interest income............................................ (3,056) (2,601) (2,516) (2,102)
---------- ---------- ------------ ------------
Net loss..................................................... $ (10,699) $ (18,116) $ (21,212) $ (33,696)
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Net loss per share........................................... $ (0.39) $ (0.65) $ (0.75) $ (1.18)
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Weighted average shares outstanding.......................... 27,214 27,720 28,133 28,553
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
</TABLE>
The financial data presented above reflects certain reclassifications from
the amounts presented in the Company's filings on form 10-Q for the periods
ending March 31, June 30 and September 30, 1996. The reclassifications
principally relate to the breakout of revenues by operating segment and the
reclassification of certain telecommunication network costs from the selling,
general and administrative caption to the cost of services and products caption.
NOTE 19--SUBSEQUENT EVENTS TO DECEMBER 31, 1996 (UNAUDITED)
AGREEMENT TO PURCHASE ADDITIONAL LICENSES
On January 28, 1997, the Company executed agreements to acquire 47
additional 38 GHz licenses, subject to FCC approval. The total purchase price
for the licenses will be $16 million, payable in the Company's common stock,
which will be priced at the time of closing. The acquisitions are expected to
close within approximately one year. In addition, the Company agreed to purchase
additional 38 GHz licenses, subject to FCC approval, which may be granted with
respect to certain license applications currently on file with the FCC.
ISSUANCE OF CONVERTIBLE PREFERRED STOCK
On February 11, 1997, the Company sold 4 million shares of 6% Series A
cumulative convertible preferred stock, par value $1.01, and 1.6 million
warrants to purchase common stock of the Company, par
F-29
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 19--SUBSEQUENT EVENTS TO DECEMBER 31, 1996 (UNAUDITED) (CONTINUED)
value $1.01, for gross proceeds of $100 million. The preferred stock earns a 6%
annual dividend, payable quarterly in kind, and matures on February 11, 2002.
Two million shares of the preferred stock are convertible beginning on
August 11, 1997, at $25 per share or, if the average closing sale price of the
Company's common stock for the preceding twenty trading days is less than $25,
such average closing sale price, while the remainder becomes convertible on
February 11, 1998, at $25 per share or, if the average closing sale price of the
Company's common stock for the preceding twenty trading days is less than $25,
such average closing sale price. On February 11, 2002, any preferred stock still
outstanding will be automatically converted into shares of the Company's common
stock, unless the Company elects to pay, in lieu of conversion, the equivalent
value in cash.
The warrants are exerciseable at $25 per share, and expire on February 11,
2002. The Company has the right to call the warrants after February 11, 2001, if
the Company's common stock price has exceeded $40 on each of the previous twenty
trading days.
DEBT PLACEMENT
On March 18, 1997, the Company and a wholly owned subsidiary of the Company
issued an aggregate of $300 million of notes in an institutional private
placement (the 1997 Debt Placement). In addition, the Company obtained a
commitment for an additional $150 million facility which may be drawn by the
Company beginning March 31, 1999, subject to certain operating and financial
criteria.
The 1997 Debt Placement consisted of (i) $100 million of the Company's 14.5%
Senior Deferred Interest Notes due 2005 (the "New Senior Notes"), ranking PARI
PASSU with the Company's Senior Discount Notes due 2005, and (ii) $200 million
of 12.5% Guaranteed Senior Secured Notes (the "Senior Secured Notes") which were
issued by a wholly owned subsidiary and are unconditionally guaranteed by the
Company. Interest on the New Senior Notes will accrue and compound semiannually
through October 15, 2000, but will not be payable in cash. Interest will be
payable on the New Senior Notes each April 15 and October 15 commencing April
15, 2001, through final maturity in 2005. Interest on the Senior Secured Notes
is payable semiannually through maturity.
Under the terms of the 1997 Debt Placement, the Company is obligated to
consummate an exchange offer with respect to the New Senior Notes and the Senior
Secured Notes whereby these notes will be exchanged for new notes (the "New
Notes") which will be identical in every respect to the original New Senior
Notes and Senior Secured Notes except that the New Notes will be registered
under the Securities Act of 1933. The terms of the 1997 Debt Placement also
place certain restrictions on the ability of the Company to pay dividends or
make other restricted payments, incur additional indebtedness, issue guarantees,
sell assets, or enter into certain other specified transactions.
F-30
<PAGE>
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS ON SCHEDULES
Board of Directors
WinStar Communications, Inc.
In connection with our audit of the consolidated financial statements of
WinStar Communications, Inc. and Subsidiaries referred to in our report dated
January 24, 1997, which is included in this Annual Report on Form 10-K, we have
also audited Schedule II for the year ended February 28, 1995, the ten months
ended December 31, 1995 and the year ended December 31, 1996.
In our opinion, this schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information required to be set forth therein.
GRANT THORNTON LLP
New York, New York
January 24, 1997
F-31
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- -------------------------------------------------------------------------------------------------------------
BALANCE AT ADDITIONS CHARGED
BEGINNING TO COSTS AND BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
- --------------------------------------- ------------------- ----------------- ------------ --------------
<S> <C> <C> <C> <C>
Reserves deducted from assets to which
they apply:
Year ended February 28, 1995
Allowance for doubtful
accounts (a)....................... $ 357,843 $ 893,857 $ 427,991(b) $ 823,709
-------- ----------------- ------------ --------------
-------- ----------------- ------------ --------------
Ten months ended December 31, 1995
Allowance for doubtful
accounts (a)....................... $ 823,709 $ 887,425 $ 911,403(b) $ 799,731
-------- ----------------- ------------ --------------
-------- ----------------- ------------ --------------
Year ended December 31, 1996
Allowance for doubtful
accounts (a)....................... $ 799,731 $ 1,872,164 $ 1,670,015(b) $ 1,001,880
-------- ----------------- ------------ --------------
-------- ----------------- ------------ --------------
</TABLE>
- ------------------------
(a) Deducted from accounts receivable
(b) Uncollectible accounts receivable charged against allowance
F-32
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF WINSTAR COMMUNICATIONS, INC.
WinStar Wireless, Inc.
WinStar Wireless Fiber Corp.
WinStar Telecommunications, Inc.
WinStar Gateway Network, Inc.
WinStar Milliwave, Inc.
WinStar Equipment Corp.
WinStar Credit Corp.
WinStar Global Products, Inc.
WinStar Locate, Inc.
WinPinn Corp.
WinStar New Media Company, Inc.
The Winning Line, Inc.
Global Media The Sales and Marketing Company, Inc.
WinStar Broadcasting Corp.
WinStar for Business Inc.
WinStar Interactive Media Sales Inc.
Non Fiction Films Inc.
GFL Communications, Inc.
Fox/Lorber Associates, Inc.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated January 24, 1997, accompanying the
consolidated financial statements and schedules included in the Annual Report of
WinStar Communications, Inc. and Subsidiaries on Form 10-K for the year ended
December 31, 1996. We hereby consent to the incorporation by reference of said
report in the Registration Statement of WinStar Communications, Inc. on Form S-8
(Registration Nos. 33-87568; 33-98668 and 333-15073) and Form S-3 (Registration
Nos. 33-95242; 333-6079 and 333-18465).
GRANT THORNTON LLP
New York, New York
March 31, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 122,487
<SECURITIES> 688
<RECEIVABLES> 17,649<F1>
<ALLOWANCES> 0<F5>
<INVENTORY> 13,615
<CURRENT-ASSETS> 171,165
<PP&E> 63,287<F2>
<DEPRECIATION> 0<F5>
<TOTAL-ASSETS> 290,223
<CURRENT-LIABILITIES> 55,555
<BONDS> 284,339
0<F5>
0
<COMMON> 290
<OTHER-SE> (49,961)
<TOTAL-LIABILITY-AND-EQUITY> 290,223
<SALES> 0<F3>
<TOTAL-REVENUES> 68,048
<CGS> 0<F3>
<TOTAL-COSTS> 52,136
<OTHER-EXPENSES> 72,434
<LOSS-PROVISION> 0<F5>
<INTEREST-EXPENSE> 37,476
<INCOME-PRETAX> (83,723)
<INCOME-TAX> 0<F4>
<INCOME-CONTINUING> (83,723)
<DISCONTINUED> 0<F5>
<EXTRAORDINARY> 0<F5>
<CHANGES> 0<F5>
<NET-INCOME> (83,723)
<EPS-PRIMARY> (3.00)
<EPS-DILUTED> (3.00)
<FN>
<F1>Net of allowance for doubtful accounts.
<F5>Not applicable
<F2>Net of accumulated depreciation.
<F3>Winstar Global Product sales (health & beauty aids) are grouped with "total
revenue".
<F4>Taxes reported on income statement are primarily based on capital, and are
included on this line.
</FN>
</TABLE>
