<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 15, 1996
REGISTRATION NO. 333-13885
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
POST-EFFECTIVE AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
MCLEOD, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 4813 58-421407240
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
221 THIRD AVENUE SE, SUITE 500
CEDAR RAPIDS, IA 52401
(319) 364-0000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
CLARK E. MCLEOD
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
MCLEOD, INC.
221 THIRD AVENUE SE, SUITE 500
CEDAR RAPIDS, IA 52401
(319) 364-0000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
JOSEPH G. CONNOLLY, JR., ESQ.
NANCY J. KELLNER, ESQ. JAMES J. JUNEWICZ, ESQ.
HOGAN & HARTSON L.L.P. MAYER, BROWN & PLATT
555 THIRTEENTH STREET, N.W. 190 SOUTH LASALLE STREET
WASHINGTON, D.C. 20004 CHICAGO, IL 60603
(202) 637-5600 (312) 782-0600
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act of 1933 registration statement number
of the earlier effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act of 1933 registration statement number of the earlier effective
registration statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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- --------------------------------------------------------------------------------
<PAGE> 2
EXPLANATORY NOTE
This Post-Effective Amendment No. 1 to Form S-1 Registration Statement is
being filed to reduce the number of shares subject to this Registration
Statement to 5,980,000 and to reduce the proposed maximum offering price per
share to $28.00. The form of Prospectus contained herein reflects these
reductions. The remaining 1,150,000 shares originally subject to this
Registration Statement are deregistered upon the effectiveness of this
Post-Effective Amendment No. 1.
<PAGE> 3
PROSPECTUS
5,200,000 SHARES
MCLEOD, INC.
CLASS A COMMON STOCK
($.01 PAR VALUE)
(*MCLEOD LOGO)
Of the 5,200,000 shares of Class A Common Stock, $.01 par value per share (the
"Class A Common Stock"), offered hereby (the "Offering"), 4,768,903 shares are
being sold by McLeod, Inc. (the "Company") and 431,097 shares are being sold by
certain stockholders of the Company (the "Selling Stockholders"). See "Principal
and Selling Stockholders." The Company will not receive any of the proceeds from
the sale of shares of Class A Common Stock by the Selling Stockholders. Certain
investors (the "Investors"), including Clark E. McLeod, the Company's Chief
Executive Officer, have agreed to purchase directly from the Company for
investment purposes an aggregate of 892,857 shares of Class A Common Stock at
the Price to Public. No Underwriting Discount will be paid with respect to any
shares purchased by the Investors. See "Underwriting."
The Company has two classes of common stock, the Class A Common Stock and Class
B Common Stock, $.01 par value per share (the "Class B Common Stock" and,
together with the Class A Common Stock, the "Common Stock"). The rights of the
Class A Common Stock and the Class B Common Stock are substantially identical,
except that holders of the Class A Common Stock are entitled to one vote per
share and holders of the Class B Common Stock are entitled to .40 vote per
share. The Class B Common Stock is fully convertible at any time into Class A
Common Stock, at the option of the holder, on a one-for-one basis. Both classes
of Common Stock vote together as one class on all matters generally submitted to
a vote of stockholders, including the election of directors. See "Description of
Capital Stock."
The Class A Common Stock is quoted on the Nasdaq National Market under the
symbol "MCLD." On November 14, 1996, the last reported sale price of the Class A
Common Stock on the Nasdaq National Market was $28.25 per share. See "Price
Range of Class A Common Stock and Dividend Policy."
SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR A DISCUSSION OF CERTAIN MATTERS THAT
SHOULD BE CONSIDERED BY POTENTIAL INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS(2)
<S> <C> <C> <C> <C>
Per Share(3)................ $28.00 $1.26 $26.74 $26.74
Total(4)(5)................. $145,600,000 $5,427,000 $128,645,466 $11,527,534
</TABLE>
- --------------------------------------------------------------------------------
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deducting offering expenses payable by the Company, estimated at
$1,000,000.
(3) Excludes the shares of Class A Common Stock that the Investors have agreed
to purchase directly from the Company at the Price to Public without payment
of any Underwriting Discount. See "Underwriting."
(4) Includes the shares of Class A Common Stock that the Investors have agreed
to purchase directly from the Company at the Price to Public without payment
of any Underwriting Discount.
(5) The Company has granted to the Underwriters a 30-day option to purchase up
to an aggregate of 780,000 additional shares of Class A Common Stock at the
Price to Public, less Underwriting Discount, solely to cover
over-allotments, if any. If the Underwriters exercise such option in full,
the total Price to Public, Underwriting Discount and Proceeds to Company
will be $167,440,000, $6,409,800 and $149,502,666, respectively. See
"Underwriting."
The shares of Class A Common Stock (other than the shares of Class A Common
Stock to be sold by the Company to the Investors) are offered subject to receipt
and acceptance by the Underwriters, to prior sale and to the Underwriters' right
to reject any order in whole or in part and to withdraw, cancel or modify the
offer without notice. It is expected that delivery of the shares of Class A
Common Stock offered hereby will be made at the office of Salomon Brothers Inc,
Seven World Trade Center, New York, New York or through the facilities of The
Depository Trust Company, on or about November 20, 1996.
SALOMON BROTHERS INC
BEAR, STEARNS & CO. INC.
MORGAN STANLEY & CO.
INCORPORATED
The date of this Prospectus is November 15, 1996.
<PAGE> 4
(*MCLEOD LOGO)
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMPANY'S CLASS
A COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE CLASS A COMMON STOCK ON THE NASDAQ NATIONAL
MARKET IN ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934.
SEE "UNDERWRITING."
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements of the Company, the Notes
thereto and the other financial data contained elsewhere in this Prospectus.
Prospective investors should carefully consider the factors set forth herein
under the caption "Risk Factors" and are urged to read this Prospectus in its
entirety. Unless otherwise indicated, references herein to the "Company" include
the Company's predecessor, the Company and the Company's wholly owned
subsidiaries. Unless otherwise indicated, the information in this Prospectus (i)
reflects the purchase by the Investors of an aggregate of 892,857 shares of
Class A Common Stock that they have agreed to purchase directly from the Company
at the Price to Public and (ii) assumes no exercise of the Underwriters'
over-allotment option. Unless otherwise indicated, dollar amounts over $1
million have been rounded to one decimal place and dollar amounts less than $1
million have been rounded to the nearest thousand. This Prospectus includes
product names and trademarks of the Company and of other organizations. See the
"Glossary" appearing elsewhere herein for definitions of certain terms used in
this Prospectus.
THE COMPANY
The Company is a provider of integrated telecommunications services to
small and medium-sized businesses and, since June 1996, residential customers,
primarily in Iowa and Illinois. The Company derives its telecommunications
revenue from (i) the sale of "bundled" local, long distance and other
telecommunications services to end users, (ii) telecommunications network
maintenance services, (iii) competitive access services, including special
access and private line services, and (iv) ancillary services, including direct
marketing and telemarketing services and the sale of advertising space in
telephone directories. As of September 30, 1996, the Company served over 13,630
telecommunications customers in 68 cities and towns.
The Company offers "one-stop" integrated telecommunications services,
including local, long distance, voice mail, paging and Internet access services,
tailored to the customer's specific needs. For business customers, this approach
simplifies telecommunications procurement and management and makes available
customized services, such as "least-cost" long distance pricing and enhanced
calling features, that might not otherwise be directly available to such
customers on a cost-effective basis. For residential customers, this approach
provides integrated local, long distance and other telecommunications services,
flat-rate long distance pricing and enhanced calling features as part of the
Company's basic PrimeLine(R) residential service. The Company also operates a
competitive access provider that offers a variety of special access and private
line services to 76 large businesses, institutional customers and interexchange
carriers. In addition, the Company provides network maintenance services for the
State of Iowa's fiber optic network. See "Business -- Current Products and
Services."
The Company believes it is the first telecommunications provider in most of
its current markets to offer "bundled" local, long distance and other
telecommunications services. As a result, the Company believes that it is
well-positioned to take advantage of fundamental changes occurring in the
telecommunications industry resulting from the Telecommunications Act of 1996
(the "Telecommunications Act") and to challenge incumbent local exchange
carriers. See "Business -- Market Potential" and "Business -- Regulation." The
Company provides local service using existing telephone lines obtained from
incumbent local exchange carriers, which allows customers to switch to local
service provided by the Company without changing existing telephone numbers. The
Company provides long distance services by purchasing bulk capacity from a long
distance carrier. Using the Company's sophisticated proprietary software, known
as Raterizer(R), each business customer receives the lowest long distance rate
available each month from among the pricing plans of AT&T Corp. ("AT&T"), MCI
Communications Corporation ("MCI") and Sprint Corporation ("Sprint") that
currently are most popular with the Company's business customers, and, in
certain cases, rates specifically identified by a business customer and agreed
to by the Company. The Company also provides paging and Internet access
services. See "Business -- Current Products and Services."
Since the Company completed its initial public offering of Class A Common
Stock in June 1996, it has actively pursued its strategy of increasing market
penetration and expanding into new markets in the following ways: (i) in June
1996, the Company began offering to residential customers in
1
<PAGE> 6
Cedar Rapids, Iowa and Iowa City, Iowa an integrated package of
telecommunications services, marketed under the name PrimeLine(R), that includes
local and long distance service, voice mail, paging, Internet access and travel
card services; PrimeLine(R) services are expected to be available in other
residential markets in the near future; (ii) the Company has positioned itself
to enter the Minnesota and Wisconsin markets in late 1996 in addition to the
Iowa and Illinois markets currently served; (iii) in July 1996, the Company
acquired Ruffalo, Cody & Associates, Inc. ("Ruffalo, Cody"), which specializes
in direct marketing and telemarketing services, to enhance the Company's
marketing of its telecommunications services; (iv) in September 1996, the
Company acquired Telecom*USA Publishing Group, Inc. ("Telecom*USA Publishing"),
which publishes and distributes "white page" and "yellow page" telephone
directories in fifteen states in the midwestern and Rocky Mountain regions of
the United States, to increase the Company's penetration of its current markets
and to accelerate its entry into new markets; (v) the Company has constructed
approximately 1,000 new route miles of fiber optic network at a cost of
approximately $20.4 million; and (vi) the Company is bidding for certain
personal communications services ("PCS") licenses as part of its strategy to
increase the range of services provided to customers in its target markets.
BUSINESS STRATEGY
The Company's objective is to become a leading provider of integrated
telecommunications services in Iowa, Illinois, Nebraska, Minnesota, Wisconsin,
South Dakota, North Dakota, Colorado, Wyoming, Montana, Utah and Idaho. The
Company intends to increase its penetration of its current markets and expand
into new markets by: (i) aggressively capturing market share and generating
revenues using leased network capacity and (ii) concurrently constructing
additional network infrastructure to more cost-effectively serve its customers.
The Company estimates that as of September 30, 1996 it had a market share of
approximately 20.6% of business local telephone lines in its Iowa markets (based
on 1994 market data) and a market share of approximately 12.7% of business local
telephone lines in its Illinois markets (based on 1994 Iowa market data,
assuming that the Company's Illinois markets are substantially similar to the
Company's Iowa markets). There can be no assurance that the Company will attain
similar market share in other markets.
The principal elements of the Company's business strategy include:
PROVIDE INTEGRATED TELECOMMUNICATIONS SERVICES. The Company believes that
there is substantial demand among business and residential customers in its
target markets for an integrated package of telecommunications services that
meets all of the customer's telecommunications needs. The Company believes that,
by bundling a variety of telecommunications services, it will position itself to
become an industry leader in offering "one-stop" integrated telecommunications
services, to penetrate rapidly its target markets and to build customer loyalty.
BUILD MARKET SHARE THROUGH BRANDING AND CUSTOMER SERVICE. The Company
believes that, by branding its telecommunications services with the trade name
*McLeod USA in combination with the distinctive black-and-yellow motif of the
Telecom*USA Publishing directories, it will create and strengthen brand
awareness in all of the Company's markets. The Company also believes that the
key to revenue growth in its target markets is capturing and retaining customers
through an emphasis on marketing, sales and customer service. The Company's
customer-focused software and network architecture allow immediate access to the
Company's customer data by Company personnel, enabling a quick and effective
response to customer requests and needs at any time. This software permits the
Company to present its customers with one fully integrated monthly billing
statement for local, long distance, 800, international, voice mail, paging,
Internet access and travel card services. The Company believes that its
customer-focused software platform is an important element in the marketing of
its telecommunications services and gives it a competitive advantage in the
marketplace. The Company has been successful in obtaining long-term commitments
from its business customers and responding rapidly and creatively to customer
needs. See "Business -- Current Products and Services" and "Business -- Sales
and Marketing."
FOCUS ON SMALL AND MID-SIZED MARKETS. The Company principally targets
small and mid-sized markets (cities and towns with a population between 8,000
and 350,000) in its service areas. The Company estimates that its current and
planned target markets have a combined population of approximately 9.5 million.
The Company strives to be the first to market integrated telecommunica-
2
<PAGE> 7
tions services in its principal markets and expects that intense competition in
bundled telecommunications services will be slower to develop in these markets
than in larger markets.
EXPAND ITS FIBER OPTIC NETWORK. The Company is constructing a
state-of-the-art digital fiber optic telecommunications network designed to
serve markets in Iowa. In the future, the Company expects to expand its fiber
optic network to include additional markets. The Company's decision to expand
its fiber optic network will be based on various economic factors, including:
(i) the number of its customers in a market; (ii) the anticipated operating cost
savings associated with such construction; and (iii) any strategic relationships
with owners of existing infrastructure (e.g., utilities and cable operators).
The Company currently owns approximately 1,700 route miles of fiber optic
network and, subject to the foregoing factors, presently expects to construct
approximately 6,000 route miles of fiber optic network during the next five
years. Through its strategic relationships with its electric utility
stockholders and its contracts to build and lease the final links of the Iowa
Communications Network to the State of Iowa, the Company believes that it will
be able to achieve capital efficiencies in constructing its fiber optic network
in a rapid and cost-effective manner. The Iowa Communications Network is a fiber
optic network that links certain of the state's schools, libraries and other
public buildings. The Company also believes that its fiber optic network in
combination with its proprietary software will create an attractive
customer-focused platform for the provision of local, long distance, wireless
and enhanced services. See "Business -- Network Facilities."
TRANSITION INTO LOCAL SWITCHED SERVICES BUSINESS. When certain judicial
and regulatory proceedings are resolved, and assuming the economics are
favorable to the Company, the Company intends to begin offering facilities-based
switched services by using its existing high capacity digital AT&T switch and
installing additional switches. In August 1996, the Federal Communications
Commission ("FCC") released a decision implementing the interconnection portions
of the Telecommunications Act (the "Interconnection Decision"). Certain
provisions of the Interconnection Decision have been stayed by an October 1996
court decision, and will be subject to further judicial and regulatory
proceedings. The Company believes that these proceedings should be substantially
resolved, and that the Company could begin offering local facilities-based
switched services, over the next three years. In March 1995 and April 1996,
respectively, the Company received state regulatory approval in Iowa and
Illinois to offer local switched services in Cedar Rapids, Iowa and in Illinois
cities other than Chicago. The Company intends to seek regulatory approval to
provide such services in other cities and towns in Iowa and other states
targeted by the Company when the economic terms of interconnection with the
incumbent local exchange carrier make the provision of local switched services
cost-effective. See "Business -- Expansion of Certain Facilities-based Services"
and "Business -- Regulation."
EXPLORE POTENTIAL ACQUISITIONS AND STRATEGIC ALLIANCES. The Company
believes that its strategic alliances with two utilities in its Iowa markets
provide it with access to rights-of-way and other resources on favorable terms.
The Company believes that its recent acquisitions of Ruffalo, Cody and
Telecom*USA Publishing will increase the Company's penetration of its current
markets and accelerate its entry into new markets. As part of its expansion
strategy, the Company contemplates additional acquisitions, joint ventures and
strategic alliances with businesses that are related or complementary to its
current operations. The Company believes that the addition of such related or
complementary businesses will help it to expand its operations into its target
markets. As a result, the Company plans to consider acquisitions, joint ventures
and strategic alliances in areas such as wireline and wireless services,
directory publishing, network construction and infrastructure and Internet
access. In undertaking these transactions, the Company may use proceeds from the
Offering, credit facilities and other borrowings, and additional debt and equity
issuances.
LEVERAGE PROVEN MANAGEMENT TEAM. The Company has recruited a team of
veteran competitive telecommunications managers, led by entrepreneur Clark
McLeod, who have together in the past successfully implemented a similar
customer-focused telecommunications strategy in the same regions. Eight of the
ten executive officers of the Company served as officers of Teleconnect Company
("Teleconnect") or of Teleconnect's successor, Telecom*USA, Inc.
("Telecom*USA"). Teleconnect began providing long distance services in Iowa in
1982 and rapidly expanded into
3
<PAGE> 8
dozens of cities and towns in the Midwest. Telecom*USA was the fourth-largest
U.S. long distance provider when MCI purchased it in 1990 for $1.25 billion. See
"Management."
The Company was incorporated as an Iowa corporation on June 6, 1991 and was
reincorporated in the State of Delaware on August 1, 1993. The Company's
principal executive offices are located at 221 Third Avenue SE, Suite 500, Cedar
Rapids, Iowa 52401, and its phone number is (319) 364-0000.
RECENT DEVELOPMENTS
On September 20, 1996, the Company acquired Telecom*USA Publishing for
approximately $74.1 million in cash and an additional amount currently estimated
to be approximately $1.6 million to be paid to certain employees of Telecom*USA
Publishing as part of an incentive plan. At the time of the acquisition,
Telecom*USA Publishing had outstanding debt of approximately $6.6 million.
Telecom*USA Publishing publishes and distributes "white page" and "yellow page"
telephone directories in fifteen states in the midwestern and Rocky Mountain
regions of the United States. In fiscal year 1996, Telecom*USA Publishing
published and distributed over 7 million directories and had revenues of $52.1
million. The Company believes that the acquisition of Telecom*USA Publishing
furthers the Company's business plan in several ways. First, it gives the
Company an immediate presence in states where it is initiating service
(Minnesota and Wisconsin) and also in states where it does not yet provide
service but expects to do so in the future (such as Colorado, Wyoming, Montana,
Utah and Idaho). Second, the Company believes that the acquisition will increase
the Company's penetration of its current markets and accelerate its entry into
new markets. The directories published by Telecom*USA Publishing will serve as
"direct mail" advertising for the Company's telecommunications products,
containing detailed product descriptions and step-by-step instructions on the
use of the Company's telecommunications products. The Company believes that
telephone directories are commonly used sources of information that potentially
provide the Company with a long-term marketing presence in millions of
households and businesses that receive a Telecom*USA Publishing directory. By
using the directories to market its products, the Company can reach more
customers than would be possible if the acquisition had not occurred. Third, the
Company believes that combining the directories' distinctive black-and-yellow
motif with the trade name *McLeod USA will create and strengthen brand awareness
in all of the Company's markets.
On July 15, 1996, the Company acquired Ruffalo, Cody for an aggregate of
approximately $4.8 million in cash, 361,420 shares of Class A Common Stock, and
options to purchase 158,009 shares of Class A Common Stock. An additional
$50,782 in cash and 113,387 shares of Class A Common Stock were placed into
escrow and will be delivered to certain of the shareholders of Ruffalo, Cody
over a period of 18 months, contingent upon the fulfillment of certain
conditions relating to Ruffalo, Cody's ongoing revenues from an agreement with a
major long distance carrier to provide telemarketing services. The major long
distance carrier has informed the Company that it intends to terminate this
agreement effective December 31, 1996. Ruffalo, Cody specializes in direct
marketing and telemarketing services, including telecommunications sales. The
Company believes that, as with the acquisition of Telecom*USA Publishing, the
acquisition of Ruffalo, Cody has great strategic significance for the Company.
The Company plans to use Ruffalo, Cody's information database to identify
attractive sales opportunities and to pursue those opportunities through a
variety of methods, including calls from Ruffalo, Cody's telemarketing
personnel. See "Risk Factors -- Risks Associated with Acquisitions,"
"Business -- Recent Transactions" and "Business -- Sales and Marketing."
4
<PAGE> 9
THE OFFERING
<TABLE>
<S> <C>
Class A Common Stock offered by the
Company.................................... 4,768,903 shares
Class A Common Stock offered by the Selling
Stockholders............................... 431,097 shares
Total Class A Common Stock offered hereby.... 5,200,000 shares
Common Stock outstanding after the
Offering(1)................................ 35,735,602 shares of Class A Common Stock
15,625,929 shares of Class B Common Stock
Use of Proceeds.............................. The net proceeds to the Company from the
Offering will be used to fund development and
construction costs of the Company's fiber
optic network; market expansion activities of
the Company's telecommunications business;
potential acquisitions, joint ventures and
strategic alliances; the acquisition of PCS
licenses and related development,
construction and operating costs;
construction of the Company's network
operations center and corporate headquarters;
and for additional working capital and
general corporate purposes, including funding
operating deficits and net losses. See "Use
of Proceeds."
Nasdaq National Market Symbol................ MCLD
Dividend Policy.............................. The Company has never declared or paid any
cash dividends on its capital stock and does
not anticipate paying cash dividends in the
foreseeable future. See "Price Range of Class
A Common Stock and Dividend Policy."
</TABLE>
- ---------------
(1) Based on the number of shares of Class A Common Stock and Class B Common
Stock outstanding as of September 30, 1996 and the consummation of the
Offering. Includes 113,387 shares of Class A Common Stock placed into escrow
in connection with the acquisition of Ruffalo, Cody and 110,702 shares of
Class A Common Stock issued in November 1996 pursuant to the exercise of
options by certain Selling Stockholders. See "Business -- Recent
Transactions." Excludes (a) 7,537,267 shares of Class A Common Stock
issuable upon exercise of stock options granted to directors, officers and
employees of the Company and (b) 1,300,688 shares of Class B Common Stock
issuable upon exercise of stock options granted to a principal stockholder
of the Company in connection with the guarantee and support by such
stockholder of certain portions of a bank credit facility maintained by the
Company from May 1994 until June 1996 (the "Credit Facility"). See
"Management -- Stock Option Plans."
RISK FACTORS
POTENTIAL INVESTORS SHOULD CONSIDER CAREFULLY CERTAIN FACTORS RELATING TO
AN INVESTMENT IN THE CLASS A COMMON STOCK. SEE "RISK FACTORS."
5
<PAGE> 10
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
(IN THOUSANDS EXCEPT PER SHARE AND OPERATING DATA)
The following table summarizes certain selected financial and operating data
of the Company and should be read in conjunction with and is qualified by
reference to "Management's Discussion and Analysis of Financial Condition and
Results of Operations," the Consolidated Financial Statements of the Company,
the Notes thereto and the other financial data contained elsewhere in this
Prospectus. The unaudited pro forma information reflects the acquisitions by the
Company of MWR Telecom, Inc. ("MWR"), Ruffalo, Cody and Telecom*USA Publishing
on April 28, 1995, July 15, 1996 and September 20, 1996, respectively, using the
purchase method of accounting, assuming, for purposes of the pro forma statement
of operations data, that such acquisitions were consummated at the beginning of
the periods presented. The unaudited pro forma information should be read in
conjunction with the Financial Statements of MWR, Ruffalo, Cody and Telecom*USA
Publishing and the Notes thereto included elsewhere in this Prospectus. The
financial and operating data presented below are derived from the records of the
Company, MWR, Ruffalo, Cody and Telecom*USA Publishing.
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 6, 1991 TO YEAR ENDED DECEMBER 31,
DECEMBER 31, --------------------------------------------------------- PRO FORMA
1991(1) 1992 1993 1994 1995(2)(3) 1995(4)(5)
--------------- ----- ------ ------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT DATA:
Revenue.................................... $ -- $ 250 $ 1,550 $ 8,014 $ 28,998 $ 86,476
---- ----- ------- -------- -------- --------
Operating expenses:
Cost of service.......................... -- 262 1,528 6,212 19,667 48,666
Selling, general and administrative...... 56 219 2,390 12,373 18,054 45,836
Depreciation and amortization............ 2 6 235 772 1,835 7,933
---- ----- ------- -------- -------- --------
Total operating expenses.............. 58 487 4,153 19,357 39,556 102,435
---- ----- ------- -------- -------- --------
Operating loss............................. (58) (237) (2,603) (11,343) (10,558) (15,959)
Interest income (expense), net............. -- -- 163 (73) (771) (1,049)
Other non-operating expenses............... -- -- -- -- -- (997)
Income taxes............................... -- -- -- -- -- --
---- ----- ------- -------- -------- --------
Net loss................................... $ (58) $(237) $ (2,440) $ (11,416) $(11,329) $(18,005)
==== ===== ======= ======== ======== ========
Loss per common and common equivalent
share.................................... $ -- $(.02) $ (.08) $ (.31) $ (.31) $ (.48)
==== ===== ======= ======== ======== ========
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------
PRO FORMA
1995 1996(2)(6) 1996(7)
--------------- ------------- ---------
<S> <C> <C> <C>
OPERATIONS STATEMENT DATA:
Revenue.................................... $ 19,438 $ 45,497 $ 92,798
-------- -------- -------
Operating expenses:
Cost of service.......................... 12,672 31,693 54,481
Selling, general and administrative...... 13,087 25,626 48,944
Depreciation and amortization............ 1,229 4,734 9,005
-------- -------- -------
Total operating expenses.............. 26,988 62,053 112,430
-------- -------- -------
Operating loss............................. (7,550) (16,556) (19,632)
Interest income (expense), net............. (614) 2,860 2,746
Other non-operating expenses............... -- 278 (211)
Income taxes............................... -- -- --
-------- -------- -------
Net loss................................... $ (8,164) $ (13,418) $(17,097)
======== ======== =======
Loss per common and common equivalent
share.................................... $ (.22) $ (.33) $ (.41)
======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------------
1991 1992 1993 1994 1995(2)(8)
-------- --------- -------- ------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets............................. $ 2 $ 544 $ 7,077 $ 4,862 $ 9,624
Working capital (deficit).................. $ (72) $(440) $ 5,962 $ 1,659 $ (92)
Property and equipment, net................ -- $ 135 $ 1,958 $ 4,716 $ 15,078
Total assets............................... $ 21 $ 694 $ 9,051 $ 10,687 $ 28,986
Long-term debt............................. -- -- -- $ 3,500 $ 3,600
Stockholders' equity (deficit)............. $ (53) $(290) $ 7,936 $ 3,291 $ 14,958
<CAPTION>
SEPTEMBER 30, 1996
--------------------------------
ACTUAL(9) AS ADJUSTED(10)
---------- ---------------
<S> <C> <C>
BALANCE SHEET DATA:
Current assets............................. $146,563 $ 274,208
Working capital (deficit).................. $106,622 $ 234,268
Property and equipment, net................ $ 61,394 $ 61,394
Total assets............................... $324,077 $ 451,722
Long-term debt............................. $ 4,155 $ 4,155
Stockholders' equity (deficit)............. $273,707 $ 401,353
</TABLE>
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 6, 1991 TO YEAR ENDED DECEMBER 31,
DECEMBER 31, --------------------------------------------------------- PRO FORMA
1991(1) 1992 1993 1994 1995(2)(3) 1995(4)(5)
--------------- ----- ------ ------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures, including business
acquisitions............................. -- $ 138 $ 2,052 $ 3,393 $ 14,697 $ 17,489
EBITDA (11)................................ $ (56) $(231) $ (2,368) $ (10,571) $ (8,723) $ (8,026)
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------
PRO FORMA
1995 1996(2)(6) 1996(7)
--------------- ------------- ---------
<S> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures, including business
acquisitions............................. $ 10,735 $ 136,404 $137,968
EBITDA (11)................................ $ (6,321) $ (11,822) $(10,627)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------- SEPTEMBER 30,
1994 1995 1996
--------------- ------ -------------
<S> <C> <C> <C>
OTHER OPERATING DATA:
Local lines........................... 17,112 35,795 55,993
Number of telecommunications
customers........................... 5,137 8,776 13,635
Markets served........................ 26 50 68
Route miles........................... 8 218 1,696
Employees............................. 302 419 1,815
</TABLE>
(Footnotes on following page)
6
<PAGE> 11
- ---------------
(1) The Company was organized on June 6, 1991.
(2) The acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing in April
1995, July 1996 and September 1996, respectively, affect the comparability
of the historical data presented to the historical data for prior periods
shown.
(3) Includes operations of MWR from April 29, 1995 to December 31, 1995.
(4) The acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing in April
1995, July 1996 and September 1996, respectively, affect the comparability
of the pro forma data presented to the data for prior periods shown.
(5) Includes operations of MWR, Ruffalo, Cody and Telecom*USA Publishing from
January 1, 1995 to December 31, 1995 and certain adjustments attributable
to the acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing by the
Company.
(6) Includes operations of Ruffalo, Cody from July 16, 1996 to September 30,
1996 and operations of Telecom*USA Publishing from September 21, 1996 to
September 30, 1996.
(7) Includes operations of Ruffalo, Cody and Telecom*USA Publishing from
January 1, 1996 to September 30, 1996 and certain adjustments attributable
to the acquisitions of Ruffalo, Cody and Telecom*USA Publishing by the
Company.
(8) Includes MWR, which was acquired by the Company on April 28, 1995.
(9) Includes Ruffalo, Cody and Telecom*USA Publishing, which were acquired by
the Company on July 15, 1996 and September 20, 1996, respectively.
(10) Adjusted to reflect the application of the estimated net proceeds to the
Company from the sale of the Class A Common Stock offered hereby.
(11) EBITDA consists of operating loss before depreciation and amortization. The
Company has included EBITDA data because it is a measure commonly used in
the industry. EBITDA is not a measure of financial performance under
generally accepted accounting principles and should not be considered an
alternative to net income as a measure of performance or to cash flows as a
measure of liquidity.
7
<PAGE> 12
RISK FACTORS
An investment in the Class A Common Stock involves a significant degree of
risk. In determining whether to make an investment in the Class A Common Stock,
potential investors should consider carefully all of the information set forth
in this Prospectus and, in particular, the following factors.
LIMITED OPERATING HISTORY; OPERATING LOSSES AND NEGATIVE CASH FLOW FROM
OPERATIONS
The Company began operations in 1992 and has only a limited operating
history upon which investors may base an evaluation of its performance. As a
result of operating expenses and development expenditures, the Company has
incurred significant operating and net losses to date. Net losses for 1993,
1994, 1995 and the nine months ended September 30, 1996 were approximately $2.4
million, $11.4 million, $11.3 million and $13.4 million, respectively. At
September 30, 1996, the Company had an accumulated deficit of $38.9 million.
Although its revenue has increased substantially in each of the last three
years, the Company also has experienced significant increases in expenses
associated with the development and expansion of its fiber optic network and its
customer base. The Company expects to incur significant operating losses and to
generate negative cash flows from operating and construction activities during
the next several years, while it develops its businesses and installs and
expands its fiber optic network. There can be no assurance that the Company will
achieve or sustain profitability or positive cash flows from operating
activities in the future. If the Company cannot achieve operating profitability
or positive cash flows from operating activities, it may not be able to meet its
debt service or working capital requirements, which could have a material
adverse effect on the Company. See "-- Significant Capital Requirements,"
"Selected Consolidated Financial Data" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
SIGNIFICANT CAPITAL REQUIREMENTS
Expansion of the Company's operations, facilities, network and services
will require significant capital expenditures. As of September 30, 1996, the
Company estimates that its aggregate capital requirements for the remainder of
1996, 1997 and 1998 will be approximately $310 million. The Company's estimated
capital requirements include the estimated cost of (i) developing and
constructing its fiber optic network, (ii) market expansion activities, (iii)
constructing its network operations center and corporate headquarters, and (iv)
obtaining PCS licenses and related capital expenditures, including those
licenses described below for which the Company currently has bids outstanding.
These capital requirements are expected to be funded, in large part, out of the
net proceeds to the Company from the Offering, the net proceeds remaining from
the Company's initial public offering of Class A Common Stock (approximately
$123 million as of September 30, 1996), and lease payments to the Company for
portions of the Company's networks.
The Company may require additional capital in the future for business
activities related to those specified above and also for acquisitions, joint
ventures and strategic alliances, as well as to fund operating deficits and net
losses. These activities could require significant additional capital not
included in the foregoing estimated aggregate capital requirements of $310
million.
The Company's estimate of its future capital requirements is a "forward
looking statement" within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. The Company's actual capital
requirements may differ materially as a result of regulatory, technological and
competitive developments (including new opportunities) in the Company's
industry.
The Company is currently bidding for certain PCS licenses being auctioned
by the FCC and expects to explore alternatives to permit it to provide other
wireless services, which may require substantial additional capital. As of
November 13, 1996, the Company had submitted bids totaling approximately $29.9
million for "D" and "E" block frequency licenses covering areas of Iowa,
Illinois, Nebraska and Minnesota in the FCC's auctions of PCS licenses. If the
Company is
8
<PAGE> 13
successful in obtaining PCS licenses, it will be required to make significant
expenditures to develop, construct and operate a PCS system.
The Company expects to meet its additional capital needs with the proceeds
from credit facilities and other borrowings, and additional debt and equity
issuances. The Company currently plans to obtain one or more lines of credit,
although no such lines of credit have yet been negotiated. There can be no
assurance, however, that the Company will be successful in producing sufficient
cash flows or raising sufficient debt or equity capital to meet its strategic
objectives or that such funds, if available at all, will be available on a
timely basis or on terms that are acceptable to the Company. Failure to generate
or raise sufficient funds may require the Company to delay or abandon some of
its future expansion plans or expenditures, which could have a material adverse
effect on the Company. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
WIRELINE COMPETITION
The telecommunications industry is highly competitive. The Company faces
intense competition from local exchange carriers, including the Regional Bell
Operating Companies (primarily U S WEST Communications, Inc. ("U S WEST") and
Ameritech Corporation ("Ameritech")) and the General Telephone Operating
Companies, which currently dominate their local telecommunications markets. The
Company also competes with long distance carriers in the provision of long
distance services. The long distance market is dominated by three major
competitors, AT&T, MCI and Sprint. Hundreds of other companies also compete in
the long distance marketplace. Other competitors of the Company may include
cable television companies, competitive access providers, microwave and
satellite carriers and private networks owned by large end users. In addition,
the Company competes with the Regional Bell Operating Companies and other local
exchange carriers, numerous direct marketers and telemarketers, equipment
vendors and installers and telecommunications management companies with respect
to certain portions of its business. Many of the Company's existing and
potential competitors have financial and other resources far greater than those
of the Company.
The local and access telephone services offered by the Company compete
principally with the services offered by the incumbent local exchange carrier
serving each of the Company's markets. Incumbent local exchange carriers have
long-standing relationships with their customers and have the potential to
subsidize competitive services from less competitive service revenues.
In addition, a continuing trend toward business combinations and strategic
alliances in the telecommunications industry may create significant new
competitors. For example, the national long distance carrier WorldCom, Inc.
("WorldCom") recently announced its agreement to acquire MFS Communications
Company, Inc., a competitive access provider. Moreover, in November 1996,
British Telecommunications plc, an international telecommunications company,
announced its agreement to acquire the national long distance carrier MCI. The
ability of these or other competitors of the Company to enter into strategic
alliances could put the Company at a significant disadvantage.
The Company may, in the future, face competition in the markets in which it
operates from one or more competitive access providers operating fiber optic
networks, in many cases in conjunction with the local cable television operator.
Each of AT&T, MCI and Sprint has indicated its intention to offer local
telecommunications services, either directly or in conjunction with other
competitive access providers or cable television operators. There can be no
assurance that these firms, and others, will not enter the small and mid-sized
markets where the Company focuses its sales efforts. Like the Company, MCI
currently holds a certificate of public convenience and necessity to offer local
and long distance service in Iowa through partitioning of U S WEST's central
office switch. Two small telecommunication companies also hold such certificates
in Iowa. On February 29, 1996, AT&T filed an application before the Iowa
Utilities Board to offer local service in Iowa on both a
9
<PAGE> 14
resale and facilities-based basis. On July 26, 1996, the Iowa Utilities Board
approved AT&T's application, subject to certain additional filing requirements.
The Company believes that the Telecommunications Act and state legislative
and regulatory initiatives and developments in Illinois, Iowa and other states
within the Company's target markets, as well as a recent series of transactions
and proposed transactions between telephone companies, long distance carriers
and cable companies, increase the likelihood that barriers to local exchange
competition will be substantially reduced or removed. These initiatives include
requirements that the Regional Bell Operating Companies negotiate with entities
such as the Company to provide interconnection to the existing local telephone
network, to allow the purchase, at cost-based rates, of access to unbundled
network elements, to establish dialing parity, to obtain access to rights-of-way
and to resell services offered by the incumbent local exchange carriers. See
"Business -- Regulation." The Company's plans to provide local switched services
are dependent upon obtaining favorable interconnection agreements with local
exchange carriers. In October 1996, the U.S. Eighth Circuit Court of Appeals
stayed the effectiveness of certain portions of the Interconnection Decision,
including provisions establishing a pricing methodology and a procedure
permitting new entrants to "pick and choose" among various provisions of
existing interconnection agreements. Although the judicial stay of the
Interconnection Decision does not prevent the Company from negotiating
interconnection agreements with local exchange carriers, it does create
uncertainty about the rules governing pricing, terms and conditions of
interconnection agreements, and could make negotiating such agreements more
difficult and protracted. The FCC applied to the U.S. Supreme Court to vacate
the judicial stay, but the U.S. Supreme Court, on November 12, 1996, refused to
vacate the stay. The U.S. Eighth Circuit Court of Appeals is expected to hear
oral arguments in this case in January 1997 and further appeals are possible.
There can be no assurance that the Company will be able to obtain
interconnection agreements on terms acceptable to the Company.
The Telecommunications Act provides the incumbent local exchange carriers
with new competitive opportunities. The Telecommunications Act removes previous
restrictions concerning the provision of long distance service by the Regional
Bell Operating Companies and also provides them with increased pricing
flexibility. Under the Telecommunications Act, the Regional Bell Operating
Companies will, upon the satisfaction of certain conditions, be able to offer
long distance services that would enable them to duplicate the "one-stop"
integrated telecommunications approach used by the Company. The Company believes
that it has certain advantages over these companies in providing its
telecommunications services, including management's prior experience in the
competitive telecommunications industry and the Company's emphasis on marketing
(primarily using a direct sales force for sales to business customers and
telemarketing for sales to residential customers) and on responsive customer
service. However, there can be no assurance that the anticipated increased
competition will not have a material adverse effect on the Company. The
Telecommunications Act provides that rates charged by incumbent local exchange
carriers for interconnection to the incumbent carrier's network are to be
nondiscriminatory and based upon the cost of providing such interconnection, and
may include a "reasonable profit," which terms are subject to interpretation by
regulatory authorities. If the incumbent local exchange carriers, particularly
the Regional Bell Operating Companies, charge alternative providers such as the
Company unreasonably high fees for interconnection to the local exchange
carriers' networks, significantly lower their rates for access and private line
services or offer significant volume and term discount pricing options to their
customers, the Company could be at a significant competitive disadvantage.
DEPENDENCE ON REGIONAL BELL OPERATING COMPANIES; U S WEST CENTREX ACTION
The Company is dependent on the Regional Bell Operating Companies for
provision of its local and certain of its long distance services. U S WEST and
Ameritech are currently the Company's sole suppliers of access to local central
office switches. The Company uses such access to partition the local switch and
provide local service to its customers.
10
<PAGE> 15
The Company purchases access in the form of a product generally known as
"Centrex." Without such access, the Company could not currently provide bundled
local and long distance services, although it could provide stand-alone long
distance service. Since the Company believes its ability to offer bundled local
and long distance services is critical to its current sales efforts, any
successful effort by U S WEST or Ameritech to deny or substantially limit the
Company's access to partitioned switches would have a material adverse effect on
the Company.
On February 5, 1996, U S WEST filed tariffs and other notices announcing
its intention to limit future Centrex access to its switches by Centrex
customers (including the Company) throughout U S WEST's fourteen-state service
region, effective February 5, 1996 (the "U S WEST Centrex Action"). Although U S
WEST stated that it would "grandfather" existing Centrex agreements with the
Company and permit the Company to continue to use U S WEST's central office
switches through April 29, 2005, it also indicated that it would not permit the
Company to expand to new cities and would severely limit the number of new lines
it would permit the Company to partition onto U S WEST's portion of the switches
in cities currently served by the Company. Because of U S WEST's commitment to
"grandfather" service to the Company, the Company does not believe its current
customers are at risk that service will be interrupted. The Company has
challenged, or is challenging, the U S WEST Centrex Action before the public
utilities commissions in certain of the states served by U S WEST where the
Company is doing business or currently plans to do business. The Company bases
such challenges on various state and federal laws, regulations and regulatory
policies, including Sections 251(b)(1) and 251(c)(4)(B) of the
Telecommunications Act, which the Company believes impose upon the Regional Bell
Operating Companies the duty not to prohibit, and not to impose unreasonable or
discriminatory conditions or limitations on, the resale of their
telecommunications services, and Section 251(c)(4)(A) of the Telecommunications
Act, which the Company believes obligates the Regional Bell Operating Companies
to offer for resale at wholesale rates any telephone communications services
that are provided at retail to subscribers who are not telecommunications
carriers. Additional statutes cited in the Company's challenges include
provisions of the laws of Iowa, Minnesota, Nebraska, South Dakota, North Dakota
and Colorado, which the Company believes prohibit restrictions on the resale of
local exchange services, functions or capabilities; prohibit local exchange
carriers from refusing access by other carriers to essential facilities on the
same terms and conditions as the local exchange carrier provides to itself; and
prohibit the provision of carrier services pursuant to rates, terms and
conditions that are unreasonably discriminatory.
In Iowa, the Company filed a complaint with the Iowa Utilities Board
against U S WEST's actions and was granted interim relief on an ex parte basis
that allowed the Company to continue to expand to new cities and expand the
number of new lines partitioned onto U S WEST's switches. Subsequent to the
grant of interim relief, the Company on March 18, 1996 agreed to a settlement
agreement with U S WEST that permits the Company to continue to expand, without
restrictions, the number of new lines it serves in Iowa through March 18, 2001.
In addition, the settlement agreement provides that the Company may expand to
seven new markets (central offices) in Iowa per year through March 18, 2001. As
a result of the settlement agreement, the Company withdrew its complaint before
the Iowa Utilities Board. Because MCI, AT&T and others also challenged U S
WEST's action, the Iowa Utilities Board continued to review the U S WEST Centrex
Action and on June 14, 1996 issued an order rejecting U S WEST's filing. The
order of the Iowa Utilities Board was appealed by U S WEST to the Iowa District
Court for Polk County on July 12, 1996. The appeal remains pending.
In Nebraska, a complaint filed by the Company with respect to the U S WEST
Centrex Action is awaiting decision by the Nebraska Public Service Commission.
In Minnesota, U S WEST's initial filing was rejected on procedural grounds by
the Public Utilities Commission. Nevertheless, on April 30, 1996, U S WEST
refiled its proposed limitations on Centrex service in Minnesota, proposing to
"grandfather" the service to existing customers as of July 9, 1996. The Company
opposed this filing in a letter to the Minnesota Public Utilities Commission on
May 20, 1996. On
11
<PAGE> 16
May 31, 1996, the Minnesota Public Utilities Commission issued an order
suspending the new U S WEST filing and scheduling a contested-case proceeding to
consider it. An administrative law judge is expected to render a ruling in the
proceeding by December 20, 1996. In South Dakota, the Public Utilities
Commission rejected the U S WEST Centrex Action on August 22, 1996. U S WEST has
appealed the unfavorable decision of the Public Utilities Commission in South
Dakota state court and has been granted a stay that prevents the Company from
marketing and selling Centrex service in South Dakota pending a ruling on
appeal. In North Dakota, on November 6, 1996, the Public Service Commission
concluded that the U S WEST Centrex Action is unlawful and ordered U S WEST to
reinstate Centrex service in North Dakota. The Company anticipates that U S WEST
will appeal the unfavorable decision by the North Dakota Public Service
Commission and unfavorable decisions by public utilities commissions in other
states with respect to the U S WEST Centrex Action.
There can be no assurance that the Company will succeed in its legal
challenges to the U S WEST Centrex Action, or that this action by U S WEST, or
similar actions by other Regional Bell Operating Companies, will not have a
material adverse effect on the Company. See "Business -- Legal Proceedings."
REFUSAL OF U S WEST TO IMPROVE ITS PROCESSING OF SERVICE ORDERS
As a result of its use of the Centrex product, the Company depends upon U S
WEST to process service orders placed by the Company to transfer new customers
to the Company's local service. U S WEST has imposed a limit of processing one
new local service order of the Company per hour for each U S WEST central
office. Furthermore, according to the Company's records, U S WEST commits an
error on one of every three lines ordered by the Company, thereby further
delaying the transition of new customers to the Company's local service. The
Company repeatedly requested that U S WEST increase its local service order
processing rate and improve the accuracy of such processing, which U S WEST
refused to do.
On July 12, 1996, the Company filed a complaint with the Iowa Utilities
Board against U S WEST in connection with such actions. At a hearing held to
consider the complaint, U S WEST acknowledged that it had not dedicated
resources to improve its processing of the Company's service orders to switch
new customers to the Company's local service because of its desire to limit
Centrex service. See "-- Dependence on Regional Bell Operating Companies; U S
WEST Centrex Action." In an order issued on October 10, 1996, the Iowa Utilities
Board determined that U S WEST's limitation on the processing of the Company's
service orders constituted an unlawful discriminatory practice under Iowa law.
The Iowa Utilities Board ordered the Company and U S WEST jointly to file
supplemental evidence regarding potential modifications of current order
processing practices that would increase U S WEST's rate of processing service
orders. There can be no assurance, however, that the decision of the Iowa
Utilities Board will adequately resolve the service order problems or that such
problems will not impair the Company's ability to expand or to attract new
customers, which could have a material adverse effect on the Company.
FAILURE OF U S WEST TO FURNISH CALL DETAIL RECORDS
The Company depends on certain call detail records provided by U S WEST
with respect to long distance services, and Ameritech with respect to both local
and long distance services, in order to verify its customers' bills for both
local and long distance service. The Company has in the past experienced certain
omissions in the call detail records it receives from U S WEST on a monthly
basis. For example, during the period from January 1995 through January 1996,
U S WEST failed to furnish, on average, monthly call detail records for 2.5% of
the long distance calls placed by the Company's customers in Iowa. Thus, the
Company was unable to verify with certainty that a given long distance call
placed by a customer and known by the Company to have been terminated by the
Company's wholesale long distance supplier was, in fact, placed by the customer.
12
<PAGE> 17
These call detail omissions typically occur in connection with new
customers of the Company. The telephone numbers of such customers, on the date
they begin service with the Company, are transferred to the portion of the U S
WEST central office switch partitioned for use by the Company. This transfer is
effected by a U S WEST technician, who makes certain keystroke entries in the
software database controlling the switch in order to transfer the telephone
number to the Company's portion of the switch. At that time, an additional
keystroke entry is required in order to activate the software (or "set the
flag") that records and stores both the telephone number originating a long
distance call and the beginning time and duration of the call. Occasionally,
this additional keystroke entry is not made and, therefore, the call detail
records are not captured, and cannot be recovered, for the period during which
the flag is not set.
The Company receives a weekly report from U S WEST listing all telephone
numbers assigned to the Company's portion of the switch, which the Company
compares to its own list of customers. When the telephone number of a customer
of the Company does not appear on the weekly U S WEST list, the Company contacts
U S WEST to ascertain whether the flag has been set for such customer and, if
the flag has not been set, the Company requests that U S WEST make the necessary
keystroke entry.
On a monthly basis, the Company receives a report from its wholesale long
distance supplier listing all long distance calls originating from the Company's
portion of the U S WEST switch and the telephone number to which the call was
terminated, as well as the time and the duration of the call. The long distance
supplier's records do not, however, provide the telephone number from which the
call was originated. Therefore, if there has been an omission by U S WEST in
setting the flag in connection with a particular customer of the Company, the
Company is unable to verify with complete certainty the long distance calls
originating from such customer until the flag has been set. Absent such
verification, the Company does not bill its customer for the call.
The Company does not believe this impediment to billing certain customers
for a small percentage of calls in a given month materially adversely affects
its relationships with or contractual obligations to its customers. The failure
to bill the customer does have a negative effect on the Company's gross margins,
because the Company incurs expenses for calls it does not bill. During the year
ended December 31, 1995, the Company estimates that it was unable to bill
approximately $126,000 in long distance calls due to this situation.
The Company believes that U S WEST is contractually obligated to provide
the Company with such call detail records. Accordingly, in paying its invoices
from U S WEST, the Company withholds amounts representing the cost of the lines
with respect to which call detail records were not provided, together with a pro
rata amount of the central office and related costs associated therewith. During
the year ended December 31, 1995, the Company withheld approximately $216,000
from payments of amounts invoiced by U S WEST due to the failure by U S WEST to
furnish 100% of the call detail records. U S WEST disputes the Company's right
to make these withholdings, and the Company and U S WEST have agreed to
undertake non-binding mediation in an effort to resolve the financial aspects of
the dispute. No date for such mediation has been set. The Company has expensed
the amounts withheld from U S WEST on its financial statements. As a result, in
the event U S WEST prevails in its dispute with the Company, there will be no
effect on the Company's historical financial condition or results of operations.
However, if U S WEST prevails in the dispute and continues to fail to provide
call detail records for a significant percentage of calls, there could be a
material adverse effect on the Company's future financial condition and results
of operations.
In January 1996, U S WEST advised the Company that it had instituted
certain new procedures, primarily involving data entry protocols, in an effort
to "capture" 100% of call detail records. Since implementing the protocol
changes, U S WEST has furnished the Company with approximately 99% of the
requisite call detail records for March through September 1996. There can be no
assurance, however, that U S WEST will not continue to experience difficulties
in furnishing complete call detail
13
<PAGE> 18
records to the Company, that the percentage of call detail records not provided
to the Company will not increase, or that the resulting negative effect on gross
margins will not have a material adverse effect on the Company.
WIRELESS COMPETITION
The Company believes that the market for wireless telecommunications
services is likely to expand significantly as equipment costs and service rates
continue to decline, equipment becomes more convenient and functional, and
wireless services become more diverse. The Company also believes that providers
of wireless services increasingly will offer, in addition to products that
supplement a customer's landline communications (similar to cellular telephone
services in use today), wireline replacement products that may result in
wireless services becoming the customer's primary mode of communication. The
Company anticipates that in the future there could potentially be eight wireless
competitors in each of its current and/or target markets: two existing cellular
providers and, in view of the ongoing PCS auctions for spectrum in these
markets, as many as six additional PCS providers. Principal cellular providers
in the Company's current and target markets include Ameritech Mobile
Communications, Inc., AT&T Wireless Services, Inc., Southwestern Bell Mobile
Systems, Inc., Western Wireless Corporation, CommNet Cellular Incorporated, GTE
Mobilnet Service Corporation, 360 DEGREES Communications Company, Airtouch
Cellular, United States Cellular Corporation and BellSouth Corporation.
Principal PCS licensees in the Company's current and target markets include AT&T
Wireless PCS, Inc., PRIMECO Personal Communications, L.P., WirelessCo, d/b/a
Sprint PCS, American Portable Telecommunications, Inc., Western PCS Corp., Cox
Communications, Inc., AerForce Communications, L.P., BRK WIRELESS CO., INC.,
Pocket Communication Corp., Wireless PCS, Inc., GTE Macro Communications Corp.
and Nextel Communications, Inc.
The Company does not currently offer PCS or cellular services. The Company
is, however, currently bidding for "D" and "E" block frequency licenses covering
areas of Iowa, Illinois, Nebraska and Minnesota in the FCC's auctions of PCS
licenses. As of November 13, 1996, the Company had submitted bids totaling
approximately $29.9 million for such licenses. If the Company is successful in
obtaining PCS licenses, it will be required to make significant expenditures to
develop, construct and operate a PCS system. There can be no assurance that the
Company will be successful in acquiring any PCS licenses. Nevertheless, as the
wireline and wireless markets converge, the Company believes that it can
identify opportunities to generate revenues from the wireless industry on a
wholesale and a retail basis. On a wholesale basis, these opportunities may
include leasing tower sites to wireless providers or switching wireless traffic
through the Company's switching platform. On a retail basis, the Company
believes that it will be able to enter into "bundling/branding" arrangements
with both cellular and PCS companies on favorable economic terms. However,
except for its participation in the FCC auction of PCS licenses, the Company has
no current or pending negotiations, arrangements or agreements to acquire the
ability to provide wireless services. There can be no assurance that the Company
will identify any such opportunities, or that competition from PCS and other
providers of wireless telecommunications services will not have a material
adverse effect on the Company. See "Business -- Wireless Services."
PCS SYSTEM IMPLEMENTATION RISKS
The Company's proposed investment in the ownership, development,
construction and operation of a PCS system involves a high degree of risk. In
the event the Company is successful in acquiring one or more PCS licenses, and
in the absence of FCC mandated technology protocols, the Company would be
required to choose from among several competing and potentially incompatible
technologies in order to build and operate a PCS system. Currently, PCS
providers must select a digital protocol for their PCS systems. The selection of
a particular digital protocol technology could adversely affect the ability of
the Company to successfully offer PCS service. For example, in order for the
Company's potential PCS subscribers to roam in markets served by other PCS
licensees, at
14
<PAGE> 19
least one of the other PCS licensees must utilize a digital protocol technology
that is compatible with that of the Company. To the extent that PCS providers
outside the Company's potential PCS service area use an incompatible technology,
the Company's PCS business would be adversely affected.
The Company does not own or operate any facilities for providing wireless
telecommunication services to the public. The successful implementation of a PCS
system would require the Company to develop such facilities. The Company would
need to, among other things, lease or acquire sites for the Company's base
stations, construct the base stations, install the necessary equipment and
conduct system testing. Each stage of implementing PCS service involves various
risks and contingencies, many of which are not in the Company's control. In the
event the Company encountered delays or other problems, the Company's plans for
providing PCS services could be adversely affected.
If the Company is successful in acquiring one or more PCS licenses, the
Company will be required to abide by various FCC rules governing PCS license
holders, such as rules limiting the percentage of the Company's capital stock
that may be owned, directly or indirectly, or voted by non-U.S. citizens, by a
foreign government or by a foreign corporation to 20%, except in extraordinary
circumstances. See "-- Regulation." Failure on the part of the Company to abide
by the FCC rules could lead to the Company being fined or losing its PCS
licenses. Furthermore, certain of the FCC rules would require the Company to
meet certain buildout and population coverage requirements. Such requirements
may limit the markets in which the Company could implement PCS service.
Finally, the ownership, development, construction and operation of a PCS
system is expected to impose significant demands on the Company's management,
operational and financial resources. There can be no assurance that the Company
will be able to successfully manage the implementation and operation of a PCS
system. Any failure to effectively manage the implementation and operation of
any future PCS system (including implementing adequate systems, procedures and
controls in a timely manner) could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Wireless Services."
DEPENDENCE ON KEY PERSONNEL
The Company's business is dependent upon a small number of key executive
officers, particularly Clark E. McLeod, the Company's Chairman and Chief
Executive Officer, and Stephen C. Gray, the Company's President and Chief
Operating Officer. The Company does not currently have any term employment
agreements with these or any other employees. However, the Company has entered
into employment, confidentiality and non-competition agreements with Messrs.
McLeod and Gray and certain other key employees of the Company providing for
employment by the Company for an indefinite period, subject to termination by
either party (with or without cause) on 30 days' prior written notice, and an
agreement not to compete with the Company for a period of one or two years,
depending on the employee, following termination for cause or voluntary
termination of employment. The Company maintains "key man" insurance on Mr.
McLeod, in the amount of $2,000,000, and on Mr. Gray, in the amount of
$1,000,000.
There can be no assurance that the employment, confidentiality and
non-competition agreements will improve the Company's ability to retain its key
managers or employees or that the Company can attract or retain other skilled
management personnel in the future. The loss of the services of key personnel,
or the inability to attract additional qualified personnel, could have a
material adverse effect on the Company. See "Management -- Management
Agreements."
REGULATION
The Company is subject to varying degrees of federal, state and local
regulation relating to its local, long distance and access telecommunications
services. McLeod Telemanagement, Inc., a wholly owned subsidiary of the Company
("McLeod Telemanagement"), is currently required by
15
<PAGE> 20
federal and state regulation to file tariffs listing the rates, terms and
conditions of certain services provided. In most states, McLeod Telemanagement
also is required to obtain certification from the relevant state public
utilities commission prior to the initiation of intrastate or interstate
interexchange service. Any failure to maintain proper federal and state
tariffing or state certification, or noncompliance with federal or state laws or
regulations, could have a material adverse effect on the Company. The Company
has never experienced difficulties in receiving certification or maintaining
such tariffing. McLeod Telemanagement also has obtained authority from the FCC
to provide international services. The FCC's rules applicable to the provision
of international services may, under certain conditions, limit the size of
investments in the Company by foreign telecommunications carriers. The Company
does not currently hold any common carrier radio licenses issued by the FCC,
although it may obtain or acquire radio licenses in the future in connection
with the provision of wireless services. The Telecommunications Act limits the
ownership by non-U.S. citizens, foreign governments, and corporations organized
under the laws of a foreign country in companies holding a common carrier radio
license. The Company, through its wholly owned subsidiary MWR, provides certain
competitive access services as a private carrier on a non-regulated basis. The
Company believes that MWR's private carrier status is consistent with applicable
federal and state laws, as well as regulatory decisions interpreting and
implementing those laws as of the date of this Prospectus. Should such laws
and/or regulatory interpretations change in the future to reclassify MWR's
regulatory status, the Company believes that compliance with such
reclassification would not have a material adverse effect on the Company. In
addition, the recently enacted Telecommunications Act has significantly altered
regulation of the telecommunications industry by preempting state and local laws
to the extent that they prevent competition and by imposing a variety of new
duties on incumbent local exchange carriers in order to promote competition in
local exchange and access services. The Telecommunications Act also eliminates
previous prohibitions on the provision of long distance services by the Regional
Bell Operating Companies and the General Telephone Operating Companies. Although
the Company believes that the enactment of the Telecommunications Act and other
trends in federal and state legislation and regulation that favor increased
competition are to the advantage of the Company, there can be no assurance that
the resulting increased competitive opportunities or other changes in current
regulations or future regulations at the federal or state level will not have a
material adverse effect on the Company. See "-- Wireline Competition" and
"Business -- Regulation."
The Company, through its wholly owned subsidiary Ruffalo, Cody, is also
subject to certain federal and state regulatory requirements due to its direct
marketing, telemarketing and fund-raising activities, including, in certain
states, bonding requirements. There can be no assurance that any failure on the
part of Ruffalo, Cody to abide by applicable direct marketing, telemarketing and
fund-raising rules would not have a material adverse effect on the Company. See
"Business -- Regulation."
CONTRACT WITH THE STATE OF IOWA
The Company's telecommunications network maintenance services revenue is
derived almost exclusively from the State of Iowa under a fiber optic
maintenance contract (the "Iowa Communications Network Maintenance Contract")
expiring in 2004. Revenues from the Company's services performed for the State
of Iowa under the Iowa Communications Network Maintenance Contract and related
contracts totaled $1.6 million, $3.4 million and $4.9 million in 1993, 1994 and
1995, respectively, or 100%, 42% and 17%, of the Company's total revenues in
1993, 1994 and 1995, respectively. Revenues from these contracts totaled $3.6
million and $4.4 million, respectively, or 19% and 10% of the Company's total
revenues during the nine months ended September 30, 1995 and 1996, respectively.
The State of Iowa has the right to terminate the Iowa Communications
Network Maintenance Contract in the event of a lack of funding as well as for
material breach by the Company. The Company does not believe that there are
currently grounds for terminating the Iowa Communica-
16
<PAGE> 21
tions Network Maintenance Contract or that the State of Iowa currently intends
to do so. However, termination of the Iowa Communications Network Maintenance
Contract by the State of Iowa could have a material adverse effect on the
Company.
UNCERTAINTIES OF EXPANSION
The Company is engaged in the expansion and development of its network and
services. The expansion and development of its network and services will depend
on, among other things, its ability to partition the incumbent local exchange
company's central office switch, enter markets, design fiber optic network
routes, install facilities and obtain rights-of-way, building access and any
required government authorizations and/or permits, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions. Implementation of the
Company's current and future expansion plans will also depend on factors such
as: (i) the availability of financing and regulatory approvals; (ii) the number
of potential customers in a target market; (iii) the existence of strategic
alliances or relationships; (iv) technological, regulatory or other developments
in the Company's business; (v) changes in the competitive climate in which the
Company operates; and (vi) the emergence of future opportunities. There can be
no assurances that the Company will be able to expand its existing network or
services. Furthermore, the Company's ability to manage its expansion effectively
also will require it to continue to implement and improve its operating,
financial and accounting systems and to expand, train and manage its employee
base. The inability to manage its planned expansion effectively could have a
material adverse effect on the Company. Finally, if the Company's challenges to
the U S WEST Centrex Action fail and no favorable settlement agreement is
reached, there could be a material adverse effect on the Company's planned
expansions and business prospects. See "-- Dependence on Regional Bell Operating
Companies; U S WEST Centrex Action" and "Business -- Legal Proceedings."
RISKS ASSOCIATED WITH ACQUISITIONS
As part of its business strategy, the Company has recently acquired
Ruffalo, Cody and Telecom*USA Publishing and will continue to evaluate
additional strategic acquisitions and alliances principally relating to its
current operations. Such transactions commonly involve certain risks including,
among others: the difficulty of assimilating the acquired operations and
personnel; the potential disruption of the Company's ongoing business; the
possible inability of management to maximize the financial and strategic
position of the Company through the successful incorporation of acquired assets
and rights into the Company's service offerings and the maintenance of uniform
standards, controls, procedures and policies; the risks of entering markets in
which the Company has little or no direct prior experience; and the potential
impairment of relationships with employees or customers as a result of changes
in management. For example, over 40% of Ruffalo, Cody's revenues in 1995 were
derived from an agreement with a major long distance carrier to provide
telemarketing services. Both Ruffalo, Cody and the major long distance carrier
can terminate this agreement after giving notice to the other party. The major
long distance carrier has informed the Company that it intends to terminate this
agreement effective December 31, 1996. Upon termination of this agreement, the
Company intends to redirect telemarketing resources towards selling the
Company's local, long distance and other telecommunications services. There can
be no assurance that the Company will be successful in overcoming these risks or
any other problems encountered in connection with the acquisitions of Ruffalo,
Cody and Telecom*USA Publishing or other future transactions. In addition, any
such transactions could materially adversely affect the Company's operating
results due to dilutive issuances of equity securities, the incurrence of
additional debt and the amortization of expenses related to goodwill and other
intangible assets, if any. Except as described in this Prospectus, the Company
has no definitive agreement with respect to any material acquisition, although
from time to time it has discussions with other companies and assesses
acquisition opportunities on an on-going basis. See "Business -- Recent
Transactions."
17
<PAGE> 22
NEED TO OBTAIN AND MAINTAIN PERMITS AND RIGHTS-OF-WAY
In order to develop and construct its network, the Company must obtain
local franchises and other licenses and permits, as well as rights to utilize
underground conduit and aerial pole space and other rights-of-way and easements
from entities such as local exchange carriers and other utilities, railroads,
interexchange carriers, state highway authorities, local governments and transit
authorities. The Company has entered into long-term agreements with its two
principal electric utility stockholders, IES Industries Inc. (collectively with
its subsidiaries, "IES"), and MidAmerican Energy Company (collectively with its
predecessors and subsidiaries, "MidAmerican"), pursuant to which the Company
generally has access to the electric utilities' rights-of-way, poles and towers,
primarily located in Iowa, for so long as the utilities maintain their
franchises to provide electrical services in a given locality. There can be no
assurance that IES, MidAmerican or the Company will be able to maintain its
existing franchises, permits and rights-of-way or to obtain and maintain the
other franchises, permits and rights-of-way needed to implement its business
plan on acceptable terms. Although the Company believes that its existing
arrangements will not be canceled and will be renewed as needed in the near
future, if any of the existing franchises, license agreements or rights-of-way
were terminated or not renewed and the Company were forced to remove its
facilities, such cancellation or non-renewal of certain of such arrangements
could have a material adverse effect on the Company. See "Business -- Network
Facilities" and "Business -- Regulation."
RAPID TECHNOLOGICAL CHANGES
The telecommunications industry is subject to rapid and significant changes
in technology. While the Company believes that for the foreseeable future these
changes will neither materially affect the continued use of its fiber optic
telecommunications network nor materially hinder the Company's ability to
acquire necessary technologies, the effect of technological changes on the
business of the Company cannot be predicted. There can be no assurance that
technological developments in telecommunications will not have a material
adverse effect on the Company.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying cash dividends in the foreseeable future.
See "Price Range of Class A Common Stock and Dividend Policy."
CONTROL OF THE COMPANY
Upon completion of the Offering, IES, MidAmerican, and Clark and Mary
McLeod will own, directly or indirectly, in the aggregate approximately 32% of
the outstanding Class A Common Stock and all of the Class B Common Stock, which
will represent approximately 42% of the combined voting power of the Common
Stock. The Class B Common Stock is convertible into Class A Common Stock at any
time at the option of the holders of Class B Common Stock. If all of the Class B
Common Stock were converted into Class A Common Stock, upon completion of the
Offering, IES, MidAmerican and Mr. and Mrs. McLeod would hold approximately 52%
of the Class A Common Stock and voting power of the Company. IES, MidAmerican
and Mr. and Mrs. McLeod also have entered into a voting agreement with respect
to the election of directors. Accordingly, upon completion of the Offering, such
stockholders will collectively be able to control the management policy of the
Company and all fundamental corporate actions, including mergers, substantial
acquisitions and dispositions, and election of the Board of Directors of the
Company (the "Board"). The Company's Amended and Restated Certificate of
Incorporation (the "Restated Certificate") contains provisions that may make it
more difficult to effect a hostile takeover of the Company or to remove members
of the Board. See "Management -- Investor Agreement," "Principal and Selling
Stockholders" and "Description of Capital Stock."
18
<PAGE> 23
VARIABILITY OF OPERATING RESULTS
As a result of the significant expenses associated with the construction
and expansion of its network and services, including, without limitation, the
possible acquisition of PCS licenses, the Company anticipates that its operating
results could vary significantly from period to period. Such variability could
have a material adverse effect on the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
VOLATILITY OF STOCK PRICE
Since the Class A Common Stock has been publicly traded, the market price
of the Class A Common Stock has fluctuated over a wide range and may continue to
do so in the future. See "Price Range of Class A Common Stock and Dividend
Policy." In the future, the market price of the Class A Common Stock could be
subject to significant fluctuations in response to various factors and events,
including, among other things: the depth and liquidity of the trading market of
the Class A Common Stock; quarterly variations in the Company's actual or
anticipated operating results or growth rates; changes in estimates by analysts;
market conditions in the industry; announcements by competitors; regulatory and
judicial actions; and general economic conditions. In addition, the stock market
has from time to time experienced significant price and volume fluctuations,
which have particularly affected the market prices of the stocks of high growth
companies, and which may be unrelated to the operating performance of particular
companies. As a result of the foregoing, there can be no assurance that the
price of the Class A Common Stock will not continue to fluctuate or will not
decline below the price to the public set forth on the cover of this Prospectus.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have approximately
51,361,531 shares of Common Stock outstanding (including 113,387 shares of Class
A Common Stock placed into escrow in connection with the acquisition of Ruffalo,
Cody and 110,702 shares of Class A Common Stock issued in November 1996 pursuant
to the exercise of options by certain Selling Stockholders), including 4,768,903
shares of Class A Common Stock offered hereby and 32,455,005 "restricted" shares
of Common Stock. See "Business -- Recent Transactions." The shares of Class A
Common Stock offered hereby will be freely tradeable without restriction or
further registration under the Securities Act of 1933, as amended (the
"Securities Act"), by persons other than "affiliates" of the Company within the
meaning of Rule 144 promulgated under the Securities Act. The holders of
restricted shares generally will be entitled to sell these shares in the public
securities market without registration under the Securities Act to the extent
permitted by Rule 144 (or Rule 145, as applicable) promulgated under the
Securities Act or any exemption under the Securities Act. Of the 32,455,005
restricted shares, 22,070,187 shares of Common Stock generally are currently
eligible for sale under Rule 144 as currently in effect, and 10,384,818 shares
of Common Stock generally will be eligible for sale under Rule 144 as currently
in effect beginning in January 1997 through July 1998.
The Company, its directors and officers, the Selling Stockholders and
certain other stockholders have entered into "lock-up" agreements with the
Underwriters, providing that, subject to certain exceptions, they will not, for
a period of 120 days after the date of this Prospectus, without the prior
written consent of Salomon Brothers Inc, offer, sell or contract to sell, or
otherwise dispose of, directly or indirectly, or announce an offering of, any
shares of Common Stock or any securities convertible into, or exchangeable for,
shares of Common Stock. See "Underwriting." In addition, certain directors,
executive officers and stockholders have agreed that, for a period of two years
commencing on June 10, 1996, the date of the Company's initial public offering
of Class A Common Stock, they will not sell or otherwise dispose of any equity
securities of the Company without the consent of the Board. See
"Management -- Investor Agreement."
19
<PAGE> 24
At September 30, 1996, the Company had reserved 11,726,105 shares of Class
A Common Stock for issuance under the Company's employee stock purchase plan and
upon exercise of options outstanding or to be granted pursuant to the Company's
stock option plans. No shares have been issued under the Company's employee
stock purchase plan and options to purchase 7,647,969 shares of Class A Common
Stock were outstanding and unexercised under the Company's stock option plans as
of September 30, 1996. The Company has registered the shares of Class A Common
Stock reserved for issuance under the Company's stock purchase plan and stock
option plans. See "Management -- Stock Option Plans" and "Management -- The
Employee Stock Purchase Plan." In addition, options to purchase 1,300,688 shares
of Class B Common Stock, which were granted to IES in connection with its
guarantee and/or support of certain portions of the Credit Facility, were
outstanding as of September 30, 1996.
Future sales of a substantial amount of Class A Common Stock in the public
market, or the perception that such sales may occur, could adversely affect the
market price of the Class A Common Stock prevailing from time to time in the
public market and could impair the Company's ability to raise additional capital
through the sale of its equity securities. Several of the Company's principal
stockholders hold a significant portion of the Company's Class A Common Stock,
and a decision by one or more of these stockholders to sell their shares could
adversely affect the market price of the Class A Common Stock. See "Principal
and Selling Stockholders" and "Shares Eligible for Future Sale."
20
<PAGE> 25
USE OF PROCEEDS
The net proceeds to the Company from the Offering are estimated to be
approximately $127.6 million, after deducting the underwriting discount and
estimated offering expenses payable by the Company. The Company will not receive
any of the proceeds from the sale of shares of Class A Common Stock by the
Selling Stockholders. The Company intends to use the net proceeds of the
Offering as follows: (i) to fund development and construction costs of the
Company's fiber optic network; (ii) to fund market expansion activities as well
as potential acquisitions, joint ventures and strategic alliances; (iii) to bid
for PCS licenses and fund related development, construction and operating costs;
(iv) to fund the construction of the Company's network operations center and
corporate headquarters; and (v) for additional working capital and other general
corporate purposes, including funding operating deficits and net losses. The
Company currently intends to allocate substantial proceeds to each of the
foregoing categories. However, the precise allocation of funds among these uses
will depend on future technological, regulatory and other developments in or
affecting the Company's business, the competitive climate in which it operates
and the emergence of future opportunities.
As part of its business strategy, the Company intends to continue to
evaluate potential acquisitions, joint ventures and strategic alliances in areas
such as wireline and wireless services, directory publishing, network
construction and infrastructure and Internet access. Except as described
elsewhere in this Prospectus, the Company has no definitive agreement with
respect to any material acquisition, although from time to time it has
discussions with other companies and assesses acquisition opportunities on an
on-going basis. A portion of the proceeds of the Offering, as well as additional
sources of capital such as credit facilities and other borrowings, and
additional debt and equity issuances, may be used to fund any such acquisitions,
joint ventures and strategic alliances. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and "Business -- Recent Transactions."
Prior to the application of the net proceeds to the Company from the
Offering as described above, such funds will be invested in short-term,
investment grade securities.
PRICE RANGE OF CLASS A COMMON STOCK AND DIVIDEND POLICY
The Company completed its initial public offering of Class A Common Stock
on June 10, 1996, at a price per share of Class A Common Stock of $20.00. Since
that date, the Class A Common Stock has been quoted on the Nasdaq National
Market under the symbol "MCLD." The following table sets forth for the periods
indicated the high and low sales price per share of the Class A Common Stock as
reported by the Nasdaq National Market.
<TABLE>
<CAPTION>
1996 HIGH LOW
----------------------------------------------------------- ------- -------
<S> <C> <C>
Second Quarter (from June 10, 1996)........................ $ 26.75 $ 22.25
Third Quarter.............................................. $ 39.50 $ 23.50
Fourth Quarter (through November 14, 1996)................. $ 34.50 $ 27.75
</TABLE>
On November 14, 1996, the last reported sale price of the Class A Common
Stock on the Nasdaq National Market was $28.25 per share. On November 13, 1996,
there were 375 holders of record of the Class A Common Stock.
The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying dividends in the foreseeable future. Future
dividends, if any, will be at the discretion of the Board and will depend upon,
among other things, the Company's operations, capital requirements and surplus,
general financial condition, contractual restrictions in financing agreements
and such other factors as the Board may deem relevant. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
21
<PAGE> 26
CAPITALIZATION
The following table sets forth, as of September 30, 1996, the actual
capitalization of the Company and the capitalization of the Company as adjusted
for the Offering, including application of the net proceeds to the Company
therefrom as set forth under "Use of Proceeds." This table should be read in
conjunction with the Selected Consolidated Financial Data, the Consolidated
Financial Statements of the Company, the Notes thereto and the other financial
data included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
-------------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
Short-term debt..................................................... $ 2,917 $ 2,917
-------- --------
Long-term debt...................................................... 4,155 4,155
-------- --------
Stockholders' equity:
Preferred Stock, $.01 par value, 2,000,000 shares
authorized; none outstanding................................... -- --
Preferred Stock, Class A, $5.50 par value, 1,150,000 shares
authorized; none outstanding................................... -- --
Class A Common Stock, $.01 par value, 75,000,000 shares
authorized; 30,742,610 shares issued and outstanding and
35,622,215 shares, as adjusted for the Offering(1)............. 307 356
Class B Common Stock, convertible, $.01 par value, 22,000,000
shares authorized; 15,625,929 shares
issued and outstanding......................................... 156 156
Additional paid-in capital........................................ 312,141 439,738
Accumulated deficit............................................... (38,897) (38,897)
-------- --------
Total stockholders' equity................................ 273,707 401,353
-------- --------
Total capitalization...................................... $ 280,779 $ 408,425
======== ========
</TABLE>
- ---------------
(1) Excludes 113,387 shares of Class A Common Stock placed into escrow in
connection with the acquisition of Ruffalo, Cody and includes 110,702 shares
of Class A Common Stock issued in November 1996 pursuant to the exercise of
options by certain Selling Stockholders. See "Business -- Recent
Transactions."
22
<PAGE> 27
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE DATA)
The following table sets forth selected consolidated financial data and
should be read in conjunction with and is qualified by reference to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Consolidated Financial Statements of the Company, the Notes
thereto and the other financial data contained elsewhere in this Prospectus. All
of the financial data as of and for each of the five periods ended December 31,
1991, 1992, 1993, 1994 and 1995 have been derived from Consolidated Financial
Statements of the Company that have been audited by McGladrey & Pullen, LLP,
independent auditors. The information as of and for the nine month periods ended
September 30, 1995 and 1996 is unaudited, but in the opinion of the Company
reflects all adjustments necessary for the fair presentation of the Company's
financial position and results of operations for such periods, and may not be
indicative of the results of operations for a full year.
The unaudited pro forma information reflects the acquisitions by the Company
of MWR, Ruffalo, Cody and Telecom*USA Publishing on April 28, 1995, July 15,
1996 and September 20, 1996, respectively, using the purchase method of
accounting, assuming, for purposes of the pro forma statement of operations
data, that such acquisitions were consummated at the beginning of the periods
presented. The unaudited pro forma information should be read in conjunction
with the Financial Statements of MWR, Ruffalo, Cody and Telecom*USA Publishing
and the Notes thereto included elsewhere in this Prospectus. The financial and
operating data presented below are derived from the records of the Company, MWR,
Ruffalo, Cody and Telecom*USA Publishing.
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED DECEMBER 31,
JUNE 6, 1991 TO ---------------------------------------------------
DECEMBER 31, PRO FORMA
1991(1) 1992 1993 1994 1995(2)(3) 1995(4)(5)
--------------- ------ ------ ------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT DATA:
Revenue....................................... $ -- $ 250 $ 1,550 $ 8,014 $ 28,998 $ 86,476
------- -------- -------- --------- -------- --------
Operating expenses:
Cost of service............................. -- 262 1,528 6,212 19,667 48,666
Selling, general and administrative......... 56 219 2,390 12,373 18,054 45,836
Depreciation and amortization............... 2 6 235 772 1,835 7,933
------- -------- -------- --------- -------- --------
Total operating expenses................. 58 487 4,153 19,357 39,556 102,435
------- -------- -------- --------- -------- --------
Operating loss................................ (58) (237) (2,603) (11,343) (10,558) (15,959)
Interest income (expense), net................ -- -- 163 (73) (771) (1,049)
Other non-operating expenses.................. -- -- -- -- -- (997)
Income taxes.................................. -- -- -- -- -- --
------- -------- -------- --------- -------- --------
Net loss...................................... $ (58) $ (237) $ (2,440) $ (11,416) $(11,329) $(18,005)
======= ======== ======== ========= ======== ========
Loss per common and common equivalent share... $ -- $ (.02) $ (.08) $ (.31) $ (.31) $ (.48)
======= ======== ======== ========= ======== ========
Weighted average common and common equivalent
shares outstanding.......................... 14,925 14,925 29,655 36,370 37,055 37,416
======= ======== ======== ========= ======== ========
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------
PRO FORMA
1995 1996(2)(6) 1996(7)
------- ---------- ---------
<S> <C> <C> <C>
OPERATIONS STATEMENT DATA:
Revenue....................................... $19,438 $ 45,497 $ 92,798
------- ------- --------
Operating expenses:
Cost of service............................. 12,672 31,693 54,481
Selling, general and administrative......... 13,087 25,626 48,944
Depreciation and amortization............... 1,229 4,734 9,005
------- ------- --------
Total operating expenses................. 26,988 62,053 112,430
------- ------- --------
Operating loss................................ (7,550) (16,556) (19,632)
Interest income (expense), net................ (614) 2,860 2,746
Other non-operating expenses.................. -- 278 (211)
Income taxes.................................. -- -- --
------- ------- --------
Net loss...................................... $(8,164) $(13,418) $(17,097)
======= ======= ========
Loss per common and common equivalent share... $ (.22) $ (.33) $ (.41)
======= ======= ========
Weighted average common and common equivalent
shares outstanding.......................... 37,055 41,188 41,446
======= ======= ========
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------------ SEPTEMBER 30,
1991 1992 1993 1994 1995(2)(8) 1996(9)
------- ------- ------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Current assets................................ $ 2 $ 544 $ 7,077 $ 4,862 $ 9,624 $ 146,563
Working capital (deficit)..................... $ (72) $ (440) $ 5,962 $ 1,659 $ (92) $ 106,622
Property and equipment, net................... -- $ 135 $ 1,958 $ 4,716 $ 15,078 $ 61,394
Total assets.................................. $ 21 $ 694 $ 9,051 $ 10,687 $ 28,986 $ 324,077
Long-term debt................................ -- -- -- $ 3,500 $ 3,600 $ 4,155
Stockholders' equity (deficit)................ $ (53) $ (290) $ 7,936 $ 3,291 $ 14,958 $ 273,707
<CAPTION>
PERIOD FROM
JUNE 6, 1991 TO YEAR ENDED DECEMBER 31,
DECEMBER 31, ----------------------------------------------- PRO FORMA
1991(1) 1992 1993 1994 1995(2)(3) 1995(4)(5)
------- ------- ------- -------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures, including
business acquisitions....................... -- $ 138 $ 2,052 $ 3,393 $ 14,697 $ 17,489
EBITDA(10).................................... $ (56) $ (231) $ (2,368) $ (10,571) $ (8,723) $ (8,026)
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------
PRO FORMA
1995 1996(2)(6) 1996(7)
------- ---------- --------
<S> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures, including
business acquisitions....................... $10,735 $136,404 $137,968
EBITDA(10).................................... $(6,321) $(11,822) $(10,627)
</TABLE>
(Footnotes on following page)
23
<PAGE> 28
- ---------------
(1) The Company was organized on June 6, 1991.
(2) The acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing in April
1995, July 1996 and September 1996, respectively, affect the comparability
of the historical data presented to the historical data for prior periods
shown.
(3) Includes operations of MWR from April 29, 1995 to December 31, 1995.
(4) The acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing in April
1995, July 1996 and September 1996, respectively, affect the comparability
of the pro forma data presented to the data for prior periods shown.
(5) Includes operations of MWR, Ruffalo, Cody and Telecom*USA Publishing from
January 1, 1995 to December 31, 1995 and certain adjustments attributable
to the acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing by the
Company.
(6) Includes operations of Ruffalo, Cody from July 16, 1996 to September 30,
1996 and operations of Telecom*USA Publishing from September 21, 1996 to
September 30, 1996.
(7) Includes operations of Ruffalo, Cody and Telecom*USA Publishing from
January 1, 1996 to September 30, 1996 and certain adjustments attributable
to the acquisitions of Ruffalo, Cody and Telecom*USA Publishing by the
Company.
(8) Includes MWR, which was acquired by the Company on April 28, 1995.
(9) Includes Ruffalo, Cody and Telecom*USA Publishing, which were acquired by
the Company on July 15, 1996 and September 20, 1996, respectively.
(10) EBITDA consists of operating loss before depreciation and amortization. The
Company has included EBITDA data because it is a measure commonly used in
the industry. EBITDA is not a measure of financial performance under
generally accepted accounting principles and should not be considered an
alternative to net income as a measure of performance or to cash flows as a
measure of liquidity.
24
<PAGE> 29
PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial information has been prepared to
give effect to the acquisitions of MWR, Ruffalo, Cody and Telecom*USA Publishing
by the Company in April 1995, July 1996 and September 1996, respectively. The
unaudited pro forma financial statements reflect such acquisitions using the
purchase method of accounting, assuming, for the pro forma statements of
operations data, that such acquisitions were consummated at the beginning of the
periods presented. The unaudited pro forma financial information is derived from
and should be read in conjunction with the Consolidated Financial Statements of
the Company, Ruffalo, Cody and Telecom*USA Publishing and the Financial
Statements of MWR and the related Notes thereto included elsewhere in this
Prospectus. The pro forma adjustments are based upon available information and
certain assumptions that management believes to be reasonable. Final purchase
adjustments may differ from the pro forma adjustments herein.
The unaudited pro forma financial information is provided for informational
purposes only and is not necessarily indicative of the operating results that
would have occurred had the acquisitions been consummated at the beginning of
the periods presented, nor is it necessarily indicative of future operating
results or financial position.
The unaudited historical information for the nine month period ended
September 30, 1996 may not be indicative of the results of operations for a full
year.
MCLEOD, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
-------------------------------------------------------------------------------------
MWR TELECOM*USA ADJUSTMENTS PRO FORMA
MCLEOD, TELECOM, RUFFALO, CODY & PUBLISHING FOR FOR
INC.(1) INC.(2) ASSOCIATES, INC. GROUP, INC. ACQUISITIONS ACQUISITIONS
--------- -------- ---------------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Operations Statement Data:
Revenue................................. $ 28,998 $873 $ 13,286(3) $43,319 $ -- $ 86,476
--------- ---- -------- ------- ---------- --------
Operating expenses:
Cost of service....................... 19,667 376 6,619 18,226 3,778(4) 48,666
Selling, general and administrative... 18,054 98 5,376 20,362 1,946(4) 45,836
Depreciation and amortization......... 1,835 220 475 2,104 3,311(5) 7,933
(12)(6)
--------- ---- -------- ------- ---------- --------
Total operating expenses.......... 39,556 694 12,470 40,692 9,023 102,435
--------- ---- -------- ------- ---------- --------
Operating income (loss)................. (10,558) 179 816 2,627 (9,023) (15,959)
Interest income (expenses), net......... (771) (55) (77) (1,546) 1,400(7) (1,049)
Other non-operating expenses............ -- -- -- (997) -- (997)
Income taxes............................ -- (51) (274) (34) 359(8) --
--------- ---- -------- ------- ---------- --------
Net income (loss)....................... $ (11,329) $ 73 $ 465 $ 50 $ (7,264) $(18,005)
========= ==== ======== ======= ========== ========
Loss per common and common equivalent
share................................. $ (0.31) $ (0.48)
========= ========
Weighted average common and common
equivalent shares outstanding......... 37,055 37,416
========= ========
Other Financial Data:
EBITDA (9).............................. $ (8,723) $399 $ 1,291 $ 4,731 $ (5,724) $ (8,026)
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1996
------------------------------------------------------------------------------
RUFFALO, CODY & TELECOM*USA ADJUSTMENTS PRO FORMA
MCLEOD, ASSOCIATES, PUBLISHING FOR FOR
INC.(10) INC.(11) GROUP, INC.(12) ACQUISITIONS ACQUISITIONS
--------- --------------- --------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Operations Statement Data:
Revenue........................................ $ 45,497 $ 8,891(3) $38,410 $ -- $ 92,798
--------- ------- ------- ---------- --------
Operating expenses:
Cost of service.............................. 31,693 4,529 14,481 3,778(4) 54,481
Selling, general and administrative.......... 25,626 3,550 17,822 1,946(4) 48,944
Depreciation and amortization................ 4,734 293 1,725 2,253(5) 9,005
--------- ------- ------- ---------- --------
Total operating expenses................. 62,053 8,372 34,028 7,977 112,430
--------- ------- ------- ---------- --------
Operating income (loss)........................ (16,556) 519 4,382 (7,977) (19,632)
Interest income (expenses), net................ 2,860 (6) (1,119) 1,011(7) 2,746
Other non-operating expenses................... 278 -- (489) -- (211)
Income taxes................................... -- (182) (1,120) 1,302(8) --
--------- ------- ------- ---------- --------
Net income (loss).............................. $ (13,418) $ 331 $ 1,654 $ (5,664) $(17,097)
========= ======= ======= ========== ========
Loss per common and common equivalent share.... $ (0.33) $ (0.41)
========= ========
Weighted average common and common equivalent
shares outstanding........................... 41,188 41,446
========= ========
Other Financial Data:
EBITDA (9)..................................... $ (11,822) $ 812 $ 6,107 $ (5,724) $(10,627)
</TABLE>
(Footnotes on following page)
25
<PAGE> 30
- ---------------
(1) Includes operations of MWR from April 29, 1995 to December 31, 1995.
(2) Includes operations of MWR from January 1, 1995 to April 28, 1995.
(3) Includes revenue from an agreement with a major long distance carrier to
provide telemarketing services. Over 40% of Ruffalo, Cody's revenues in
1995 and a significant portion of its revenues in 1996 were derived from
this agreement. The major long distance carrier has informed the Company
that it intends to terminate this agreement effective December 31, 1996.
(4) To recognize the costs associated with the directories in progress at the
time of the Company's acquisition of Telecom*USA Publishing.
(5) To adjust depreciation and amortization to include amortization of
intangibles acquired in the Company's acquisitions of Ruffalo, Cody and
Telecom*USA Publishing. Intangibles acquired in these acquisitions will be
amortized over periods ranging from 5 years to 25 years. These adjustments
assume that none of the conditions for the payment of certain additional
consideration in the Ruffalo, Cody acquisition are met. If all such
conditions were met, amortization of the intangibles would be increased
over their estimated remaining lives.
(6) To adjust depreciation and amortization to include amortization of
intangibles and to reflect the estimated depreciation of the purchase price
allocated to MWR's property and equipment from January 1, 1995 to April 28,
1995, the date of the Company's acquisition of MWR. Intangibles acquired in
the Company's acquisition of MWR are being amortized over 15 years.
(7) To eliminate the interest expense recorded on Telecom*USA Publishing
convertible debentures that were converted to shares of Telecom*USA
Publishing common stock immediately prior to the acquisition of Telecom*USA
Publishing by the Company.
(8) Net income (loss) does not include a pro forma adjustment for income taxes
due to the availability of net operating loss carryforwards and a valuation
allowance.
(9) EBITDA consists of operating loss before depreciation and amortization. The
Company has included EBITDA data because it is a measure commonly used in
the industry. EBITDA is not a measure of financial performance under
generally accepted accounting principles and should not be considered an
alternative to net income as a measure of performance or to cash flows as a
measure of liquidity.
(10) Includes operations of Ruffalo, Cody from July 16, 1996 to September 30,
1996 and operations of Telecom*USA Publishing from September 21, 1996 to
September 30, 1996.
(11) Includes operations of Ruffalo, Cody from January 1, 1996 to July 15, 1996.
(12) Includes operations of Telecom*USA Publishing from January 1, 1996 to
September 20, 1996.
26
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Company's Consolidated Financial Statements and the Notes thereto and the
other financial data appearing elsewhere in this Prospectus.
OVERVIEW
The Company has historically derived its telecommunications revenue from
(i) the sale of local and long distance telecommunications services to end
users, (ii) telecommunications network maintenance services and (iii) special
access and private line services. The Company also derives revenue from
ancillary services as a result of its acquisitions of Ruffalo, Cody and
Telecom*USA Publishing in July 1996 and September 1996, respectively. The
Company began deriving revenue from direct marketing and telemarketing services
on July 15, 1996, the date the Company acquired Ruffalo, Cody. The Company also
began deriving revenue from the sale of advertising space in telephone
directories published by Telecom*USA Publishing on September 20, 1996, the date
the Company acquired Telecom*USA Publishing. See "-- Liquidity and Capital
Resources" and "Business -- Recent Transactions." The table set forth below
summarizes the Company's percentage of revenues from these sources:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------------- ------------------
1993 1994 1995 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Local and long distance
telecommunications services........ -- % 58% 74% 75% 63%
Telecommunications network
maintenance services............... 100 42 17 19 10
Special access and private line
services........................... -- -- 9 6 18
Ancillary services................... -- -- -- -- 9
---- ---- ---- ---- ----
100% 100% 100% 100% 100%
==== ==== ==== ==== ====
</TABLE>
The Company began offering "bundled" local and long distance services to
business customers in January 1994. At the end of 1995, the Company began
providing, on a test basis, long distance services to residential customers. In
June 1996, the Company began marketing and providing to residential customers in
Cedar Rapids, Iowa and Iowa City, Iowa an integrated package of
telecommunications services, marketed under the name PrimeLine(R), that includes
local and long distance service, voice mail, paging, Internet access and travel
card services. The Company plans to continue its efforts to market and provide
local, long distance and other telecommunications services to business customers
and plans to accelerate its efforts to market its PrimeLine(R) service to
residential customers. The Company believes its efforts to market its integrated
telecommunications services will be enhanced by its July 1996 acquisition of
Ruffalo, Cody, which specializes in direct marketing and telemarketing services,
including telecommunications sales, and its September 1996 acquisition of
Telecom*USA Publishing, which publishes and distributes "white page" and "yellow
page" telephone directories in fifteen states in the midwestern and Rocky
Mountain regions of the United States, including most of the Company's target
markets.
Because its revenue from network maintenance is derived almost exclusively
from the Iowa Communications Network Maintenance Contract and such revenue is
expected to increase more slowly than the Company's other types of revenue, the
Company expects that revenue derived from network maintenance services will
continue to constitute a decreasing percentage of the Company's revenue in the
future. Special access and private line services as a percentage of the
Company's total revenue increased in 1995 due to the revenue generated by MWR,
which was acquired in
27
<PAGE> 32
April 1995. The percentage increase in revenue from this source for the nine
months ended September 30, 1996 was due primarily to non-recurring revenue from
the construction, installation and sale of fiber optic networks and related
equipment. Excluding the revenue from these projects, as well as the ancillary
revenues the Company began deriving from the acquisitions of Ruffalo, Cody and
Telecom*USA Publishing, the percentage of total revenues from the Company's
three historical sources would have been 77%, 12% and 11%, respectively.
The Company's principal operating expenses consist of cost of service;
selling, general and administrative expenses ("SG&A"); and depreciation and
amortization. Cost of service primarily includes local services purchased from
two Regional Bell Operating Companies, costs to terminate the long distance
calls of the Company's customers through an interexchange carrier, costs
associated with maintaining the Iowa Communications Network and costs associated
with operating the Company's network. Cost of service also includes the costs of
printing and distributing the telephone directories published by Telecom*USA
Publishing. SG&A consists of selling and marketing, customer service and
corporate administrative expenses. Depreciation and amortization include
depreciation of the Company's telecommunications network and equipment;
amortization of goodwill related to the Company's acquisitions of MWR, Ruffalo,
Cody and Telecom*USA Publishing; amortization expense related to the excess of
estimated fair market value in aggregate of certain options over the aggregate
exercise price of such options granted to certain officers, other employees and
directors; and amortization of one-time installation costs associated with
transferring customers' local line service from the Regional Bell Operating
Companies to the Company's telemanagement service.
As the Company expands into new markets, both cost of service and SG&A will
increase. The Company expects to incur SG&A expenses prior to achieving
significant revenues in new markets. Significant levels of marketing activity
may be necessary in new markets in order for the Company to build a customer
base large enough to generate sufficient revenue to offset such marketing
expenses. In addition, SG&A may increase as a percentage of total revenue in the
short term after the Company enters a new market, because many of the fixed
costs of providing service in new markets are incurred before significant
revenue can be expected from those markets.
In January and February 1996, the Company granted options to purchase an
aggregate of 965,166 and 688,502 shares of Class A Common Stock, respectively,
at an exercise price of $2.67 per share, to certain directors, officers and
other employees. The estimated fair market value of these options, in the
aggregate, at the date of grant was later determined to exceed the aggregate
exercise price by approximately $9.2 million. This amount will be amortized on a
monthly basis over the four-year vesting period of the options.
The Company has experienced operating losses since its inception as a
result of efforts to build its customer base, develop and construct its network
infrastructure, build its internal staffing, develop its systems and expand into
new markets. The Company expects to continue to focus on increasing its customer
base and geographic coverage. Accordingly, the Company expects that its cost of
service, SG&A and capital expenditures will continue to increase significantly,
all of which may have a negative impact on operating results. The Company
expects to incur significant operating losses and to generate negative cash
flows from operating and construction activities during the next several years
while it develops its business and installs and expands its fiber optic network.
In addition, the Company may be forced to change its pricing policies to respond
to a changing competitive environment, and there can be no assurance that the
Company will be able to maintain its operating margin. See "Risk
Factors -- Wireline Competition" and "Risk Factors -- Regulation." There can be
no assurance that growth in the Company's revenue or customer base will continue
or that the Company will be able to achieve or sustain profitability or positive
cash flows.
The Company has generated net operating losses since its inception and,
accordingly, has incurred no income tax expense. The Company has reduced the net
deferred tax assets generated
28
<PAGE> 33
by these losses by a valuation allowance which offsets the net deferred tax
asset due to the uncertainty of realizing the benefit of the tax loss
carryforwards. The Company will reduce the valuation allowance when, based on
the weight of available evidence, it is more likely than not that some portion
or all of the deferred tax assets will be realized.
NINE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1995
Revenue increased from $19.4 million for the nine-month period ended
September 30, 1995 to $45.5 million for the nine months ended September 30,
1996, representing an increase of $26.1 million or 134%. Revenue from the sale
of local and long distance telecommunications services accounted for $14.3
million of this increase. Total local and long-distance customers increased 72%
from 7,870 at September 30, 1995 to 13,552 at September 30, 1996. Local lines
under the Company's management increased 76% from 31,763 at September 30, 1995
to 55,993 at September 30, 1996. Average lines per customer increased from 4.03
at September 30, 1995 to 4.33 at September 30, 1996. Average monthly revenue per
line decreased from $66.71 for the month ended September 30, 1995 to $65.77 for
the month ended September 30, 1996.
Revenue from telecommunications network maintenance services increased from
$3.6 million for the nine-month period ended September 30, 1995 to $4.4 million
for the nine months ended September 30, 1996. This increase was primarily
attributable to increased revenues from the Company's Iowa Communications
Network Maintenance Contract. Revenue from special access and private line
services accounted for $6.9 million of the total increase in telecommunications
revenue, of which $2.9 million was from the non-recurring construction and sale
of fiber-optic networks. The Company acquired MWR, a competitive access provider
that offers most of the Company's special access and private line services, in
April 1995 in an acquisition accounted for as a purchase. MWR represented $1
million and $2.6 million, respectively, of the Company's special access and
private line services revenue for the nine-month periods ended September 30,
1995 and 1996. Revenue of $4 million from ancillary services was due wholly to
Ruffalo, Cody direct marketing and telemarketing sales since its acquisition in
July 1996.
Cost of service increased from $12.7 million for the nine-month period
ended September 30, 1995 to $31.7 million for the nine-month period ended
September 30, 1996, an increase of $19 million or 150%. This increase in cost of
service resulted primarily from increased costs of providing local and long
distance services. Cost of service as a percentage of telecommunications revenue
increased from 65% for the nine-month period ended September 30, 1995 to 70% for
the nine-month period ended September 30, 1996. The cost of providing local and
long-distance services increased as a percentage of the local and long-distance
telecommunications revenue by 2.7% primarily as a result of an increased number
of higher volume, price-sensitive customers and increased local line costs
associated with expansion into new markets. The additional increase in cost of
service as a percentage of telecommunication revenue was due primarily to the
low margin realized on the construction and sale of fiber optic networks.
SG&A increased from $13.1 million for the nine-month period ended September
30, 1995 to $25.6 million for the nine-month period ended September 30, 1996, an
increase of $12.5 million or 96%. This increase was due to increased
compensation expense resulting from selling and customer support activities of
$4.3 million, additional administrative personnel expense of $2.3 million,
additional expenses of $1.6 million related to Ruffalo, Cody and Telecom*USA
Publishing and associated costs of $4.3 million related to the growth
experienced primarily in local and long distance revenues.
Depreciation and amortization expenses increased from $1.2 million for the
nine-month period ended September 30, 1995 to $4.7 million for the nine-month
period ended September 30, 1996, an increase of $3.5 million or 285%. This
increase consisted of $1.5 million of amortization expense related to the excess
of estimated aggregate fair market value of certain options over the aggregate
exercise price of such options granted to certain officers, other employees, and
directors; deprecia-
29
<PAGE> 34
tion of $634,000 related to the additional fiber optic network purchased and
built during 1995 and the first nine months of 1996; $764,000 of depreciation
related to capital costs associated with the growth of the Company; $144,000
resulting from the amortization of one-time installation costs primarily
associated with transferring customers' local line service from the Regional
Bell Operating Companies to the Company's telemanagement service; and
amortization of goodwill and other intangible assets of $514,000 related to the
Company's acquisition of MWR in April 1995, Ruffalo, Cody in July 1996 and
Telecom*USA Publishing in September 1996.
Interest income increased from $79,000 for the nine-month period ended
September 30, 1995 to $3.4 million for the same period in 1996. This increase
resulted from earnings on investments made with a portion of the proceeds of the
Company's initial public offering of Class A Common Stock.
Interest expense decreased from $693,000 for the nine months ended
September 30, 1995 to $543,000 for the nine months ended September 30, 1996.
This decrease was primarily a result of lower interest expense on reduced
borrowings as a result of the Company's payment of all amounts outstanding under
the Credit Facility in June 1996 with a portion of the net proceeds from the
Company's initial public offering of Class A Common Stock. The Company also had
other non-operating income of $278,000 for the nine-month period ended September
30, 1996.
Net loss increased from $8.2 million for the nine-month period ended
September 30, 1995 to $13.4 million for the nine-month period ended September
30, 1996, an increase of $5.2 million. This increase resulted primarily from the
expansion of the local and long distance businesses and amortization expense
related to stock options granted to certain officers, other employees and
directors. The development of the Company's business and the construction and
expansion of its network require significant expenditures, a substantial portion
of which is incurred before the realization of revenues.
Operating loss before depreciation and amortization ("EBITDA") decreased
from a negative $6.3 million for the nine months ended September 30, 1995 to a
negative $11.8 million for the nine months ended September 30, 1996, a decrease
of $5.5 million. The change reflected the increase in the net loss incurred in
1996 due primarily to the expansion of the Company's local, long distance and
other telecommunications services and the factors described above.
YEAR ENDED 1995 COMPARED WITH YEAR ENDED 1994
Revenue increased from $8 million in 1994 to $29 million in 1995,
representing an increase of $21 million or 262%. Revenue from the increase in
the sale of local and long distance telecommunications services accounted for
$16.9 million of this increase. Total local and long distance customers served
increased 69% from 5,137 at December 31, 1994 to 8,700 at December 31, 1995.
Local lines under the Company's management increased 109% from 17,112 at
December 31, 1994 to 35,795 at December 31, 1995. Average lines per customer
increased from 3.33 at December 31, 1994 to 4.31 at December 31, 1995. Average
monthly revenue per line increased from $58.30 for the month ended December 31,
1994 to $62.68 for the month ended December 31, 1995.
Revenue from telecommunications network maintenance services was $4.9
million in 1995. The Company acquired MWR, a competitive access provider that
offers most of the Company's special access and private line services, in April
1995 in an acquisition accounted for as a purchase. MWR represented $1.6 million
of the Company's revenue in 1995.
Cost of service increased from $6.2 million in 1994 to $19.7 million in
1995, an increase of $13.5 million or 217%. This increase in cost of service
resulted primarily from costs for providing local and long distance services.
Cost of service as a percentage of telecommunications revenue decreased from 78%
in 1994 to 68% in 1995, principally as a result of certain economies of scale.
SG&A increased from $12.4 million in 1994 to $18.1 million in 1995, an
increase of $5.7 million or 46%. This increase was due to increased compensation
resulting from selling and customer support activities of $2.8 million,
additional administrative personnel expense of $1.6 million and associated
30
<PAGE> 35
costs of $1.3 million required to handle the growth experienced primarily in
local and long distance revenues.
Depreciation and amortization expenses increased from $772,000 in 1994 to
$1.8 million in 1995, an increase of $1 million or 138%. This increase consisted
of depreciation of $362,000 related to the additional fiber optic network
purchased and built during 1995; $304,000 of depreciation related to capital
costs associated with the growth of the Company; $266,000 resulting from the
amortization of one-time installation costs primarily associated with
transferring customers' local line service from the Regional Bell Operating
Companies to the Company's telemanagement service; and amortization of goodwill
of $117,000 related to the Company's acquisition of MWR in 1995.
Net interest expense increased from $73,000 in 1994 to $771,000 in 1995.
This net increase resulted from an increase in interest expense of $692,000 due
to the need for additional secured debt in 1995 to fund the Company's growth and
operating losses and a decrease in interest income of $6,000 resulting from
reduced investment of funds due to the use of funds needed to satisfy working
capital needs.
The Company's net loss decreased from $11.4 million in 1994 to $11.3
million in 1995, a decrease of $87,000. This decrease resulted from the ability
of the Company to generate additional service income while reducing customer
acquisition and support costs as a percentage of service income.
EBITDA improved from a negative $10.6 million in 1994 to a negative $8.7
million in 1995, an improvement of $1.9 million. The improvement reflected the
decrease in the net loss and the increase in depreciation and amortization in
1995 resulting from the capital expenditures necessary to support the Company's
revenue growth.
YEAR ENDED 1994 COMPARED WITH YEAR ENDED 1993
Telecommunications revenue increased from $1.6 million in 1993 to $8
million in 1994, representing an increase of $6.4 million or 417%. This increase
reflected an increase in revenue from the Iowa Communications Network
Maintenance Contract of $1.9 million as well as the Company's commencement of
local and long distance service. The increased revenue from the Iowa
Communications Network Maintenance Contract resulted from the ability to charge
full maintenance costs in 1994 versus reduced charges in 1993 because of a
warranty period on the network.
Cost of service increased from $1.5 million in 1993 to $6.2 million in
1994, an increase of $4.7 million or 307%. This increase in cost of service
resulted primarily from costs for providing local and long distance services.
SG&A increased from $2.4 million in 1993 to $12.4 million in 1994, an
increase of $10 million or 418%. This increase was due to increased compensation
resulting from selling and customer support activities of $5.5 million,
additional administrative personnel of $1.8 million and associated costs of $2.7
million resulting from the start-up of local and long distance services.
Depreciation and amortization expenses increased from $235,000 in 1993 to
$772,000 in 1994, an increase of $537,000 or 228%. This increase was primarily
due to depreciation on the increased capital expenditures required to enter the
local and long distance businesses and the amortization of one time installation
costs associated with transferring customers' local line service from the
Regional Bell Operating Companies to the Company's telemanagement service.
Interest income in 1993 was $163,000 compared to net interest expense of
$73,000 in 1994. The decrease resulted from an increase in interest expense of
$218,000 due to the need for additional secured debt in 1994 to fund the
Company's growth and operating losses and a decrease in interest income of
$18,000 resulting from reduced investment of funds due to the use of funds
needed to satisfy the Company's working capital needs.
The Company's net loss increased from $2.4 million in 1993 to $11.4 million
in 1994, an increase of $9 million. This increase was primarily due to the
Company's entry into the local and long distance businesses.
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EBITDA decreased from a negative $2.4 million in 1993 to a negative $10.6
million in 1994, a decrease of $8.2 million. The decrease reflected the
increased losses incurred in 1994 related to the Company's entry into the local
and long distance businesses.
YEAR ENDED 1993 COMPARED WITH YEAR ENDED 1992
Because the Company's revenue-producing operations began in November 1992,
the Company does not believe a comparison of financial results between 1992 and
1993 would be meaningful.
LIQUIDITY AND CAPITAL RESOURCES
Since the inception of the Company in June 1991, the Company's total assets
have grown to $324.1 million at September 30, 1996. At September 30, 1996, $61.4
million of the total assets consisted of property and equipment, net of
depreciation. The growth of the Company has been funded through private sales of
equity securities yielding proceeds of $41 million, drawings under the Credit
Facility, and net proceeds of approximately $258.1 million from the Company's
initial public offering of Class A Common Stock. At September 30, 1996, the
Company's current assets of $146.6 million exceeded its current liabilities of
$39.9 million, providing working capital of $106.7 million, which represents an
improvement of $106.7 million compared to December 31, 1995 primarily
attributable to the Company's completion of its initial public offering of Class
A Common Stock. At December 31, 1995, the Company's current liabilities of $9.7
million exceeded current assets of $9.6 million, resulting in a working capital
deficit of $92,000. This working capital deficit resulted from the growth
experienced by the Company, the increase in working capital components and the
substantial investment in property and equipment.
The net cash used in operating activities totaled $10.5 million for the
nine months ended September 30, 1996 and $9.5 million for the year ended
December 31, 1995. During the nine months ended September 30, 1996, cash for
operating activities was used primarily to fund the Company's net loss of $13.4
million for such period. The Company also required cash to fund the growth in
trade receivables of $6.6 million and other assets of $4.3 million as a result
of the growth in local and long distance telecommunications services and special
access and private line services. These uses of cash were partially offset by an
increase in accounts payable and accrued expenses of $4.1 million due to the
costs associated with the increase in telecommunications revenue, an increase in
deferred revenue of $6.4 million resulting primarily from amounts received in
advance in connection with the completion of construction of network segments
under long-term leases of fiber optic telecommunication networks and an increase
in depreciation and amortization expense. During the year ended December 31,
1995, cash for operating activities was used primarily to fund the Company's net
loss of $11.3 million for such period. The Company also required cash to fund
the growth in trade receivables of $3.6 million and deferred line installation
costs of $800,000 as a result of the growth in local and long distance
telecommunications services and entry into special access and private line
services. The use of cash during the year ended December 31, 1995 was partially
offset by an increase in accounts payable and accrued expenses of $4.1 million
due to the costs associated with the increase in telecommunications revenue and
an increase in depreciation and amortization expense.
The Company's investing activities used cash of $208.4 million during the
nine months ended September 30, 1996 and $5.5 million during the year ended
December 31, 1995. The significant use of cash for investing activities for the
nine months ended September 30, 1996 consisted of the purchase of
available-for-sale securities with certain of the net proceeds from the
Company's initial public offering of Class A Common Stock, the purchase of
Ruffalo, Cody and Telecom*USA Publishing, and the Company's continued
development and expansion of its fiber optic telecommunications network.
During 1994, the Company started building its telemanagement business by
offering local and long distance services to business customers through the
purchase of Centrex services from two Regional Bell Operating Companies and
interexchange carrier services for termination of long distance calls. The
equipment required for the growth of the telemanagement business and the
Company's development and construction of its fiber optic telecommunications
network resulted in
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purchases of equipment and fiber optic cable totaling $39.7 million and $5.3
million during the nine months ended September 30, 1996 and the year ended
December 31, 1995, respectively.
Cash received from net financing activities was $257.6 million during the
nine months ended September 30, 1996, primarily as a result of the Company's
initial public offering of Class A Common Stock. The Company paid off and
canceled the Credit Facility with a portion of the net proceeds from the initial
public offering of Class A Common Stock during the same period. Cash received
from financing activities during 1995 was $15 million and was primarily obtained
through the issuance of Common Stock for an aggregate purchase price of $14
million in a private placement transaction. In addition, in April 1995 the
Company issued Class B Common Stock valued at $8.3 million to acquire MWR.
On July 15, 1996, the Company acquired Ruffalo, Cody in a cash and stock
transaction valued at up to a maximum of approximately $19.9 million, based on
the average closing sales price of the Class A Common Stock on the Nasdaq
National Market at the time of the transaction. On July 15, 1996, the Company
paid approximately $4.8 million in cash and issued 361,420 shares of Class A
Common Stock to the shareholders of Ruffalo, Cody, and granted options to
purchase 158,009 shares of Class A Common Stock to the holders of options to
purchase shares of Ruffalo, Cody common stock. An additional $50,782 in cash and
113,387 shares of Class A Common Stock were placed into escrow and will be
delivered to certain of the shareholders of Ruffalo, Cody over a period of 18
months, contingent upon the fulfillment of certain conditions relating to
Ruffalo, Cody's ongoing revenues from an agreement with a major long distance
carrier to provide telemarketing services. The major long distance carrier has
informed the Company that it intends to terminate this agreement effective
December 31, 1996. See "Business -- Recent Transactions." The Company recorded
the Ruffalo, Cody acquisition as a purchase for accounting purposes.
On September 20, 1996, the Company acquired Telecom*USA Publishing for
approximately $74.1 million in cash and an additional amount currently estimated
to be approximately $1.6 million to be paid to certain employees of Telecom*USA
Publishing as part of an incentive plan. At the time of the acquisition,
Telecom*USA Publishing had outstanding debt of approximately $6.6 million. The
Company recorded the Telecom*USA Publishing acquisition as a purchase for
accounting purposes.
The Company used a portion of the net proceeds from the Company's initial
public offering of Class A Common Stock to fund the Telecom*USA Publishing
acquisition and for the cash portion of the Ruffalo, Cody acquisition.
Telecom*USA Publishing has a revolving line of credit and term loan (the
"Telecom Credit Facility") with Norwest Bank Iowa, National Association (the
"Telecom Credit Facility Bank"), with an aggregate credit limit of approximately
$9.8 million. As of September 30, 1996, Telecom*USA Publishing had borrowings of
approximately $3.7 million outstanding under the Telecom Credit Facility.
Borrowings of less than $6 million under the Telecom Credit Facility bear
interest at the Telecom Credit Facility Bank prime rate as in effect from time
to time. Borrowings in excess of $6 million under the Telecom Credit Facility
bear interest at the Telecom Credit Facility Bank prime rate as in effect from
time to time plus .75%. Borrowings under the Telecom Credit Facility are secured
by substantially all of Telecom*USA Publishing's assets. The Company currently
intends to retain the Telecom Credit Facility.
At September 30, 1996, the Company had actual contractual capital
commitments of approximately $1.8 million for costs associated with the
construction of fiber optic networks.
The Company is currently bidding for certain PCS licenses being auctioned
by the FCC and expects to explore alternatives to permit it to provide other
wireless services which may require substantial additional capital. As of
November 13, 1996, the Company had submitted bids totaling approximately $29.9
million for "D" and "E" block frequency licenses covering areas of Iowa,
Illinois, Nebraska and Minnesota in the FCC's auctions of PCS licenses. If the
Company is successful in obtaining PCS licenses, it will be required to make
significant expenditures to develop, construct and operate a PCS system.
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As of September 30, 1996, the Company estimates that its aggregate capital
requirements for the remainder of 1996, 1997 and 1998 will be approximately $310
million. The Company's estimated capital requirements include the estimated cost
of (i) developing and constructing its fiber optic network, (ii) market
expansion activities, (iii) constructing its network operations center and
corporate headquarters, and (iv) obtaining PCS licenses and related capital
expenditures, including those licenses described above for which the Company
currently has bids outstanding. These capital requirements are expected to be
funded, in large part, out of the net proceeds to the Company from the Offering,
the net proceeds remaining from the Company's initial public offering of Class A
Common Stock (approximately $123 million as of September 30, 1996), and lease
payments to the Company for portions of the Company's networks.
The Company may require additional capital in the future for business
activities related to those specified above and also for acquisitions, joint
ventures and strategic alliances, as well as to fund operating deficits and net
losses. These activities could require significant additional capital not
included in the foregoing estimated aggregate capital requirements of $310
million.
The Company's estimate of its future capital requirements is a "forward
looking statement" within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. The Company's actual capital
requirements may differ materially as a result of regulatory, technological and
competitive developments (including new opportunities) in the Company's
industry.
The Company expects to meet its additional capital needs with the proceeds
from credit facilities and other borrowings, and additional debt and equity
issuances. The Company currently plans to obtain one or more lines of credit,
although no such lines of credit have yet been negotiated. There can be no
assurance, however, that the Company will be successful in producing sufficient
cash flows or raising sufficient debt or equity capital to meet its strategic
objectives or that such funds, if available at all, will be available on a
timely basis or on terms that are acceptable to the Company. See "Risk
Factors -- Significant Capital Requirements."
EFFECTS OF NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board (FASB) issued SFAS
No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to Be Disposed Of, which will require the Company to account for the
impairment of long-lived assets and certain identifiable intangibles to be held
and used by the Company whenever events or changes in circumstances indicate
that the carrying amount of any asset may not be recoverable. Adoption of SFAS
No. 121 is required in fiscal 1996.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation, which establishes a fair value based method for financial
accounting and reporting stock-based employee compensation plans. However, the
new standard allows compensation to continue to be measured by using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees, but requires
expanded disclosures. SFAS No. 123 is effective in fiscal year 1996. The Company
has elected to continue to apply the intrinsic value-based method of accounting
for stock options.
While the Company does not know precisely the impact of adopting SFAS No.
121 and SFAS No. 123, the Company does not expect that the adoption of SFAS No.
121 or SFAS No. 123 will have a material effect on the Company's consolidated
financial statements.
INFLATION
The Company does not believe that inflation has had a significant impact on
the Company's consolidated operations.
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BUSINESS
OVERVIEW
The Company is a provider of integrated telecommunications services to
small and medium-sized businesses and, since June 1996, residential customers,
primarily in Iowa and Illinois. The Company derives its telecommunications
revenue from (i) the sale of "bundled" local, long distance and other
telecommunications services to end users, (ii) telecommunications network
maintenance services, (iii) competitive access services, including special
access and private line services, and (iv) ancillary services, including direct
marketing and telemarketing services and the sale of advertising space in
telephone directories. As of September 30, 1996, the Company served over 13,630
telecommunications customers in 68 cities and towns.
The Company offers "one-stop" integrated telecommunications services,
including local, long distance, voice mail, paging and Internet access services,
tailored to the customer's specific needs. For business customers, this approach
simplifies telecommunications procurement and management and makes available
customized services, such as "least-cost" long distance pricing and enhanced
calling features, that might not otherwise be directly available to such
customers on a cost-effective basis. For residential customers, this approach
provides integrated local, long distance and other telecommunications services,
flat-rate long distance pricing and enhanced calling features as part of the
Company's basic PrimeLine(R) residential services. The Company also operates a
competitive access provider that offers a variety of special access and private
line services to 76 large businesses, institutional customers and interexchange
carriers. In addition, the Company provides network maintenance services for the
State of Iowa's fiber optic network.
The Company was formed on June 6, 1991 as McLeod Telecommunications, Inc.
It began operations in November of 1992, providing fiber optic maintenance
services for the Iowa Communications Network. On August 1, 1993, the Company was
reincorporated in the State of Delaware. McLeod Telemanagement received
regulatory approvals in Iowa and Illinois to offer local and long distance
services in December 1993 and began providing such services in January 1994. In
April 1995, July 1996 and September 1996, respectively, the Company acquired
MWR, a competitive access provider in Des Moines, Iowa, Ruffalo, Cody, a
telemarketing company, and Telecom*USA Publishing, a publisher of telephone
directories.
The Company is organized as a holding company and operates through six
wholly owned subsidiaries. Since September 1996, the Company's business has been
organized into four operational groups: (i) Business Services, which develops,
markets and sells the Company's telecommunications services to business
customers; (ii) Consumer Services, which markets and sells the Company's
PrimeLine(R) service to residential customers and engages in various direct
marketing and telemarketing activities; (iii) Network Services, which designs,
constructs, and operates the Company's fiber optic network and engages in the
Company's network maintenance activities; and (iv) Publishing Services, which
publishes and distributes telephone directories.
The Company is currently offering telecommunications services to business
and residential customers located primarily in Iowa and Illinois. The Company
also offers long distance service in Omaha, Nebraska. The Company has recently
begun sales of telecommunications services in a number of markets in Minnesota
and Wisconsin. The Company plans to enter markets in South Dakota, North Dakota,
Colorado, Wyoming and Utah in 1997. Over the next several years, depending on
competitive and other factors, the Company also intends to offer
telecommunications services in Nebraska, Montana and Idaho.
The statements in the foregoing paragraph about the Company's expansion
plans are "forward looking statements" within the meaning of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These plans
may be revised, and the Company's actual geographic expansion may differ
materially from that indicated by its current plans, in each case as a result of
a variety of factors, including: (i) the availability of financing and
regulatory approvals (e.g., the
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Company may not provide service in South Dakota until a judicial stay is
vacated; see "Risk Factors -- Dependence on Regional Bell Operating Companies;
U S WEST Centrex Action"); (ii) the number of potential customers in a target
market; (iii) the existence of strategic alliances or relationships; (iv)
technological, regulatory or other developments in the Company's business; (v)
changes in the competitive climate in which the Company operates; and (vi) the
emergence of future opportunities.
The Company believes it is the first telecommunications provider in most of
its current markets to offer "bundled" local, long distance and other
telecommunications services. As a result, the Company believes that it is
well-positioned to take advantage of fundamental changes occurring in the
telecommunications industry resulting from the Telecommunications Act and to
challenge incumbent local carriers. The Company provides local service using
existing telephone lines obtained from incumbent local exchange carriers, which
allows customers to switch to local service provided by the Company without
changing existing telephone numbers. The Company provides long distance services
by purchasing bulk capacity from a long distance carrier. Using the Company's
sophisticated proprietary software, known as Raterizer(R), each business
customer receives the lowest long distance rate available each month from among
the pricing plans of AT&T, MCI and Sprint that currently are most popular with
the Company's business customers, and, in certain cases, rates specifically
identified by a business customer and agreed to by the Company. The Company also
provides paging and Internet access services.
Since the Company completed its initial public offering of Class A Common
Stock in June 1996, it has actively pursued its strategy of increasing market
penetration and expanding into new markets in the following ways: (i) in June
1996, the Company began offering to residential customers in Cedar Rapids, Iowa
and Iowa City, Iowa an integrated package of telecommunications services,
marketed under the name PrimeLine(R), that includes local and long distance
service, voice mail, paging, Internet access and travel card services;
PrimeLine(R) services are expected to be available in other residential markets
in the near future; (ii) the Company has positioned itself to enter the
Minnesota and Wisconsin markets in late 1996 in addition to the Iowa and
Illinois markets currently served; (iii) in July 1996, the Company acquired
Ruffalo, Cody, which specializes in direct marketing and telemarketing services,
to enhance the Company's marketing of its telecommunications services; (iv) in
September 1996, the Company acquired Telecom*USA Publishing, which publishes and
distributes "white page" and "yellow page" telephone directories in fifteen
states in the midwestern and Rocky Mountain regions of the United States, to
increase the Company's penetration of its current markets and to accelerate its
entry into new markets; (v) the Company has constructed approximately 1,000 new
route miles of fiber optic network at a cost of approximately $20.4 million; and
(vi) the Company is bidding for certain PCS licenses as part of its strategy to
increase the range of services provided to customers in its target markets.
RECENT TRANSACTIONS
On September 20, 1996, the Company acquired Telecom*USA Publishing by means
of a merger of a newly formed wholly owned subsidiary of the Company with and
into Telecom*USA Publishing. As consideration for the acquisition, the Company
paid approximately $74.1 million in cash and an additional amount currently
estimated to be approximately $1.6 million to be paid to certain employees of
Telecom*USA Publishing as part of an incentive plan. At the time of the
acquisition, Telecom*USA Publishing had outstanding debt of approximately $6.6
million.
Telecom*USA Publishing publishes and distributes "white page" and "yellow
page" telephone directories in fifteen states in the midwestern and Rocky
Mountain regions of the United States, including most of the Company's target
markets. Telecom*USA Publishing derives its revenues primarily from the sale of
advertising space in its telephone directories.
On July 15, 1996, the Company acquired Ruffalo, Cody by means of a merger
of Ruffalo, Cody with and into a newly formed wholly owned subsidiary of the
Company. As consideration for the
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acquisition, the Company paid approximately $4.8 million in cash and issued an
aggregate of 361,420 shares of Class A Common Stock to the shareholders of
Ruffalo, Cody, and granted options to purchase an aggregate of 158,009 shares of
Class A Common Stock to the holders of options to purchase shares of Ruffalo,
Cody common stock. An additional $50,782 in cash and 113,387 shares of Class A
Common Stock were placed into escrow and will be delivered to certain of the
shareholders of Ruffalo, Cody over a period of 18 months, contingent upon the
fulfillment of certain conditions relating to Ruffalo, Cody's ongoing revenues
from an agreement with a major long distance carrier to provide telemarketing
services. The major long distance carrier has informed the Company that it
intends to terminate this agreement effective December 31, 1996.
Ruffalo, Cody specializes in direct marketing and telemarketing services,
including telecommunications sales, as well as a variety of fund-raising
services for colleges, universities and other non-profit organizations
throughout the United States.
On April 28, 1995, the Company purchased all of the outstanding stock of
MWR from Midwest Capital Group, Inc. ("Midwest Capital Group"), a non-regulated
subsidiary of MidAmerican. As consideration for the acquisition, the Company
issued 3,676,058 shares of the Company's Class B Common Stock valued at $8.3
million to Midwest Capital Group. As part of the transaction, Midwest Capital
Group received the right to appoint one director to the Board and one "observer
Board member." Subsequently, Midwest Capital Group agreed to reduce its Board
representation to one director. See "Management -- Investor Agreement." It was
also granted an option to purchase an additional 3,529,414 shares of Class B
Common Stock at a purchase price of $2.27 per share, which option Midwest
Capital Group exercised in June 1995.
MWR is a competitive access provider which owns and operates a fiber optic
network in Des Moines, Iowa and which offers special access and private line
services to 76 large businesses, institutional customers and interexchange
carriers.
The Company, through McLeod Telemanagement, has entered into an Asset
Purchase Agreement, as amended, pursuant to which the Company agreed to purchase
the customer base of Total Communication Systems, Inc. ("TCSI") for an aggregate
cash purchase price of approximately $510,000. TCSI is an Iowa corporation that
offers local and long distance service in Iowa by partitioning of U S WEST's
central office switches. TCSI currently manages approximately 1,500 local and
long distance lines in Iowa. Completion of the transaction is subject to the
fulfillment of certain conditions imposed by the Iowa Utilities Board relating
to notice to the customers of TCSI.
On April 27, 1995, Telecom*USA Publishing entered into an option agreement
with Fronteer Directory Company, Inc. ("Fronteer") pursuant to which Fronteer
granted to Telecom*USA Publishing the right and option to acquire nine telephone
directories published by Fronteer (the "Fronteer Option"). The Fronteer Option
may be exercised between June 1, 1997 and June 1, 1999, at a price to be
determined based on the sum of the revenues derived from the nine directories at
the time of exercise. The Company currently intends to exercise the Fronteer
Option.
BUSINESS STRATEGY
The Company's objective is to become a leading provider of integrated
telecommunications services in Iowa, Illinois, Nebraska, Minnesota, Wisconsin,
South Dakota, North Dakota, Colorado, Wyoming, Montana, Utah and Idaho. The
Company intends to increase its penetration of its current markets and expand
into new markets by: (i) aggressively capturing market share and generating
revenues using leased network capacity and (ii) concurrently constructing
additional network infrastructure to more cost-effectively serve its customers.
The Company estimates that as of September 30, 1996 it had a market share of
approximately 20.6% of business local telephone lines in its Iowa markets (based
on 1994 market data) and a market share of approximately 12.7% of business local
telephone lines in its Illinois markets (based on 1994 Iowa market data,
assuming that the Company's Illinois markets are substantially similar to the
Company's Iowa markets). There can be no assurance that the Company will attain
similar market share in other markets.
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The principal elements of the Company's business strategy include:
- PROVIDE INTEGRATED TELECOMMUNICATIONS SERVICES. The Company believes
that there is substantial demand among business and residential customers
in its target markets for an integrated package of telecommunications
services that meets all of the customer's telecommunications needs. The
Company believes that, by bundling a variety of telecommunications
services, it will position itself to become an industry leader in
offering "one-stop" integrated telecommunications services, to penetrate
rapidly its target markets and to build customer loyalty.
- BUILD MARKET SHARE THROUGH BRANDING AND CUSTOMER SERVICE. The Company
believes that, by branding its telecommunications services with the trade
name *McLeod USA in combination with the distinctive black-and-yellow
motif of the Telecom*USA Publishing directories, it will create and
strengthen brand awareness in all of the Company's markets. The Company
also believes that the key to revenue growth in its target markets is
capturing and retaining customers through an emphasis on marketing, sales
and customer service. The Company's customer-focused software and network
architecture allow immediate access to the Company's customer data by
Company personnel, enabling a quick and effective response to customer
requests and needs at any time. This software permits the Company to
present its customers with one fully integrated monthly billing statement
for local, long distance, 800, international, voice mail, paging,
Internet access and travel card services. The Company believes that its
customer-focused software platform is an important element in the
marketing of its telecommunications services and gives it a competitive
advantage in the marketplace. The Company has been successful in
obtaining long-term commitments from its business customers and
responding rapidly and creatively to customer needs.
- FOCUS ON SMALL AND MID-SIZED MARKETS. The Company principally targets
small and mid-sized markets (cities and towns with a population between
8,000 and 350,000) in its service areas. The Company estimates that its
current and planned target markets have a combined population of
approximately 9.5 million. The Company strives to be the first to market
integrated telecommunications services in its principal markets and
expects that intense competition in bundled telecommunications services
will be slower to develop in these markets than in larger markets.
- EXPAND ITS FIBER OPTIC NETWORK. The Company is constructing a
state-of-the-art digital fiber optic telecommunications network designed
to serve markets in Iowa. In the future, the Company expects to expand
its fiber optic network to include additional markets. The Company's
decision to expand its fiber optic network will be based on various
economic factors, including: (i) the number of its customers in a market;
(ii) the anticipated operating cost savings associated with such
construction; and (iii) any strategic relationships with owners of
existing infrastructure (e.g., utilities and cable operators). The
Company currently owns approximately 1,700 route miles of fiber optic
network and, subject to the foregoing factors, presently expects to
construct approximately 6,000 route miles of fiber optic network during
the next five years. Through its strategic relationships with its
electric utility stockholders and its contracts to build and lease the
final links of the Iowa Communications Network to the State of Iowa, the
Company believes that it will be able to achieve capital efficiencies in
constructing its fiber optic network in a rapid and cost-effective
manner. The Iowa Communications Network is a fiber optic network that
links certain of the state's schools, libraries and other public
buildings. The Company also believes that its fiber optic network in
combination with its proprietary software will create an attractive
customer-focused platform for the provision of local, long distance,
wireless and enhanced services.
- TRANSITION INTO LOCAL SWITCHED SERVICES BUSINESS. When certain judicial
and regulatory proceedings are resolved, and assuming the economics are
favorable to the Company, the Company intends to begin offering
facilities-based switched services by using its existing
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high capacity digital AT&T switch and installing additional switches. In
August 1996, the FCC released the Interconnection Decision implementing
the interconnection portions of the Telecommunications Act. Certain
provisions of the Interconnection Decision have been stayed by an October
1996 court decision, and will be subject to further judicial and
regulatory proceedings. The Company believes that these proceedings
should be substantially resolved, and that the Company could begin
offering local facilities-based switched services, over the next three
years. In March 1995 and April 1996, respectively, the Company received
state regulatory approval in Iowa and Illinois to offer local switched
services in Cedar Rapids, Iowa and in Illinois cities other than Chicago.
The Company intends to seek regulatory approval to provide such services
in other cities and towns in Iowa and other states targeted by the
Company when the economic terms of interconnection with the incumbent
local exchange carrier make the provision of local switched services
cost-effective.
- EXPLORE POTENTIAL ACQUISITIONS AND STRATEGIC ALLIANCES. The Company
believes that its strategic alliances with two utilities in its Iowa
markets provide it with access to rights-of-way and other resources on
favorable terms. The Company believes that its recent acquisitions of
Ruffalo, Cody and Telecom*USA Publishing will increase the Company's
penetration of its current markets and accelerate its entry into new
markets. As part of its expansion strategy, the Company contemplates
additional acquisitions, joint ventures and strategic alliances with
businesses that are related or complementary to its current operations.
The Company believes that the addition of such related or complementary
businesses will help it to expand its operations into its target markets.
As a result, the Company plans to consider acquisitions, joint ventures
and strategic alliances in areas such as wireline and wireless services,
directory publishing, network construction and infrastructure and
Internet access. In undertaking these transactions, the Company may use
proceeds from the Offering, credit facilities and other borrowings, and
additional debt and equity issuances.
- LEVERAGE PROVEN MANAGEMENT TEAM. The Company has recruited a team of
veteran competitive telecommunications managers, led by entrepreneur
Clark McLeod, who have together in the past successfully implemented a
similar customer-focused telecommunications strategy in the same regions.
Eight of the ten executive officers of the Company served as officers of
Teleconnect or its successor, Telecom*USA. Teleconnect began providing
long distance services in Iowa in 1982 and rapidly expanded into dozens
of cities and towns in the Midwest. Telecom*USA was the fourth-largest
U.S. long distance provider when MCI purchased it in 1990 for $1.25
billion.
MARKET POTENTIAL
The telecommunications industry is currently undergoing substantial changes
due to statutory, regulatory and technological developments. The Company
believes that it is well-positioned to take advantage of these fundamental
changes.
The market for local exchange services consists of a number of distinct
service components. These service components are defined by specific regulatory
tariff classifications including: (i) local network services, which generally
include basic dial tone, local area charges, enhanced calling features and
private line services (dedicated point-to-point intraLATA service); (ii) network
access services, which consist of access provided by local exchange carriers to
long distance network carriers; (iii) long distance network services, which
include intraLATA long distance calls; and (iv) other varied services, including
the publication of "white page" and "yellow page" telephone directories.
Industry sources have estimated that the 1995 aggregate revenues of all local
exchange carriers approximated $95 billion. Until recently, there was virtually
no competition in the local exchange markets.
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Until 1984, AT&T largely monopolized local and long distance telephone
services in the United States. Technological developments gradually enabled
others to compete with AT&T in the long distance market. In 1984, largely as the
result of a court decree, AT&T was required to divest its local telephone
systems (the "Divestiture"), which created the present structure of the
telecommunications industry. The Divestiture and subsequent related proceedings
divided the country into 201 Local Access and Transport Areas ("LATAs"). As part
of the Divestiture, AT&T's former local telephone systems were organized into
seven independent Regional Bell Operating Companies. The Regional Bell Operating
Companies were given the right to provide local telephone service, local access
service and intraLATA long distance service, but were prohibited from providing
interLATA service. AT&T retained its long distance services operations. The
separation of the Regional Bell Operating Companies from AT&T's long distance
business created two distinct telecommunications market segments: local exchange
and long distance. The Divestiture decreed direct, open competition in the long
distance segment, but continued the regulated monopoly environment in local
exchange services.
In 1984, a separate court decree (the "GTE Decree") required the local
exchange operations of the General Telephone Operating Companies to be
structurally separated from the competitive operations of GTE Corp., their
parent company. As a result, the GTE Decree also prohibited the General
Telephone Operating Companies from providing interLATA services.
On February 8, 1996, the Telecommunications Act was enacted. The
Telecommunications Act removed the restrictions in the Divestiture and the GTE
Decree concerning the provision of interLATA service by the Regional Bell
Operating Companies and the General Telephone Operating Companies. These decree
restrictions have been replaced, with respect to the Regional Bell Operating
Companies, by provisions of the Telecommunications Act setting forth the
conditions under which the Regional Bell Operating Companies may enter formerly
prohibited markets. The Telecommunications Act requires all local exchange
carriers to "unbundle" their local network offerings and allow other providers
of telecommunications services to interconnect with their facilities and
equipment. Most significantly, the incumbent local exchange carriers will be
required to complete local calls originated by the Company's customers and
switched by the Company and to deliver inbound local calls to the Company for
termination to its customers, assuring customers of unimpaired local calling
ability. Although there can be no assurance, the Company believes that it should
also be able to obtain access to incumbent carrier "loop" facilities (the
transmission lines connecting customers' premises to the public telephone
network) on an unbundled basis at reasonable and non-discriminatory rates. In
addition, local exchange carriers are obligated to provide local number
portability and dialing parity upon request and make their local services
available for resale by competitors. Local exchange carriers also are required
to allow competitors non-discriminatory access to local exchange carrier pole
attachments, conduit space and other rights-of-way. Moreover, states may not
erect "barriers to entry" of local competition, although they may regulate such
competition.
The Company believes that each of these requirements is likely, when fully
implemented, to increase competition among providers of local telecommunications
services and simplify the process of switching from local exchange carrier
services to those offered by competitive access provider/competitive local
exchange carriers. However, the Telecommunications Act also offers important
benefits to the incumbent local exchange carriers. The incumbent local exchange
carriers have been granted substantial new pricing flexibility. Regional Bell
Operating Companies and General Telephone Operating Companies have regained the
ability to provide long distance services under specified conditions and have
new rights to provide certain cable TV services. The Telecommunications Act,
however, also provides for certain safeguards to attempt to protect against
anticompetitive abuses by the Regional Bell Operating Companies. Among other
protections, the ability of the Regional Bell Operating Companies to market
jointly interLATA and local services is limited under certain circumstances.
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Prior to the enactment of the Telecommunications Act, several factors
served to promote competition in the local exchange market, including: (i)
rapidly growing customer demand for an alternative to the local exchange carrier
monopoly, spurred partly by the development of competitive activities in the
long distance market; (ii) advances in the technology for transmission of data
and video, which require greater capacity and reliability levels than many local
exchange carrier networks (which principally are copper-based) can accommodate;
(iii) the development of fiber optics and digital electronic technology, which
reduced network construction costs while increasing transmission speeds,
capacity and reliability as compared to the local exchange carriers' copper-
based network; (iv) the significant access charges interexchange carriers are
required to pay to local exchange carriers to access the local exchange
carriers' networks; and (v) a willingness on the part of legislators to enact
and regulators to enforce legislation and regulations permitting and promoting
competition in the local exchange market.
Competitors in the local exchange market, designated as competitive access
providers by the FCC, were first established in the mid-1980s. Initially,
competitive access providers were allowed to compete for only the non-switched
special access/private line service of the local exchange market. In New York
City, Chicago and Washington, D.C., newly formed companies provided dedicated
non-switched services by installing fiber optic facilities capable of connecting
points of presence of interexchange carriers within a metropolitan area,
connecting two or more customer locations with private line service and, in some
cases, connecting business and government users with interexchange carriers.
Competitive access providers used the substantial capacity and economies of
scale inherent in fiber optic cable to offer customers service that was
generally less expensive and of higher quality than could be obtained from the
local exchange carriers due, in part, to copper-based facilities used in many
local exchange carrier networks. In addition, competitive access providers
offered shorter installation and repair intervals and improved reliability in
comparison to the local exchange carriers.
Most of the early competitive access providers were entrepreneurial
enterprises that operated limited networks in the central business districts of
major cities in the United States where the highest concentration of voice and
data traffic, including interexchange carrier to interexchange carrier traffic,
were located. The provision of competitive access services, however, need not be
confined to large metropolitan areas. The Company believes that, through proper
design and installation of its network in its targeted markets, it can
effectively provide integrated local and long distance services not only to
interexchange carriers and large users, but also to residential and small to
medium-sized business customers.
As a result of regulatory changes and competitive trends, competitive local
telecommunications companies and access providers appear to be positioned for
dramatic growth. Effective in early 1994, FCC decisions announced in September
1992 and August 1993, as modified by subsequent FCC and court decisions (the
"Initial Interconnection Decisions"), opened additional segments of the market
by permitting competitive access providers expanded authority to interconnect
with and use facilities owned by local exchange companies for interstate
traffic. The Company believes that the Initial Interconnection Decisions,
together with other statutory and regulatory initiatives in the
telecommunications industry (including the Telecommunications Act), recently
introduced to foster competition in the local exchange markets, have stimulated
demand for competitive local services. In August 1996 the FCC released the
Interconnection Decision implementing the interconnection portions of the
Telecommunications Act. The Interconnection Decision establishes rules for
negotiating interconnection agreements and guidelines for review of such
agreements by state public utilities commissions. Certain provisions of the
Interconnection Decision have been stayed by an October 1996 court decision, and
will be subject to further judicial and regulatory proceedings. Although this
judicial stay does not prevent the Company from negotiating interconnection
agreements, it does create uncertainty about the rules governing pricing, terms
and conditions of interconnection agreements and will likely delay the execution
of these agreements. If the Company can negotiate favorable interconnection
agreements, and subject to the resolution of judicial and
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regulatory proceedings necessary to implement such agreements, the Company
believes that it could begin offering local facilities-based switched services
within three years.
As of September 30, 1996, a number of states, including Iowa, Illinois,
Minnesota, Wisconsin and North Dakota, have taken regulatory and legislative
action to open local telecommunications markets to various degrees of
competition. State regulatory agencies in other states within the Company's
target market area, including South Dakota, Nebraska, Colorado, Montana and
Wyoming, are conducting administrative proceedings to investigate opening local
telecommunications markets to competition. The Telecommunications Act preempts
any remaining state prohibitions of local competition and also forbids
unreasonable restrictions on resale of local services. The Company expects that
continuing pro-competitive regulatory changes, together with increasing customer
demand, will create more opportunities for competitive service providers to
introduce additional services, expand their networks and address a larger
customer base.
CURRENT PRODUCTS AND SERVICES
The Company has historically derived revenue from: (i) the sale of local
and long distance telecommunications services, (ii) special access and private
line services and (iii) telecommunications network maintenance services. As a
result of the acquisition by the Company of Ruffalo, Cody and Telecom*USA
Publishing in July 1996 and September 1996, respectively, the Company also
derives revenue from ancillary services, including direct marketing and
telemarketing services and the sale of advertising space in telephone
directories. For the nine months ended September 30, 1996, excluding
non-recurring revenue from the construction, installation and sale of fiber
optic networks and related equipment, these services represented 70%, 10%, 11%
and 9%, respectively, of the Company's total revenues. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Overview."
INTEGRATED TELECOMMUNICATIONS SERVICES. Since beginning sales activities
in January 1994, the Company has increased its revenue approximately 367% from
the sale of bundled local and long distance telecommunications services from
$4.6 million for the year ended December 31, 1994 to $21.5 million for the year
ended December 31, 1995. In order to provide integrated telecommunications
services to its business and residential customers, the Company, pursuant to
agreements with U S WEST for its Iowa customers and Ameritech for its Illinois
customers, partitions part of the central office switches serving the
communities in which the Company provides such services ("Centrex" services).
The Company's customers' telephone lines and numbers are assigned to the
Company's portion of the switch. U S WEST or Ameritech, as the case may be,
bills the Company for all the lines that the Company has assigned to the
Company's customers and provides the Company with call detail reports, which
enable the Company to verify its customers' bills for both local and long
distance service. See "Risk Factors -- Failure of U S WEST to Furnish Call
Detail Records."
The Company believes that these services are superior to a standard
business or residential telephone line, since the Company can offer features,
such as three-way calling, consultation hold and call transfer, at no extra
charge to the end user. Certain other custom calling features are also available
at additional cost to the end user. Because the Company has also purchased the
"Centrex Management System" and the "Centrex Mate Service" from U S WEST and
Ameritech, respectively, Company personnel have on-line access to U S WEST and
Ameritech facilities and may make changes to the customers' services
electronically and quickly.
In March 1996, the Company entered into a settlement agreement with U S
WEST in connection with a complaint brought against U S WEST by the Company
before the Iowa Utilities Board. The settlement agreement permits the Company to
obtain access to the partitioned portion of U S WEST central office switches in
Iowa until March 18, 2001 and contains rates that may not be increased by
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U S WEST unless the rates are renegotiated by the parties based on U S WEST's
rates for access to unbundled elements of its network. See "-- Legal
Proceedings." In Illinois, the Company's seven-year agreements with Ameritech
extend through 2001 or 2002 and provide for stabilized rates that may not be
unilaterally increased by Ameritech.
The Company provides long distance service by purchasing capacity, in bulk,
from WorldCom Network Services, Inc., d/b/a Wiltel ("WilTel"), a wholly owned
subsidiary of WorldCom, and routing its customers' long distance traffic over
this capacity. The Company is subject to certain minimum monthly purchase and
minutes-of-usage requirements under its agreement with WilTel. If the Company
fails to meet the minimum purchase requirement in any month, it is obligated to
pay WilTel the difference between its actual purchases and the minimum
commitment. If the Company fails to meet the minimum minutes-of-usage
requirement in any month, it is obligated to pay WilTel an amount equal to the
difference between its actual usage and the minimum usage requirement multiplied
by a flat rate per minute. The Company has consistently met the minimum purchase
requirements and generally has met the minimum usage requirements under its
agreement with WilTel. The Company did, however, fail to meet the minimum usage
requirements from December 1994 through February 1995, which obligated the
Company to pay WilTel an aggregate of approximately $67,000. The Company
believes that it will be able to continue to meet such requirements in the
future. Because of the many potential suppliers of wholesale long distance
services in the marketplace, the Company currently expects that it will be able
to continue to obtain favorable wholesale long distance pricing.
The Company has also developed and installed state-of-the-art,
"customer-focused" software for providing integrated telecommunications
services. This software permits the Company to present its customers with one
fully integrated monthly billing statement for local, long distance, 800,
international, voice mail, paging, Internet access and travel card services. The
Company believes that its customer-focused software platform is an important
element in the marketing of its telecommunications services and gives it a
competitive advantage in the marketplace.
Business Services. End-user business customers in each of the 68 cities
and towns currently served by the Company can obtain local, long distance and
ancillary (such as three-way calling and call transfer) services directly from
the Company. By using Centrex service instead of a private branch exchange
("PBX") to direct their telecommunications traffic, business customers can also
avoid the large investment in equipment required and the fixed costs associated
with maintaining a PBX network infrastructure. The Company's telemanagement
services allow small to mid-sized business customers, which may lack the
resources to support their own PBX, to benefit from a sophisticated
telecommunications system managed by industry experts.
The Company generally offers its business customers local service at prices
that are substantially similar to the published retail local exchange carrier
rates for basic business service provided by the incumbent local exchange
carrier. Long distance rates for business customers generally are calculated by
totaling each business customer's monthly calls and comparing the total charges
that would be applicable to that customer's calls under each of the pricing
plans of the major long distance carriers that currently are most popular with
the Company's business customers. The Company then bills the customer the lowest
long distance charges identified in this comparison. Specifically, the Company's
billing software, known as Raterizer(R), enables the Company to calculate the
monthly charges that each customer would be billed based on the customer's
actual calls under each of several long distance plans offered by AT&T, MCI and
Sprint and, in certain instances, other rates specifically identified by a
customer and agreed to by the Company. The customer is then billed an amount
equal to such "lowest cost" monthly charges calculated using this software,
minus any discount to which the customer may be entitled as a result of having
made a long-term
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commitment to use the Company's services. Currently, the Company compares its
business customers' monthly calls to the following plans offered by other long
distance carriers:
Outbound Products. AT&T Commercial Long Distance; AT&T CustomNet; AT&T
ProWATS/Plan Q; AT&T Megacom; AT&T Uniplan; MCI Commercial Dial 1; MCI
Prism Plus; MCI Preferred; MCI Vision (Switched Access); MCI Vision
(Dedicated Access); MCI Prism I; Sprint Business Sense; Sprint Business
Sense ($200 minimum usage required); Sprint Clarity "Most for Business";
Sprint Clarity (Dedicated Access); and Sprint UltraWATS.
800 Service Products. AT&T Readyline; AT&T Starterline (Plan K); AT&T
Megacom 800; AT&T Uniplan 800; MCI Business Line 800; MCI Preferred 800;
MCI Vision 800; MCI 800; Sprint FONline 800; Sprint Business Sense ($0
commitment); Sprint Business Sense ($200 minimum usage required); Sprint
Clarity 800; and Sprint Ultra 800.
The Company also offers other long distance rates to certain business
customers, based on the customer's particular needs. The Company has developed
the software that performs its long distance rating analysis. Like other Company
software, it is designed around the customer rather than around a given product.
The Company believes that its method of computing long distance service rates is
an important factor in attracting and retaining business customers. The
Company's average business telemanagement service contract has an approximately
49-month term.
Residential Services. In June 1996, the Company introduced its
PrimeLine(R) service to residential and certain small business customers in the
Cedar Rapids, Iowa and Iowa City, Iowa markets. PrimeLine(R) service includes
local and long distance telephone service, paging, voice mail, Internet access
and travel card services, as well as enhanced features such as three-way
calling, call transfer and consultation hold. PrimeLine(R) customers may choose
from five integrated telecommunications service packages generally ranging in
price from $19.95 to $32.95 per month. Per minute long distance rates for
PrimeLine(R) customers range from $.12 to $.15, depending on monthly calling
volumes. These rates are applied 24 hours a day, seven days a week for all calls
within the continental United States. The Company's standard PrimeLine(R)
service contract has either a month-to-month or a 12-month term. The Company
intends to begin offering PrimeLine(R) service in all of its Iowa markets and in
Illinois, Minnesota and Wisconsin in the near future.
SPECIAL ACCESS AND PRIVATE LINE SERVICES. The Company currently provides,
on a private carrier basis, a wide range of special access and private line
services to its interexchange carrier and end-user (including two cable
television company) customers. These services include POP-to-POP special access,
end user/interexchange carrier special access and private line services. POP-
to-POP special access services provide telecommunications lines that link the
points of presence ("POPs") of one interexchange carrier, or the POPs of
different interexchange carriers, in a market, allowing these POPs to exchange
telecommunications traffic for transport to final destinations. End
user/interexchange carrier special access services provide telecommunications
lines that connect an end user (such as a large business) to the local POP of
its selected interexchange carrier. Private line services provide
telecommunications lines that connect various locations of a customer's
operation to transmit internal voice, video and/or data traffic.
To provide these services, the Company offers various types of highly
reliable fiber optic lines that operate at different speeds and handle varying
amounts of traffic to provide tailor-made solutions to meet its customers'
needs. These lines include:
DS-0. A dedicated line that meets the requirements of everyday
business communications, with transmission capacity of up to 64 kilobits of
bandwidth per second (one voice-grade equivalent circuit). This service
offers a basic low-capacity dedicated digital channel for connecting
telephones, fax machines, personal computers and other telecommunications
equipment.
DS-1. A high-speed channel typically linking high volume customer
locations to interexchange carriers or other customer locations. Used for
voice transmissions as well as the
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interconnection of local area networks, DS-1 service accommodates
transmission speeds of up to 1.544 megabits per second, the equivalent of
24 voice-grade equivalent circuits. The Company offers this high-capacity
service for customers who need a larger communications pipeline.
DS-3. A very high-capacity digital channel with transmission capacity
of 45 megabits per second, which is equivalent to 28 DS-1 circuits or 672
voice-grade circuits. This is a digital service used by interexchange
carriers for central office connections and by some large commercial users
to link multiple sites.
The Company's networks are designed to support this wide range of
communications services, provide increased network reliability and reduce costs
for its customers. The Company's network consists of fiber optic cables, which
typically contain between 24 and 144 fiber strands, each of which is capable of
providing many telecommunications circuits. A single pair of fibers on the
Company's network can currently transmit 32,256 simultaneous voice
conversations, whereas a typical pair of copper wires can currently carry a
maximum of 24 digitized simultaneous voice conversations. The Company expects
that continuing developments in compression technology and multiplexing
equipment will increase the capacity of each fiber, thereby providing more
capacity at relatively low incremental cost.
NETWORK MAINTENANCE SERVICES. In 1990, the State of Iowa authorized
construction of Parts I and II of the Iowa Communications Network. Parts I and
II, which were completed in 1993 and are owned by the State of Iowa, provide
fiber optic connections to over 100 classrooms or other meeting facilities in
Iowa, and are used primarily for interactive distance learning, telemedicine and
the State's own long distance telephone traffic. The Company maintains Parts I
and II of the 2,900 miles of the Iowa Communications Network pursuant to the
Iowa Communications Network Maintenance Contract. The Company's maintenance
activities under the Iowa Communications Network Maintenance Contract are
available on a 24-hour-per-day, 365-days-per-year basis, and consist of alarm
monitoring, repair services (include splicing, digital circuit card replacement,
cable relocation and circuit installation testing) and cable location services.
The Iowa Communications Network Maintenance Contract expires in 2004.
For its services under the Iowa Communications Network Maintenance
Contract, the Company receives approximately $3.2 million per year, plus an
additional amount based on an hourly rate for certain overtime, equipment and
repair supervision activities. The Company's network maintenance activities are
provided by a 57-member team headquartered on-site at the Iowa Communications
Network network operations center, which is located at the STARC National Guard
Armory in Des Moines, Iowa. The Company believes that the expertise in fiber
optic maintenance developed through the maintenance of the Iowa Communications
Network will provide significant advantages in maintenance of the Company's own
network facilities. Because commercial telecommunications use of the Part I and
II segments is forbidden, however, neither the Company nor any other
telecommunications carrier may use the Part I and II capacity to provide
telecommunications services to customers.
ANCILLARY SERVICES. Through Telecom*USA Publishing, which the Company
acquired in September 1996, the Company publishes and distributes an aggregate
of over 7 million copies of 80 annual "white page" and "yellow page" telephone
directories to local telephone subscribers in fifteen states in the midwestern
and Rocky Mountain regions of the United States, including most of the Company's
target markets. Telecom*USA Publishing derives its revenues primarily from the
sale of advertising space in its telephone directories. In addition, through
Ruffalo, Cody, which the Company acquired in July 1996, the Company provides
direct marketing and telemarketing services, including telecommunications sales,
as well as a variety of fund-raising services for colleges, universities and
other non-profit organizations throughout the United States. Ruffalo, Cody
derived over 40% of its revenues in 1995 from an agreement with a major long
distance carrier to provide telemarketing services. Both Ruffalo, Cody and the
major long distance carrier can terminate this
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agreement after giving notice to the other party. The major long distance
carrier has informed the Company that it intends to terminate this agreement
effective December 31, 1996. Upon termination of this agreement, the Company
intends to redirect telemarketing resources towards selling the Company's local,
long distance and other telecommunications services.
The Company believes that its telephone directories and its direct
marketing and telemarketing services will provide valuable marketing
opportunities and expertise for its telecommunications services, particularly
with respect to potential residential customers. The Company intends to utilize
Telecom*USA Publishing's sales force of 258 direct sales personnel and
telemarketers to sell both advertising space in the Company's telephone
directories and, where available, the Company's telecommunications services.
Furthermore, by September 30, 1996, ten of the Company's 140 full-time
telemarketing sales personnel at its Ruffalo, Cody subsidiary were engaged in
sales of the Company's PrimeLine(R) residential services. See "-- Sales and
Marketing."
EXPANSION OF CERTAIN FACILITIES-BASED SERVICES
The Company currently is constructing a fiber optic network that will
enable it, upon receipt of all necessary regulatory approvals, to serve its
end-user customers on a local switched basis as well as to serve other wireline
and wireless carriers on a wholesale basis.
The Company has leased and is currently testing a state-of-the-art
high-capacity digital AT&T switch and plans to acquire additional switches in
the future. Although the Company is not currently engaged in negotiations to
acquire additional switches, such products are readily available from several
suppliers, and the Company does not believe it will experience any difficulties
or delays when it determines to acquire additional switches. It is anticipated
that these switches will provide the switching platform for the local exchange
switched telephone and long distance services to be offered by the Company.
Given the size and regional concentration of the Company's markets, available
technology and current cost structures, the Company plans ultimately to deploy a
hubbed switching strategy, whereby one or more central switches would serve
multiple markets via remote switching modules.
In March 1995, the Iowa Utilities Board approved the Company's application
for authorization to provide competitive switched local telephone service to
business and residential customers in Cedar Rapids, Iowa. In April 1996, the
Company received similar approval from the Illinois Commerce Commission to offer
such service in Illinois cities other than in Chicago (which was not included in
the Company's application). The Company intends to seek authorizations from the
appropriate public utilities commissions to provide similar services in other
markets served by the Company.
The Company's plans to provide local switched services are dependent upon
obtaining favorable interconnection agreements with local exchange carriers. In
October 1996, the U.S. Eighth Circuit Court of Appeals stayed the effectiveness
of certain portions of the Interconnection Decision, including provisions
establishing a pricing methodology and a procedure permitting new entrants to
"pick and choose" among various provisions of existing interconnection
agreements. Although the judicial stay of the Interconnection Decision does not
prevent the Company from negotiating interconnection agreements with local
exchange carriers, it does create uncertainty about the rules governing pricing,
terms and conditions of interconnection agreements, and could make negotiating
such agreements more difficult and protracted. The FCC applied to the U.S.
Supreme Court to vacate the judicial stay, but the U.S. Supreme Court, on
November 12, 1996, refused to vacate the stay. The U.S. Eighth Circuit Court of
Appeals is expected to hear oral arguments in this case in January 1997 and
further appeals are possible. There can be no assurance that the Company will be
able to obtain interconnection agreements on terms acceptable to the Company.
Although the Company has made no final determinations as to its target
markets for facilities-based switched services, the Company intends initially to
provide facilities-based switched services in Cedar Rapids, Des Moines,
Waterloo, Cedar Falls, Dubuque, Sioux City, Council Bluffs, and Iowa City, Iowa
and the Quad Cities of Iowa/Illinois (Davenport, Bettendorf, Rock Island and
Moline),
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among other places. The Company plans to expand its facilities-based services to
other cities as its network develops and its market penetration increases. The
foregoing statements are "forward looking statements" under the Private
Securities Litigation Reform Act of 1995 and where the Company actually provides
such services will depend on factors such as the outcome of the judicial
proceedings regarding the Interconnection Decision. See "-- Regulation."
For a detailed description of the expansion of the Company's fiber optic
network, see "-- Network Facilities."
WIRELESS SERVICES
The Company believes that the market for wireless telecommunications
services is likely to expand significantly as equipment costs and service rates
continue to decline, equipment becomes more convenient and functional and
wireless services become more diverse. The Company also believes that wireline
and wireless markets are converging, and that providers of wireless services
increasingly will offer, in addition to products that supplement a customer's
landline communications (similar to cellular telephone services in use today),
wireline replacement products that may result in wireless services becoming the
customer's primary mode of communication. The Company anticipates that in the
future there could potentially be eight wireless competitors in its current and/
or target markets: two existing cellular providers and, in view of the ongoing
PCS auctions for spectrum in these markets, as many as six additional PCS
providers.
The Company does not currently offer PCS or cellular services. The Company
is, however, currently bidding for "D" and "E" block frequency licenses covering
areas of Iowa, Illinois, Nebraska and Minnesota in the FCC's auctions of PCS
licenses. As of November 13, 1996, the Company had submitted bids totaling
approximately $29.9 million for such licenses. If the Company is successful in
obtaining PCS licenses, it will be required to make significant expenditures to
develop, construct and operate a PCS system. There can be no assurance that the
Company will be successful in acquiring any PCS licenses. Nevertheless, as the
wireline and wireless markets converge, the Company believes that it can
identify opportunities to generate revenues from the wireless industry on both a
wholesale and a retail basis. On a wholesale basis, these opportunities may
include (i) leasing tower sites to wireless providers, (ii) switching wireless
traffic through the Company's switching platform and (iii) transporting wireless
traffic using the Company's fiber optic network to interconnect wireless
providers' cell sites or to connect such sites to either the Company's switches
or to switches of other providers of wireline services. In May 1996, the Company
entered into an agreement with a paging company to provide access to several of
the towers controlled by the Company. On a retail basis, the Company believes
that it will be able to enter into "bundling/branding" arrangements with both
cellular and PCS companies on favorable economic terms. However, except for its
participation in the FCC auction of PCS licenses, the Company has no current or
pending negotiations, arrangements or agreements to acquire the ability to
provide wireless services. See "Risk Factors -- Wireless Competition."
NETWORK FACILITIES
As the incumbent local exchange carriers are compelled, by regulatory
changes and competitive forces, to "unbundle" their network components and to
permit resale of their products, the Company expects to be able to provide its
customers with a full range of telecommunications services using a combination
of its own network, the networks of the incumbent local exchange carriers and
the networks of other competitive carriers.
In April 1995, as part of its overall business strategy, the Company
acquired MWR from MidAmerican. MWR is a competitive access provider which
currently owns and operates a fiber optic network and offers special access and
private line services to 76 large businesses, institutional customers and
interexchange carriers, primarily in Des Moines, Iowa. As a result of this
strategic acquisition, the Company believes that it is the only competitive
access provider in the Des Moines
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market. The Company believes the already-installed MWR network is an important
aspect of its efforts to become the first state wide integrated
telecommunications provider.
In 1995, the Iowa General Assembly passed legislation to extend the Iowa
Communications Network to 543 more "endpoints" (which are usually located in
schools or public libraries) throughout the state (the "Part III segments"). The
majority of these fiber optic links, unlike Parts I and II of the Iowa
Communications Network, are not to be owned by the State of Iowa, but are to be
leased from a private entity, such as the Company. As a result of public
bidding, the Company has the right to build and then lease capacity to the State
of Iowa on 265 of such segments. Under its lease agreements with the State, the
Company is currently constructing a "fiber-rich" broadband network, on which the
State of Iowa has agreed to lease one DS-3 circuit for a period of seven years
for a total aggregate lease cost of approximately $30.5 million. Upon completion
of installation of each segment, the leases provide that the State of Iowa will
make a one-time up-front lease payment to the Company for the capacity, with
nominal monthly lease payments thereafter. At the end of a seven-year period,
the leases may be extended, upon terms to be mutually agreed upon. During the
term of the leases, the State may order additional DS-3 circuits at a mutually
agreed upon price.
The Company has reached agreements with its electric utility stockholders
(MidAmerican and IES) that allow the Company to make use of those utilities'
underground conduits, distribution poles, transmission towers and building
entrances in exchange for rights by such stockholders to use certain capacity on
the Company's network. These agreements give the Company access to rights-of-way
in Iowa and in certain portions of Illinois for installation of the Company's
networks. The Company's access to these rights-of-way are expected to have a
significant positive impact on the Company's capital costs for network
construction and the speed with which the Company can construct its network. The
Company believes that its strategic relationships with its electric utility
stockholders give it a significant competitive advantage.
Concurrently with construction of the Part III segments, the Company is
also installing low-cost network facilities that are expected to form a series
of fiber optic "self-healing rings" intended to enable the Company to provide
facilities-based local and long distance service to most significant cities and
towns in Iowa. Thus, the Company believes it is well positioned to become the
first facilities-based state-wide integrated provider of competitive
telecommunications services in the Midwest.
The Company currently expects to build 6,000 route miles of fiber optic
cable in the next five years. Approximately two-thirds of this fiber capacity
will be in the State of Iowa, with the balance built throughout the Company's
other target markets. The Company will decide whether to begin construction of
fiber optic network in a market based on various economic factors, including:
(i) the number of its customers in a market, (ii) the anticipated operating cost
savings associated with such construction and (iii) any strategic relationships
with owners of existing infrastructure (e.g., utilities and cable operators).
SALES AND MARKETING
Until June 1996, the Company directed its local and long distance
telecommunications sales efforts primarily toward small and medium-sized
businesses. In June 1996, the Company began marketing its PrimeLine(R) services
to residential customers.
Marketing of the Company's telecommunications services is handled by a
sales and marketing group composed of direct sales personnel and telemarketers.
The Company's sales force is trained to emphasize the Company's customer-focused
sales and customer service efforts, including its 24-hours-per-day,
365-days-per-year customer service center, which a customer may call with any
question or problem regarding the Company's services. The Company's employees
answer customer service calls directly rather than requiring customers to use an
automated queried message system. The Company believes that its emphasis on a
"single point of contact" for
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meeting the customer's telecommunications needs, as well as its ability to
provide one fully integrated monthly billing statement for local, long distance,
800, international, voice mail, paging, Internet access and travel card service,
is very appealing to its prospective customers.
Marketing of the Company's telecommunications services to business
customers is conducted by 140 direct sales personnel, located both at the
Company's headquarters in Cedar Rapids, Iowa and in 35 branch sales offices in
Iowa, Illinois, Minnesota, Wisconsin and Omaha, Nebraska. The sales personnel
make direct calls to prospective and existing business customers, conduct
analyses of business customers' call usage histories, and demonstrate that the
Company's software systems will rate the customers' calls by comparison to the
lowest cost plan of the most popular business calling plans offered by AT&T, MCI
and Sprint.
Marketing of the Company's telecommunications services to residential
customers is currently conducted by ten telemarketers from the Company's
Ruffalo, Cody subsidiary. The Company plans to increase this number in the
future. The telemarketers emphasize the PrimeLine(R) integrated package of
telecommunications services and its flat-rated per minute pricing structure for
long distance service. The Company also plans to use Ruffalo, Cody's information
database to identify attractive sales opportunities and to pursue those
opportunities through a variety of methods, including calls from Ruffalo, Cody's
telemarketing personnel. Furthermore, the Company believes that its acquisition
of Telecom*USA Publishing in September 1996 will further the Company's sales and
marketing efforts of its residential services in several ways. First, it gives
the Company an immediate presence in states where it is initiating service
(Minnesota and Wisconsin) and also in states where it does not yet provide
service but expects to do so in the future (such as Colorado, Wyoming, Montana,
Utah and Idaho). Second, the Company believes that the acquisition will increase
the Company's penetration of current markets and accelerate its entry into new
markets. The telephone directories published and distributed by Telecom*USA
Publishing will serve as "direct mail" advertising for the Company's
telecommunications products. The directories will contain detailed product
descriptions and step-by-step instructions on the use of the Company's
telecommunications products. The Company believes that telephone directories are
commonly used sources of information that potentially provide the Company with a
long-term marketing presence in millions of households and businesses that
receive a Telecom*USA Publishing directory. By using the directories to market
its products, the Company can reach more customers than would be possible if the
acquisition had not occurred. Third, the Company believes that combining the
directories' distinctive black-and-yellow motif with the trade name *McLeod USA
will create and strengthen brand awareness in all of the Company's markets.
In the fourth quarter of 1996 and in 1997, the Company expects to expand
its telecommunications sales and marketing efforts primarily by opening new
branch sales offices in approximately 25 cities and towns in Minnesota and
approximately 13 cities and towns in Wisconsin, by continuing its expansion in
Iowa and Illinois and by increasing its sales of long distance service in Omaha,
Nebraska. The Company also expects to begin sales and marketing efforts in 1997
in South Dakota, North Dakota, Colorado, Wyoming and Utah, assuming the Company
is successful in its challenges to the U S WEST Centrex Action in those states,
and in Nebraska, Montana and Idaho. See "Risk Factors -- Dependence on Regional
Bell Operating Companies; U S WEST Centrex Action" and "-- Legal Proceedings."
In addition, the Company expects to expand its long distance sales and marketing
efforts in 1997 to the remaining states in the continental United States upon
receipt of required certifications from various state regulatory authorities.
The foregoing statements are "forward looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 and the results of the
Company's actual expansion efforts may be materially different, depending on a
variety of other factors, including: (i) the availability of financing and
regulatory approvals; (ii) the number of potential customers in a target market;
(iii) the existence of strategic alliances or relationships; (iv) technological,
regulatory or other developments in the Company's business; (v) changes in the
competitive climate in which the Company operates; and (vi) the emergence of
future opportunities.
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The Company estimates that as of September 30, 1996, after 33 months of
operations, it had a market share of approximately 20.6% of business local
telephone lines in its Iowa markets (based on 1994 market data) and a market
share of approximately 12.7% of business local telephone lines in its Illinois
markets (based on 1994 Iowa market data, assuming that the Company's Illinois
markets are substantially similar to the Company's Iowa markets). There can be
no assurance that the Company will attain similar market share in other markets.
Because residential sales efforts have begun so recently, the Company has not
achieved any significant share of the residential telecommunications services
market. As of September 30, 1996, the Company was providing, on a retail basis,
approximately 56,000 lines in its Iowa and Illinois markets, primarily to small
and medium-sized business customers. Since beginning sales activities in January
1994, the Company has increased its revenues 367% from the sale of bundled local
and long distance products from $4.6 million for the year ended December 31,
1994 to $21.5 million for the year ended December 31, 1995.
Sales and marketing of the Company's competitive access services are
handled by a 6-member sales staff located in Des Moines and Cedar Rapids. These
sales people work closely with the Company's network engineers to design and
market special access and private line services.
COMPETITION
The telecommunications industry is highly competitive. The Company faces
intense competition from local exchange carriers, including the Regional Bell
Operating Companies (primarily U S WEST and Ameritech) and the General Telephone
Operating Companies, which currently dominate their local telecommunications
markets. The Company also competes with long distance carriers in the provision
of long distance services. The long distance market is dominated by three major
competitors, AT&T, MCI and Sprint. Hundreds of other companies also compete in
the long distance marketplace. Other competitors of the Company may include
cable television companies, competitive access providers, microwave and
satellite carriers, wireless telecommunications providers, teleports and private
networks owned by large end-users. In addition, the Company competes with the
Regional Bell Operating Companies and other local exchange carriers, numerous
direct marketers and telemarketers, equipment vendors and installers and
telecommunications management companies with respect to certain portions of its
business. Many of the Company's existing and potential competitors have
financial and other resources far greater than those of the Company. See "Risk
Factors -- Wireline Competition."
The Company believes that the Telecommunications Act and state legislative
and regulatory initiatives and developments in Illinois, Iowa and other states
within the Company's target markets, as well as a recent series of transactions
and proposed transactions between telephone companies, long distance carriers
and cable companies, increase the likelihood that barriers to local exchange
competition will be substantially reduced or removed. These initiatives include
requirements that the Regional Bell Operating Companies negotiate with entities
such as the Company to provide interconnection to the existing local telephone
network, to allow the purchase, at cost-based rates, of access to unbundled
network elements, to establish dialing parity, to obtain access to rights-of-way
and to resell services offered by the incumbent local exchange carriers. Certain
provisions of the Interconnection Decision implementing the interconnection
portions of the Telecommunications Act have been stayed by the U.S. Eighth
Circuit Court of Appeals, which may limit or delay the development of
competition in the local exchange switched services market.
The Telecommunications Act provides the incumbent local exchange carriers
with new competitive opportunities. The Telecommunications Act removes previous
restrictions concerning the provision of long distance service by the Regional
Bell Operating Companies and also provides them with increased pricing
flexibility. Under the Telecommunications Act, the Regional Bell Operating
Companies will, upon the satisfaction of certain conditions, be able to offer
long distance services that would enable them to duplicate the "one-stop"
integrated telecommunications approach used by the Company. The Company believes
that it has certain advantages over these
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companies in providing its telecommunications services, including management's
prior experience in the competitive telecommunications industry and the
Company's emphasis on marketing (primarily using a direct sales force for sales
to business customers and telemarketing for sales to residential customers) and
on responsive customer service. However, there can be no assurance that the
anticipated increased competition will not have a material adverse effect on the
Company. The Telecommunications Act provides that rates charged by incumbent
local exchange carriers for interconnection to the incumbent carrier's network
are to be nondiscriminatory and based upon the cost of providing such
interconnection, and may include a "reasonable profit," which terms are subject
to interpretation by regulatory authorities. If the incumbent local exchange
carriers, particularly the Regional Bell Operating Companies, charge alternative
providers such as the Company unreasonably high fees for interconnection to the
local exchange carriers' networks, significantly lower their rates for access
and private line services or offer significant volume and term discount pricing
options to their customers, the Company could be at a significant competitive
disadvantage. See "Risk Factors -- Regulation" and "-- Regulation."
The Company believes that there are currently no other competitive access
providers operating or building networks in any of the Company's current
markets. Based on management's experience, the initial market entrant with an
operational fiber optic competitive access provider network generally enjoys a
competitive advantage over other competitive access providers that later attempt
to enter the market, because it has the first opportunity to contact customers
who are willing to switch from the local exchange carrier serving the market.
Competition for local and access telecommunications services is based
principally on price, quality, network reliability, customer service and service
features. The Company believes that its management expertise allows it to
compete effectively with the incumbent local exchange carriers. The Company
generally offers its business customers local exchange services at prices that
are substantially similar to the established retail local exchange carrier rates
for basic business service, while generally providing enhanced calling features
and a higher level of customer service. Using the Company's sophisticated
proprietary software, each business customer receives the lowest long distance
rate available each month from among the pricing plans of AT&T, MCI and Sprint
that currently are most popular with the Company's business customers, and, in
certain cases, rates specifically identified by a business customer and agreed
to by the Company. Residential customers receive flat-rate long distance
pricing. The Company's fiber optic networks will provide both diverse access
routing and redundant electronics, which design features are not widely deployed
by the local exchange carriers' networks.
REGULATION
OVERVIEW. The Company's services are subject to federal, state and local
regulation. The FCC exercises jurisdiction over all facilities of, and services
offered by, telecommunications common carriers to the extent those facilities
are used to provide, originate or terminate interstate or international
communications. State regulatory commissions retain some jurisdiction over the
same facilities and services to the extent they are used to originate or
terminate intrastate common carrier communications. Local governments may
require the Company to obtain licenses, permits or franchises regulating use of
public rights-of-way necessary to install and operate its networks.
The Company, through its wholly owned subsidiary McLeod Telemanagement,
holds various federal and state regulatory authorizations and often joins other
industry members in seeking regulatory reform at the federal and state levels to
open additional telecommunications markets to competition.
The Company, through its wholly owned subsidiary MWR, provides certain
competitive access services as a private carrier on a non-regulated basis. In
general, a private carrier is one that provides service to customers on an
individually negotiated contractual basis, as opposed to a common carrier that
provides service to the public on the basis of generally available rates, terms,
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and conditions. The Company believes that MWR's private carrier status is
consistent with applicable federal and state laws, as well as regulatory
decisions interpreting and implementing those laws as of the date of this
Prospectus. Should such laws and/or regulatory interpretations change in the
future to reclassify MWR's regulatory status, the Company believes that
compliance with such reclassification would not have a material adverse effect
on the Company.
The Company, through its wholly owned subsidiary Ruffalo, Cody, is subject
to certain federal and state regulatory requirements due to its direct
marketing, telemarketing and fund-raising activities, including in certain
states, bonding requirements.
FEDERAL REGULATION. The Telecommunications Act became effective February
8, 1996. The Telecommunications Act preempts state and local laws to the extent
that they prevent competitive entry into the provision of any telecommunications
service. Subject to this limitation, however, the state and local governments
retain most of their existing regulatory authority. The Telecommunications Act
imposes a variety of new duties on incumbent local exchange carriers in order to
promote competition in local exchange and access services. Some smaller
telephone companies may seek suspension or modification of these duties, and
some companies serving rural areas are exempt from these duties. Some duties are
also imposed on non-incumbent local exchange carriers, such as the Company. The
duties created by the Telecommunications Act include the following:
Reciprocal
Compensation Requires all local exchange carriers to complete
calls originated by competing carriers under
reciprocal arrangements at prices based on a
reasonable approximation of incremental cost or
through mutual exchange of traffic without explicit
payment.
Resale Requires all local exchange carriers to permit
resale of their telecommunications services without
unreasonable restrictions or conditions. In
addition, incumbent local exchange carriers are
required to offer wholesale versions of all retail
services to other telecommunications carriers for
resale at discounted rates, based on the costs
avoided by the incumbent local carrier in the
wholesale offering.
Interconnection Requires incumbent local exchange carriers to
permit their competitors to interconnect with their
facilities at any technically feasible point within
their networks, on nondiscriminatory terms, at
prices based on cost (which may include a
reasonable profit). At the option of the carrier
seeking interconnection, physical collocation of
the requesting carrier's equipment in the incumbent
local exchange carrier's premises must be offered,
except where the incumbent local exchange carrier
can demonstrate space limitations or other
technical impediments to collocation.
Unbundled Access Requires incumbent local exchange carriers to
provide nondiscriminatory access to unbundled
network elements (including network facilities,
equipment, features, functions, and capabilities)
at any technically feasible point within their
networks, on nondiscriminatory terms, at prices
based on cost (which may include a reasonable
profit).
Number Portability Requires all local exchange carriers to permit
users of telecommunications services to retain
existing telephone numbers without impairment of
quality, reliability or convenience when switching
from one telecommunications carrier to another.
Dialing Parity Requires all local exchange carriers to provide
"1+" equal access to competing providers of
telephone exchange service and toll
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service, and to provide nondiscriminatory access to
telephone numbers, operator services, directory
assistance, and directory listing, with no
unreasonable dialing delays.
Access to
Rights-of-Way Requires all local exchange carriers to permit
competing carriers access to poles, ducts, conduits
and rights-of-way at regulated prices.
Incumbent local exchange carriers are required to negotiate in good faith
with carriers requesting any or all of the above arrangements. Certain FCC rules
regarding negotiation and pricing of interconnection agreements have been stayed
by the U.S. Eighth Circuit Court of Appeals. However, carriers still may
negotiate agreements, and if the negotiating carriers cannot reach agreement
within a prescribed time, either carrier may request binding arbitration of the
disputed issues by the state regulatory commission.
The Telecommunications Act also eliminates previous prohibitions on the
provision of interLATA long distance services by the Regional Bell Operating
Companies and the General Telephone Operating Companies. The Regional Bell
Operating Companies are now permitted to provide interLATA long distance service
outside those states in which they provide local exchange service
("out-of-region long distance service") upon receipt of any necessary state
and/or federal regulatory approvals that are otherwise applicable to the
provision of intrastate and/or interstate long distance service. Under the
Telecommunications Act, the Regional Bell Operating Companies will be allowed to
provide long distance service within the regions in which they also provide
local exchange service ("in-region service") upon specific approval of the FCC
and satisfaction of other conditions, including a checklist of interconnection
requirements. The General Telephone Operating Companies are permitted to enter
the long distance market without regard to limitations by region, although
regulatory approvals otherwise applicable to the provision of long distance
service will need to be obtained. The General Telephone Operating Companies are
also subject to the provisions of the Telecommunications Act that impose
interconnection and other requirements on local exchange carriers.
The Telecommunications Act imposes certain restrictions on the Regional
Bell Operating Companies in connection with the Regional Bell Operating
Companies' entry into long distance services. Among other things, the Regional
Bell Operating Companies must pursue such activities only through separate
subsidiaries with separate books and records, financing, management and
employees, and all affiliate transactions must be conducted on an arm's length
and nondiscriminatory basis. The Regional Bell Operating Companies are also
prohibited from jointly marketing local and long distance services, equipment
and certain information services unless competitors are permitted to offer
similar packages of local and long distance services in their market. Further,
the Regional Bell Operating Company must obtain in-region long distance
authority before jointly marketing local and long distance services in a
particular state. Additionally, AT&T and other major carriers serving more than
5% of the nation's presubscribed long distance access lines are also restricted,
under certain conditions, from packaging their long distance services and local
services provided over Regional Bell Operating Company facilities. These
restrictions do not, however, apply to the Company because it does not serve
more than 5% of the nation's presubscribed access lines.
Prior to passage of the Telecommunications Act, the FCC had already
established different levels of regulations for dominant and non-dominant
carriers. For domestic common carrier telecommunications regulation, large local
exchange carriers and the Regional Bell Operating Companies are currently
considered dominant carriers for the provision of interstate access services,
while other interstate service providers, such as the Company, are considered
non-dominant carriers. The FCC has recently proposed that the Regional Bell
Operating Companies offering out-of-region interstate long distance services be
regulated as non-dominant carriers, as long as such services are offered by an
affiliate of the Regional Bell Operating Company that
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complies with certain structural separation requirements. The FCC regulates many
of the rates, charges and services of dominant carriers to a greater degree than
non-dominant carriers.
As a non-dominant carrier, the Company may install and operate facilities
for the transmission of domestic interstate communications without prior FCC
authorization, although FCC authorization is required for the provision of
international telecommunications by non-dominant carriers. Services of
non-dominant carriers are subject to relatively limited regulation by the FCC.
Non-dominant carriers currently are required to file tariffs listing the rates,
terms and conditions of interstate and international services provided by the
carrier. Periodic reports concerning the carrier's interstate circuits and
deployment of network facilities also are required to be filed. The FCC
generally does not exercise direct oversight over cost justification and the
level of charges for services of non-dominant carriers, although it has the
power to do so. The Company must offer its interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remains subject to
FCC complaint procedures. Pursuant to these FCC requirements, the Company's
subsidiary, McLeod Telemanagement, has filed and maintains with the FCC a tariff
for its interstate and international services. All of the interstate and
international retail "basic" services (as defined by the FCC) provided by the
Company (through such subsidiary) and the rates charged for those services are
described therein. McLeod Telemanagement also has obtained FCC authority to
provide international services.
On October 29, 1996, the FCC adopted an order in which it eliminated the
requirement that non-dominant interstate carriers such as the Company maintain
tariffs on file with the FCC for domestic interstate services. The FCC's order
was issued pursuant to authority granted to the FCC in the Telecommunications
Act to "forebear" from regulating any telecommunications service provider if the
FCC determines that the public interest will be served. Following a nine-month
transition period, relationships between carriers and their customers will be
set by contract and long distance companies will no longer be required to file
with the FCC tariffs for interstate interexchange services. Carriers also have
the option to immediately cease filing tariffs. The FCC's order may, however, be
subject to further changes by the FCC and/or appeal to the courts.
The FCC also imposes prior approval requirements on transfers of control
and assignments of operating authorizations. The FCC has the authority to
generally condition, modify, cancel, terminate or revoke operating authority for
failure to comply with federal laws and/or the rules, regulations and policies
of the FCC. Fines or other penalties also may be imposed for such violations.
There can be no assurance that the FCC or third parties will not raise issues
with regard to the Company's compliance with applicable laws and regulations.
The Company does not currently hold any radio licenses issued by the FCC,
although FCC radio licenses may be acquired in the future in connection with the
provision of wireless services. In general, applications for FCC radio licenses
may be denied, and in extreme cases radio licenses may be revoked after grant,
if the FCC finds that an entity lacks the requisite "character" qualification to
be a licensee. In making that determination, the FCC considers whether an
applicant or licensee has been the subject of adverse findings in a judicial or
administrative proceeding involving, among other things, the possession or sale
of unlawful drugs, fraud, antitrust violations or unfair competition.
Under the Telecommunications Act, non-U.S. citizens or their
representatives, foreign governments or their representatives, or corporations
organized under the laws of a foreign country may not own, in the aggregate,
more than 20% of companies holding a common carrier radio license; or more than
25% of the parent of a common carrier radio licensee if the FCC determines that
the public interest would be served by prohibiting such ownership. If the
Company acquires or is granted FCC radio licenses in the future, the Company
will be required to comply with these foreign ownership restrictions. In
addition, the FCC has imposed reporting requirements with respect to foreign
affiliations between U.S. international and foreign telecommunications carriers,
as well as reports of certain investments by other foreign entities. Depending
on the particular foreign affiliate and its "home" market, the FCC may limit the
size of the foreign affiliate's investment in the U.S.
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carrier or subject the U.S. carrier to dominant carrier regulation on one or
more international routes. The Company's subsidiary, McLeod Telemanagement,
holds FCC authority to provide international services, and therefore is subject
to the FCC's rules on foreign affiliations.
Failure to comply with statutory requirements on foreign ownership of
companies holding radio licenses, or with the FCC's foreign affiliation
reporting requirements, may result in the FCC issuing an order to the entity
requiring divestiture of alien ownership to bring the entity into compliance
with the Telecommunications Act and the FCC's rules. In addition, fines, a
denial of renewal or revocation of radio licenses are possible. The Restated
Certificate permits the Board to redeem any of the Company's capital stock from
stockholders to the extent necessary to prevent the loss or secure the
reinstatement of any license, operating authority or franchise from any
governmental authority. The Company has no knowledge of any present alien
ownership or affiliation with foreign telecommunications carriers in violation
of the Telecommunications Act or the FCC's rules. See "Description of Capital
Stock--Certain Charter and Statutory Provisions."
The FCC, through the Initial Interconnection Decisions, has ordered the
Regional Bell Operating Companies and all but one of the other local exchange
carriers having in excess of $100 million in gross annual revenue for regulated
services to provide expanded interconnection to local exchange carrier central
offices to any competitive access provider, interexchange carrier or end user
seeking such interconnection for the provision of interstate access services. As
a result, the Company is able to reach most business customers in its
metropolitan service areas and can expand its potential customer base. The FCC
has imposed mandatory virtual collocation obligations on the local exchange
carriers. Virtual collocation is a service in which the local exchange carrier
leases or purchases equipment designated by the interconnector and exerts
complete physical control over this equipment, including central office
installation, maintenance and repair. Some local exchange carriers have
voluntarily filed tariffs making "physical collocation" available, enabling the
interconnector to place its equipment in the local exchange carriers central
office space. As noted above, the Telecommunications Act now requires most
incumbent local exchange companies to offer physical collocation. Subsequent to
the enactment of the Telecommunications Act, the FCC has begun a series of
expedited rulemaking proceedings to implement the requirements of the
Telecommunications Act concerning interconnection with local exchange carrier
facilities and other essential terms of the relationships between competing
local carriers. On August 8, 1996, the FCC adopted the Interconnection Decision
to implement the interconnection, resale and number portability provisions of
the Telecommunications Act. Certain provisions of these rules have been appealed
to various U.S. Courts of Appeals. These appeals have been consolidated into
proceedings currently pending before the U.S. Eighth Circuit Court of Appeals.
Applications for a stay of the proposed rules were rejected by the FCC. However,
the U.S. Eighth Circuit Court of Appeals has granted a stay of certain
provisions of the Interconnection Decision, including the pricing rules and
rules that would have permitted new entrants to "pick and choose" among various
provisions of existing interconnection agreements. The FCC applied to the U.S.
Supreme Court to vacate the judicial stay, but the U.S. Supreme Court, on
November 12, 1996, refused to vacate the stay. All other provisions of the
Interconnection Decision remain in effect pending resolution of the appeal on
the merits.
When ordering interconnection, the FCC granted local exchange carriers
additional flexibility in pricing their interstate special and switched access
services on a central office specific basis. Under this pricing scheme, local
exchange carriers may establish pricing zones based on access traffic density
and charge different prices for central offices in each zone. Although no
assurances are possible, the Company anticipates that the FCC will grant local
exchange carriers increasing pricing flexibility as the number of
interconnection agreements and competitors increases. In a concurrent
proceeding, the FCC enacted interim pricing rules that restructure local
exchange carrier switched transport rates in order to facilitate competition for
switched access.
The Company, through its wholly owned subsidiary Ruffalo, Cody, is also
subject to rules governing telemarketing that have been promulgated by both the
FCC and the Federal Trade Commission (the "FTC"). The FCC and FTC telemarketing
rules prohibit telemarketers, such as
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Ruffalo, Cody, from engaging in certain deceptive telemarketing practices and
require that telemarketers make certain disclosures. For example, these
telemarketing rules: prohibit the use of autodialers that employ prerecorded
voice messages without the prior express consent of the dialed party; proscribe
the facsimile transmission of unsolicited advertisements; require telemarketers
to disclose clear and conspicuous information concerning quality, cost and
refunds to a customer before a customer makes a purchase; require telemarketers
to compile lists of individuals who desire not to be contacted; limit
telemarketers to calling residences between the hours of 8:00 a.m. and 9:00
p.m.; require telemarketers to explicitly identify the seller and state that the
purpose of the call is to sell goods; and prohibit product misrepresentations.
STATE REGULATION. McLeod Telemanagement, the Company's subsidiary that
provides intrastate common carrier services, is also subject to various state
laws and regulations. Most public utilities commissions subject providers such
as the Company to some form of certification requirement, which requires
providers to obtain authority from the state public utilities commission prior
to the initiation of service. In most states, including Iowa and Illinois, the
Company also is required to file tariffs setting forth the terms, conditions and
prices for services that are classified as intrastate. The Company also is
required to update or amend its tariffs when it adjusts its rates or adds new
products, and is subject to various reporting and record-keeping requirements.
Many states also require prior approval for transfers of control of
certified carriers, corporate reorganizations, acquisitions of
telecommunications operations, assignment of carrier assets, carrier stock
offerings and incurrence by carriers of significant debt obligations.
Certificates of authority can generally be conditioned, modified, canceled,
terminated or revoked by state regulatory authorities for failure to comply with
state law and/or the rules, regulations and policies of state regulatory
authorities. Fines or other penalties also may be imposed for such violations.
There can be no assurance that state utilities commissions or third parties will
not raise issues with regard to the Company's compliance with applicable laws or
regulations.
The Company, through McLeod Telemanagement, currently holds certificates to
offer local services through partitioning U S WEST switches in Iowa and
Ameritech switches in Illinois, has long distance authority in Iowa and Illinois
and has tariffs on file in these states, as necessary, governing the provision
of local and intrastate long distance services. In March 1995 and April 1996,
respectively, the Company received state regulatory approval in Iowa and in
Illinois to offer local switched services in Cedar Rapids, Iowa and in Illinois
cities other than Chicago. The Company intends to seek regulatory approval to
provide such services in other cities and towns in Iowa and other states
targeted by the Company when the economic terms of interconnection with the
incumbent local exchange carrier make the provision of local switched services
cost-effective. See "-- Expansion of Certain Facilities-based Services." In
addition, the Company holds a certificate to provide local exchange and long
distance services through resale in Minnesota, Wisconsin, South Dakota and North
Dakota. The Company also is authorized to offer long distance service in
Nebraska, Missouri, Colorado, New Jersey, Michigan, Montana, Indiana, Ohio and
Utah. Applications for authority to provide long distance service are pending in
several states, including Arizona, California, Georgia, Kansas, Oregon,
Pennsylvania, Texas, Washington and Wyoming. The Company has applied for
authority to provide long distance service in such states, including states
outside of its target markets, because it believes this capability will enhance
the Company's ability to attract business customers that have offices outside of
the Company's target markets. The Company may also apply for authority to
provide services in other states in the future. While the Company expects and
intends to obtain necessary operating authority in each jurisdiction where it
intends to operate, there can be no assurance that each jurisdiction will grant
the Company's request for authority.
Although the Telecommunications Act preempts the ability of states to
forbid local service competition, it is so recently enacted that public
utilities commissions in certain states, such as Nebraska, South Dakota,
Montana, Colorado, Wyoming and Missouri, where the legality of such competition
was previously uncertain, have not yet taken regulatory or statutory actions to
comply
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with the Telecommunications Act. Furthermore, the Telecommunications Act
preserves the ability of states to impose reasonable terms and conditions of
service and other regulatory requirements. In the last several years, Iowa,
Illinois, Minnesota, Wisconsin and North Dakota have enacted broad changes in
those states' telecommunications laws that authorize the entry of competitive
local exchange carriers and provide for new regulations to promote competition
in local and other intrastate telecommunications services. The Company believes
that these state statutes provide some protection to the Company against any
discriminatory conduct by the Regional Bell Operating Companies. The Iowa
Utilities Board, for example, has determined in three separate instances that
the conduct of U S WEST discriminated against the Company in violation of Iowa
law. U S WEST has appealed two of these decisions by the Iowa Utilities Board
and both appeals are currently pending before the Iowa District Court for Polk
County.
The Company believes that, as the degree of intrastate competition
increases, the states will offer the local exchange carriers increasing pricing
flexibility. This flexibility may present the local exchange carriers with an
opportunity to subsidize services that compete with the Company's services with
revenues generated from non-competitive services, thereby allowing incumbent
local exchange carriers to offer competitive services at prices below the cost
of providing the service. The Company cannot predict the extent to which this
may occur or its impact on the Company's business.
The Company, through Ruffalo, Cody, engages in various direct marketing,
telemarketing and fund-raising activities. Most states have laws that govern
either direct marketing, telemarketing or fund-raising activities. In states
that regulate such activities, several types of restriction have been imposed,
either singly or in combination, including: (i) pre-commencement and
post-completion registration requirements; (ii) posting of professional bonds;
(iii) filing of operational contracts; (iv) imposing statutory waiting periods;
(v) requiring employee registration; and (vi) prohibiting control over funds
collected from such activities.
LOCAL GOVERNMENT AUTHORIZATIONS. The Company is required to obtain street
use and construction permits and licenses and/or franchises to install and
expand its fiber optic networks using municipal rights-of-way. In some
municipalities where the Company has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenues or on a per linear foot basis. There can be no
assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, the local exchange carriers do
not pay such franchise fees or pay fees that are substantially less than those
required to be paid by the Company. To the extent that competitors do not pay
the same level of fees as the Company, the Company could be at a competitive
disadvantage. Termination of the existing franchise or license agreements prior
to their expiration dates or a failure to renew the franchise or license
agreements and a requirement that the Company remove its facilities or abandon
its network in place could have a material adverse effect on the Company.
EMPLOYEES
As of September 30, 1996, the Company employed a total of 1,554 full-time
employees and 261 part-time employees. The Company believes that its future
success will depend on its continued ability to attract and retain highly
skilled and qualified employees. The Company believes that its relations with
its employees are good.
PROPERTY
The Company leases offices and space in a number of locations, primarily
for sales offices and network equipment installations. The Company's
headquarters is housed in 55,000 square feet of office space in Cedar Rapids,
Iowa, under a lease expiring in March 2001. In August 1996, the Company
purchased approximately 194 acres of farm land in southern Cedar Rapids, Iowa,
and announced plans to construct a one-story, 160,000 square foot building to
serve as the Company's
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headquarters. Adjacent to the new headquarters, the Company plans to construct a
network operations center that will house the Company's telephone switching and
computer equipment. The total cost of the construction of the Company's
corporate headquarters and network operations center is estimated to be
approximately $25 million. See "Use of Proceeds." The new headquarters is
scheduled for occupancy by mid-1997. In addition, the Company owns 88 acres of
undeveloped farm and forest land in southern Cedar Rapids, Iowa.
LEGAL PROCEEDINGS
The Company is not aware of any material litigation against the Company.
The Company is involved in numerous regulatory proceedings before various public
utilities commissions, particularly the Iowa Utilities Board, as well as before
the FCC. The Company and Clark E. McLeod are also plaintiffs in a civil action,
instituted in the Iowa District Court for Linn County on September 19, 1994,
seeking actual and punitive damages, and alleging that the defendants, Iowa
Network Services, Inc. ("INS") and William P. Bagley, the general manager of
INS, engaged in libel and other tortious acts against Clark E. McLeod, the
Company and its wholly owned subsidiaries, through the publication and wide
circulation of a "Letter to the Editor" sent to a number of newspapers and
others in August 1994 regarding, among other things, the Company's business
dealings with the State of Iowa. The lawsuit has been set for trial in February
1997. On October 9, 1996, the parties began non-binding mediation in an attempt
to resolve this dispute. See "Management -- Compensation Committee Interlocks
and Insider Participation."
The Company is dependent on the Regional Bell Operating Companies for
provision of its local and certain of its long distance services. U S WEST and
Ameritech are currently the Company's sole suppliers of access to local central
office switches. The Company uses such access to partition the local switch and
provide local service to its customers.
The Company purchases access in the form of a product generally known as
"Centrex." Without such access, the Company could not currently provide bundled
local and long distance services, although it could provide stand-alone long
distance service. Since the Company believes its ability to offer bundled local
and long distance services is critical to its current sales efforts, any
successful effort by U S WEST or Ameritech to deny or substantially limit the
Company's access to partitioned switches would have a material adverse effect on
the Company.
On February 5, 1996, U S WEST filed tariffs and other notices announcing
its intention to limit future Centrex access to its switches by Centrex
customers (including the Company) throughout U S WEST's fourteen-state service
region, effective February 5, 1996. Although U S WEST stated that it would
"grandfather" existing Centrex agreements with the Company and permit the
Company to continue to use U S WEST's central office switches through April 29,
2005, it also indicated that it would not permit the Company to expand to new
cities and would severely limit the number of new lines it would permit the
Company to partition onto U S WEST's portion of the switches in cities currently
served by the Company. Because of U S WEST's commitment to "grandfather" service
to the Company, the Company does not believe its current customers are at risk
that service will be interrupted. The Company has challenged, or is challenging,
the U S WEST Centrex Action before the public utilities commissions in certain
of the states served by U S WEST where the Company is doing business or
currently plans to do business. The Company based such challenges on various
state and federal laws, regulations and regulatory policies, including Sections
251(b)(1) and 251(c)(4)(B) of the Telecommunications Act, which the Company
believes impose upon the Regional Bell Operating Companies the duty not to
prohibit, and not to impose unreasonable or discriminatory conditions or
limitations on, the resale of their telecommunications services, and Section
251(c)(4)(A) of the Telecommunications Act, which the Company believes obligates
the Regional Bell Operating Companies to offer for resale at wholesale rates any
telephone communications services that are provided at retail to subscribers who
are not telecommunications carriers. Additional statutes cited in the Company's
challenges include provisions of the laws of Iowa, Minnesota, Nebraska, South
Dakota, North Dakota and Colorado, which the Company believes
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prohibit restrictions on the resale of local exchange services, functions or
capabilities; prohibit local exchange carriers from refusing access by other
carriers to essential facilities on the same terms and conditions as the local
exchange carrier provides to itself; and prohibit the provision of carrier
services pursuant to rates, terms and conditions that are unreasonably
discriminatory.
In Iowa, the Company filed a complaint with the Iowa Utilities Board
against U S WEST's actions and was granted interim relief on an ex parte basis
that allowed the Company to continue to expand to new cities and expand the
number of new lines partitioned onto U S WEST's switches. Subsequent to the
grant of interim relief, the Company on March 18, 1996 agreed to a settlement
agreement with U S WEST that permits the Company to continue to expand, without
restrictions, the number of new lines it serves in Iowa through March 18, 2001.
In addition, the settlement agreement provides that the Company may expand to
seven new markets (central offices) in Iowa per year through March 18, 2001. As
a result of the settlement agreement, the Company withdrew its complaint before
the Iowa Utilities Board. Because MCI, AT&T and others also challenged U S
WEST's action, the Iowa Utilities Board continued to review the U S WEST Centrex
Action and on June 14, 1996 issued an order rejecting U S WEST's filing. The
order of the Iowa Utilities Board was appealed by U S WEST to the Iowa District
Court for Polk County on July 12, 1996. The appeal remains pending.
In Nebraska, a complaint filed by the Company with respect to the U S WEST
Centrex Action is awaiting decision by the Nebraska Public Utilities Commission.
In Minnesota, U S WEST's initial filing was rejected on procedural grounds by
the Public Utilities Commission. Nevertheless, on April 30, 1996, U S WEST
refiled its proposed limitations on Centrex service in Minnesota, proposing to
"grandfather" the service to existing customers as of July 9, 1996. The Company
opposed this filing in a letter to the Minnesota Public Utilities Commission on
May 20, 1996. On May 31, 1996, the Minnesota Public Utilities Commission issued
an order suspending the new U S WEST filing and scheduling a contested-case
proceeding to consider it. An administrative law judge is expected to render a
ruling in the proceedings by December 20, 1996. In South Dakota, the Public
Utilities Commission rejected the U S WEST Centrex Action on August 22, 1996.
U S WEST has appealed the unfavorable decision of the Public Utilities
Commission in state court and has been granted a stay that prevents the Company
from marketing and selling Centrex service in South Dakota pending a ruling on
appeal. In North Dakota, on November 6, 1996, the Public Service Commission
concluded that the U S WEST Centrex Action is unlawful and ordered U S WEST to
reinstate Centrex service in North Dakota. The Company anticipates that U S WEST
will appeal the unfavorable decision by the North Dakota Public Service
Commission and other unfavorable decisions by public utilities commissions in
other states with respect to the U S WEST Centrex Action.
Other telecommunication firms also have challenged the U S WEST Centrex
Action in each of the other states where U S WEST engages in local telephone
service and public utilities commissions in several of those states have also
rejected the U S WEST Centrex Action. In Oregon, U S WEST's filing was rejected
by the Public Utilities Commission on March 7, 1996. In South Dakota, the Public
Utilities Commission rejected the U S WEST Centrex Action on August 22, 1996. In
Colorado, on September 3, 1996, an Administrative Law Judge issued a
recommendation that the U S WEST Centrex Action be rejected. In Wyoming, U S
WEST's filing was rejected by the Public Service Commission on September 6,
1996. On October 29, 1996, the Arizona Corporation Commission rejected the U S
WEST Centrex Action. In New Mexico, the Public Service Commission has not
allowed U S WEST's filing to become effective. In Utah, on September 25, 1996,
the Public Service Commission rejected the U S WEST Centrex Action and ordered
U S WEST to continue the availability of Centrex service for resale. In Montana,
the Public Service Commission is expected to render a decision with respect to
the U S WEST Centrex Action in November 1996.
There can be no assurance that the Company will succeed in its legal
challenges to the U S WEST Centrex Action, or that this action by U S WEST, or
similar actions by other Regional Bell Operating Companies, will not have a
material adverse effect on the Company. See "-- Competi-
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tion" and "Risk Factors -- Dependence on Regional Bell Operating Companies; U S
WEST Centrex Action."
As a result of its use of the Centrex product, the Company depends upon U S
WEST to process service orders placed by the Company to transfer new customers
to the Company's local service. U S WEST has imposed a limit of processing one
new local service order of the Company per hour for each U S WEST central
office. Furthermore, according to the Company's records, U S WEST commits an
error on one of every three lines ordered by the Company, thereby further
delaying the transition of new customers to the Company's local service. The
Company repeatedly requested that U S WEST increase its local service order
processing rate and improve the accuracy of such processing, which U S WEST
refused to do.
On July 12, 1996, the Company filed a complaint with the Iowa Utilities
Board against U S WEST in connection with such actions. At a hearing held to
consider the complaint, U S WEST acknowledged that it had not dedicated
resources to improve its processing of the Company's service orders to switch
new customers to the Company's local service because of its desire to limit
Centrex service. In an order issued on October 10, 1996, the Iowa Utilities
Board determined that U S WEST's limitation on the processing of the Company's
service orders constituted an unlawful discriminatory practice under Iowa law.
The Iowa Utilities Board ordered the Company and U S WEST jointly to file
supplemental evidence regarding potential modifications of current order
processing practices that would increase U S WEST's rate of processing service
orders. There can be no assurance, however, that the decision of the Iowa
Utilities Board will adequately resolve the service order problems or that such
problems will not impair the Company's ability to expand or to attract new
customers, which could have a material adverse effect on the Company. U S WEST
has, however, recently begun to increase its local service order processing rate
for the Company's residential orders. See "Risk Factors -- Dependence on
Regional Bell Operating Companies; U S WEST Centrex Action" and "Risk
Factors -- Refusal of U S WEST to Improve its Processing of Service Orders."
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are listed below. The
Board currently consists of seven directors, divided into three classes of
directors serving staggered three-year terms. The Company intends to expand the
Board to nine directors pursuant to an Investor Agreement with certain principal
stockholders. See "-- Investor Agreement." Directors and executive officers of
the Company are elected to serve until they resign or are removed, or are
otherwise disqualified to serve, or until their successors are elected and
qualified. Directors of the Company are elected at the annual meeting of
stockholders. Executive officers of the Company generally are appointed at the
Board's first meeting after each annual meeting of stockholders. The ages of the
persons set forth below are as of September 30, 1996.
<TABLE>
<CAPTION>
NAME AGE POSITION(S) WITH COMPANY TERM AS DIRECTOR EXPIRES
- ------------------------------ --- ------------------------------- ------------------------
<S> <C> <C> <C>
Clark E. McLeod............... 49 Chairman, Chief Executive 1997
Officer and Director
Stephen C. Gray............... 38 President, Chief Operating 1999
Officer and Director
Blake O. Fisher, Jr........... 52 Chief Financial Officer, 1997
Executive Vice President,
Corporate Administration,
Treasurer and Director
James L. Cram................. 52 Chief Accounting Officer
Kirk E. Kaalberg.............. 37 Executive Vice President,
Network Services
Stephen K. Brandenburg........ 44 Executive Vice President and
Chief Information Officer
David M. Boatner.............. 47 Executive Vice President,
Business Services
Albert P. Ruffalo............. 49 Executive Vice President,
Consumer Services
Arthur L. Christoffersen...... 49 Executive Vice President,
Publishing Services
Casey D. Mahon................ 44 Senior Vice President, General
Counsel and Secretary
Russell E. Christiansen(1).... 61 Director 1998
Thomas M. Collins(1)(2)....... 68 Director 1998
Paul D. Rhines(2)............. 53 Director 1999
Lee Liu(2).................... 63 Director 1997
</TABLE>
- ---------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Clark E. McLeod. Mr. McLeod founded the Company and has served as
Chairman, Chief Executive Officer and a director of the Company since its
inception in June 1991. His previous business venture, Teleconnect, an
Iowa-based long distance telecommunications company, was founded in January
1980. Mr. McLeod served as Chairman and Chief Executive Officer of Teleconnect
from January 1980 to December 1988, and from December 1988 to August 1990, he
served as President of Telecom*USA, the successor to Teleconnect following its
merger with SouthernNet, Inc. in December 1988. By 1990, Telecom*USA had become
America's fourth largest long distance telecommunications company with nearly
6,000 employees. MCI purchased Telecom*USA in August 1990 for $1.25 billion.
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Stephen C. Gray. Mr. Gray has been Chief Operating Officer of the Company
since September 1992, President since October 1994 and a director since April
1993. Prior to joining the Company, Mr. Gray served from August 1990 to
September 1992 as Vice President of Business Services at MCI, where he was
responsible for MCI's local access strategy and for marketing and sales support
of the Business Markets division. From February 1988 to August 1990, he served
as Senior Vice President of National Accounts and Carrier Services for
Telecom*USA, where his responsibilities included sales, marketing, key contract
negotiations and strategic acquisitions and combinations. Prior to joining
Telecom*USA, from September 1986 to February 1988, Mr. Gray held a variety of
management positions with Williams Telecommunications Company, a long distance
telephone company. From August 1983 to September 1986, Mr. Gray held a variety
of management positions with Clay Desta Communications, Inc., a long distance
company.
Blake O. Fisher, Jr. Mr. Fisher has served as a director of the Company
since October 1996, as Executive Vice President, Corporate Administration since
September 1996 and as Chief Financial Officer and Treasurer since February 1996.
Mr. Fisher also served as one of IES' nominees on the Board from April 1993 to
February 1996. He served as Executive Vice President and Chief Financial Officer
of IES, a diversified electric utility holding company, from January 1991 to
February 1996. Mr. Fisher also served as President of IES Utilities Inc. from
February 1995 to February 1996. Prior to joining IES, Mr. Fisher held a variety
of management positions with Consumers Power Company, an electric utility,
including Vice President of Finance and Treasurer.
James L. Cram. Mr. Cram has served as Chief Accounting Officer of the
Company since February 1996 and served as a director from April 1993 to October
1996. From June 1991 to February 1996, he served as Chief Financial Officer and
Treasurer of the Company. From August 1990 to May 1991, Mr. Cram acted as a
private financial consultant. From December 1987 to August 1990, he served as
Executive Vice President of Finance of Long Distance Operations, Central
Division of Telecom*USA. From 1982 to December 1987, he served as Vice
President, Chief Financial Officer and Treasurer of Teleconnect. Prior to
joining Teleconnect, Mr. Cram served from 1973 to 1982 in various management
positions with HawkBilt Company, a farm equipment manufacturer, including
Controller, Treasurer and General Manager. Mr. Cram has announced his retirement
to be effective in January 1997.
Kirk E. Kaalberg. Mr. Kaalberg has served since September 1996 as the
Company's Executive Vice President, Network Services where he is responsible for
the maintenance of the Iowa Communications Network and the design and
development of the Company's network and switching platforms. From March 1994 to
September 1996, Mr. Kaalberg served as Senior Vice President, Network Design and
Development and from January 1992 to February 1994, he served as Vice President
of the Company. From August 1990 to January 1992, Mr. Kaalberg served as a
senior manager of MCI, where he managed a 175-person conference calling,
financial and operations group. From August 1987 to August 1990, Mr. Kaalberg
was an employee of Teleconnect and its successor, Telecom*USA, where he was
responsible for business planning and management information systems project
prioritization. From 1983 to 1987, he held a variety of product management
positions with Banks of Iowa, Computer Services, Inc., a computer services
company, and Source Data Systems, a software company.
Stephen K. Brandenburg. Mr. Brandenburg has served since September 1996 as
Executive Vice President and Chief Information Officer of the Company, where he
is responsible for the design and deployment of the Company's internal computing
systems and operations. From June 1995 to September 1996, he served as Senior
Vice President, Intelligent Technologies and Systems of the Company. Prior to
joining the Company, Mr. Brandenburg served from August 1990 to June 1995 as
Vice President, Revenue Management Systems at MCI, where he was responsible for
MCI's 1,400 person business markets traffic/call processing, order/entry,
billing and calling card operations. From 1987 to August 1990, he served as
Senior Vice President of Information Systems at Teleconnect and its successor,
Telecom*USA. Prior to joining Teleconnect, Mr. Brandenburg held a
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variety of information systems positions with academic medical centers,
including the Mayo Medical Clinic and the University of Wisconsin.
David M. Boatner. Mr. Boatner has served since September 1996 as Executive
Vice President, Business Services of the Company. From February 1996 to
September 1996, he served as the Company's Senior Vice President, Sales and
Marketing. Prior to joining the Company, Mr. Boatner served from January 1995 to
February 1996 as Regional Vice President of Sales of WorldCom, a long distance
telecommunications company, where he was responsible for sales in the central,
western and southwest regions of the United States. From May 1989 to January
1995, Mr. Boatner served as Vice President for Commercial Sales of WilTel, Inc.,
a long distance telecommunications company which was acquired by WorldCom in
January 1995. Prior to joining WilTel, Inc., Mr. Boatner held a variety of
positions at AT&T and its Bell operating subsidiaries.
Albert P. Ruffalo. Mr. Ruffalo has served as the Company's Executive Vice
President, Consumer Services since September 1996. Since August 1991 Mr. Ruffalo
has served as President and Chief Executive Officer of Ruffalo, Cody, which was
acquired by the Company on July 15, 1996. From September 1990 to July 1991, Mr.
Ruffalo served as President of MCI Direct, Inc., an indirect wholly owned
subsidiary of MCI. From 1983 to August 1990, Mr. Ruffalo held various executive
positions at Teleconnect and Telecom*USA Data Base Marketing Company, an
indirect wholly owned subsidiary of Telecom*USA, Teleconnect's successor. From
1980 to 1983, Mr. Ruffalo was Marketing Manager of National Oats Corporation, a
grain distribution firm.
Arthur L. Christoffersen. Mr. Christoffersen has served as the Company's
Executive Vice President, Publishing Services since September 20, 1996, the date
the Company acquired Telecom*USA Publishing. Mr. Christoffersen has served as
Chairman, President and Chief Executive Officer of Telecom*USA Publishing since
November 1990, the date Mr. Christoffersen and other investors acquired
Telecom*USA Publishing from MCI. From December 1987 to August 1990, Mr.
Christoffersen served as Executive Vice President and Chief Financial Officer of
Teleconnect and its successor, Telecom*USA. From 1975 to 1987, Mr.
Christoffersen held a variety of management positions, including Executive Vice
President, of Life Investors, Inc., a diversified financial services company.
Casey D. Mahon. Ms. Mahon is responsible for the legal and regulatory
affairs of the Company, which she joined in June 1993 as General Counsel. Ms.
Mahon has served as Senior Vice President of the Company since February 1996 and
as the Company's Secretary since July 1993. Prior to joining the Company, she
was engaged in the private practice of law, with emphasis on telecommunications,
regulatory and corporate law. From August 1990 to December 1990, she served as
Vice President of Corporate Affairs at MCI, where she assisted in transitional
matters relating to MCI's purchase of Telecom*USA. From March 1986 to August
1990, Ms. Mahon served as Senior Vice President, General Counsel and Secretary
of Teleconnect and its successor, Telecom*USA. From 1977 to 1986, Ms. Mahon
served in various legal, financial and faculty positions at the University of
Iowa.
Russell E. Christiansen. Mr. Christiansen has been a director of the
Company since June 1995, during which time he has been MidAmerican's nominee to
the Board. Since June 1995, he has also been Chairman and Chairman of the Office
of the Chief Executive Officer of MidAmerican. Mr. Christiansen has been a
director of MidAmerican and its predecessors since 1983. He served as Chairman
and Chief Executive Officer of Midwest Resources Inc., the predecessor to
MidAmerican, from October 1992 to June 1995, President from 1990 to 1995 and
Vice Chairman and Chief Operating Officer from November 1990 to 1992.
Thomas M. Collins. Mr. Collins has been a director of the Company since
April 1993. Mr. Collins is Chairman of Shuttleworth & Ingersoll, P.C., a law
firm in Cedar Rapids, Iowa, where he has practiced law since 1952. Mr. Collins
was a director of Teleconnect and its successor, Telecom*USA, from December 1988
to August 1990. He is also a director of APAC TeleServices, Inc., a
telemarketing company.
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Paul D. Rhines. Mr. Rhines has been a director of the Company since April
1993, during which time he has been the nominee of Allsop Venture Partners III,
L.P. ("Allsop") to the Board. He is a founder and a general partner of R.W.
Allsop and Associates, L.P., R.W. Allsop and Associates II Limited Partnership
and Allsop, three venture capital limited partnerships established in Cedar
Rapids, Iowa, in 1981, 1983 and 1987, respectively. He has served since 1987 as
a general partner of Mark Venture Partners, L.P., a venture capital limited
partnership. He has also served since 1980 as Executive Vice President and a
director of RWA, Inc., a venture capital management firm. Mr. Rhines was a
director of Teleconnect and its successor, Telecom*USA from 1982 to 1990. He is
also a director of American Safety Razor Company, a consumer product
manufacturing company.
Lee Liu. Mr. Liu has been a director of the Company since April 1993,
during which time he has been one of IES' nominees to the Board. Mr. Liu has
served since July 1993 as Chairman of IES. He has also served as President and
Chief Executive Officer of IES since July 1991. From May 1986 to July 1991, Mr.
Liu was Chairman, Chief Executive Officer and President of the predecessor to
IES. Mr. Liu has worked for IES since 1957. Mr. Liu is also a director of Hon
Industries, an office furniture manufacturing company, Eastman Chemical Company,
a chemical company and the Principal Financial Group, a financial services
company.
INVESTOR AGREEMENT
The Company has entered into an agreement (as amended, the "Investor
Agreement") with IES, MidAmerican and Clark E. and Mary E. McLeod (collectively,
the "Investor Stockholders") and certain other stockholders. The Investor
Agreement provides that each Investor Stockholder, for so long as such Investor
Stockholder owns at least 10% of the outstanding capital stock of the Company,
shall vote such Investor Stockholder's stock and take all action within its
power to (i) establish the size of the Board at nine directors; (ii) cause to be
elected to the Board one director designated by IES (for so long as IES owns at
least 10% of the outstanding capital stock of the Company); (iii) cause to be
elected to the Board one director designated by MidAmerican (for so long as
MidAmerican owns at least 10% of the outstanding capital stock of the Company);
(iv) cause to be elected to the Board three directors who are executive officers
of the Company designated by Clark E. McLeod (for so long as Clark E. and Mary
E. McLeod collectively own at least 10% of the outstanding capital stock of the
Company); and (v) cause to be elected to the Board four independent directors
nominated by the Board. The Investor Agreement also provides that, for a period
ending in March 1999 and subject to certain exceptions, each of IES and
MidAmerican will refrain from acquiring, or agreeing or seeking to acquire,
beneficial ownership of any securities issued by the Company. In addition, the
Investor Agreement provides that, for a two-year period commencing on June 10,
1996 and subject to certain exceptions, no Investor Stockholder will sell or
otherwise dispose of any equity securities of the Company without the consent of
the Board.
In the event that either IES or MidAmerican becomes the beneficial owner of
50% or more of the shares of capital stock of the Company beneficially owned by
the other (the "Acquired Investor Stockholder"), the Investor Agreement provides
that (i) the Acquired Investor Stockholder will lose the right to nominate a
director to the Board, (ii) until October 23, 1999, the acquiring party (the
"Acquiring Investor Stockholder") will vote all shares beneficially owned by
such party in excess of 25% of the voting power of the outstanding capital stock
of the Company either (A) in accordance with the recommendations of the Board or
(B) for or against or abstaining in the same proportion as the shares owned by
all other stockholders, (iii) the Acquiring Investor Stockholder will cause, or
use its best efforts to cause, all shares of capital stock of the Company
beneficially owned by it to be represented in person or by proxy at all
stockholder meetings through October 23, 1999, and (iv) the Acquiring Investor
Stockholder will not, and will use its best efforts to cause its affiliates and
associates not to, deposit any such shares of capital stock of the Company in a
voting trust or enter into a voting agreement or other agreement of similar
effect with any other person prior to October 23, 1999.
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In the event a third party becomes the beneficial owner of 50% or more of
the shares of capital stock of the Company beneficially owned by MidAmerican and
50% or more of the shares of capital stock of the Company beneficially owned by
IES, the Investor Agreement provides that IES and MWR (i) will lose the right to
nominate any directors to the Board, (ii) until October 23, 1999, will vote, or
use their respective best efforts to direct the voting of, all shares
beneficially owned by such third party in excess of 25% of the voting power of
the outstanding capital stock of the Company either (A) in accordance with the
recommendations of the Board of Directors of the Company or (B) for or against
or abstaining in the same proportion as the shares owned by all other
stockholders, (iii) will cause, or use their best efforts to cause, all shares
of capital stock of the Company beneficially owned by them to be represented in
person or by proxy at all meetings of the Company's stockholders through October
23, 1999, and (iv) will not, and will use their respective best efforts to cause
their affiliates and associates not to, deposit any such shares of capital stock
of the Company in a voting trust or enter into a voting agreement or other
agreement of similar effect with any other person prior to October 23, 1999.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board currently has two committees, the Audit Committee and the
Compensation Committee, each of which was appointed in March 1996. Prior to
March 1996, there were no Board committees. The Audit Committee, among other
things, recommends the firm to be appointed as independent accountants to audit
the Company's financial statements, discusses the scope and results of the audit
with the independent accountants, reviews with management and the independent
accountants the Company's interim and year-end operating results, considers the
adequacy of the internal accounting controls and audit procedures of the Company
and reviews the non-audit services to be performed by the independent
accountants. The current members of the Audit Committee are Messrs. Collins and
Christiansen. The Compensation Committee reviews and recommends the compensation
arrangements for management of the Company and administers the Company's stock
option plans and stock purchase plan. The current members of the Compensation
Committee are Messrs. Collins, Rhines and Liu.
DIRECTOR COMPENSATION
Directors of the Company who are also employees of the Company receive no
directors' fees. Non-employee directors receive directors fees of $1,000 for
each Board and committee meeting attended in person and $500 for each Board and
committee meeting attended by telephone. In addition, directors are reimbursed
for their reasonable out-of-pocket travel expenditures incurred. Directors of
the Company are also eligible to receive grants of stock options under the
Company's Director Stock Option Plan. See "-- Stock Option Plans -- Directors
Stock Option Plan."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Compensation Committee are Messrs. Collins,
Rhines and Liu. Prior to March 1996, there was no Compensation Committee and the
entire Board participated in deliberations regarding executive officer
compensation. During the fiscal year ended December 31, 1995, Messrs. McLeod,
Gray and Cram were executive officers of the Company. During such period, no
member of the Board served as a director or a member of the compensation
committee of any other company of which any executive officer served as a member
of the Board.
Of the 5,200,000 shares of Class A Common Stock offered hereby, Clark E.
McLeod, Mary E. McLeod, MidAmerican and IES have agreed to purchase 53,572,
53,571, 357,143 and 357,143 shares of Class A Common Stock, respectively, at the
public offering price without any underwriting discount. See "Principal and
Selling Stockholders" and "Underwriting." The Company has been advised that such
shares will be purchased for investment purposes. Such shares will be sold
directly by the Company to the Investors and will not be subject to the terms
and conditions of the Underwriting Agreement. Mr. McLeod is a director and
executive officer of the Company and Mrs. McLeod, MidAmerican and IES are
significant stockholders of the Company.
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<PAGE> 70
In connection with their proposed purchase of Class A Common Stock in the
Offering, Clark E. and Mary E. McLeod filed a notification with the Federal
Trade Commission pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended. The applicable filing fee of $45,000 for this notification was
paid by the Company. Mr. McLeod is a director and executive officer of the
Company and Mrs. McLeod is a significant stockholder of the Company.
Prior to September 20, 1996, the Company purchased advertising space in
telephone directories published by Telecom*USA Publishing, a corporation whose
directors included, among others, Clark E. McLeod, Paul D. Rhines and James L.
Cram. Messrs. McLeod and Rhines and Ms. Casey D. Mahon were stockholders of
Telecom*USA Publishing. Telecom*USA Publishing also purchased telecommunications
service from the Company. The Company paid Telecom*USA Publishing $1,397,
$11,000 and $54,500 in 1993, 1994 and 1995, respectively, for advertising fees
and charged Telecom*USA Publishing $103,112 for telecommunications services in
1995. Messrs. McLeod and Rhines are directors of the Company, and Messrs. McLeod
and Cram and Ms. Mahon are executive officers of the Company.
On September 20, 1996, the Company acquired Telecom*USA Publishing for
approximately $74.1 million in cash and an additional amount currently estimated
to be approximately $1.6 million to be paid to certain employees of Telecom*USA
Publishing as part of an incentive plan. At the time of the acquisition,
Telecom*USA had outstanding debt of approximately $6.6 million. Clark E. McLeod,
a director and executive officer of the Company, Mary E. McLeod, a significant
stockholder of the Company, the McLeod Charitable Foundation, Inc., a non-profit
foundation controlled by Mr. and Mrs. McLeod, Aaron, Holly, Frank and Jane
McLeod, relatives of Mr. and Mrs. McLeod, Paul D. Rhines, a director of the
Company, James L. Cram, an executive officer of the Company, Casey D. Mahon, an
executive officer of the Company, and IES, a stockholder of the Company, were
shareholders of Telecom*USA Publishing. The Company paid $18,571,982,
$1,195,313, $105,187, $1,459,563, $46,125, $250,219 and $1,000,875 to Mr. and
Mrs. McLeod, the McLeod Charitable Foundation, Inc., Aaron, Holly, Frank and
Jane McLeod, Mr. Rhines, Mr. Cram, Ms. Mahon and IES, respectively, in exchange
for the shares of Telecom*USA Publishing common stock held by them. Messrs.
McLeod, Rhines and Cram served as directors of Telecom*USA Publishing. A Special
Committee of the Board, consisting of disinterested directors, approved the
acquisition of Telecom*USA Publishing as fair to, and in the best interests of,
the stockholders of the Company.
In August 1996, Ryan Properties, Inc. ("Ryan Properties") assigned to the
Company all of its right, title and interest in and to a purchase agreement
between Ryan Properties and Iowa Land and Building Company ("Iowa Land"), and
the Company assumed Ryan Properties' obligation to pay Iowa Land $691,650 for
approximately 75 of the approximately 194 acres of farm land in southern Cedar
Rapids, Iowa upon which the Company is constructing its new corporate
headquarters and network operations center. See "Business -- Property."
Following the assignment, the Company paid Iowa Land $691,650 for the title to
such land. Iowa Land is an indirect wholly owned subsidiary of IES, a
significant stockholder of the Company.
On July 15, 1996, the Company acquired Ruffalo, Cody in a cash and stock
transaction valued at up to a maximum of $19.9 million, based on the average
price of the Class A Common Stock on the Nasdaq National Market at the time of
the transaction. An additional $50,782 in cash and 113,387 shares of Class A
Common Stock were placed into escrow and will be delivered to certain of the
shareholders of Ruffalo, Cody over a period of 18 months, contingent upon the
fulfillment of certain conditions relating to Ruffalo, Cody's ongoing revenues
from an agreement with a major long distance carrier to provide telemarketing
services. Clark E. McLeod, a director and executive officer of the Company, and
Mary E. McLeod owned 110,454 shares of Ruffalo, Cody common stock, which were
exchanged for 77,218 shares of Class A Common Stock, of which 11,584 shares were
placed in escrow to be released to Mr. and Mrs. McLeod, if at all, over a period
of 18 months, contingent upon the fulfillment of certain conditions relating to
Ruffalo, Cody's ongoing revenues. Allsop, a stockholder of the Company the
general partner of which is Paul D. Rhines, a director of the Company, owned
278,182 shares of Ruffalo, Cody common stock, which were exchanged for
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<PAGE> 71
194,476 shares of Class A Common Stock, of which 29,171 shares were placed in
escrow to be released to Allsop, if at all, after six months, contingent upon
the fulfillment of certain conditions relating to Ruffalo, Cody's ongoing
revenues. Mr. Rhines served as a director of Ruffalo, Cody. A Special Committee
of the Board, consisting of disinterested directors, approved the acquisition of
Ruffalo, Cody as fair to, and in the best interests of, the stockholders of the
Company.
In June 1996, in connection with the initial public offering of the
Company's Class A Common Stock, Clark E. McLeod, Mary E. McLeod, MidAmerican and
IES purchased 125,000, 125,000, 1,000,000 and 500,000 shares of Class A Common
Stock, respectively, directly from the Company at the initial public offering
price of $20.00 per share for $2,500,000, $2,500,000, $20,000,000 and
$10,000,000, respectively. The Company was advised that such shares were
purchased for investment purposes. Mr. McLeod is a director and executive
officer of the Company and Mrs. McLeod, MidAmerican and IES are significant
stockholders of the Company.
During 1993, 1994 and 1995 the Company paid $91,191, $79,114 and $147,313,
respectively, to Shuttleworth & Ingersoll, P.C., a law firm in Cedar Rapids,
Iowa, for legal services rendered. The Company plans to retain the firm in 1996.
Thomas M. Collins, a director of the Company, is Chairman and a stockholder of
Shuttleworth & Ingersoll, P.C.
The Company paid $17,750, $50,932 and $38,000 during 1993, 1994 and 1995,
respectively, for use of an aircraft owned by ABCM Corporation ("ABCM"). McLeod
Transportation, Inc., an Iowa corporation whose stockholders include, among
others, the Company, Clark E. McLeod and McLeod Educational Group, Inc. (a
corporation controlled by Mr. McLeod) ("McLeod Educational Group"), owned 19% of
ABCM until March 1995. McLeod Transportation, Inc. was later liquidated. Mr.
McLeod is a director and executive officer of the Company.
The Company rents facilities and equipment, purchases maintenance and
installation services and pays commission on local and long distance sales to
customers of Digital Communications, Inc. ("Digital"), a corporation that is
controlled by Mary E. and Clark E. McLeod. Mr. McLeod and Mr. James L. Cram
serve on the Board of Directors of Digital. The Company paid Digital $36,393,
$83,591 and $94,871 in 1993, 1994 and 1995, respectively. Mr. McLeod is a
director and executive officer of the Company and Mr. Cram is an executive
officer of the Company.
The Company provided accounting, payroll and administrative services to
McLeod Educational Group, a corporation that owns and operates an elementary
school in Cedar Rapids, Iowa. McLeod Educational Group paid the Company $6,297,
$51,664 and $38,411 for these services in 1993, 1994 and 1995, respectively.
Since June 1996, the Company has rented office space from McLeod Educational
Group. The Company paid McLeod Educational Group an aggregate of approximately
$36,055 from June 1996 through September 1996 for this space. Clark E. McLeod
and Mary E. McLeod own over 99% of the stock of McLeod Educational Group. James
L. Cram owns less than 1% of the stock of McLeod Educational Group. Mr. McLeod
is a director and executive officer of the Company and Mr. Cram is an executive
officer of the Company.
The Company and Clark E. McLeod have entered into an agreement under which
they have agreed to share equally in the costs and damage awards, if any, of a
lawsuit brought by the Company and Mr. McLeod in Linn County, Iowa. The Company
has not to date incurred any material costs or received any damage awards in
connection with this lawsuit. See "Business -- Legal Proceedings."
The Company and McLeod Network Services, Inc. (a wholly owned subsidiary of
the Company) have entered into two agreements with IES pursuant to which IES has
agreed to grant the Company access to certain of IES' towers, rights-of-way,
conduits and poles in exchange for capacity on the Company's network. IES
purchased 5,625,000 shares of Class B Common Stock in April 1993 at an aggregate
price of $4.5 million. In February 1994, IES purchased 2,045,457 shares of Class
B Common Stock for an aggregate price of $3 million. IES also purchased 750,000
shares of Class B Common Stock for an aggregate price of $1.7 million on June
15, 1995. IES also guaranteed and/or supported certain portions of the Credit
Facility, for which IES received (i) fees
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<PAGE> 72
from the Company equal to $37,500, $60,000 and $28,000, respectively, for the
years ended December 31, 1994 and 1995 and the six months ended June 30, 1996,
and (ii) options to purchase an aggregate of 1,875,500 shares of Class B Common
Stock at an exercise price of $1.47 per share and an aggregate of 1,912,500
shares of Class B Common Stock at an exercise price of $2.27 per share. Options
to purchase shares of Class B Common Stock granted to IES in connection with the
Credit Facility vested quarterly so long as IES remained exposed under the
Credit Facility. At the time the Credit Facility was terminated, options to
purchase an aggregate of 1,300,688 shares of Class B Common Stock had vested.
Lee Liu, a director of the Company, is Chairman, Chief Executive Officer and
President of IES. Blake O. Fisher, Jr., a director and executive officer of the
Company, was the Executive Vice President and Chief Financial Officer of IES
until February 1996. IES is also a significant stockholder of the Company. See
"Principal and Selling Stockholders."
In February 1996, the Company entered into two agreements with MidAmerican,
which incorporate prior agreements entered into between the parties or their
subsidiaries, pursuant to which MidAmerican has agreed to grant the Company
access to certain of MidAmerican's towers, rights-of-way, conduits and poles in
exchange for capacity on the Company's network. In April 1995, McLeod, Inc.
acquired MWR from MidAmerican in return for 3,676,058 shares of Class B Common
Stock issued to Midwest Capital Group Inc. MidAmerican purchased 3,529,414
shares of Class B Common Stock of the Company in June 1995 at an aggregate price
of $8 million. Russell E. Christiansen, a director of the Company, is Chairman
and Chairman of the Office of the Chief Executive Officer of MidAmerican.
MidAmerican is also a significant stockholder of the Company. See "Principal and
Selling Stockholders."
In 1995, the Company paid 2060 Partnership, L.P. $377,640 for the rental of
the Company's headquarters office and parking spaces in Cedar Rapids, Iowa. 2001
Development Corporation ("2001"), an Iowa corporation, is the general partner
and 80% owner of 2060 Partnership, L.P. IES and the Company own 54.55% and
3.03%, respectively, of the outstanding stock of 2001. The Company purchased its
stock in 2001 for $250,000 in July 1995. The directors and officers of 2001
included Lee Liu and Thomas M. Collins, directors of the Company, and Clark E.
McLeod, a director and executive officer of the Company.
In April 1993, the Company sold 2,500,002 shares of Class A Common Stock to
Allsop for an aggregate price of $2 million. In February 1994, the Company sold
1,022,727 shares of Class A Common Stock to Allsop for an aggregate price of
$1.5 million. In June 1995, the Company sold 171,188 shares of Class A Common
Stock to Allsop for an aggregate price of $388,025. Mr. Paul D. Rhines, an
affiliate of Allsop, is a director of the Company.
In July 1991, January 1993, April 1993, February 1994 and June 1995, the
Company sold 18,750, 2,462,334, 1,250,003, 511,365 and 64,163 shares,
respectively, of Class A Common Stock to Clark E. McLeod for $5,000, $656,622,
$1,000,002, $750,002 and $145,435, respectively. Mr. McLeod is a director and
executive officer of the Company.
In January 1993, April 1993, February 1994 and June 1995, the Company sold
2,481,080, 1,249,999, 511,362 and 64,159 shares, respectively, of Class A Common
Stock to Mary E. McLeod for $661,621, $999,999, $749,997 and $145,427,
respectively. Mary E. McLeod is Mr. McLeod's wife. In January 1993, the Company
sold 34,459 shares of Class A Common Stock to Holly A. McLeod, Mr. and Mrs.
McLeod's daughter, for $9,189.
In January 1993 and in April 1993, the Company sold 153,548 and 18,750
shares, respectively, of Class A Common Stock to James L. Cram for $40,946 and
$15,000, respectively. In December 1995, the Company sold 11,250 shares of Class
A Common Stock to James L. Cram, upon exercise of stock options, for $3,000. Mr.
Cram is an executive officer of the Company. In January 1993 and in April 1993,
the Company sold 153,548 and 18,750 shares, respectively, of Class A Common
Stock to Virginia A. Cram for $40,946 and $15,000, respectively. Virginia A.
Cram is Mr. Cram's wife. In January 1993, Mr. Cram's children purchased an
aggregate of 37,500 shares of Class A Common Stock for $10,000.
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In January 1993, April 1993 and in February 1994, the Company sold 86,149,
18,750 and 15,000 shares, respectively, of Class A Common Stock to Stephen C.
Gray and Sally W. Gray as tenants in common, for $22,973, $15,000 and $22,000,
respectively. In April 1993, the Company sold 3,750 shares of Class A Common
Stock to the Stephen Samuel Gray Irrevocable Trust for $3,000. In January 1995,
the Company sold 22,500 shares of Class A Common Stock to Mernat & Co. f/b/o
Stephen C. Gray for $39,000. In June 1995, the Company sold 26,352 shares of
Class A Common Stock to Stephen C. Gray for $59,730, and 3,750 shares of Class A
Common Stock to Mernat & Co. f/b/o Stephen C. Gray IRA for $8,500. In June 1995,
the Company also sold 88,238 shares of Class A Common Stock to a profit sharing
trust, the beneficiary of which is Fred L. Wham, III, for $200,005. Mr. Gray
serves as a director and executive officer of the Company. Sally W. Gray,
Stephen Samuel Gray and Mr. Wham are Mr. Gray's wife, son and father-in-law,
respectively.
In January 1993, the Company sold 17,232 shares of Class A Common Stock to
Kirk E. Kaalberg for $4,595. In February 1996, the Company sold 23,438 shares of
Class A Common Stock to Blake O. Fisher, Jr., upon exercise of stock options,
for $23,125. In February 1994, the Company sold 34,092 and 34,092 shares,
respectively, of Class A Common Stock to Casey D. Mahon and to Dain Bosworth &
Company as custodian for Ms. Mahon's IRA for $50,001 and $50,001, respectively.
Mr. Fisher is a director and executive officer of the Company and Mr. Kaalberg
and Ms. Mahon are executive officers of the Company.
In April 1993, the Company sold 45,000 shares of Class A Common Stock for
$36,000 to each of two trusts (an aggregate of 90,000 shares for $72,000),
beneficiaries of which are Thomas M. Collins and Joanne H. Collins,
respectively. In February 1994, the Company sold 102,274 shares of Class A
Common Stock to a trust, the beneficiary of which is Thomas M. Collins, for
$150,002. Mr. Collins is a director of the Company and Joanne Collins is Mr.
Collins' wife.
Except for the stock issued in connection with the Company's April 1995
acquisition of MWR and the July 1996 acquisition of Ruffalo, Cody, all of the
stock issuances described above were for cash consideration.
In March 1996, the Board adopted a policy requiring that any material
transactions between the Company and persons or entities affiliated with
officers, directors or principal stockholders of the Company be on terms no less
favorable to the Company than reasonably could have been obtained in arms'
length transactions with independent third parties or be approved by a majority
of disinterested directors.
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EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the cash and
non-cash compensation during fiscal year 1995 earned by or awarded to the Chief
Executive Officer and to the four other most highly compensated executive
officers of the Company whose combined salary and bonus exceeded $100,000 during
the fiscal year ended December 31, 1995 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
-------------------- UNDERLYING ALL OTHER
SALARY BONUS OPTIONS COMPENSATION(1)
-------- ------- ------------ ---------------
<S> <C> <C> <C> <C>
Clark E. McLeod...................... $142,803 $74,902 75,000 1,500
Chairman and Chief
Executive Officer
Stephen C. Gray...................... 142,807 74,902 131,250 1,500
President and Chief
Operating Officer
Kirk E. Kaalberg..................... 101,528 56,177 75,000 1,463
Executive Vice President, Network
Services
James L. Cram........................ 102,884 56,177 84,375 1,500
Chief Accounting Officer
Stephen K. Brandenburg............... 106,692 33,842 187,500 --
Chief Information Officer
</TABLE>
- ---------------
(1) All other compensation represents matching contributions made by the Company
to the McLeod, Inc. 401(k) plan on behalf of the Named Executive Officers.
OPTION GRANTS
The following table sets forth information with respect to grants of stock
options to each of the Named Executive Officers during the year ended December
31, 1995.
OPTION GRANTS DURING 1995
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS(1) POTENTIAL REALIZED
-------------------------------------------------------------------------- VALUE AT
PERCENT OF ASSUMED ANNUAL
NUMBER OF TOTAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO FOR OPTION TERM(2)
OPTIONS EMPLOYEES IN EXERCISE -------------------
NAME GRANTED FISCAL YEAR PRICE GRANT DATE EXPIRATION DATE 5% 10%
- ------------------------------- ---------- ------------ -------- ---------------- ---------------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Clark E. McLeod................ 18,750(4) 1.0% $ 1.91 January 26, 1995 January 26, 2000 $ 9,877 $ 21,826
56,250(5) 3.1% 2.49 July 27, 1995 July 27, 2000 38,748 85,624
Stephen C. Gray................ 75,000(4) 4.1% 1.73 January 26, 1995 January 26, 2002 52,931 123,344
56,250(5) 3.1% 2.27 July 27, 1995 July 27, 2005 80,184 203,202
Kirk E. Kaalberg............... 18,750(4) 1.0% 1.73 January 26, 1995 January 26, 2002 13,239 30,844
56,250(5) 3.1% 2.27 July 27, 1995 July 27, 2005 80,184 203,202
James L. Cram.................. 28,125(4) 1.5% 1.73 January 26, 1995 January 26, 2002 19,854 46,260
56,250(3) 3.1% 2.27 July 27, 1995 July 27, 2002 51,916 120,975
Stephen K. Brandenburg......... 131,250(4) 7.2% 2.27 June 29, 1995 June 29, 2002 121,123 282,257
56,250(5) 3.1% 2.27 July 27, 1995 July 27, 2005 80,184 203,202
</TABLE>
- ---------------
(1) All options are exercisable for shares of Class A Common Stock. Options
granted pursuant to the 1992 and 1993 Incentive Stock Option Plans will
become exercisable as follows: (i) 25% of the options will become
exercisable on the first anniversary of the date of grant, (ii) an
additional 25% will become exercisable on the second anniversary of the date
of grant, (iii) an additional 25% will
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become exercisable on the third anniversary of the date of grant, and (iv)
the remaining 25% will become exercisable on the fourth anniversary of the
date of grant. Options granted pursuant to the 1995 Incentive Stock Option
Plan will become exercisable at a rate of 25% per year, on a cumulative
basis, beginning five years from the date of grant, except for options
issued to Clark E. McLeod, the Company's Chairman and Chief Executive
Officer. Options issued to Mr. McLeod under the 1995 Incentive Stock Option
Plan vest at a rate of 20% per year, on a cumulative basis.
(2) Based on exercise price.
(3) Granted pursuant to the 1992 Incentive Stock Option Plan.
(4) Granted pursuant to the 1993 Incentive Stock Option Plan.
(5) Granted pursuant to the 1995 Incentive Stock Option Plan.
OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table sets forth the information with respect to the Named
Executive Officers concerning the exercise of options during fiscal year 1995
and unexercised options held as of December 31, 1995.
OPTION EXERCISES DURING 1995
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------ ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Clark E. McLeod............... 0 $ 0 219,224 208,074 $ 467,492 $ 287,029
Stephen C. Gray............... 0 0 390,000 333,750 878,000 520,500
Kirk E. Kaalberg.............. 0 0 145,313 192,187 302,501 252,499
James L. Cram................. 11,250 27,000 207,974 228,699 451,138 347,128
Stephen K. Brandenburg........ 0 0 0 187,500 0 75,000
</TABLE>
- ---------------
(1) Represents the difference between the exercise price and a fair market value
of $2.67 as determined by the Board.
MANAGEMENT AGREEMENTS
Employment, Confidentiality and Non-Competition Agreements. The Company
has entered into employment, confidentiality and non-competition agreements with
54 members of senior management, including the Named Executive Officers,
pursuant to which the senior managers have agreed that during the term of
employment and for a two-year period following a termination for cause,
resignation or voluntary termination of employment (other than on account of the
Company's discontinuance of activities), the executive employee will not compete
with the Company. The two-year period is reduced to a one-year period for senior
management employees who are not executive employees. The agreements also
provide that employees subject to the agreements may not disclose any Company
confidential information while employed by the Company or thereafter. The
agreements have an indefinite term but may be terminated on 30 days' written
notice by either party, provided, however, that the confidentiality and
non-competition obligations will survive any such termination. As partial
consideration for the execution of the employment, confidentiality and
non-competition agreements, the Company has granted to the employees signing
such agreements options to purchase an aggregate of 919,500 shares of Class A
Common Stock at exercise prices ranging from $20.00 to $33.875 per share. Such
options were granted pursuant to the Company's 1996 Employee Stock Option Plan,
with vesting generally to occur with respect to one-third of the shares subject
to such options in the last month of the fourth year following the date of
grant, and with an additional one-third of the shares subject to such options
vesting in each of the two subsequent seven-month periods. As an owner of more
than 10% of the outstanding Common Stock of the Company, Clark E. McLeod is
ineligible, pursuant to Sections 422(b)(6) and 424(d) of the Internal Revenue
Code of 1986, as amended (the "Code"), to receive options intended to qualify as
incentive stock options under the Code if such options vest after the expiration
of five years from the date of grant. Accordingly, options to purchase 23,000
shares of Class A Common
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<PAGE> 76
Stock granted to Clark E. McLeod pursuant to an employment, confidentiality and
non-competition agreement vest (i) with respect to options to purchase 13,636
shares of Class A Common Stock, one-third in the last month of the third year
following the date of grant and one-third in each of the two subsequent seven
month periods (which options are intended to qualify as incentive stock options
under the Code) and (ii) as to the remaining options (which are not intended to
qualify as incentive stock options under the Code), one-third in the last month
of the fourth year following the date of grant and one-third in each of the two
subsequent seven month periods. See "Management -- Stock Option Plans -- 1996
Employee Stock Option Plan."
Change-of-Control Agreements. The Company has entered into
change-of-control agreements with certain executive employees, including the
Named Executive Officers, which provide for certain payments and benefits in
connection with certain terminations of employment after a change of control of
the Company. The change of control agreements terminate on December 31, 2006
unless a change of control has occurred during the six months preceding December
31, 2006 in which case the agreements terminate on December 31, 2007. If an
executive who is a party to a change of control agreement terminates employment
within six months after a "change of control" or, if within 24 months after a
"change of control," the executive's employment is terminated by the Company
(other than for "disability," "cause," death or "retirement") or by the
executive following a "material reduction" in responsibilities or compensation
(as such terms are defined in the agreements), (i) the executive will be
entitled to a lump sum payment equal to 24 times the executive's "average
monthly compensation" (as defined) during the 12 months immediately preceding
the change of control or the date of termination, whichever average monthly
compensation is higher, (ii) all of the executive's outstanding options to
purchase stock of the Company will become immediately exercisable in full and
(iii) if the executive elects to continue coverage under the Company's group
health plan pursuant to Section 4980B of the Code, the Company will continue to
pay the employer portion of the premiums for such coverage for the longer of 24
months or the period of coverage provided pursuant to Section 4980B. An
executive who is entitled to payment(s) pursuant to a change of control
agreement is subject to a non-compete provision generally restricting the
executive from competing with the Company for a two-year period after the
termination of employment.
STOCK OPTION PLANS
1992 Incentive Stock Option Plan. Under the Company's 1992 Incentive Stock
Option Plan (the "1992 Plan"), the Company was authorized to grant options to
purchase up to 1,275,000 shares of Class A Common Stock to selected management
and other key employees of the Company. These options are intended to qualify as
incentive stock options under Section 422 of the Code. The Board selects
optionees and determines the number of shares covered by each option and the
terms of the option agreement to be executed by the Company and each optionee.
As of September 30, 1996, options to purchase 1,271,021 shares of Class A Common
Stock had been granted under the 1992 Plan and options to purchase 17,615 shares
of Class A Common Stock had been exercised. The option agreements under the 1992
Plan typically include provisions by which (i) options granted under the 1992
Plan may be exercised with respect to 25 percent of the shares subject to such
option one year after the option is granted and with respect to an additional 25
percent of the shares subject to such option in each of the three subsequent
years and (ii) options expire seven years after the date of grant. The 1992 Plan
provides that optionees may not dispose of shares of Class A Common Stock
acquired pursuant to the exercise of an option unless they have first complied
with certain transfer restrictions. The exercise price of the options granted
under the 1992 Plan is equal to the fair market value of the Class A Common
Stock as determined by the Board as of the date of grant. Shares of Class A
Common Stock issued under the 1992 Plan have been registered under the
Securities Act on Form S-8. The Board terminated the 1992 Plan in March 1996 in
connection with the adoption of the Company's 1996 Employee Stock Option Plan
(as amended, the "1996 Plan").
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<PAGE> 77
1993 Incentive Stock Option Plan. Under the Company's 1993 Incentive Stock
Option Plan (the "1993 Plan"), the Company was authorized to grant options to
purchase up to 4,513,767 shares of Class A Common Stock to selected management
and key employees of the Company. These options are intended to qualify as
incentive stock options under Section 422 of the Code. The Board selects the
optionees and determines the number of shares of Class A Common Stock covered by
each option and the terms of the option agreement to be executed by the Company
and each optionee. As of September 30, 1996, options to purchase 4,224,787
shares of Class A Common Stock had been granted under the 1993 Plan and options
to purchase 163,538 shares of Class A Common Stock had been exercised. The
option agreements under the 1993 Plan typically include provisions by which (i)
options granted under the 1993 Plan may be exercised with respect to 25 percent
of the shares subject to such option one year after the option is granted and
with respect to an additional 25 percent of the shares subject to such option in
each of the three subsequent years and (ii) options expire seven years after the
date of grant. The 1993 Plan provides that optionees may not sell shares of
Class A Common Stock acquired pursuant to the exercise of an option unless they
have first offered such shares of Class A Common Stock to the Company and all of
the other stockholders. By resolution of the Board, the Company has waived and
extinguished this right of first refusal. The exercise price of options granted
under the 1993 Plan is equal to the fair market value of a share of Class A
Common Stock as determined by the Board on the date of grant. Shares of Class A
Common Stock issued under the 1993 Plan have been registered under the
Securities Act on Form S-8. The Board terminated the 1993 Plan in March 1996 in
connection with the adoption of the 1996 Plan.
1995 Incentive Stock Option Plan. Under the Company's 1995 Incentive Stock
Option Plan (the "1995 Plan"), the Company was authorized to grant options to
purchase up to 337,500 shares of Class A Common Stock to selected management and
key employees of the Company. These options are intended to qualify as incentive
stock options under Section 422 of the Code. The Board selects the optionees and
determines the number of shares of Class A Common Stock covered by each option
and the terms of the option agreement to be executed by the Company and each
optionee. As of September 30, 1996, options to purchase 337,500 shares of Class
A Common Stock had been granted under the 1995 Plan and no options had been
exercised. The option agreements under the 1995 Plan typically include
provisions by which (i) options granted under the 1995 Plan may be exercised
with respect to 25 percent of the shares subject to such option five years after
the option is granted and with respect to an additional 25 percent of the shares
subject to such option in each of the three subsequent years and (ii) options
expire ten years after the date of grant. Options issued to Clark E. McLeod,
Chairman and Chief Executive Officer of the Company, under the 1995 Plan vest at
a rate of 20% per year on a cumulative basis and expire five years after the
date of grant. The 1995 Plan provides that optionees may not sell shares of
Class A Common Stock acquired pursuant to the exercise of an option unless they
have first offered such shares of Class A Common Stock to the Company and all of
the other stockholders. By resolution of the Board, the Company has waived and
extinguished this right of first refusal. The exercise price of options granted
under the 1995 Plan is equal to the fair market value of a share of Class A
Common Stock as determined by the Board on the date of grant. Shares of Class A
Common Stock issued under the 1995 Plan have been registered under the
Securities Act on Form S-8. The Board terminated the 1995 Plan in March 1996 in
connection with the adoption of the 1996 Plan.
1996 Employee Stock Option Plan. Under the 1996 Plan, which supersedes the
1992 Plan, the 1993 Plan and the 1995 Plan, the Company may grant options to
purchase up to 4,523,950 shares of Class A Common Stock to employees of the
Company or any of its subsidiaries, or other individuals whose participation in
the 1996 Plan is determined to be in the best interests of the Company by the
Compensation Committee. In the event there is any increase or decrease in the
number of shares of Class A Common Stock without receipt of consideration by the
Company (for instance, by a recapitalization or stock split) after the effective
date of the 1996 Plan, an appropriate and proportionate adjustment will be made
in the number and kinds of shares subject to the 1996 Plan, and in the number,
kinds, and per-share exercise price of shares subject to the unexercised portion
of options granted prior to any such change. The 1996 Plan provides for the
grant of options that are intended to qualify as "incentive stock options" under
Section 422 of the Code to employees of the
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Company as well as the grant of non-qualifying options to officers, directors or
key employees of the Company, or other individuals whose participation in the
1996 Plan is determined to be in the best interests of the Company by the
Compensation Committee. The Compensation Committee administers the 1996 Plan,
selects the optionees and determines the number of shares of Class A Common
Stock covered by each option and the terms of the option agreement to be
executed by the Company and each optionee. As of September 30, 1996, options to
purchase 1,687,489 shares of Class A Common Stock had been granted under the
1996 Plan, including options to purchase an aggregate of 919,500 shares of Class
A Common Stock, at exercise prices ranging from $20.00 to $33.875 per share,
granted to certain senior management employees of the Company as partial
consideration for the execution of employment, confidentiality and
non-competition agreements, and options to purchase an aggregate of 158,009
shares of Class A Common Stock, at exercise prices ranging from $1.43 to $9.30,
granted in connection with Company's acquisition of Ruffalo, Cody. As of
September 30, 1996, options to purchase an aggregate of 1,050 shares of Class A
Common Stock had been exercised. See "-- Management Agreements." Although
4,523,950 shares of Class A Common Stock are reserved for issuance upon exercise
of options granted pursuant to the 1996 Plan, the Board intends to limit at all
times the aggregate number of shares subject to outstanding stock options under
all stock option plans of the Company to no more than 15% of the then-issued and
outstanding shares of the authorized Class A Common Stock and the then-granted
and outstanding options. The option exercise price for incentive stock options
granted under the 1996 Plan may not be less than 100% of the fair market value
of the Class A Common Stock on the date of grant of the option (or 110% in the
case of an incentive stock option granted to an optionee beneficially owning
more than 10% of the outstanding Class A Common Stock). The option exercise
price for non-incentive stock options granted under the 1996 Plan may not be
less than 50% of the fair market value of the Class A Common Stock on the date
of grant of the option. The maximum option term is ten years (or five years in
the case of an incentive stock option granted to an optionee beneficially owning
more than 10% of the outstanding Class A Common Stock). Options may be exercised
at any time after grant, except as otherwise determined by the Compensation
Committee and provided in the particular option agreement. Options covering no
more than 2,000,000 shares of Class A Common Stock may be granted to any officer
or other employee during the term of the 1996 Plan. There is also a $100,000
limit on the value of stock (determined at the time of grant) covered by
incentive stock options that first become exercisable by an optionee in any
calendar year. Options are non-transferable. Shares of Class A Common Stock
issued or issuable under the 1996 Plan have been registered under the Securities
Act on Form S-8. The Board at any time may terminate or suspend the 1996 Plan.
Unless previously terminated, the 1996 Plan will terminate automatically on
March 28, 2006. No termination, suspension or amendment of the 1996 Plan may,
without the consent of the optionee to whom an option has been granted,
adversely affect the rights of the holder of the option.
Directors Stock Option Plan. The Company's Directors Stock Option Plan
(the "Directors Plan") was adopted by the Board and approved by the stockholders
in 1993. On March 28, 1996, the Directors Plan was amended and restated to be a
"formula" plan providing for an automatic grant of stock options to eligible
non-employee directors. Under the Directors Plan, as amended, the number of
shares reserved for purchase pursuant to options was increased to an aggregate
of 550,000 shares of Class A Common Stock (subject to adjustment for certain
events, such as recapitalizations or stock splits, effected without
consideration) for grants to directors of the Company who are not officers or
employees of the Company (each an "Eligible Director"). Options for 332,813
shares of Class A Common Stock had been granted under the Directors Plan and
options to purchase 23,438 shares of Class A Common Stock had been exercised as
of September 30, 1996. The option agreements under the Directors Plan prior to
its amendment and restatement in 1996 typically included provisions by which (i)
options granted under the Directors Plan may be exercised with respect to 25
percent of the shares subject to such option one year after the option is
granted and with respect to an additional 25 percent of the shares subject to
such option in each of the three subsequent years, (ii) all options expire seven
years after the date of grant, (iii) optionees may not dispose of shares of
Class A Common Stock acquired pursuant to the exercise of an option unless the
Company has filed an effective Registration Statement under the
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<PAGE> 79
Securities Act covering the stock or the director has furnished an opinion of
counsel satisfactory to the Company or a Securities and Exchange Commission "no
action" letter stating that no such registration is required and (iv) in the
event of an attempt to transfer shares of Class A Common Stock issued pursuant
to the exercise of an option, except a transfer to a Company employee or
director approved by the Board, the Company has the right to repurchase the
Class A Common Stock for a price which is the greater of the book value of the
Class A Common Stock or the then fair market value of the Common Stock, as
determined by the Board. Under the Directors Plan, as amended, each Eligible
Director who commences service as a director after the 1996 amendment and
restatement of the Directors Plan is granted an initial option to purchase
10,000 shares of Class A Common Stock. Each such Eligible Director is also
granted an additional option to purchase 5,000 shares of Class A Common Stock
immediately after each of the next two annual meetings of the Company's
stockholders if the Eligible Director continues to be an Eligible Director.
Options granted under the Directors Plan, as amended, may be exercised with
respect to 25 percent of the shares subject to such option one year after the
option is granted and with respect to an additional 25 percent of the shares
subject to such option in each of the three subsequent years; provided, however,
that all unvested options become fully exercisable upon a change in control of
the Company (as defined in the Directors Plan). Shares of Class A Common Stock
issued or issuable under the Directors Plan, as amended, have been registered
under the Securities Act on Form S-8. All options expire ten years after the
date of grant. The Directors Plan will terminate automatically on March 28,
2006, unless terminated at an earlier date by the Board.
THE EMPLOYEE STOCK PURCHASE PLAN
Under the Company's Employee Stock Purchase Plan (the "Employee Purchase
Plan"), 1,000,000 shares of Class A Common Stock are available for purchase by
eligible employees of the Company. The Employee Purchase Plan permits eligible
employees to elect to have a portion of their pay deducted to purchase shares of
Class A Common Stock of the Company. In the event there is any increase or
decrease in the number of shares of Class A Common Stock without receipt of
consideration by the Company (for instance, by a recapitalization or stock
split), there may be a proportionate adjustment to the number and kinds of
shares that may be purchased under the Employee Purchase Plan. Generally,
payroll deductions will be accumulated during the period to be specified by the
Compensation Committee (the "Payroll Deduction Period"). The Company has not yet
implemented the Employee Purchase Plan.
All employees of the Company are eligible to participate in the Employee
Purchase Plan, except the following: (a) an employee who has been employed by
the Company for less than six months as of the beginning of a Payroll Deduction
Period; (b) an employee whose customary employment is for less than five months
in any calendar year; (c) an employee whose customary employment is 20 hours or
less per week; and (d) an employee who, after exercising his or her rights to
purchase stock under the Employee Purchase Plan, would own stock (including
stock that may be acquired under any outstanding options) representing five
percent or more of the total combined voting power of all classes of stock of
the Company. An employee must be employed on the last day of the Payroll
Deduction Period in order to acquire stock under the Employee Purchase Plan
unless the employee has retired, died or become disabled, or was involuntarily
terminated other than for cause.
Rights to purchase shares of Class A Common Stock will be deemed granted to
participating employees as of the first trading day of each Payroll Deduction
Period. The purchase price for each share will be established by the
Compensation Committee, but will not be less than 85% of the fair market value
of the Class A Common Stock on the first or last trading day of such Payroll
Deduction Period, whichever is lower. No employee may purchase Class A Common
Stock in any calendar year under the Employee Purchase Plan and all other
"employee stock purchase plans" of the Company having an aggregate fair market
value in excess of $25,000, determined as of the first trading date of the
Payroll Deduction Period. No participating employee may assign his or her rights
to purchase shares of Class A Common Stock under the Employee Purchase Plan,
whether
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voluntarily, by operation of law or otherwise. Shares of Class A Common Stock
issuable under the Employee Purchase Plan have been registered under the
Securities Act on Form S-8.
The Board in its sole discretion may terminate the Employee Purchase Plan
at any time, provided, however, that such termination shall not impair any
rights of participants that have vested at the time of termination. In any
event, the Employee Purchase Plan shall, without further action of the Board,
terminate at the earlier of (i) March 28, 2006 and (ii) such time as all shares
of Class A Common Stock that may be made available for purchase under the
Employee Purchase Plan have been issued.
INCENTIVE COMPENSATION PLAN
On September 20, 1996, in connection with the Company's acquisition of
Telecom*USA Publishing, the Company adopted the McLeod, Inc. Incentive Plan (the
"Incentive Plan"). The 155 employees of Telecom*USA Publishing who held
non-vested options (the "Telecom Non-Vested Options") to purchase shares of
Telecom*USA Publishing common stock under its incentive stock option plan on
September 20, 1996 (the "Telecom Participants") are eligible to participate in
the Incentive Plan. Under the Incentive Plan, each Telecom Participant received
a unit of participation (a "Unit") for each Telecom Non-Vested Option held by
such Telecom Participant. On September 20, 1996, an aggregate of 210,825 Units
were granted to the Telecom Participants under the Incentive Plan and each Unit
had a value of $12.75 less the option exercise price of the corresponding
Telecom Non-Vested Option. Units accrue earnings at an annual rate of no less
than 6% and can, in certain circumstances, accrue earnings up to 31% annually
depending on Telecom*USA Publishing's operating income. Units vest on January 1
of the year following the year in which the corresponding Telecom Non-Vested
Option would have vested. Distributions with respect to each vested Unit and the
earnings accrued thereon are made as soon as practicable following the January 1
vesting date. The Incentive Plan is administered by the Board, which may
terminate or amend the Incentive Plan at any time. No additional Units will be
granted under the Incentive Plan.
CERTAIN TRANSACTIONS
On July 18, 1995 and March 29, 1996, respectively, the Company loaned
$75,000 to each of Kirk E. Kaalberg and Stephen K. Brandenburg in exchange for
unsecured notes executed by Mr. Kaalberg and Mr. Brandenburg, respectively.
Interest accrues on both loan amounts at the applicable rate as determined in
accordance with Internal Revenue Service regulations. Pursuant to the terms of
the notes executed by Mr. Kaalberg and Mr. Brandenburg, respectively, annual
interest-only payments will be made through 1997 and 1998, respectively. They
will then make annual payments of $25,000 plus accrued interest in each of the
respective three years thereafter. Messrs. Kaalberg and Brandenburg are
executive officers of the Company.
For a description of certain other transactions, see "Business -- Legal
Proceedings" and "Management -- Compensation Committee Interlocks and Insider
Participation."
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Class A Common Stock as of September 30,
1996 by (i) each stockholder who is known by the Company to beneficially own 5%
or more of any class of the Company's capital stock, (ii) each director of the
Company, (iii) each Named Executive Officer, (iv) each Selling Stockholder and
(v) all directors and executive officers of the Company as a group.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
PRIOR TO BENEFICIAL OWNERSHIP
OFFERING(1)(2) AFTER OFFERING(1)
-------------------- NUMBER OF --------------------
NUMBER OF SHARES NUMBER OF
NAME OF BENEFICIAL OWNER SHARES PERCENT OFFERED SHARES PERCENT
- ------------------------------------------- ---------- ------- --------- ---------- -------
<S> <C> <C> <C> <C> <C>
IES Investments Inc.(3).................... 10,221,145 25.2% -- 10,578,288 23.3%
Clark E. McLeod(4)......................... 9,285,942 29.8 -- 9,393,085 26.0
MWR Investments Inc.(5).................... 8,205,472 21.6 -- 8,562,615 19.9
Mary E. McLeod(6).......................... 4,451,459 14.4 -- 4,505,030 12.6
Allsop Venture Partners III, L.P.(7)....... 3,888,393 12.6 -- 3,888,393 10.9
Putnam Investments, Inc.(8)................ 3,281,270 10.6 -- 3,281,270 9.2
Russell E. Christiansen(9)................. 9,375 * -- 9,375 *
Thomas M. Collins(10)...................... 227,431 * -- 227,431 *
Paul D. Rhines(11)......................... 3,923,550 12.7 -- 3,923,550 11.0
Lee Liu(12)................................ 35,157 * -- 35,157 *
James L. Cram(13).......................... 609,240 2.0 142,581 466,659 1.3
Stephen C. Gray(14)........................ 747,190 2.4 125,806 621,384 1.7
Kirk E. Kaalberg(15)....................... 246,921 * 33,548 213,373 *
Stephen K. Brandenburg(16)................. 46,876 * -- 46,876 *
Casey D. Mahon(17)......................... 225,217 * 50,323 174,894 *
Albert P. Ruffalo(18)...................... 105,976 * 16,774 89,202 *
Michael J. Brown(19)....................... 106,989 * 41,935 65,054 *
Laura L. Dement(20)........................ 56,240 * 10,065 46,175 *
Joseph P. Cunningham(21)................... 56,052 * 10,065 45,987 *
Directors and executive officers as a group
(14 persons)(22)......................... 15,496,313 47.5% 369,032 15,234,424 40.7%
</TABLE>
- ---------------
* Less than one percent.
(1) In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), a person is deemed to be a "beneficial owner"
of a security if he or she has or shares the power to vote or direct the
voting of such security or the power to dispose or direct the disposition
of such security. A person is also deemed to be a beneficial owner of any
securities of which that person has the right to acquire beneficial
ownership within 60 days. More than one person may be deemed to be a
beneficial owner of the same securities. The percentage ownership of each
stockholder is calculated based on the total number of outstanding shares
of Class A Common Stock as of September 30, 1996 and those shares of Class
A Common Stock that may be acquired by such stockholder within 60 days.
Consequently, the denominator for calculating such percentage may be
different for each stockholder.
(2) This table is based upon information supplied by directors, executive
officers, selling stockholders and principal stockholders. Unless otherwise
indicted in the footnotes to this table, each of the stockholders named in
this table has sole voting and investment power with respect to the shares
shown as beneficially owned.
(3) Includes 500,000 shares of Class A Common Stock, 8,420,457 shares of Class
B Common Stock and 357,143 shares of Class A Common Stock that IES has
agreed to purchase in the Offering. IES Investments Inc. is a wholly owned
indirect subsidiary of IES. The address of IES is 200 1st St., SE, Cedar
Rapids, IA 52401. Includes 1,300,688 shares of Class B Common Stock that
IES has the right to purchase pursuant to options. IES has entered into a
definitive agreement of merger with WPL Holdings, Inc., the parent of
Wisconsin Power Light Company, and with Interstate Power Company, which
merger is subject to certain regulatory and other approvals.
(4) Includes 4,508,418 shares of Class A Common Stock held of record by members
of Clark E. McLeod's family, including Mary E. McLeod, Mr. McLeod's wife.
Mr. McLeod's address is c/o McLeod, Inc., Suite 500, Town Centre, 221 3rd
Ave., SE, Cedar Rapids, IA 52401. Includes 326,050 shares of Class A Common
Stock that Mr. McLeod has the right to purchase within 60 days from
September 30, 1996 pursuant to options and 107,143 shares of Class A Common
Stock that Clark and Mary McLeod have agreed to purchase in the Offering.
(Footnotes continued on following page)
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<PAGE> 82
(5) Includes 1,000,000 shares of Class A Common Stock, 7,205,472 shares of
Class B Common Stock and 357,143 shares of Class A Common Stock that
MidAmerican has agreed to purchase in the Offering. MWR Investments Inc. is
a wholly owned indirect subsidiary of MidAmerican. The address of MWR
Investments, Inc. is c/o MidAmerican Energy Company, 500 E. Court Ave., Des
Moines, IA 50309.
(6) Includes 53,571 shares of Class A Common Stock that Mrs. McLeod has agreed
to purchase in the Offering. Mrs. McLeod's address is c/o McLeod, Inc.,
Suite 500, Town Centre, 221 3rd Ave., SE, Cedar Rapids, IA 52401.
(7) The address of Allsop is 2750 1st Ave., NE, Cedar Rapids, IA 52402.
(8) Includes 3,214,270 and 67,000 shares of Class A Common Stock held as of
August 6, 1996 by Putnam Investment Management, Inc. and The Putnam
Advisory Group, Inc., respectively, as disclosed on a Schedule 13G filed by
Putnam Investments, Inc. with the Securities and Exchange Commission (the
"Commission"). The address of Putnam Management, Inc. and The Putnam
Advisory Group, Inc. is c/o Putnam Investments, Inc., One Post Office
Square, Boston, MA 02109.
(9) Includes 9,375 shares of Class A Common Stock that Mr. Christiansen has the
right to purchase within 60 days from September 30, 1996 pursuant to
options.
(10) Includes 35,157 shares of Class A Common Stock that Mr. Collins has the
right to purchase within 60 days from September 30, 1996 pursuant to
options.
(11) Mr. Rhines' address is c/o Allsop Venture Partners III, L.P., 2750 1st
Ave., NE, Cedar Rapids, IA 52402. Includes 3,888,393 shares of Class A
Common Stock held of record by Allsop. Includes 35,157 shares of Class A
Common Stock that Mr. Rhines has the right to purchase within 60 days from
September 30, 1996 pursuant to options.
(12) Includes 35,157 shares of Class A Common Stock that Mr. Liu has the right
to purchase within 60 days from September 30, 1996 pursuant to options.
(13) Includes 140,423 shares of Class A Common Stock held of record by members
of James L. Cram's family. Includes 317,144 shares of Class A Common Stock
that Mr. Cram has the right to purchase within 60 days from September 30,
1996 pursuant to options.
(14) Includes 119,899 shares of Class A Common Stock held as tenants in common
with Sally W. Gray, Mr. Gray's wife. Also includes 3,750 shares of Class A
Common Stock held of record by the Stephen Samuel Gray Irrevocable Trust,
and 3,750 shares of Class A Common Stock held of record by the Elizabeth
Mary Fletcher Gray Education Trust, of which Mr. Gray is the trustee.
Includes 26,250 shares of Class A Common Stock held of record by Mernat &
Co. for the benefit of Mr. Gray. Includes 570,939 shares of Class A Common
Stock that Mr. Gray has the right to purchase within 60 days from September
30, 1996 pursuant to options.
(15) Includes 229,689 shares of Class A Common Stock that Mr. Kaalberg has the
right to purchase within 60 days from September 30, 1996 pursuant to
options.
(16) Includes 46,876 shares of Class A Common Stock that Mr. Brandenburg has the
right to purchase within 60 days from September 30, 1996 pursuant to
options.
(17) Includes 157,033 shares of Class A Common Stock that Ms. Mahon has the
right to purchase within 60 days from September 30, 1996 pursuant to
options.
(18) Includes 73,600 shares of Class A Common Stock and options to purchase
32,376 shares of Class A Common Stock issued in connection with the
Company's acquisition of Ruffalo, Cody on July 15, 1996.
(19) Includes 93,751 shares of Class A Common Stock that Mr. Brown has the right
to purchase within 60 days from September 30, 1996 pursuant to options. Mr.
Brown is a Senior Vice President of McLeod Telemanagement.
(20) Includes 37,386 shares of Class A Common Stock and options to purchase
18,854 shares of Class A Common Stock issued in connection with the
Company's acquisition of Ruffalo, Cody on July 15, 1996. Ms. Dement is a
Vice President of Ruffalo, Cody.
(21) Includes 40,301 shares of Class A Common Stock and options to purchase
15,751 shares of Class A Common Stock issued in connection with the
Company's acquisition of Ruffalo, Cody on July 15, 1996. Mr. Cunningham is
the Vice President and Chief Financial Officer of Ruffalo, Cody.
(22) Includes 1,794,953 shares of Class A Common Stock that such persons have
the right to purchase within 60 days from September 30, 1996 pursuant to
options. Includes 107,143 shares of Class A Common Stock that Clark and
Mary McLeod have agreed to purchase in the Offering.
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<PAGE> 83
DESCRIPTION OF CAPITAL STOCK
The following summary description of the capital stock of the Company does
not purport to be complete and is subject to the provisions of the Company's
Restated Certificate and Amended and Restated Bylaws (the "Bylaws"), which are
included as exhibits to the Registration Statement of which this Prospectus
forms a part and by the provisions of applicable law.
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
Pursuant to the Restated Certificate, the Company has authority to issue
100,150,000 shares of capital stock, consisting of 75,000,000 shares of Class A
Common Stock, par value $.01 per share, 22,000,000 shares of Class B Common
Stock, par value $.01 per share, 2,000,000 shares of Preferred Stock, par value
$.01 per share and 1,150,000 shares of Class A Preferred Stock, par value $5.50
per share (the "Class A Preferred Stock"). As of November 13, 1996, the Class A
Common Stock was held by 375 holders of record and the Class B Common Stock was
held by two holders of record.
As of September 30, 1996, 30,855,997 shares of Class A Common Stock
(including 113,387 shares of Class A Common Stock placed into escrow in
connection with the acquisition of Ruffalo, Cody and 110,702 shares of Class A
Common Stock issued in November 1996 pursuant to the exercise of options by
certain Selling Stockholders), 15,625,929 shares of Class B Common Stock, no
shares of Preferred Stock, par value $.01 per share and no shares of Class A
Preferred Stock were issued and outstanding. See "Business -- Recent
Transactions."
The rights of the holders of Common Stock discussed below are subject to
the rights of the holders of Class A Preferred Stock and to such rights as the
Board may hereafter confer on the holders of Preferred Stock; accordingly,
rights conferred on holders of Preferred Stock that may be issued in the future
under the Restated Certificate may adversely affect the rights of holders of
Common Stock.
CLASS A COMMON STOCK
Voting Rights. Each holder of the Class A Common Stock shall be entitled
to attend all special and annual meetings of the stockholders of the Company
and, together with the holders of shares of Class B Common Stock and the holders
of all other classes of stock entitled to attend and vote at such meetings, to
vote upon any matter or thing (including, without limitation, the election of
one or more directors) properly considered and acted upon by the stockholders.
Holders of the Class A Common Stock are entitled to one vote per share.
Liquidation Rights. In the event of any dissolution, liquidation or
winding up of the Company, whether voluntary or involuntary, the holders of the
Class A Common Stock, the holders of the Class B Common Stock and holders of any
class or series of stock entitled to participate therewith, shall become
entitled to participate in the distribution of any assets of the Company
remaining after the Company shall have paid, or provided for payment of, all
debts and liabilities of the Company and after the Company shall have paid, or
set aside for payment, to the holders of any class of stock having preference
over the Common Stock in the event of dissolution, liquidation or winding up the
full preferential amounts (if any) to which they are entitled.
Dividends. Dividends may be paid on the Class A Common Stock, the Class B
Common Stock and on any class or series of stock entitled to participate
therewith when and as declared by the Board.
CLASS B COMMON STOCK
Voting Rights. Each holder of the Class B Common Stock shall be entitled
to attend all special and annual meetings of stockholders of the Company and,
together with the holders of shares of Class A Common Stock and the holders of
all other classes of stock entitled to attend and vote at
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<PAGE> 84
such meetings, to vote upon any matter or thing (including, without limitation,
the election of one or more directors) properly considered and acted upon by the
stockholders. Holders of the Class B Common Stock are entitled to .40 vote per
share.
Liquidation Rights. In the event of any dissolution, liquidation or
winding up of the Company, whether voluntary or involuntary, the holders of the
Class B Common Stock, the holders of the Class A Common Stock, and the holders
of any class or series of stock entitled to participate therewith, shall become
entitled to participate in the distribution of any assets of the Company
remaining after the Company shall have paid, or provided for payment of, all
debts and liabilities of the Company and after the Company shall have paid, or
set aside for payment, to the holders of any class of stock having preference
over the Common Stock in the event of dissolution, liquidation or winding up the
full preferential amounts (if any) to which they are entitled.
Dividends. Dividends may be paid on the Class B Common Stock, the Class A
Common Stock and any class or series of stock entitled to participate therewith
when and as declared by the Board.
Conversion Into Class A Common Stock. The shares of Class B Common Stock
may be converted at any time at the option of the holder into fully paid and
nonassessable shares of Class A Common Stock at the rate of one share of Class A
Common Stock for each share of Class B Common Stock (as adjusted for any stock
split).
CLASS A PREFERRED STOCK
The Class A Preferred Stock was authorized in connection with the guarantee
and support by a principal stockholder of the Company of certain portions of the
Credit Facility, which was repaid in full and terminated subsequent to the
Company's initial public offering of Class A Common Stock. No shares of Class A
Preferred Stock have been issued. The Company currently anticipates eliminating
from the Restated Certificate the Class A Preferred Stock at its next annual
meeting of stockholders.
Voting Rights. Except as otherwise required by law, the holders of shares
of Class A Preferred Stock are not entitled to vote on matters that are voted on
by stockholders generally, except that the holders of shares of Class A
Preferred Stock shall be entitled to vote as a class, with each such holder
entitled to cast one vote for each share of Class A Preferred Stock registered
in the name of such holder, to elect two directors to the Board.
Liquidation Rights. In the event of any dissolution, liquidation or
winding up the Company, whether voluntary or involuntary, the holders of shares
of Class A Preferred Stock are entitled to receive out of assets of the Company
legally available for distribution to stockholders before any payment or
distribution is made on the Common Stock cash in the amount of $5.50 per share
plus any accumulated but unpaid dividends thereon (the "Class A Preferred
Liquidation Distribution"). If the assets distributable upon such dissolution,
liquidation or winding up are insufficient to pay cash in an amount equal to the
Class A Preferred Liquidation Distribution to the holders of the shares of Class
A Preferred Stock, then such assets or the proceeds thereof are distributed
among the holders of the Class A Preferred Stock ratably in proportion to the
respective amounts of the Class A Preferred Liquidation Distribution to which
they would otherwise be entitled.
Dividends. The Class A Preferred Stock ranks, as to dividends, senior and
prior to the Common Stock and to all other classes or series of stock issued by
the Company.
Mandatory Redemption. The shares of Class A Preferred Stock will be
redeemed by the Company, at $5.50 per share plus accumulated but unpaid
dividends thereon, to the extent of the Company's cash available for such
redemption pursuant to a formula, provided that if any dividends on the Class A
Preferred Stock are in arrears, no such redemption will occur unless (i) the
holders of two-thirds of the outstanding shares of Class A Preferred Stock
consent thereto, or (ii) all outstanding shares of the Class A Preferred Stock
are redeemed.
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OTHER AUTHORIZED PREFERRED STOCK
The Restated Certificate authorizes the Board, from time to time and
without further stockholder action, to provide for the issuance of up to
2,000,000 shares of Preferred Stock, par value $.01 per share, in one or more
series, and to fix the relative rights and preferences of the shares, including
voting powers, dividend rights, liquidation preferences, redemption rights and
conversion privileges. As of the date hereof, the Board has not provided for the
issuance of any series of such Preferred Stock and there are no agreements or
understandings for the issuance of any such Preferred Stock. Because of its
broad discretion with respect to the creation and issuance of Preferred Stock
without stockholder approval, the Board could adversely affect the voting power
of the holders of Common Stock and, by issuing shares of Preferred Stock with
certain voting, conversion and/or redemption rights, could discourage any
attempt to obtain control of the Company.
CERTAIN CHARTER AND STATUTORY PROVISIONS
The Restated Certificate provides for the division of the Board into three
classes of directors, serving staggered three-year terms. The Restated
Certificate further provides that the approval of the holders of at least
two-thirds of the shares entitled to vote thereon and the approval of a majority
of the entire Board are necessary for the alteration, amendment or repeal of
certain sections of the Restated Certificate relating to the election and
classification of the Board, limitation of director liability, indemnification
and the vote requirements for such amendments to the Restated Certificate. These
provisions may have the effect of deterring hostile takeovers or delaying
changes in control or management of the Company.
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law. In general, the statute prohibits a publicly held
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless (i)
prior to such date, the board approved either the business combination or the
transaction that resulted in the stockholder becoming an interested stockholder,
(ii) upon consummation of the transaction that resulted in such person becoming
an interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced (excluding, for purposes of determining the number of shares
outstanding, shares owned by certain directors or certain employee stock plans),
or (iii) on or after the date the stockholder became an interested stockholder,
the business combination is approved by the board of directors and authorized by
the affirmative vote (and not by written consent) of at least two-thirds of the
outstanding voting stock excluding that stock owned by the interested
stockholder. A "business combination" includes a merger, asset sale or other
transaction resulting in a financial benefit to the interested stockholder. An
"interested stockholder" is a person who (other than the corporation and any
direct or indirect majority-owned subsidiary of the corporation), together with
affiliates and associates, owns (or, as an affiliate or associate, within three
years prior, did own) 15% or more of the corporation's outstanding voting stock.
Section 203 expressly exempts from the requirements described above any
business combination by a corporation with an interested stockholder who became
an interested stockholder at a time when the section did not apply to the
corporation. As permitted by the Delaware General Corporation Law, the Company's
original certificate of incorporation provided that it would not be governed by
Section 203. Clark E. McLeod, Mary E. McLeod, IES and MidAmerican became
interested stockholders within the meaning of Section 203 while that certificate
of incorporation was in effect. Accordingly, future transactions between the
Company and any of such stockholders will not be subject to the requirements of
Section 203.
The Restated Certificate empowers the Board to redeem any of the Company's
outstanding capital stock, at a price determined by the Board, which price shall
be at least equal to the lesser of
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<PAGE> 86
(i) fair market value (as determined in accordance with the Restated
Certificate) or (ii) in the case of a "Disqualified Holder," such holder's
purchase price (if the stock was purchased within one year of such redemption),
to the extent necessary to prevent the loss or secure the reinstatement of any
license, operating authority or franchise from any governmental agency. A
"Disqualified Holder" is any holder of shares of stock of the Company whose
holding of such stock may result in the loss of, or the failure to secure the
reinstatement of, any license or franchise from any governmental agency held by
the Company or any of its subsidiaries to conduct any portion of the business of
the Company or any of its subsidiaries. Under the Telecommunications Act,
non-U.S. citizens or their representatives, foreign governments or their
representatives, or corporations organized under the laws of a foreign country
may not own, in the aggregate, more than 20% of a common carrier licensee or
more than 25% of the parent of a common carrier licensee if the FCC determines
that the public interest would be served by prohibiting such ownership.
Additionally, the FCC's rules may under certain conditions limit the size of
investments by foreign telecommunications carriers in U.S. international
carriers. See "Business -- Regulation."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Class A Common Stock is Norwest
Bank Minnesota, N.A.
SHARES ELIGIBLE FOR FUTURE SALE
The Class A Common Stock has been traded on the Nasdaq National Market
since June 10, 1996. Future sales of a substantial amount of Class A Common
Stock in the public market, or the perception that such sales may occur, could
adversely affect the market price of the Class A Common Stock prevailing from
time to time in the public market and could impair the Company's ability to
raise additional capital through the sale of its equity securities.
Upon completion of the Offering, the Company will have approximately
51,361,531 shares of Common Stock outstanding (including 113,387 shares of Class
A Common Stock placed into escrow in connection with the acquisition of Ruffalo,
Cody and 110,702 shares of Class A Common Stock issued in November 1996 pursuant
to the exercise of options by certain Selling Stockholders), including 4,768,903
shares of Class A Common Stock offered hereby and 32,455,005 "restricted" shares
of Common Stock. See "Business -- Recent Transactions." Of these restricted
shares, 22,070,187 shares of Common Stock generally are currently eligible for
sale under Rule 144 as currently in effect, and 10,384,818 shares of Common
Stock generally will be eligible for sale under Rule 144 as currently in effect
beginning in January 1997 through July 1998.
The shares of Class A Common Stock offered hereby will be freely tradable
without restriction or further registration under the Securities Act by persons
other than "affiliates" of the Company within the meaning of Rule 144
promulgated under the Securities Act. The holders of restricted shares generally
will be entitled to sell these shares in the public securities market without
registration under the Securities Act to the extent permitted by Rule 144 (or
Rule 145, as applicable) promulgated under the Securities Act or any exemption
under the Securities Act.
In general, under Rule 144 as currently in effect, if two years have
elapsed since the later of the date of acquisition of restricted shares from the
Company or any "affiliate" of the Company, as that term is defined under the
Securities Act, the holder is entitled to sell within any three-month period a
number of shares of Class A Common Stock that does not exceed the greater of 1%
of the then-outstanding shares of Class A Common Stock or the average weekly
trading volume of shares of Class A Common Stock on all exchanges and reported
through the automated quotation system of a registered securities association
during the four calendar weeks preceding the date on which notice of the sale is
filed with the Commission. Sales under Rule 144 are also subject to certain
restrictions on the manner of sales, notice requirements and the availability of
current public information about the Company. If three years have elapsed since
the date of acquisition of restricted shares from the
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<PAGE> 87
Company or from any "affiliate" of the Company, and the holder thereof is deemed
not to have been an affiliate of the Company at any time during the 90 days
preceding a sale, such person would be entitled to sell such Class A Common
Stock in the public market under Rule 144(k) without regard to the volume
limitations, manner of sale provisions, public information requirements or
notice requirements.
The Company, its directors and officers, the Selling Stockholders and
certain other stockholders have entered into "lock-up" agreements with the
Underwriters, providing that, subject to certain exceptions, they will not, for
a period from 120 days after the date of this Prospectus, without the prior
written consent of Salomon Brothers Inc, offer, sell or contract to sell, or
otherwise dispose of, directly or indirectly, or announce an offering of, any
shares of Common Stock or any securities convertible into, or exchangeable for,
shares of Common Stock. In connection with the Company's initial public offering
of Class A Common Stock, Clark E. McLeod, Mary E. McLeod, IES and MidAmerican
have each agreed with the Representatives (as defined under the heading
"Underwriting") that, subject to certain exceptions, they will not offer, sell
or contract to sell, or otherwise dispose of, directly or indirectly, or
announce an offering of, shares of Common Stock or any securities convertible
into, or exchangeable for, any shares of Common Stock for a period of one year
from June 10, 1996, without the prior written consent of the Representatives.
See "Underwriting." In addition, certain directors, executive officers and
stockholders have agreed that, for a period of two years commencing on June 10,
1996, they will not sell or otherwise dispose of any equity securities of the
Company without the consent of the Board. See "Management -- Investor
Agreement."
At September 30, 1996, the Company has reserved 11,726,105 shares of Class
A Common Stock for issuance under the Company's employee stock purchase plan and
upon exercise of options outstanding or to be granted pursuant to the Company's
stock option plans. No shares have been issued under the Company's employee
stock purchase plan and options to purchase 7,647,969 shares of Class A Common
Stock were outstanding and unexercised under the Company's stock option plans as
of September 30, 1996. The Company has registered the shares of Class A Common
Stock reserved for issuance under the Company's stock option plans and stock
purchase plan. See "Management -- Stock Option Plans" and "Management -- The
Employee Stock Purchase Plan." In addition, options to purchase 1,300,688 shares
of Class B Common Stock, which were granted to IES in connection with its
guarantee and/or support of certain portions of the Credit Facility, were
outstanding as of September 30, 1996.
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<PAGE> 88
UNDERWRITING
Subject to the terms and conditions set forth in an underwriting agreement
among the Company, the Selling Stockholders and the Underwriters (the
"Underwriting Agreement"), the Company and the Selling Stockholders have agreed
to sell to each of the Underwriters named below (the "Underwriters"), for whom
Salomon Brothers Inc, Bear, Stearns & Co. Inc. and Morgan Stanley & Co.
Incorporated are acting as representatives (the "Representatives"), and each of
the Underwriters has severally agreed to purchase from the Company and the
Selling Stockholders the aggregate number of shares of Class A Common Stock set
forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
------------------------------------------------------------------------- ---------
<S> <C>
Salomon Brothers Inc .................................................... 935,977
Bear, Stearns & Co. Inc. ................................................ 935,976
Morgan Stanley & Co. Incorporated........................................ 935,976
Donaldson, Lufkin & Jenrette Securities Corporation...................... 120,103
A.G. Edwards & Sons, Inc. ............................................... 120,103
Lehman Brothers Inc. .................................................... 120,103
Merrill Lynch, Pierce, Fenner & Smith Incorporated....................... 120,103
Smith Barney Inc. ....................................................... 120,103
William Blair & Company, L.L.C. ......................................... 86,971
Dain Bosworth Incorporated............................................... 86,971
Everen Securities, Inc. ................................................. 86,971
McDonald & Company Securities, Inc. ..................................... 86,971
Principal Financial Securities, Inc. .................................... 86,971
The Robinson-Humphrey Company, Inc. ..................................... 86,971
Robert W. Baird & Co. Incorporated....................................... 53,839
Gerard Klauer Mattison & Co., LLC ....................................... 53,839
Edward D. Jones & Co., L.P. ............................................. 53,839
Kirkpatrick, Pettis, Smith, Polian Inc. ................................. 53,839
Brad Peery Inc. ......................................................... 53,839
Pennsylvania Merchant Group Ltd ......................................... 53,839
Securities Corporation of Iowa........................................... 53,839
----------
Total.......................................................... 4,307,143
==========
</TABLE>
In the Underwriting Agreement, the Underwriters have severally agreed,
subject to the terms and conditions set forth therein, to purchase all of the
shares of Class A Common Stock offered hereby (other than those subject to the
over-allotment option described below) if any such shares are purchased. In the
event of a default by any Underwriter, the Underwriting Agreement provides that,
in certain circumstances, the purchase commitments of the non-defaulting
Underwriters may be increased or the Underwriting Agreement may be terminated.
The Company has been advised by the Representatives that the several
Underwriters propose initially to offer the shares of Class A Common Stock to
the public at the public offering price set forth on the cover page of this
Prospectus, and to certain dealers at such price less a concession not in excess
of $.76 per share. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $.10 per share to certain other dealers. After the
public offering, the public offering price and such concessions may be changed.
The Company has granted the Underwriters an option, exercisable within 30
days of the date of this Prospectus, to purchase up to 780,000 additional shares
of Class A Common Stock to cover over-allotments, if any, at the price to the
public set forth on the cover page of this Prospectus. To the extent that the
Underwriters exercise such option, in whole or in part, each Underwriter will
have a firm commitment, subject to certain conditions, to purchase the same
proportion of the option shares as the number of shares of Class A Common Stock
to be purchased by such Underwriter in
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<PAGE> 89
the above table bears to the total number of shares of Class A Common Stock
offered by the Underwriters hereby.
The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the several Underwriters against certain
liabilities, including liabilities under the Securities Act, or contribute to
payments the Underwriters may be required to make in respect thereof.
The Company, its directors and officers, the Selling Stockholders, two
irrevocable trusts founded by Theodore G. Schwartz and certain other
stockholders have each agreed with the Underwriters that they will not offer,
sell or contract to sell, or otherwise dispose of, directly or indirectly, or
announce an offering of, any shares of Common Stock or any securities
convertible into, or exchangeable for, shares of Common Stock for a period of
120 days from the date of this Prospectus, without the prior written consent of
Salomon Brothers Inc, and Clark E. McLeod, Mary E. McLeod, IES and MidAmerican
have each agreed with the underwriters, in connection with the Company's initial
public offering of the Class A Common Stock, that they will not offer, sell or
contract to sell, or otherwise dispose of, directly or indirectly, or announce
an offering of, shares of Common Stock or any securities convertible into, or
exchangeable for, any shares of Common Stock for a period of one year from June
10, 1996, without the prior written consent of the Representatives, except (a)
in the case of the Company, (i) grants of options and issuances and sales of
Common Stock issued pursuant to any employee or director stock option plan,
stock ownership plan or stock purchase plan in effect on the date the
Underwriting Agreement is executed or (ii) issuances of Common Stock upon the
conversion of securities or the exercise of warrants outstanding on the date the
Underwriting Agreement is executed; and (b) in the case of directors, officers
and stockholders of the Company, shares of Common Stock disposed of as bona fide
gifts or pledges where the recipients of such gifts or the pledgees, as the case
may be, agree in writing with the Underwriters to be bound by the terms of such
agreement. In addition, the Investor Agreement provides that, for a two-year
period commencing on June 10, 1996, none of Clark E. McLeod, Mary E. McLeod, IES
or MidAmerican will sell or otherwise dispose of any equity securities of the
Company without the consent of the Board. See "Management -- Investor
Agreement."
Of the 5,200,000 shares of Class A Common Stock offered hereby, Clark E.
McLeod, Mary E. McLeod, MidAmerican, IES and two irrevocable trusts founded by
Theodore G. Schwartz have agreed to purchase 53,572, 53,571, 357,143, 357,143,
and 71,428 shares of Class A Common Stock, respectively, at the public offering
price without any underwriting discount. See "Management -- Compensation
Committee Interlocks and Insider Participation" and "Principal and Selling
Stockholders." The Company has been advised that such shares will be purchased
for investment purposes. Such shares will be sold directly by the Company to the
Investors and will not be subject to the terms and conditions of the
Underwriting Agreement.
In connection with the Offering, certain Underwriters may engage in passive
market making transactions in the Class A Common Stock on the Nasdaq National
Market in accordance with Rule 10b-6A under the Exchange Act, during the two
business day period before commencement of offers or sales of the Class A Common
Stock offered hereby. Passive market making transactions must comply with
certain volume and price limitations and be identified as such. In general, a
passive market maker may display its bid at a price not in excess of the highest
independent bid for the security, and if all independent bids are lowered below
the passive market maker's bid, then such bid must be lowered when certain
purchase limits are exceeded.
VALIDITY OF SECURITIES
The validity of the Class A Common Stock and certain other legal matters in
connection with the Class A Common Stock offered hereby are being passed upon
for the Company by Hogan & Hartson L.L.P., Washington, D.C., special counsel for
the Company. The validity of the Class A Common Stock is being passed upon for
the Underwriters by Mayer, Brown & Platt, Chicago, Illinois.
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EXPERTS
The consolidated balance sheets of the Company as of December 31, 1994 and
1995, and the consolidated statements of operations, stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1995 and financial statement schedule included herein and elsewhere in the
Registration Statement have been audited by McGladrey & Pullen, LLP, as
indicated in their reports with respect thereto, and are included herein in
reliance and upon the authority of said firm as experts in giving said reports.
The statements of income, stockholders' equity and cash flows for MWR
Telecom, Inc., for the years ended December 31, 1993 and December 31, 1994 and
for the period from January 1, 1995 to April 28, 1995, included herein and
elsewhere in the Registration Statement have been audited by McGladrey & Pullen,
LLP, as indicated in their reports with respect thereto, and are included herein
in reliance and upon the authority of said firm as experts in giving said
reports.
The consolidated balance sheets of Ruffalo, Cody & Associates, Inc. as of
December 31, 1994 and 1995, and the consolidated statements of income,
statements of stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1995 and financial statement schedule,
included herein and elsewhere in this Registration Statement have been audited
by McGladrey & Pullen, LLP, as indicated in their reports with respect thereto,
and are included herein in reliance and upon authority of said firm as experts
in giving said reports.
The consolidated balance sheets of Telecom*USA Publishing Group, Inc. as of
August 31, 1995 and 1996, and the consolidated statements of income, statements
of stockholders' equity and cash flows for each of the years in the three-year
period ended August 31, 1996 and financial statement schedule, included herein
and elsewhere in this Registration Statement have been audited by McGladrey &
Pullen, LLP, as indicated in their reports with respect thereto, and are
included herein in reliance and upon authority of said firm as experts in giving
said reports.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act, and, in accordance therewith, is required to file reports, proxy statements
and other information with the Commission. Such reports, proxy statements and
other information can be inspected and copied at the Public Reference Section of
the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the Commission's regional offices at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite
1300, New York, New York 10048. Copies of the reports, proxy statements and
other information can be obtained from the Public Reference Section of the
Commission, Washington, D.C. 20549, upon payment of prescribed rates or in
certain cases by accessing the Commission's World Wide Web site at
http://www.sec.gov. The Class A Common Stock of the Company is quoted on the
Nasdaq National Market under the symbol "MCLD", and such reports, proxy
statements and other information concerning the Company also can be inspected at
the offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006.
The Company has filed a Registration Statement under the Securities Act
with respect to the shares of Class A Common Stock offered hereby. As permitted
by the rules and regulations of the Commission, this Prospectus does not contain
all the information set forth in the Registration Statement. For further
information about the Company and the Class A Common Stock, reference is made to
the Registration Statement and to the financial statements, exhibits and
schedules filed therewith. The statements contained in this Prospectus about the
contents of any contract or other document referred to are not necessarily
complete, and in each instance, reference is made to a copy of such contract or
other document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. Copies of each such
document may be obtained from the Commission at its principal office in
Washington, D.C. upon payment or the charges prescribed by the Commission or, in
the case of certain such documents, by accessing the Commission's World Wide Web
site at http://www.sec.gov.
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GLOSSARY
Access -- Telecommunications services that permit long distance carriers to
use local exchange facilities to originate and/or terminate long distance
service.
Access to Rights-of-Way -- Access to poles, ducts, conduits and other
rights-of-way.
CAP (competitive access provider) -- A company that provides its customers
with an alternative to the local exchange company for local transport of private
line and special access telecommunications services.
Central offices -- The switching centers or central switching facilities of
the local exchange companies.
Collocation -- The ability of a CAP such as the Company to connect its
network to the LECs central offices. Physical collocation occurs when a CAP
places its network connection equipment inside the local exchange company's
central offices. Virtual collocation is an alternative to physical collocation
pursuant to which the local exchange company permits a CAP to connect its
network to the local exchange company's central offices on comparable terms,
even through the CAP's network connection equipment is not physically located
inside the central offices.
Dedicated -- Telecommunications lines reserved for use by particular
customers.
Dialing Parity -- The ability of a competing local or toll service provider
to provide telecommunications services in such a manner that customers have the
ability to route automatically, without the use of any access code, their
telecommunications to the service provider of the customer's designation.
Digital -- A method of storing, processing and transmitting information
through the use of distinct electronic or optical pulses that represent the
binary digits 0 and 1. Digital transmission and switching technologies employ a
sequence of these pulses to represent information as opposed to the continuously
variable analog signal. The precise digital numbers minimize distortion (such as
graininess or snow in the case of video transmission, or static or other
background distortion in the case of audio transmission).
FCC -- Federal Communications Commission.
Interconnection -- Interconnection of facilities between or among local
exchange carriers, including potential physical collocation of one carrier's
equipment in the other carrier's premises to facilitate such interconnection.
Initial Interconnection Decisions -- Rulings by the FCC announced in
September 1992 and August 1993, which require the Regional Bell Operating
Companies and most other large local exchange carriers to provide
interconnection in local exchange company central offices to any CAP, long
distance carrier or end user seeking such interconnection for the provision of
interstate special access and switched access transport services.
Interconnection Decision -- The August 1996 order issued by the FCC
implementing the interconnection provisions of the Telecommunications Act.
Portions of this order have been stayed by the U.S. Eighth Circuit Court of
Appeals.
InterLATA -- Telecommunications services originating in a LATA and
terminating outside of that LATA.
IntraLATA -- Telecommunications services originating and terminating in the
same LATA.
LATA (local access and transport area) -- A geographic area composed of
contiguous local exchanges, usually but not always within a single state. The
State of Iowa contains all or part of five LATAs; the State of Illinois contains
all or part of 17 LATAs. There are approximately 200 LATAs in the United States.
Local exchange -- A geographic area determined by the appropriate state
regulatory authority in which calls generally are transmitted without toll
charges to the calling or called party.
LEC (local exchange carrier) -- A company providing local telephone
services.
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Long distance carriers (interexchange carriers) -- Long distance carriers
provide services between local exchanges on an interstate or intrastate basis. A
long distance carrier may offer services over its own or another carrier's
facilities.
Number portability -- The ability of an end user to change local exchange
carriers while retaining the same telephone number.
POPs (points of presence) -- Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.
Private line -- A dedicated telecommunications connection between end user
locations.
Public switched network -- That portion of a local exchange company's
network available to all users generally on a shared basis (i.e., not dedicated
to a particular user). Traffic along the public switched network is generally
switched at the local exchange company's central offices.
Public utilities commission -- A state regulatory body, established in most
states, which regulates utilities, including telephone companies providing
intrastate services.
Reciprocal compensation -- The same compensation of a new competitive local
exchange carrier for termination of a local call by the local exchange carrier
on its network, as the new competitor pays the local exchange carrier for
termination of local calls on the local exchange carrier network.
Resale -- Resale by a provider of telecommunications services (such as a
local exchange carrier) of such services to other providers or carriers on a
wholesale or a retail basis.
Route mile -- The number of miles of the telecommunications path in which
fiber optic cables are installed.
Self-healing ring -- A self-healing ring is a network design in which the
network backbone consists of a continuous ring connecting a central hub facility
with one or more network nodes (such as customer premises). Traffic is routed
between the hub and each of the nodes simultaneously in both a clockwise and a
counterclockwise direction. In the event of a cable cut or component failure
along one of these paths, traffic will continue to flow along the alternate path
so no traffic is lost. In the event of a catastrophic node failure, other nodes
will be unaffected because traffic will continue to flow along whichever path
(primary or alternate) does not pass through the affected node. The switch from
the primary to the alternate path will be imperceptible to most users.
Special access services -- The lease of private, dedicated
telecommunications lines or "circuits" along the network of a local exchange
company or a CAP, which lines or circuits run to or from the long distance
carrier POPs. Examples of special access services are telecommunications lines
running between POPs of a single long distance carrier, from one long distance
carrier POP to the POP of another long distance carrier or from an end user to a
long distance carrier POP.
Switch -- A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of information. Switching is a process of
interconnecting circuits to form a transmission path between users.
Switched access transport services -- Transportation of switched traffic
along dedicated lines between the local exchange company central offices and
long distance carrier POPs.
Switched traffic -- Telecommunications traffic along the public switched
network. This traffic is generally switched at the local exchange company's
central offices.
Unbundled Access -- Access to unbundled elements of a telecommunications
services provider's network, including network facilities, equipment, features,
functions and capabilities, at any technically feasible point within such
network.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MCLEOD, INC. AND SUBSIDIARIES
Independent Auditor's Report....................................................... F-2
Consolidated Balance Sheets as of December 31, 1994 and 1995 and September 30, 1996
(Unaudited)..................................................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1993, 1994
and 1995 and the nine months ended September 30, 1995 and 1996 (Unaudited)...... F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1993, 1994 and 1995 and the nine months ended September 30, 1996 (Unaudited).... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994
and 1995 and the nine months ended September 30, 1995 and 1996 (Unaudited)...... F-6
Notes to Consolidated Financial Statements......................................... F-8
MWR TELECOM, INC.
Independent Auditor's Report....................................................... F-25
Statements of Income for the years ended December 31, 1993 and 1994 and
for the period from January 1, 1995 to April 28, 1995........................... F-26
Statements of Stockholder's Equity for the years ended December 31, 1993 and 1994
and for the period from January 1, 1995 to April 28, 1995....................... F-27
Statements of Cash Flows for the years ended December 31, 1993 and 1994
and for the period from January 1, 1995 to April 28, 1995....................... F-28
Notes to Financial Statements...................................................... F-29
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
Independent Auditor's Report....................................................... F-32
Consolidated Balance Sheets as of December 31, 1994 and 1995 and June 30, 1996
(Unaudited)..................................................................... F-33
Consolidated Statements of Income for the years ended December 31, 1993, 1994 and
1995 and the six months ended June 30, 1995 and 1996 (Unaudited)................ F-34
Consolidated Statements of Redeemable Common Stock and Warrants and Common
Stockholders' Equity (Deficit) for the years ended December 31, 1993, 1994 and
1995 and the six months ended June 30, 1996 (Unaudited)......................... F-35
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994
and 1995 and the six months ended June 30, 1995 and 1996 (Unaudited)............ F-37
Notes to Consolidated Financial Statements......................................... F-38
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
Independent Auditor's Report....................................................... F-45
Consolidated Balance Sheets as of August 31, 1995 and 1996......................... F-46
Consolidated Statements of Income for the years ended August 31, 1994,
1995 and 1996................................................................... F-47
Consolidated Statements of Stockholders' Equity for the years ended August 31,
1994, 1995 and 1996............................................................. F-48
Consolidated Statements of Cash Flows for the years ended August 31, 1994,
1995 and 1996................................................................... F-49
Notes to Consolidated Financial Statements......................................... F-51
</TABLE>
F-1
<PAGE> 94
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
McLeod, Inc.
Cedar Rapids, Iowa
We have audited the accompanying consolidated balance sheets of McLeod, Inc. and
subsidiaries as of December 31, 1994 and 1995, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1995. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of McLeod, Inc. and
subsidiaries as of December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995 in conformity with generally accepted accounting principles.
McGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
March 28, 1996, except
for Note 13, as to
which the date is
May 29, 1996
F-2
<PAGE> 95
MCLEOD, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- SEPTEMBER 30,
1994 1995 1996
------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS (NOTE 5)
Current Assets
Cash and cash equivalents (Note 4)............................................ $ -- $ -- $ 38,758,319
Investment in available-for-sale securities (Note 4).......................... -- -- 53,002,215
Trade receivables, net (Notes 2 and 3)........................................ 2,723,249 6,689,069 24,827,369
Inventory..................................................................... 1,930,208 2,638,829 5,332,799
Deferred expenses............................................................. -- -- 15,608,132
Prepaid expenses and other.................................................... 208,776 295,689 9,033,698
----------- ----------- ------------
TOTAL CURRENT ASSETS.................................................... 4,862,233 9,623,587 146,562,532
----------- ----------- ------------
Property and Equipment
Land.......................................................................... 310,917 310,917 2,262,838
Telecommunication networks.................................................... 922,769 7,696,101 21,996,064
Equipment..................................................................... 4,328,732 6,100,470 16,547,313
Networks in progress (Note 3)................................................. -- 3,115,361 24,969,687
----------- ----------- ------------
5,562,418 17,222,849 65,775,902
Less accumulated depreciation................................................. 846,203 2,144,615 4,382,387
----------- ----------- ------------
4,716,215 15,078,234 61,393,515
----------- ----------- ------------
Investments, Intangibles and Other Assets
Investment in available-for-sale securities (Note 4).......................... -- -- 31,239,430
Deferred line installation costs, net......................................... 1,010,704 1,424,685 1,868,582
Other intangibles, net........................................................ -- 2,525,091 81,449,124
Other......................................................................... 97,544 334,855 1,563,404
----------- ----------- ------------
1,108,248 4,284,631 116,120,540
----------- ----------- ------------
$ 10,686,696 $ 28,986,452 $ 324,076,587
=========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Notes payable (Note 5)........................................................ $ -- $ -- $ 1,696,600
Current maturities of long-term debt (Note 5)................................. -- -- 1,220,577
Accounts payable.............................................................. 1,689,216 5,832,543 16,721,138
Checks issued not yet presented for payment................................... 34,115 918,932 616,740
Accrued payroll and payroll related expenses.................................. 1,216,144 1,954,621 4,464,493
Other accrued liabilities..................................................... 233,243 857,124 4,945,344
Deferred revenue, current portion............................................. 24,107 134,325 927,978
Customer deposits............................................................. 6,426 17,792 9,347,534
----------- ----------- ------------
TOTAL CURRENT LIABILITIES............................................... 3,203,251 9,715,337 39,940,404
----------- ----------- ------------
Long-Term Debt, less current maturities (Note 5)................................ 3,500,000 3,600,000 4,154,964
----------- ----------- ------------
Deferred Revenue, less current portion.......................................... 692,263 713,173 6,273,981
----------- ----------- ------------
Commitments (Notes 3, 5 and 6)
Stockholders' Equity (Notes 5, 8, 9, 13 and 14)
Capital stock:
Preferred, Class A, $5.50 par value; authorized 1,150,000 shares; none
issued..................................................................... -- -- --
Preferred, $.01 par value; authorized 2,000,000 shares; none issued; terms
determined upon issuance................................................... -- -- --
Common, Class A, $.01 par value; authorized 75,000,000 shares; issued 1994
14,478,481 shares; 1995 16,387,081 shares; 1996 30,742,610 shares.......... 144,785 163,871 307,426
Common, Class B, convertible, $.01 par value; authorized 22,000,000 shares;
issued 1994 7,670,457 shares; 1995 and 1996 15,625,929 shares.............. 76,705 156,259 156,259
Additional paid-in capital.................................................... 17,253,105 40,117,164 312,141,169
Accumulated deficit........................................................... (14,150,413) (25,479,352) (38,897,616)
Cost of common stock reacquired for the treasury, 1994 22,500 shares; 1995 and
1996 none................................................................... (33,000) -- --
----------- ----------- ------------
3,291,182 14,957,942 273,707,238
----------- ----------- ------------
$ 10,686,696 $ 28,986,452 $ 324,076,587
=========== =========== ============
</TABLE>
See Notes to Consolidated Financial Statements.
F-3
<PAGE> 96
MCLEOD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------- ---------------------------
1993 1994 1995 1995 1996
------------ ------------- ------------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue (Note 3)................... $ 1,550,098 $ 8,014,093 $ 28,997,880 $19,438,061 $ 45,497,135
----------- ------------ ------------ ----------- -----------
Operating expenses:
Cost of service.................. 1,527,658 6,211,783 19,667,138 12,671,592 31,692,725
Selling, general and
administrative................. 2,389,890 12,373,411 18,053,431 13,087,028 25,626,467
Depreciation and amortization.... 235,013 771,879 1,835,127 1,228,949 4,734,244
----------- ------------ ------------ ----------- -----------
TOTAL OPERATING
EXPENSES................ 4,152,561 19,357,073 39,555,696 26,987,569 62,053,436
----------- ------------ ------------ ----------- -----------
OPERATING LOSS............ (2,602,463) (11,342,980) (10,557,816) (7,549,508) (16,556,301)
Nonoperating income (expense):
Interest income.................. 162,846 145,193 138,691 78,644 3,403,964
Interest (expense)............... -- (218,175) (909,814) (692,670) (543,475)
Other income..................... -- -- -- -- 277,548
----------- ------------ ------------ ----------- -----------
TOTAL NONOPERATING INCOME
(EXPENSE)............... 162,846 (72,982) (771,123) (614,026) 3,138,037
----------- ------------ ------------ ----------- -----------
LOSS BEFORE INCOME TAXES.. (2,439,617) (11,415,962) (11,328,939) (8,163,534) (13,418,264)
Income taxes (Note 7).............. -- -- -- -- --
----------- ------------ ------------ ----------- -----------
NET LOSS.................. $ (2,439,617) $ (11,415,962) $ (11,328,939) $(8,163,534) $(13,418,264)
=========== ============ ============ =========== ===========
Loss per common and common
equivalent share (Note 13)....... $ (0.08) $ (0.31) $ (0.31) $ (0.22) $ (0.33)
=========== ============ ============ =========== ===========
Weighted average common and common
equivalent shares outstanding
(Note 13)........................ 29,655,063 36,369,916 37,054,744 37,054,641 41,187,816
=========== ============ ============ =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE> 97
MCLEOD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NOTES 5, 8, 9, 13 AND 14)
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND NINE MONTHS ENDED
SEPTEMBER 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
CAPITAL STOCK
-----------------------------------
COMMON ADDITIONAL
---------------------- PAID-IN ACCUMULATED TREASURY
PREFERRED CLASS A CLASS B CAPITAL DEFICIT STOCK TOTAL
--------- --------- --------- ------------ ------------ -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992..... $ $ 188 $ -- $ 4,812 $ (294,834) $ -- $ (289,834)
Net loss...................... -- -- -- -- (2,439,617) -- (2,439,617)
Issuance of 11,975,010 shares
of Class A common stock..... -- 119,750 -- 6,045,575 -- -- 6,165,325
Issuance of 5,625,000 shares
of Class B common stock..... -- 56,250 4,443,750 -- -- 4,500,000
-------- -------- -------- ----------- ------------ -------- ------------
Balance, December 31, 1993..... -- 119,938 56,250 10,494,137 (2,734,451) -- 7,935,874
Net loss...................... -- -- -- -- (11,415,962) -- (11,415,962)
Issuance of 2,484,720 shares
of Class A common stock..... -- 24,847 -- 3,604,420 -- -- 3,629,267
Issuance of 2,045,457 shares
of Class B common stock..... -- -- 20,455 2,979,548 -- -- 3,000,003
Purchase of 22,500 shares of
common stock for the
treasury.................... -- -- -- -- -- (33,000) (33,000)
Amortization of fair value of
stock options issued to
non-employees (Note 5)...... -- -- -- 175,000 -- -- 175,000
-------- -------- -------- ----------- ------------ -------- ------------
Balance, December 31, 1994..... -- 144,785 76,705 17,253,105 (14,150,413) (33,000) 3,291,182
Net loss...................... -- -- -- -- (11,328,939) -- (11,328,939)
Issuance of 1,908,600 shares
of Class A common stock..... -- 19,086 -- 4,278,164 -- -- 4,297,250
Issuance of 4,279,414 shares
of Class B common stock..... -- -- 42,794 9,652,258 -- -- 9,695,052
Issuance of 3,676,058 shares
of Class B common stock in
connection with the
acquisition of MWR Telecom
Inc. (Note 11).............. -- -- 36,760 8,295,637 -- -- 8,332,397
Reissuance of 22,500 shares of
treasury stock.............. -- -- -- 6,000 -- 33,000 39,000
Amortization of fair value of
stock options issued to
non-employees (Note 5)...... -- -- -- 632,000 -- -- 632,000
-------- -------- -------- ----------- ------------ -------- ------------
Balance, December 31, 1995..... -- 163,871 156,259 40,117,164 (25,479,352) -- 14,957,942
Net loss (Unaudited).......... -- -- -- -- (13,418,264) -- (13,418,264)
Issuance of 13,994,109 shares
of Class A common stock
(Unaudited)................. -- 139,941 -- 257,991,490 -- -- 258,131,431
Issuance of 361,420 shares of
Class A common stock in
connection with the
acquisition of Ruffalo, Cody
& Associates, Inc.
(Unaudited) (Note 14)....... -- 3,614 -- 8,941,531 -- -- 8,945,145
Options to purchase 158,009
shares of Class A common
stock granted in connection
with the acquisition of
Ruffalo, Cody & Associates,
Inc., less cash to be
received upon exercise of
the options (Unaudited)
(Note 14)................... -- -- -- 3,300,817 -- -- 3,300,817
Amortization of fair value of
stock options issued to
non-employees (unaudited)
(Note 5).................... -- -- -- 341,167 -- -- 341,167
Amortization of compensation
expense related to stock
options (unaudited) (Note
8).......................... -- -- -- 1,449,000 -- -- 1,449,000
-------- -------- -------- ----------- ------------ -------- ------------
Balance, September 30, 1996
(Unaudited)................... $ -- $ 307,426 $ 156,259 $312,141,169 $(38,897,616) $ -- $273,707,238
======== ======== ======== =========== ============ ======== ============
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE> 98
MCLEOD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER
YEARS ENDED DECEMBER 31, 30,
-------------------------------------------- -----------------------------
1993 1994 1995 1995 1996
------------ ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash Flows from Operating Activities
Net loss......................................... $ (2,439,617) $ (11,415,962) $ (11,328,939) $ (8,163,534) $ (13,418,264)
Adjustments to reconcile net loss to net cash
(used in)
operating activities:
Depreciation................................... 230,321 632,472 1,299,381 881,957 2,242,798
Amortization................................... 4,692 314,407 1,167,746 790,992 2,832,182
Changes in assets and liabilities, net of
effects of purchase business acquisitions
(Notes 11 and 14):
(Increase) in trade receivables.............. (200,813) (2,272,436) (3,574,894) (2,488,145) (6,597,572)
(Increase) in inventory...................... (1,739,861) (184,845) (269,128) (152,068) (2,693,970)
(Increase) in deferred expenses.............. -- -- -- -- (730,132)
(Increase) in deferred line installation
costs...................................... -- (1,136,504) (806,146) (661,594) (842,372)
Increase in accounts payable and accrued
expenses................................... 827,230 1,994,327 4,084,112 1,887,880 4,094,591
Increase (decrease) in deferred revenue...... -- 716,370 8,749 10,194 6,354,461
Increase in customer deposits................ -- 6,426 11,366 8,803 1,027,552
Other, net................................... (134,104) (16,302) (70,026) (187,609) (2,727,000)
----------- ------------ ------------ ------------ ------------
NET CASH (USED IN) OPERATING ACTIVITIES.... (3,452,152) (11,362,047) (9,477,779) (8,073,124) (10,457,726)
----------- ------------ ------------ ------------ ------------
Cash Flows from Investing Activities
Purchase of property and equipment............... (1,940,893) (3,363,223) (5,272,248) (2,402,614) (39,741,705)
Available-for-sale securities:
Purchases...................................... -- -- -- -- (123,012,000)
Sales.......................................... -- -- -- -- 39,047,291
Business acquisitions (Note 14).................. -- -- -- -- (78,868,325)
Deposits on PCS licenses......................... -- -- -- -- (4,889,442)
Other............................................ 152,019 (78,773) (266,092) (349,274) (950,154)
----------- ------------ ------------ ------------ ------------
NET CASH (USED IN) INVESTING ACTIVITIES.... (1,788,874) (3,441,996) (5,538,340) (2,751,888) (208,414,335)
----------- ------------ ------------ ------------ ------------
Cash Flows from Financing Activities
Increase (decrease) in checks issued not yet
presented for payment.......................... -- 34,115 884,817 286,012 (302,192)
Proceeds from line of credit agreements.......... -- 8,400,000 42,200,000 36,100,000 50,237,600
Payments on line of credit agreements............ -- (4,900,000) (42,100,000) (39,600,000) (52,441,000)
Proceeds from long-term debt..................... -- -- -- -- 2,012,400
Payments on long-term debt....................... -- -- -- -- (7,859)
Net proceeds from issuance of common stock....... 9,857,908 6,629,270 13,992,302 14,000,000 258,131,431
Reissuance (purchase) of treasury stock.......... -- (33,000) 39,000 39,000 --
----------- ------------ ------------ ------------ ------------
NET CASH PROVIDED BY FINANCING
ACTIVITIES............................... 9,857,908 10,130,385 15,016,119 10,825,012 257,630,380
----------- ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.............................. 4,616,882 (4,673,658) -- -- 38,758,319
Cash and cash equivalents:
Beginning........................................ 56,776 4,673,658 -- -- --
----------- ------------ ------------ ------------ ------------
Ending........................................... $ 4,673,658 $ -- $ -- $ -- $ 38,758,319
=========== ============ ============ ============ ============
Supplemental Disclosure of Cash Flow Information
Cash payment for interest, net of interest
capitalized 1993 and 1994 none; 1995 $61,914;
1996 $204,056.................................. $ -- $ 35,345 $ 260,922 $ 239,718 $ 761,184
=========== ============ ============ ============ ============
Supplemental Schedule of Noncash Investing and
Financing Activities
Conversion of stockholder advances
into 3,027,814 shares of Class A common
stock.......................................... $ 807,417
===========
Accounts payable incurred for property and
equipment...................................... $ 111,582 $ 141,022 $ 1,233,779 $ 141,215 $ 5,171,737
=========== ============ ============ ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE> 99
MCLEOD, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------- ------------------------------
1993 1994 1995 1995 1996
------------ ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Supplemental Disclosure of Cash Flow
Information (continued)
Acquisition of MWR Telecom Inc. (Note 11):
Working capital acquired, net.............. $ 392,508 $ 392,508
Fair value of other assets acquired,
principally fiber optic telecommunication
networks................................. 5,298,082 5,298,082
Goodwill................................... 2,641,807 2,641,807
------------ ------------
Stock issued............................... $ 8,332,397 $ 8,332,397
============ ============
Acquisition of Ruffalo, Cody & Associates,
Inc. (Note 14):
Cash purchase price........................ $ 4,807,898
Stock issued............................... 8,945,145
Options to purchase Class A common stock... 3,910,723
Less cash to be received upon exercise of
options.................................. (609,906)
------------
$ 17,053,860
============
Working capital acquired, net.............. $ 757,745
Fair value of other assets acquired,
principally equipment.................... 1,068,389
Intangibles................................ 15,227,726
------------
$ 17,053,860
============
Acquisition of Telecom*USA Publishing Group,
Inc. (Note 14):
Cash....................................... $ 74,060,427
Incentive Agreements....................... 1,610,000
------------
$ 75,670,427
============
Working capital acquired, net.............. $ 8,475,000
Fair value of other assets acquired,
principally equipment.................... 4,405,000
Intangibles................................ 64,126,427
Liabilities assumed, principally long-term
debt..................................... (1,336,000)
------------
$ 75,670,427
============
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE> 100
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business: The Company is a diversified telecommunications
company that provides a broad range of products and services to business and
residential customers and government agencies in Iowa and Illinois. The
Company's services primarily include local and long distance telephone services,
communication services between interexchange carriers and customers and
maintenance and installation services on fiber optic telecommunication networks.
The Company also provides telemarketing services to businesses and non-profit
entities throughout the United States and publishes telephone directories in a
fifteen-state area primarily in the midwestern United States. The Company's
business is highly competitive and is subject to various federal, state and
local regulations.
Accounting estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
A summary of the Company's significant accounting policies is as follows:
Principles of consolidation: The accompanying financial statements include
those of the Company and its subsidiaries, all of which are wholly-owned. All
significant intercompany items and transactions have been eliminated in
consolidation.
Cash and cash equivalents: For purposes of reporting cash flows, the
Company considers all highly liquid debt instruments purchased with a maturity
of three months or less to be cash equivalents.
Investments: Management determines the appropriate classification of the
securities at the time they are acquired and evaluates the appropriateness of
such classifications at each balance sheet date. The Company has classified its
securities as available-for-sale. Available-for-sale securities are stated at
fair value, and unrealized holding gains and losses, net of the related deferred
tax effect, are reported as a component of stockholders' equity. Realized gains
and losses are determined on the basis of the specific securities sold.
Trade receivables: In accordance with the industry practice for the
publication of telephone directories, trade receivables include certain unbilled
revenue from installment contracts. It is anticipated that a substantial portion
of all such amounts at September 30, 1996 will be collected within one year (see
Note 2).
Inventory: Inventory is carried principally at the lower of average cost
or market and consists primarily of new and reusable parts to maintain and build
fiber optic networks. Inventories of approximately $1.6 million used to support
a maintenance agreement are amortized on a straight-line basis over the 10-year
life of the agreement (see Note 3).
Property and equipment: Property and equipment is stated at cost.
Construction costs, including interest, are capitalized during the installation
of fiber optic telecommunication networks. Depreciation is computed by the
straight-line method over the following estimated useful lives:
<TABLE>
<CAPTION>
YEARS
------
<S> <C>
Telecommunication networks........................... 15
Equipment............................................ 2-10
</TABLE>
F-8
<PAGE> 101
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
The Company's telecommunications networks are subject to technological
risks and rapid market changes due to new products and services and changing
customer demand. These changes may result in changes in the estimated economic
lives of these assets.
Deferred line installation costs: Deferred line installation costs include
costs incurred in the establishment of local access lines for customers and are
being amortized by the straight-line method over the life of the average
customer contract as cost of telecommunications services. The contracts' terms
do not exceed 60 months. Accumulated amortization on deferred line installation
costs totaled $126,000, $518,000 and $916,000 at December 31, 1994, December 31,
1995 and September 30, 1996, respectively.
Other intangibles: Intangibles, consisting primarily of goodwill and
customer lists, resulting from the Company's acquisitions are being amortized
over periods ranging from 5 to 25 years using the straight-line method and are
periodically reviewed for impairment based upon an assessment of future
operations to ensure that they are appropriately valued. The Company is in the
process of determining the proper allocation of the excess of the purchase price
over the net assets of Telecom*USA Publishing Group, Inc. (See Note 14).
Accumulated amortization on these intangibles totaled none, $117,000 and
$575,000 at December 31, 1994, December 31, 1995 and September 30, 1996,
respectively.
Income tax matters: The Company recognizes deferred tax assets and
liabilities for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method, deferred
tax assets and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Net deferred tax assets are reduced by a valuation allowance when appropriate.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
Deferred revenue: Amounts received in advance under long-term leases of
fiber optic telecommunication networks are recognized as revenue on a
straight-line basis over the life of the leases.
Revenue recognition: Revenues for local and long-distance services are
recognized when subscribers use telecommunication services. The revenue from
long-term leases of fiber optic telecommunication networks is recognized over
the term of the lease. Base annual revenue for telecommunication contract
maintenance is recognized on a straight line basis over the term of the
contract. Additional services provided under these contracts are recognized as
the services are performed.
Fees from telemarketing contracts are recognized as revenue in the period
the services are performed.
Revenues from directories are recorded upon publication.
Customer deposits consist of cash received from customers at the time a
sales contract is signed. They are recorded as revenue when the related
directory is published or when the related service is performed.
Cost of service and deferred expenses: Cost of service includes local and
long-distance services purchased primarily from two Regional Bell Operating
Companies and one interexchange carrier and the cost of operating the Company's
fiber optic telecommunication networks. The
F-9
<PAGE> 102
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
agreement with the interexchange carrier requires minimum monthly purchase and
minutes-of-usage commitments. Cost of service also includes direct costs
associated with telemarketing services and the production costs associated with
the publication of directories.
Deferred expenses consist of production and selling costs on unpublished
directory advertising orders. They are expensed when the related directory is
published and the related revenue of the directory is recognized.
Stock options issued to employees: Compensation expense for stock issued
through stock option plans is accounted for using the intrinsic value based
method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock
Issued for Employees." Under this method, compensation is measured as the
difference between the estimated market value of the stock at the date of award
less the amount required to be paid for the stock. The difference, if any, is
charged to expense over the periods of service.
The estimated market value used for the stock options granted was
determined on a periodic basis by the Company's Board of Directors prior to the
Company's initial public offering on June 10, 1996 (see Note 13). Subsequent to
the Company's initial public offering, the market value used for stock options
granted is based upon the closing price of the Class A common stock on the day
before the grant date.
Stock options issued to non-employees: The Company uses the Black-Scholes
model to determine the fair value of the stock options issued to non-employees
at the date of grant. This amount is amortized to expense over the vesting
period of the options.
Loss per common and common equivalent share: Pursuant to Securities and
Exchange Commission Staff Accounting Bulletin No. 83, stock issued and stock
options granted with exercise prices below the assumed initial public offering
price during the twelve-month period preceding the effective date of the
Registration Statement have been included in the calculation as if they were
outstanding for all years presented.
Recently issued accounting standards: In March 1995, the Financial
Accounting Standards Board (FASB) issued SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
which will require the Company to account for the impairment of long-lived
assets and certain identifiable intangibles to be held and used by the Company
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Adoption of SFAS No. 121 is required in fiscal
1996.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation, which establishes a fair value based method for financial
accounting and reporting for stock-based employee compensation plans. However,
the new standard allows compensation to continue to be measured by using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees, but requires
expanded disclosures. SFAS No. 123 is effective in fiscal year 1996. The Company
has elected to continue to apply the intrinsic value based method of accounting
for stock options.
While the Company does not know precisely the impact that will result from
adopting SFAS No. 121 and SFAS No. 123, the Company does not expect the adoption
of SFAS No. 121 or SFAS No. 123 to have a material effect on the Company's
consolidated financial statements.
F-10
<PAGE> 103
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Fair value of financial instruments: The carrying amount of long-term debt
approximates fair value because these obligations bear interest at current
rates.
Interim Financial Information (unaudited): The financial statements and
notes related thereto as of September 30, 1996, and for the nine month periods
ended September 30, 1995 and 1996, are unaudited, but in the opinion of
management include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the financial position and
results of operations. The operating results for the interim periods are not
indicative of the operating results to be expected for a full year or for other
interim periods. Not all disclosures required by generally accepted accounting
principles necessary for a complete presentation have been included.
NOTE 2. TRADE RECEIVABLES, NET
The composition of trade receivables, net is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------- SEPTEMBER 30,
1994 1995 1996
----------- ----------- -------------
<S> <C> <C> <C>
Trade receivables:
Billed........................ $ 2,807,249 $ 6,908,069 $ 21,128,049
Unbilled...................... -- -- 7,172,320
----------- ----------- ------------
2,807,249 6,908,069 28,300,369
Less allowance for doubtful
accounts and discounts........... (84,000) (219,000) (3,473,000)
----------- ----------- ------------
$ 2,723,249 $ 6,689,069 $ 24,827,369
=========== =========== ============
</TABLE>
NOTE 3. MAJOR CUSTOMER AND COMMITMENTS
During 1992, the Company obtained an assignment of a contract covering the
maintenance and operations responsibilities for the State of Iowa Fiber Optic
Communications Network through October 2004. The annual fee for performing this
maintenance is adjusted annually by the change in the Consumer Price Index and
for additions to the network. The revenue from this and related contracts
amounted to approximately $1,550,000, $3,407,000 and $4,937,000 for 1993, 1994
and 1995, respectively. In addition, the Company had additional revenues from
this customer during 1995 of approximately $403,000. Trade receivables include
approximately $1,147,000 and $2,143,000 from this customer at December 31, 1994
and 1995, respectively.
During 1995, the Company was awarded contracts from the State of Iowa to
build 265 fiber optic telecommunication network segments throughout the State of
Iowa. Upon completion of each segment, the Company will receive approximately
$115,000 for a seven year lease for certain capacity on that segment. The
Company will recognize this revenue of approximately $30,475,000 on a
straight-line basis over the term of the lease based on the relationship of
individual segment costs to total projected costs. As of December 31, 1995, no
revenue had been recognized under these contracts.
The Company estimates that minimum future construction costs required to
fulfill its obligations under the 1995 contract with the State of Iowa would be
approximately $34,000,000. The Company,
F-11
<PAGE> 104
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 3. MAJOR CUSTOMER AND COMMITMENTS -- (CONTINUED)
however, expects that its actual construction costs will be higher with respect
to such network segments, because the Company is adding more fiber and route
miles than is contractually required with respect to such construction, in order
to optimize the design of its network. In addition, the Company estimates that
it will incur additional construction costs of approximately $2,000,000 to
complete two other fiber optic telecommunication networks in process. The
Company presently anticipates that the costs to complete these projects will be
incurred as follows:
<TABLE>
<S> <C>
1996.......................................... $ 20,400,000
1997.......................................... 11,800,000
1998.......................................... 3,400,000
1999.......................................... 400,000
------------
$ 36,000,000*
============
</TABLE>
- ---------------
* At December 31, 1995, the Company had actual remaining contractual commitments
of approximately $8,700,000 for costs associated with the construction of
fiber optic telecommunications networks. Subsequent to December 31, 1995, the
Company entered into $4,000,000 of similar construction contracts.
The Company plans to finance the completion of these contracts with the
above mentioned revenues and external financing.
NOTE 4. INVESTMENTS
At September 30, 1996, the Company held $83,590,614, $32,797,790 and
$2,394,969 in corporate debt securities, United States government and
governmental agency securities and mortgage backed securities, respectively. The
Company has classified these securities as available-for-sale, and at September
30, 1996, their amortized cost approximates fair value. The available-for-sale
securities have been classified as cash and cash equivalents, investment in
available-for-sale securities -- current and investment in available-for-sale
securities -- long-term, with $34,541,728, $53,002,215 and $31,239,430,
respectively, being recorded in each classification at September 30, 1996.
The contractual maturities of the available-for-sale securities at
September 30, 1996 are as follows:
<TABLE>
<S> <C>
Due within one year.......................................... $ 86,608,193
Due after one year through three years....................... 20,744,504
Due after three years........................................ 9,035,707
Mortgage-backed securities................................... 2,394,969
-------------
$ 118,783,373
=============
</TABLE>
Expected maturities will differ from contractual maturities because the issuers
of certain debt securities do have the right to call or prepay their obligations
without any penalties. The amount classified as current assets on the
accompanying balance sheets represent the expected maturities of the debt
securities during the next year.
F-12
<PAGE> 105
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 5. PLEDGED ASSETS, RELATED DEBT AND SUBSEQUENT EVENTS
At December 31, 1995, the Company had a line of credit agreement with The
First National Bank of Chicago under which it may borrow up to a total of
$20,000,000. The agreement expires on May 16, 1998 with a one year extension
upon mutual agreement. The Company is required to maintain a $2,000,000 term
life insurance policy on the chief executive officer and a $1,000,000 term life
insurance policy on the chief operating officer. Proceeds from the policies are
pledged as collateral under this agreement. Additionally, the agreement contains
various restrictive covenants, including, among others, ones which prohibit the
payment of any dividends, limit additional indebtedness, limit the annual
repurchase of stock by the Company and require the Company to maintain a
financial ratio. At December 31, 1995, the Company was in compliance with all
covenants.
The agreement is structured as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 BORROWINGS AT DECEMBER 31,
MAXIMUM ---------------------------------------
BORROWING LIMIT 1994 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Facility A..................... $ 6,000,000 $ 3,500,000 $ 3,600,000
Facility B..................... 6,000,000 -- --
Facility C..................... 8,000,000 -- --
----------- -------------- --------------
Total................ $20,000,000 $ 3,500,000 $ 3,600,000
=========== ============== ==============
</TABLE>
Facility A: The interest rate is effective on the date of the borrowings
and may be designated by the Company as either (1) the higher of the prime rate
or Federal Funds effective rate plus 0.5% or (2) London Interbank Offered Rate
plus 0.375%. The Company also pays a facilities fee of 0.1875% per annum on the
average daily commitment.
Borrowings under Facility A are unsecured and are guaranteed by a
stockholder which requires a 1% annual fee on the maximum borrowing limit. At
the inception of the agreement, the stockholder was granted 1,875,000 Class B
common stock options at $1.47 per share, the estimated market price at that
date. The options vest quarterly at the rate of 93,750 shares. Vesting would be
reduced if the maximum borrowing limit amount is reduced. The options are
exercisable for five years from the date the last options are vested. As of
December 31, 1995, 562,500 stock options are vested.
In the event of a default under Facility A, the Company must issue to the
guarantor shares of $5.50 par value preferred stock equal to the payment made by
the guarantor divided by $5.50.
Facility B: The interest rate is effective on the date of the borrowings
at the higher of the prime rate plus 0.25% or Federal Funds effective rate plus
0.75%. The effective rate at March 31, 1996 is 8.50%. The Company also pays an
annual facilities fee of 0.25% on the average daily commitment. Borrowings under
Facility B are limited based on the Company's borrowing base which includes
trade receivables and inventories. The borrowings under Facility B are
collateralized by trade receivables and inventory. As of December 31, 1995, the
maximum borrowing limit was available to the Company.
In March 1996, the Bank and the Company agreed to increase the maximum
borrowing limit under Facility B from $6,000,000 to $10,000,000.
Facility C: The Company can borrow under this facility if the aggregate
borrowings are in excess of the Facility A maximum borrowing amount plus the
borrowing base of Facility B. The interest rate is the higher of the prime rate
plus 0.75% or Federal Funds effective rate plus 1.25% on
F-13
<PAGE> 106
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 5. PLEDGED ASSETS, RELATED DEBT AND SUBSEQUENT EVENTS -- (CONTINUED)
the date of the borrowing. The borrowings under Facility C are collateralized by
trade receivables and inventory.
Upon the use of Facility C, the Company pays an annual facilities fee of
0.5% on the average daily commitment. In addition, Facility C is then guaranteed
by a stockholder which requires an annual fee equal to 0.5% of the difference
between the actual borrowing on Facility C and the total borrowing base
attributable to Facility C, which includes trade receivables and inventories.
Facility C was activated in 1995, upon which the Company granted to the
stockholder 1,912,500 Class B common stock options at $2.27 per share, the
estimated market price at that date. The options vest quarterly at the rate of
112,500 shares. Vesting would be reduced if the maximum borrowing limit amount
is reduced. The options are exercisable for five years from the date the last
options are vested. As of December 31, 1995, 225,000 stock options are vested.
In the event of a default under Facility C, the Company must issue to the
guarantor shares of $5.50 par value preferred stock equal to the payment made by
the guarantor divided by $5.50.
Stock Options: The Company has used the Black-Scholes model to value the
options issued under Facility A and C. The total value of the options under
Facility A and C was approximately $1,400,000 and $2,000,000, respectively, at
the date of issuance.
Interest expense for the years ended December 31, 1994 and 1995 is composed
of the following:
<TABLE>
<CAPTION>
1994 1995
----------------------------------------------------- -----------------------------------------------------
FACILITY A FACILITY B FACILITY C TOTAL FACILITY A FACILITY B FACILITY C TOTAL
---------- ---------- ---------- -------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Amounts to
bank......... $ 26,706 $-- $-- $ 26,706 $ 253,701 $ 29,750 $ -- $283,451
Facility
fee.......... 7,058 9,411 16,469 11,250 15,000 30,027 56,277
Capitalized
interest..... -- -- -- -- (61,914) -- -- (61,914)
Amortization
of fair value
of
stock options
issued to
non-employees... 175,000 -- -- 175,000 280,000 -- 352,000 632,000
--------- -------- -------- -------- --------- -------- --------- --------
$ 208,764 $9,411 $-- $218,175 $ 483,037 $ 44,750 $ 382,027 $909,814
========= ======== ======== ======== ========= ======== ======== ========
Effective
average
interest
rate......... 46.8% ** ** 15.9% 13.7% **
======== ======== ======== ========= ======== ========
</TABLE>
- ---------------
** No amounts borrowed during the year.
In March 1996, a Second Credit Facility for $8,000,000 was established. The
borrowings under the Second Credit Facility are unsecured and bear interest at a
rate equal to 1% over the higher of the prime rate or the Federal Funds
effective rate plus 0.5%. The Company also must pay a facilities fee of 1% on
the average daily commitment. At such time as the Company issues equity or debt
for cash, the amount of the Second Credit Facility commitment is reduced by an
amount equal to 100% of the net cash proceeds from such issuance and any amounts
due at that time must be reduced down to the new commitment amount.
A portion of the proceeds from the Company's initial public offering on
June 10, 1996 (see Note 13) was used to pay off all existing indebtedness on the
Company's credit facilities, which were subsequently cancelled. In addition, the
guarantees on Facility A and C were cancelled, which terminated the vesting of
the Class B common stock options granted in conjunction with the guarantees. At
September 30, 1996, a total of 1,300,688 Class B common stock options are
vested.
F-14
<PAGE> 107
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 5. PLEDGED ASSETS, RELATED DEBT AND SUBSEQUENT EVENTS -- (CONTINUED)
At September 30, 1996, Ruffalo, Cody & Associates, Inc., ("Ruffalo, Cody"),
which was acquired by the Company in July 1996 (see Note 14), had a line of
credit agreement with a bank, which expires May 2, 1997. As of September 30,
1996, Ruffalo, Cody had no amounts outstanding under this line of credit.
Ruffalo, Cody may borrow up to 80% of its eligible trade receivables up to a
maximum of $2,500,000. Borrowings under this agreement are collateralized by
substantially all of Ruffalo, Cody's assets and bear interest at the bank's
prime rate (the current effective rate is 8.25%). The agreement contains a
covenant requiring Ruffalo, Cody to maintain a certain amount of tangible net
worth. Additional available borrowings under the agreement totaled approximately
$2,500,000 at September 30, 1996.
TelecomQUSA Publishing Group, Inc. ("Telecom"), which was acquired by the
Company in September 1996 (see Note 14), has a $9,764,000 revolving line of
credit with a bank, which expires January 31, 1997. As of September 30, 1996,
Telecom had $1,696,600 outstanding on the line of credit. The borrowings bear
interest at prime (current effective rate is 8.25% at September 30, 1996), and
are collateralized by substantially all of Telecom's assets. If borrowings are
in excess of $6,000,000 the interest rate is prime plus 3/4%. To the extent that
the line of credit is used to finance acquisitions that cost more than
$1,000,000, the amount borrowed for the acquisition is converted to a term loan.
The amount of the term loan reduces the line of credit on a dollar for dollar
basis. The term loan will be repaid in quarterly installments of principal and
monthly installments of interest over a five-year period and will bear interest
at prime, unless over $6,000,000 is borrowed, in which case the rate shall be
prime plus 3/4%. The other terms and conditions of the term loan are the same as
the line of credit. As of September 30, 1996, there is a $2,012,400 term loan
outstanding under this agreement.
The Telecom loan agreement also contains covenants concerning various
financial ratios, additional acquisition and debt restrictions, and prohibition
of any cash dividends.
Long-term debt consists of:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
<S> <C>
Note payable, bank, principal due in quarterly payments of $111,800 through
January 31, 2001, interest is due monthly at prime (currently 8.25% at
September 30, 1996), collateralized by substantially all of Telecom's
assets. .................................................................... $ 2,012,400
Note payable, due $500,000 on January 1, 1997, including interest at 6 5/8%.
Collateralized by a second lien on publishing rights to purchased
directories. ............................................................... 470,377
Note payable, due in annual installments of $123,000 to $189,000, including
interest at 8.25%, through 2006. Collateralized by publishing rights to
purchased directories. ..................................................... 990,000
Contracts payable, to finance company, due in various monthly payments,
including interest at 8.5% to 8 5/8%, through November 1998, collateralized
by equipment with a depreciated cost of approximately $340,000. ............ 292,764
Incentive agreements, due in various estimated amounts plus interest at 6%
through January, 2001 (See Note 14). ....................................... 1,610,000
-----------
5,375,541
Less current maturities....................................................... 1,220,577
-----------
$ 4,154,964
===========
</TABLE>
F-15
<PAGE> 108
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 5. PLEDGED ASSETS, RELATED DEBT AND SUBSEQUENT EVENTS -- (CONTINUED)
Principal payments required on the long-term debt at September 30, 1996 are
as follows:
<TABLE>
<S> <C>
1997............................................ $1,220,577
1998............................................ 1,570,200
1999............................................ 964,964
2000............................................ 825,200
2001............................................ 337,600
Later years..................................... 457,000
----------
$5,375,541
==========
</TABLE>
NOTE 6. LEASE COMMITMENTS AND TOTAL RENTAL EXPENSE
The Company leases its facilities under noncancellable agreements, which
expire at various times through March 2001. These agreements require various
monthly rentals plus the payment of applicable property taxes, maintenance and
insurance. The Company also leases vehicles and equipment under agreements which
expire at various times through December 2001 and require various monthly
rentals.
The total minimum rental commitment at December 31, 1995 under the leases
mentioned above is as follows:
<TABLE>
<S> <C>
1996............................................ $1,549,000
1997............................................ 1,047,000
1998............................................ 534,000
1999............................................ 454,000
2000............................................ 411,000
Thereafter...................................... 305,000
----------
$4,300,000
==========
</TABLE>
The total rental expense included in the consolidated statements of
operations for 1993, 1994 and 1995 is approximately $125,000, $622,000 and
$1,558,000, respectively, which also includes short-term rentals for office
facilities.
F-16
<PAGE> 109
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 7. INCOME TAX MATTERS
Net deferred taxes consist of the following components as of December 31,
1994 and 1995:
<TABLE>
<CAPTION>
1994 1995
---------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards...................... $5,306,000 $ 9,681,000
Accruals and reserves not currently deductible........ 607,000 529,000
Deferred revenues..................................... 290,000 301,000
Other................................................. 8,000 17,000
---------- -----------
6,211,000 10,528,000
Less valuation allowance.............................. 5,411,000 8,418,000
---------- -----------
800,000 2,110,000
---------- -----------
Deferred tax liabilities:
Deferred line installation cost....................... 404,000 570,000
Property and equipment................................ 396,000 1,540,000
---------- -----------
800,000 2,110,000
---------- -----------
$ -- $ --
========== ===========
</TABLE>
During 1995, the Company increased the valuation allowance to $8,418,000 on
the deferred tax assets. A valuation allowance has been recognized to offset the
related net deferred tax assets due to the uncertainty of realizing the benefit
of the loss carryforwards. The Company has available net operating loss
carryforwards totaling approximately $24 million, which expire in various
amounts in the years 2008 to 2010.
The income tax provision differs from the amount of income tax determined
by applying the U.S. Federal income tax rate to pretax income for 1993, 1994 and
1995 due to the following:
<TABLE>
<CAPTION>
1993 1994 1995
--------- ----------- -----------
<S> <C> <C> <C>
Computed "expected" tax (benefit)......... $(854,000) $(3,934,000) $(3,744,000)
Increase (decrease) in income taxes
resulting from:
Change in valuation allowance........... 789,000 4,622,000 3,007,000
Deferred tax rate differential on
temporary differences................ 104,000 (656,000) 739,000
Other................................... (39,000) (32,000) (2,000)
--------- ----------- -----------
$ -- $ -- $ --
========= =========== ===========
</TABLE>
NOTE 8. STOCK OPTION PLAN AND SUBSEQUENT EVENTS
The Company has reserved 5,471,630 and 11,726,105 shares of Class A common
stock for issuance to key employees and directors under certain employee and
director stock option plans at December 31, 1995 and September 30, 1996,
respectively, which have been approved by the Board of Directors. Options are
granted at prices equal to the fair market value on the dates of grant as
determined by the Company's Board of Directors. Subsequent to the Company's
initial public offering on June 10, 1996 (see Note 13), the market value of the
options is based on the closing price of the Class A common stock on the day
before the grant date. Under the 1992, 1993 and
F-17
<PAGE> 110
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 8. STOCK OPTION PLAN AND SUBSEQUENT EVENTS (CONTINUED)
Director stock option plans, all options granted become exercisable at a rate of
25% per year, on a cumulative basis. Under the 1995 stock option plan, all
options, except for options issued to the Company's chairman and chief executive
officer, become exercisable at a rate of 25% per year, on a cumulative basis,
beginning five years from the date of grant. The options issued to the Company's
chairman and chief executive officer vest at a rate of 20% per year, on a
cumulative basis.
Other pertinent information related to the plans is as follows:
<TABLE>
<CAPTION>
SHARES OPTION PRICE
--------- --------------
<S> <C> <C>
Outstanding at January 1, 1993........................... 1,004,394 $0.27 - $ 0.29
Granted................................................ 1,564,414 0.80 - 1.07
---------
Outstanding at December 31, 1993......................... 2,568,808 0.27 - 1.07
Granted................................................ 786,113 1.47 - 1.73
Forfeited.............................................. (232,691) 0.80 - 1.73
---------
Outstanding at December 31, 1994......................... 3,122,230 0.27 - 1.73
Granted................................................ 2,006,273 1.73 - 2.67
Exercised.............................................. (11,532) 0.27 - 1.07
Forfeited.............................................. (247,923) 1.07 - 2.27
---------
Outstanding at December 31, 1995......................... 4,869,048 0.27 - 2.67
Granted................................................ 3,366,182 2.67 - 33.88
Exercised.............................................. (194,109) 0.27 - 2.27
Forfeited.............................................. (393,152) 1.73 - 2.67
---------
Under option, September 30, 1996......................... 7,647,969 $0.27 - $33.88
=========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
-------- --------- --------- -------------
NUMBER OF SHARES
<S> <C> <C> <C> <C>
Available for grant, end of year....... 393,692 590,270 591,988 4,078,136
======= ========= ========= =========
Options exercisable, end of year....... 251,100 1,035,143 1,580,989 2,442,699
======= ========= ========= =========
</TABLE>
The Company issued 965,166 and 688,502 stock options in January and
February 1996. The estimated fair market value of these options at the date of
grant was later determined to exceed the exercise price by $4,170,000 and
$5,020,000, respectively. As a result, the Company will be required to amortize
approximately $9,190,000 over the vesting period of these options. The
amortization for the nine months ended September 30, 1996 was approximately
$1,449,000.
On April 30, 1996, the stockholders approved the Amended and Restated
Directors Stock Option Plan, the 1996 Employee Stock Option Plan and the
Employee Stock Purchase Plan (see Note 13).
In addition, the Company has reserved 3,787,500 shares of Class B common
stock at December 31, 1995 for issuance to a stockholder which has guaranteed a
debt agreement. As discussed in Note 5, the vesting of these options was
terminated upon cancellation of the credit facilities and the related
guarantees, and at September 30, 1996, 1,300,688 shares of Class B common stock
are reserved for issuance upon exercise of these vested options.
F-18
<PAGE> 111
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 9. INVESTMENT AGREEMENT AND PREFERRED STOCK INFORMATION
The Company has an investment agreement under which the Company issued
7,344,964 shares of Class A common stock and 15,625,929 shares of Class B common
stock as of December 31, 1995. All Class B common stock has rights identical to
Class A common stock other than their voting rights, which are equal to .40 vote
per share. Each share of Class B common stock is convertible into one share of
Class A common stock at the option of the holder. The agreement also restricts
the payment of any dividends and redemption of stock without the prior consent
of five-sevenths of the Company's Board of Directors. On April 1, 1996, the
stockholders agreed to terminate the investment agreement and enter into a new
Investor Agreement, which became effective on June 10, 1996, the effective date
of the Registration Statement filed in connection with the Company's initial
public offering (see Note 13).
The Company has authorized but not issued 1,150,000 shares of $5.50 par
value redeemable Class A preferred stock. If issued, holders of the Class A
preferred stock would be entitled to nominate, vote and elect two additional
members to the Company's Board of Directors and to receive cash dividends on the
par value of the stock at the New York prime plus two percent. Such dividends
are cumulative.
NOTE 10. RETIREMENT PLAN
The Company has a 401(k) profit-sharing plan available to employees who
have completed one year of service and have worked 1,000 hours during the year.
The Company's contribution is discretionary. The Company contributed
approximately none, $12,000 and $44,000 for the years ended December 31, 1993,
1994 and 1995, respectively.
NOTE 11. ACQUISITION
On April 28, 1995, the Company issued 3,676,058 shares or approximately
$8.3 million of the Company's Class B common stock in exchange for all of the
outstanding common stock of MWR Telecom Inc. (MWR). In addition, the Company
granted an option to the seller to purchase 3,529,414 shares of Class B common
stock for $2.27 per share. This option was exercised on June 15, 1995.
MWR provides fiber optics telecommunication services between interexchange
carriers and their customers primarily in the Des Moines, Iowa area. The
goodwill acquired of approximately $2.6 million is being amortized over 15 years
by the straight-line method. The acquisition has been accounted for as a
purchase and results of operations since the date of acquisition are included in
the 1995 consolidated financial statements.
The unaudited consolidated results of operations on a pro forma basis as
though MWR had been acquired as of the beginning of 1994 is as follows:
<TABLE>
<CAPTION>
1994 1995
------------ ------------
<S> <C> <C>
Revenue................................................ $ 10,060,000 $ 29,871,000
Net loss............................................... (11,070,000) (10,561,000)
Loss per common and common equivalent share............ (.31) (.29)
</TABLE>
The pro forma financial information is presented for informational purposes
only and is not necessarily indicative of the operating results that would have
occurred had the MWR acquisition
F-19
<PAGE> 112
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 11. ACQUISITION (CONTINUED)
been consummated as of the above dates, nor are they necessarily indicative of
future operating results.
NOTE 12. RELATED PARTY TRANSACTIONS
During 1995, the Company entered into agreements with two stockholders that
gives certain rights-of-way to the Company for the construction of its
telecommunications network in exchange for capacity on the network. These
agreements were renegotiated in 1996 to clarify various terms of the agreements.
The Company provided and purchased services from various companies, the
principals of which are stockholders or directors of McLeod, Inc. or are
affiliates. These provided and purchased services are as follows:
<TABLE>
<CAPTION>
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
Revenue................................................. $ -- $ -- $103,000
======== ======== ========
Operating expenses:
Rent.................................................. $ 36,000 $ 19,000 $383,000
Legal services........................................ 91,000 79,000 147,000
Transportation services............................... 18,000 51,000 38,000
Advertising fees...................................... 1,000 11,000 55,000
Maintenance and installation services................. -- 51,000 36,000
Commission expense.................................... -- 11,000 31,000
Miscellaneous expense................................. -- 3,000 23,000
Reimbursement of general and administrative
expenses........................................... (6,000) (52,000) (38,000)
-------- -------- --------
$140,000 $173,000 $675,000
======== ======== ========
</TABLE>
In addition, at September 30, 1996, the Company has two $75,000 notes
receivable from officers. The notes bear interest at the applicable federal
interest rate for mid-term loans and require interest only payments for two
years and then annual $25,000 payments plus interest until paid in full.
NOTE 13. EVENTS SUBSEQUENT TO DECEMBER 31, 1995
Public offering: On June 10, 1996, the Company undertook an initial public
offering of Class A common stock for $276 million at $20 per share. The above
amount includes an over-allotment option to sell additional shares which was
exercised at the time of the initial public offering. The Company plans to use
the offering proceeds to finance (i) certain development, construction and
operating costs of the Company's fiber optic network, (ii) to fund market
expansion activities of the telemanagement business, (iii) to repay borrowings
and (iv) for additional working capital and general corporate purposes.
Recapitalization: In March 1996, the Company's Board of Directors
authorized a restatement of its Articles of Incorporation increasing the
authorized Class A common stock from 15,000,000 shares of $.01 par value stock
to 75,000,000 shares of $.01 par value stock and increasing the authorized Class
B common stock from 15,000,000 shares of $.01 par value stock to 22,000,000
shares of $.01 par value stock. The restated Articles of Incorporation also
authorizes the Board of
F-20
<PAGE> 113
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 13. EVENTS SUBSEQUENT TO DECEMBER 31, 1995 -- (CONTINUED)
Directors to issue up to 2,000,000 shares of $.01 par value preferred stock. The
terms of the preferred stock are determined at the time of issuance. The Board
of Directors also declared a 3.75 to 1 stock split for both the Class A and
Class B common stock which was effected in the form of a stock dividend. All
references to share and per share amounts give retroactive effect to this stock
split and recapitalization.
Investor agreement: On April 1, 1996, the stockholders entered into an
Investor Agreement, which became effective on June 10, 1996, the effective date
of the Registration Statement filed in connection with the Company's initial
public offering. This agreement provides for the election of directors
designated by certain principal stockholders and prevents certain principal
stockholders from disposing of any equity securities of the Company for a period
of two years unless consented to by the Board of Directors. In addition, certain
principal stockholders agreed that for a period of three years they will not
acquire any securities or options issued by the Company, except as allowed by
previous agreements or by the Board of Directors.
Employee benefit plans: On April 30, 1996, the Company's stockholders
approved the Amended and Restated Directors Stock Option Plan, the 1996 Employee
Stock Option Plan and the Employee Stock Purchase Plan. A summary of these plans
follows:
Amended and Restated Directors Stock Option Plan -- The Directors
Stock Option Plan ("Directors Plan") was amended and restated to be a
"formula" plan under which each eligible non-employee director who
subsequently commences service as a director will be granted an initial
option to purchase 10,000 shares of Class A common stock. An additional
option to purchase 5,000 shares of Class A common stock will be granted in
each of the next two years to each eligible director who remains for the
two year period. Options granted under the Directors Plan, as amended, may
be exercised with respect to 25 percent of the shares subject to such
option one year after the option is granted and with respect to an
additional 25 percent of the shares subject to such option over the next
three years. The Directors Plan, as amended, will terminate in 2006, unless
terminated earlier by the Board of Directors.
1996 Employee Stock Option Plan (1996 Plan) -- The 1996 Plan
supersedes the 1992 Incentive Stock Option Plan, the 1993 Incentive Stock
Option Plan and the 1995 Incentive Stock Option Plan. No future grants of
options will be made under such Plans. The Company has reserved 4,593,950
shares for issuance under the 1996 Plan. All officers and key employees of
the Company are eligible to receive grants under the 1996 Plan, provided
the individual does not have more than 2,000,000 shares subject to
exercise. The option price generally may not be less than 100% of the fair
market value of the Class A common stock on the grant date (or 110% if the
grantee beneficially owns more than 10% of the outstanding Class A common
stock). The options granted terminate 10 years after the grant date (or
five years after the grant date if the grantee beneficially owns more than
10% of the outstanding Class A common stock). The options vest over periods
determined by the Compensation Committee, however, no more than $100,000
worth of stock covered by the options may become exercisable in any
calendar year. The 1996 Plan will terminate in March 2006.
Employee Stock Purchase Plan -- Under the stock purchase plan,
employees may purchase up to an aggregate of 1,000,000 shares of Class A
common stock through payroll deductions. Employees of the Company who have
been employed more than six months and who are regularly scheduled to work
more than 20 hours per week are eligible to participate in the plan,
F-21
<PAGE> 114
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 13. EVENTS SUBSEQUENT TO DECEMBER 31, 1995 -- (CONTINUED)
provided that they own less than five percent of the total combined voting
power of all classes of stock of the Company. The purchase price for each
share will be determined by the Compensation Committee but may not be less
than 85% of the closing price of the shares of Class A common stock on the
first or last trading day of the payroll deduction period, whichever is
lower. No employee may purchase in any calendar year Class A common stock
having an aggregate fair market value in excess of $25,000. Upon
termination of employment, an employee other than a participating employee
who is subject to Section 16(b) under the Securities Exchange Act of 1934,
as amended, will be refunded all monies in his or her account and the
employee's option to purchase shares will terminate. The plan will
terminate in March 2006, unless terminated earlier by the Board of
Directors.
Employment, Confidentiality and Non-Competition Agreements: On May 29,
1996, the Company entered into employment, confidentiality and non-competition
agreements with 37 members of senior management. The agreements with the ten
senior management executive employees and 27 other senior management employees
provide that during their term of employment and for a two-year and one-year
period, respectively, following termination, the employees will not compete with
the Company. In addition, the ten executives and 27 senior managers have each
been granted options to purchase 23,000 and 11,500 shares of Class A common
stock, respectively, at an exercise price generally equal to the initial public
offering price per share of $20. The agreements provide that employees may not
disclose any confidential information during or after employment.
Change-of-Control Agreements: On May 29, 1996, the Company also entered
into change-of-control agreements with the ten senior management executive
employees discussed above, which provide for certain payments in connection with
termination of employment after a change of control (as defined within the
agreements) of the Company. The change-of-control agreements terminate on
December 31, 2006 unless a change of control occurs during the six-month period
prior to December 31, 2006, in which case the agreements terminate on December
31, 2007. The agreements provide that if an executive terminates his or her
employment within six months after a change of control or if the executive's
employment is terminated within 24 months after a change of control in
accordance with the terms and conditions set forth in the agreements, the
executive will be entitled to certain benefits. The benefits include cash
compensation, immediate vesting of outstanding stock options and coverage under
the Company's group health plan.
NOTE 14. ACQUISITIONS SUBSEQUENT TO DECEMBER 31, 1995
Ruffalo, Cody & Associates, Inc. -- On July 15, 1996, the Company
consummated an acquisition of Ruffalo, Cody from the shareholders of Ruffalo,
Cody by means of a forward triangular merger pursuant to an Agreement and Plan
of Reorganization, dated as of July 12, 1996 (the "Agreement"), by and among the
Company, Ruffalo, Cody and certain shareholders of Ruffalo, Cody. Pursuant to
the Agreement, (i) McLeod Merging Co., a newly incorporated Iowa corporation and
a wholly owned subsidiary of the Company, was merged with and into Ruffalo,
Cody, with McLeod Merging Co. (which has been renamed "Ruffalo, Cody &
Associates, Inc.") being the surviving corporation, (ii) the outstanding shares
of Ruffalo, Cody common stock were converted into the right to receive cash
and/or shares of the Company's Class A Common Stock (the "Class A Common
Stock"), and (iii) the outstanding options to purchase shares of Ruffalo, Cody
common stock were converted into options to purchase shares of the Class A
Common Stock (the "Substitute Options"). Under the Agreement, each issued and
outstanding share of Ruffalo, Cody
F-22
<PAGE> 115
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 14. ACQUISITIONS SUBSEQUENT TO DECEMBER 31, 1995 -- (CONTINUED)
common stock was converted into the right to receive a maximum of approximately
0.7 of a share of the Class A Common Stock.
The Company agreed to purchase Ruffalo, Cody for a maximum aggregate
purchase price of approximately $19.9 million (based on the average market price
of the Class A Common Stock during the five business days before and after the
acquisition date). The purchase price consisted of approximately $4.9 million in
cash, 474,807 shares of Class A Common Stock issuable in exchange for Ruffalo,
Cody common stock, and 158,009 shares of Class A Common Stock issuable upon the
exercise of the Substitute Options. On July 15, 1996, the Company paid an
aggregate of approximately $4.8 million in cash and issued 361,420 shares of
Class A Common Stock to the shareholders of Ruffalo, Cody, and granted to the
Ruffalo, Cody option holders Substitute Options to purchase 158,009 shares of
Class A Common Stock. An additional $50,782 in cash and 113,387 shares of Class
A Common Stock were placed into escrow and will be delivered (if at all) to
certain of the shareholders of Ruffalo, Cody over a period of 18 months,
contingent upon certain conditions relating to Ruffalo, Cody's ongoing revenues
from an agreement with a major long distance carrier to provide telemarketing
services. This long distance carrier informed Ruffalo, Cody that it intends to
terminate this contract effective December 31, 1996.
Telecom*USA Publishing Group, Inc. -- On September 20, 1996, the Company
acquired Telecom pursuant to an Agreement and Plan of Reorganization, dated as
of August 15, 1996, between the Company and Telecom. Pursuant to this agreement,
(i) Telecom was merged with and into McLeod Reverse Merging Co., a newly
incorporated Iowa corporation and a wholly owned subsidiary of the Company, with
Telecom as the surviving corporation, (ii) each outstanding share of common
stock, no par value, of Telecom was converted into the right to receive $12.75
in cash, and (iii) all outstanding non-vested options to purchase shares of
Telecom common stock were replaced with a deferred compensation program.
This acquisition resulted in a total purchase price of approximately $75.7
million. The purchase consisted of approximately $74.1 million in cash and $1.6
million resulting from the Company entering into a deferred compensation program
with all holders of non-vested options to purchase shares of Telecom.
These acquisitions have been accounted for as purchases and the results of
operations since the dates of acquisition are included in the unaudited
consolidated interim financial statements for the nine months ended September
30, 1996.
The unaudited consolidated results of operations for the nine months ended
September 30, 1995 and 1996 on a pro forma basis as though Ruffalo, Cody and
Telecom had been acquired as of the beginning of the respective periods are as
follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
1995* 1996
------------- -------------
<S> <C> <C>
Revenue............................................... $ 59,455,068 $ 92,797,912
Net loss.............................................. (14,051,942) (17,097,995)
Loss per common and common equivalent share........... (0.38) (0.41)
</TABLE>
--------------------
* Includes MWR's results of operations for the period from January 1, 1995
to April 28, 1995.
F-23
<PAGE> 116
MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 IS
UNAUDITED)
NOTE 14. ACQUISITIONS SUBSEQUENT TO DECEMBER 31, 1995 -- (CONTINUED)
The pro forma financial information is presented for informational purposes
only and is not necessarily indicative of the operating results that would have
occurred had the acquisitions been consummated as of the above dates, nor are
such operating results necessarily indicative of future operating results.
Total Communications Systems, Inc. -- The Company, through McLeod
Telemanagement, Inc., has entered into an Asset Purchase Agreement, as amended,
pursuant to which the Company agreed to purchase the customer base of Total
Communications Systems, Inc. for a cash purchase price of approximately
$510,000.
F-24
<PAGE> 117
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
MWR Telecom Inc.
Cedar Rapids, Iowa
We have audited the statements of income, stockholder's equity, and cash
flows of MWR Telecom Inc. for the years ended December 31, 1993 and 1994 and the
period from January 1, 1995 to April 28, 1995. 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 results of operations and cash flows of MWR
Telecom Inc. for the years ended December 31, 1993 and 1994 and the period from
January 1, 1995 to April 28, 1995 in conformity with generally accepted
accounting principles.
McGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
March 15, 1996
F-25
<PAGE> 118
MWR TELECOM INC.
STATEMENTS OF INCOME (NOTE 7)
<TABLE>
<CAPTION>
PERIOD FROM
YEARS ENDED DECEMBER 31, JANUARY 1,
-------------------------- 1995 TO
1993 1994 APRIL 28, 1995
----------- ----------- --------------
<S> <C> <C> <C>
Telecommunications revenue (Note 2)................... $ 1,823,056 $ 2,045,597 $872,809
----------- ----------- --------
Operating expenses:
Cost of service..................................... 673,925 806,855 375,480
Selling, general and administrative, including
management fees to parent company 1993 $18,000;
1994 $31,500; 1995 $12,000....................... 295,831 298,000 98,328
Depreciation........................................ 428,263 569,151 220,125
----------- ----------- --------
TOTAL OPERATING EXPENSES.................... 1,398,019 1,674,006 693,933
----------- ----------- --------
OPERATING INCOME............................ 425,037 371,591 178,876
Financial income (expense):
Interest income, parent company and its
affiliates....................................... 51,087 25,305 1,093
Interest (expense), parent company and its
affiliates....................................... (137,068) (252,904) (55,820)
----------- ----------- --------
INCOME BEFORE INCOME TAXES.................. 339,056 143,992 124,149
Income taxes (Note 4)................................. 138,028 59,732 51,239
----------- ----------- --------
NET INCOME.................................. $ 201,028 $ 84,260 $ 72,910
=========== =========== ========
</TABLE>
See Notes to Financial Statements.
F-26
<PAGE> 119
MWR TELECOM INC.
STATEMENTS OF STOCKHOLDER'S EQUITY (NOTE 7)
YEARS ENDED DECEMBER 31, 1993 AND 1994 AND THE
PERIOD FROM JANUARY 1, 1995 TO APRIL 28, 1995
<TABLE>
<CAPTION>
ADDITIONAL RETAINED
COMMON PAID-IN EARNINGS
STOCK CAPITAL (DEFICIT) TOTAL
------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1992............... $1,000 $1,247,031 $ (16,154) $1,231,877
Net income............................. -- -- 201,028 201,028
Conversion of related party note
payable to equity................... -- 1,200,000 -- 1,200,000
------ ---------- ---------- ----------
Balance, December 31, 1993............... 1,000 2,447,031 184,874 2,632,905
Net income............................. -- -- 84,260 84,260
Distribution to parent company
(Note 1)............................ -- -- (412,693) (412,693)
------ ---------- ---------- ----------
Balance, December 31, 1994............... 1,000 2,447,031 (143,559) 2,304,472
Net income............................. -- -- 72,910 72,910
Conversion of related party note
payable to equity................... -- 2,500,000 -- 2,500,000
Distribution to parent company
(Note 1)............................ -- -- (302,435) (302,435)
------ ---------- ---------- ----------
Balance, April 28, 1995.................. $1,000 $4,947,031 $ (373,084) $4,574,947
====== ========== ========== ==========
</TABLE>
See Notes to Financial Statements.
F-27
<PAGE> 120
MWR TELECOM INC.
STATEMENTS OF CASH FLOWS (NOTE 7)
<TABLE>
<CAPTION>
PERIOD FROM
YEARS ENDED DECEMBER 31, JANUARY 1,
---------------------------- 1995 TO
1993 1994 APRIL 28, 1995
------------ ------------ --------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income................................................ $ 201,028 $ 84,260 $ 72,910
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation............................................ 428,263 569,151 220,125
Deferred income taxes................................... 105,513 261,290 13,795
Changes in assets and liabilities:
(Increase) in trade receivables....................... (142,965) (65,761) (24,693)
(Increase) decrease in related party receivables...... 921,089 28,364 2,957
Increase (decrease) in accounts payable and accrued
expenses........................................... (96,357) (120,813) 76,509
Increase (decrease) in related party payables......... (80,266) (4,825) 30,028
Increase (decrease) in deferred revenue............... 25,945 (8,142) 83,030
Other, net............................................ 20,461 (107,607) 115,601
------------ ------------ ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES.......... 1,382,711 635,917 590,262
------------ ------------ ----------
Cash Flows from Investing Activities
Purchase of property and equipment........................ (1,148,197) (1,032,468) (366,539)
Proceeds from payments on notes receivable from parent
company and its affiliates.............................. 30,000 1,097,000 --
Advances on notes receivable from parent company and its
affiliates.............................................. (2,088,000) (712,000) (99,000)
Proceeds on notes receivable.............................. -- 1,383,609 --
------------ ------------ ----------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES....................................... (3,206,197) 736,141 (465,539)
------------ ------------ ----------
Cash Flows from Financing Activities
Increase (decrease) in checks issued not yet presented for
payment................................................. (228,411) 33,942 (39,723)
Proceeds from notes payable to parent company............. 4,684,000 581,000 44,000
Payments on notes payable to parent company............... (2,632,103) (1,987,000) (129,000)
------------ ------------ ----------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES....................................... 1,823,486 (1,372,058) (124,723)
------------ ------------ ----------
NET INCREASE (DECREASE) IN CASH.................... -- -- --
Cash:
Beginning................................................. -- -- --
------------ ------------ ----------
Ending.................................................... $ -- $ -- $ --
============ ============ ==========
Supplemental Disclosure of Cash Flow Information
Cash payment for interest, net of interest capitalized
1993 $10,777; 1994 $10,276; 1995 $6,827................. $ 137,068 $ 252,904 $ 55,820
============ ============ ==========
Cash payments for income taxes, net of refunds............ $ 94,023 $ (144,622) $ 8,000
============ ============ ==========
Supplemental Schedule of Noncash Investing and Financing
Activities
Conversion of related party notes payable to equity....... $ 1,200,000 $2,500,000
============ ==========
Distribution to parent company of certain net assets (Note
1)...................................................... $ 412,693 $ 302,435
============ ==========
</TABLE>
See Notes to Financial Statements.
F-28
<PAGE> 121
MWR TELECOM INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business: MWR Telecom Inc. (the "Company") primarily provides
fiber optics telecommunication services between interexchange carriers and their
customers primarily in the Des Moines, Iowa area. The Company was a wholly-owned
subsidiary of Midwest Capital Group, Inc. until April 28, 1995 when all of the
Company's common stock was purchased by McLeod, Inc. (see Note 7).
Accounting estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
A summary of the Company's significant accounting policies is as follows:
Basis of presentation: Prior to the sale of the operating assets of its
wholly-owned subsidiary in March 1994, the financial statements for MWR Telecom
Inc. (MWR) included the results of operations and cash flows of its subsidiary.
Subsequent to the sale, the subsidiary was liquidated and certain remaining net
assets were transferred to MWR's parent company. Since MWR's subsidiary was not
acquired by McLeod, Inc. (see Note 7), these financial statements only include
the results of operations and cash flows of MWR.
Inventory: Inventory is carried principally at average cost and consists
primarily of new and reusable parts to maintain and build fiber optic networks.
Property and equipment: Property and equipment is stated at cost.
Construction costs, including interest, are capitalized during the installation
of fiber optic telecommunication networks. Depreciation is computed by the
straight-line method over the following estimated useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Telecommunication networks........................... 7-15
Equipment............................................ 3-7
</TABLE>
Deferred revenue: Amounts received in advance under long-term leases of
fiber optic telecommunication networks are recognized as revenue on a
straight-line basis over the life of the leases.
Revenue recognition: Revenue from long-term leases of fiber optic
telecommunication networks is recognized over the term of the lease. Additional
services provided under these lease agreements are recognized as the services
are performed. Revenue from construction of fiber optic telecommunication
networks for others is recognized as the services are performed. These
construction contracts are short-term in nature and there were no material
contracts in process at the end of any periods presented.
Cost of service: Includes the cost of operating the Company's fiber optic
telecommunication networks and the cost of construction of networks for others.
Income tax matters: The Company recognizes deferred tax assets and
liabilities for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method, deferred
tax assets and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Net deferred tax assets are reduced by a valuation allowance when appropriate.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
F-29
<PAGE> 122
MWR TELECOM INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
For the periods presented, the Company was a member of a group that filed
consolidated federal and state tax returns. Accordingly, income taxes payable to
(refundable from) the tax authorities was recognized on the financial statements
of the parent company who is the taxpayer for income tax purposes. The members
of the consolidated group allocate payments to any member of the group for the
income tax reduction resulting from the member's inclusion in the consolidated
return, or the member makes payments to the parent company for its allocated
share of the consolidated income tax liability. This allocation approximates the
amounts that would be reported if the Company was separately filing its tax
returns.
Recently issued accounting standards: In March 1995, the Financial
Accounting Standards Board (FASB) issued SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
which will require the Company to account for the impairment of long-lived
assets and certain identifiable intangibles to be held and used by the Company
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Adoption of SFAS No. 121 is required in fiscal
1996.
While the Company does not know precisely the impact that will result from
adopting SFAS No. 121, the Company does not expect the adoption of SFAS No. 121
to have a material effect on the Company's financial statements.
NOTE 2. MAJOR CUSTOMERS
Telecommunications revenue includes the following approximate amounts from
major customers.
<TABLE>
<CAPTION>
PERIOD FROM
YEARS ENDED DECEMBER 31, JANUARY 1,
--------------------------- 1995 TO
1993 1994 APRIL 28, 1995
--------- --------- --------------
<S> <C> <C> <C>
Customer A.......................... $ 173,000 $ 268,000 $109,000
Customer B.......................... 354,000 449,000 170,000
-------- -------- --------
$ 527,000 $ 717,000 $279,000
======== ======== ========
</TABLE>
NOTE 3. LEASE COMMITMENTS AND TOTAL RENTAL EXPENSE
The Company leased its office and warehouse facilities from an affiliate
through December 1995 when it entered into an agreement to lease its office and
warehouse facilities from McLeod, Inc. on a month-to-month basis.
The total rental expense included in the statements of income for the years
ended December 31, 1993 and 1994 and for the period from January 1, 1995 to
April 28, 1995 is approximately $79,000, $82,000 and $31,000, respectively.
F-30
<PAGE> 123
MWR TELECOM INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. INCOME TAX MATTERS
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER PERIOD FROM
31, JANUARY 1,
---------------------- 1995 TO
1993 1994 APRIL 28, 1995
-------- --------- --------------
<S> <C> <C> <C>
Current................................ $ 32,515 $(201,558) $ 37,444
Deferred............................... 105,513 261,290 13,795
-------- --------- --------
$138,028 $ 59,732 $ 51,239
======== ========= ========
</TABLE>
The income tax provision differs from the amount of income tax determined
by applying the U.S. Federal income tax rate to pretax income due to the
following:
<TABLE>
<CAPTION>
PERIOD FROM
YEARS ENDED DECEMBER 31, JANUARY 1,
------------------------ 1995 TO
1993 1994 APRIL 28, 1995
-------- ------- --------------
<S> <C> <C> <C>
Computed "expected" tax............... $118,670 $50,397 $ 43,452
Increase (decrease) in income taxes
resulting from:
State tax, net of federal benefit... 22,276 9,460 8,157
Other............................... (2,918) (125) (370)
-------- ------- -------
$138,028 $59,732 $ 51,239
======== ======= =======
</TABLE>
NOTE 5. RETIREMENT PLANS
The Company's employees who had completed certain service and hour
requirements participated in certain retirement plans sponsored by the parent
company. The Company's expense related to these benefit plans was approximately
none, $76,000 and $21,000 for the years ended December 31, 1993 and 1994 and the
period from January 1, 1995 to April 28, 1995, respectively.
NOTE 6. RELATED PARTY TRANSACTION AND RIGHTS-OF-WAY
Prior to the sale discussed in Note 7, the Company and an affiliate entered
into a Joint Ownership Agreement which provides for the ownership and
maintenance of each entity's fiber optic networks in the Des Moines, Iowa area.
Some of the fiber optics network are constructed within rights-of-way owned by
affiliated companies. This agreement remains in force after the above mentioned
sale.
The Company also had agreements with an affiliate to use certain of their
rights-of-way at no charge. These agreements continued in force after the sale
to McLeod, Inc.
NOTE 7. SALE OF COMPANY
On April 28, 1995, all of the outstanding common stock of MWR Telecom Inc.
was sold to McLeod, Inc. of Cedar Rapids, Iowa.
F-31
<PAGE> 124
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Ruffalo, Cody & Associates, Inc.
Cedar Rapids, Iowa
We have audited the accompanying consolidated balance sheets of Ruffalo, Cody &
Associates, Inc. and subsidiary as of December 31, 1994 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1995. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Ruffalo, Cody &
Associates, Inc. and subsidiary as of December 31, 1994 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1995 in conformity with generally accepted
accounting principles.
MCGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
February 9, 1996, except
for Note 8, as to
which the date is
July 15, 1996
F-32
<PAGE> 125
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------ JUNE 30,
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
(UNAUDITED)
ASSETS (NOTE 2)
Current Assets
Cash and cash equivalents................................................. $ -- $ -- $ 46,647
Receivables:
Trade, less allowance for doubtful accounts 1994 $88,072; 1995 and 1996
$50,000 (Note 7)...................................................... 2,036,844 2,062,801 2,601,859
Income tax refund....................................................... 22,163 23,900 --
Other................................................................... 18,021 39,515 41,218
Deferred income taxes, net (Note 3)....................................... 115,000 70,000 70,000
Prepaid expenses.......................................................... 64,829 44,395 29,588
----------- ----------- -----------
TOTAL CURRENT ASSETS................................................ 2,256,857 2,240,611 2,789,312
----------- ----------- -----------
Equipment and Leasehold Improvements
Technical equipment....................................................... 1,510,401 1,773,178 1,966,626
Office equipment.......................................................... 127,578 250,494 278,772
Leasehold improvements.................................................... 16,552 108,724 122,976
In-house phones........................................................... 59,858 67,931 78,424
----------- ----------- -----------
1,714,389 2,200,327 2,446,798
Less accumulated depreciation............................................. 635,134 1,043,527 1,295,577
----------- ----------- -----------
1,079,255 1,156,800 1,151,221
----------- ----------- -----------
Intangibles, primarily software, less accumulated amortization 1994 $18,807;
1995 $51,046; 1996 $68,277................................................ 464,789 481,928 569,094
----------- ----------- -----------
Other Assets, deferred income taxes, net (Note 3)........................... 13,000 6,000 6,000
----------- ----------- -----------
$ 3,813,901 $ 3,885,339 $ 4,515,627
=========== =========== ===========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Notes payable (Note 2).................................................... $ 550,000 $ 100,000 $ 200,000
Current maturities of long-term debt...................................... 123,505 -- --
Checks issued not yet presented for payment............................... 207,773 16,376 --
Accounts payable.......................................................... 269,337 181,313 372,013
Accrued payroll and payroll related expenses.............................. 263,018 291,269 383,206
Accrued bonuses........................................................... 215,147 227,886 268,269
Accrued commissions....................................................... 104,585 128,573 190,245
Other accrued liabilities................................................. 317,065 243,349 209,507
Income taxes payable...................................................... -- -- 36,953
Customer deposits......................................................... 91,303 722,846 490,716
----------- ----------- -----------
TOTAL CURRENT LIABILITIES........................................... 2,141,733 1,911,612 2,150,909
----------- ----------- -----------
Long-Term Debt.............................................................. 222,340 -- --
----------- ----------- -----------
Commitments (Notes 5 and 6)
Redeemable Common Stock and Warrants (Notes 4 and 8)
Common stock, no par or stated value; issued 1994, 1995 and 1996 318,182
shares.................................................................. 1,590,910 2,068,183 2,227,274
Common stock held by the 401(k) profit-sharing plan....................... -- 69,453 139,853
Warrants, issued 1994, 1995 and 1996 90,909............................... 363,636 500,000 545,454
----------- ----------- -----------
1,954,546 2,637,636 2,912,581
----------- ----------- -----------
Common Stockholders' Equity (Deficit) (Notes 2, 4, 6 and 8)
Common stock, no par or stated value; authorized 5,000,000 shares; issued
1994 500,000 shares; 1995 515,685 shares; 1996 524,979 shares........... 500,000 558,925 618,894
Retained earnings (deficit)............................................... (1,004,718) (1,153,381) (1,026,904)
----------- ----------- -----------
(504,718) (594,456) (408,010)
Less maximum cash obligation related to 401(k) profit-sharing plan shares
(Note 4)................................................................ -- 69,453 139,853
----------- ----------- -----------
(504,718) (663,909) (547,863)
----------- ----------- -----------
$ 3,813,901 $ 3,885,339 $ 4,515,627
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-33
<PAGE> 126
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------------------ --------------------------
1993 1994 1995 1995 1996
----------- ----------- ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Telemarketing and other revenue (Note 7)... $ 8,370,904 $ 9,756,894 $ 13,286,146 $ 6,101,884 $ 8,278,479
---------- ---------- ----------- ---------- ----------
Operating expenses:
Cost of service.......................... 3,811,520 4,752,031 6,618,481 2,998,585 4,225,252
Selling, general and administrative...... 3,380,973 4,022,104 5,376,135 2,401,419 3,252,973
Depreciation and amortization............ 173,251 313,499 475,296 228,037 269,281
---------- ---------- ----------- ---------- ----------
TOTAL OPERATING EXPENSES.......... 7,365,744 9,087,634 12,469,912 5,628,041 7,747,506
---------- ---------- ----------- ---------- ----------
OPERATING INCOME.................. 1,005,160 669,260 816,234 473,843 530,973
Financial income (expense):
Interest income.......................... 4,854 1,034 41,780 135 10,258
Interest (expense)....................... (3,132) (45,280) (119,305) (65,626) (16,209)
---------- ---------- ----------- ---------- ----------
INCOME BEFORE INCOME TAXES........ 1,006,882 625,014 738,709 408,352 525,022
Income taxes (Note 3)...................... 340,532 223,380 273,735 143,000 194,000
---------- ---------- ----------- ---------- ----------
NET INCOME........................ $ 666,350 $ 401,634 $ 464,974 $ 265,352 $ 331,022
========== ========== =========== ========== ==========
Net income (loss) attributable to common
stockholders............................. $ 666,350 $ (416,548) $ (148,663) $ (41,467) $ 126,477
========== ========== =========== ========== ==========
Income (loss) per common and common
equivalent share......................... $ 1.10 $ (0.83) $ (0.29) $ (0.08) $ 0.19
========== ========== =========== ========== ==========
Weighted average common and common
equivalent shares outstanding............ 606,000 500,000 508,546 506,317 675,745
========== ========== =========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-34
<PAGE> 127
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF REDEEMABLE COMMON STOCK AND
WARRANTS AND COMMON STOCKHOLDERS' EQUITY (DEFICIT) (NOTE 6)
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND
SIX MONTHS ENDED JUNE 30, 1996 (UNAUDITED) (CONTINUED ON PAGE F-31)
<TABLE>
<CAPTION>
REDEEMABLE COMMON STOCK AND WARRANTS
-------------------------------------------------------
401(K) PROFIT-
COMMON SHARING PLAN
STOCK SHARES WARRANTS TOTAL
----------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1992........................ $ 1,050,000 $-- $300,000 $1,350,000
Issuance of 9,091 shares of common stock upon
the exercise of warrants...................... 27,273 -- (18,182) 9,091
Purchase of 40,909 shares of redeemable common
stock for retirement.......................... (122,727) -- -- (122,727)
Warrants cancelled or expired................... -- -- (100,000) (100,000)
Dividends ($.30 per share)...................... -- -- -- --
Net income...................................... -- -- -- --
----------- -------- -------- ----------
Balance, December 31, 1993........................ 954,546 -- 181,818 1,136,364
Net income...................................... -- -- -- --
Increase in estimated redemption price.......... 636,364 -- 181,818 818,182
----------- -------- -------- ----------
Balance, December 31, 1994........................ 1,590,910 -- 363,636 1,954,546
Common stock contributed to 401(k) profit-
sharing plan, 10,685 shares (Note 4).......... -- -- -- --
Issuance of 5,000 shares of common stock upon
the exercise of options (Note 4).............. -- -- -- --
Net income...................................... -- -- -- --
Increase in estimated redemption price.......... 477,273 -- 136,364 613,637
Change related to 401(k) profit-sharing plan
shares........................................ -- 69,453 -- 69,453
----------- -------- -------- ----------
Balance, December 31, 1995........................ 2,068,183 69,453 500,000 2,637,636
Common stock contributed to 401(k) profit-
sharing plan, 10,140 shares (unaudited) (Note
4)............................................ -- -- -- --
Issuance of 375 shares of common stock upon the
exercise of options (unaudited) (Note 4)...... -- -- -- --
Purchase of 1,221 shares of common stock for
retirement (unaudited)........................ -- -- -- --
Net income (unaudited).......................... -- -- -- --
Increase in estimated redemption price
(unaudited)................................... 159,091 -- 45,454 204,545
Change related to 401(k) profit-sharing plan
shares (unaudited)............................ -- 70,400 -- 70,400
----------- -------- -------- ----------
Balance, June 30, 1996 (unaudited)................ $ 2,227,274 $139,853 $545,454 $2,912,581
=========== ======== ======== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-35
<PAGE> 128
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF REDEEMABLE COMMON STOCK AND
WARRANTS AND COMMON STOCKHOLDERS' EQUITY (DEFICIT) (NOTE 6)
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND
SIX MONTHS ENDED JUNE 30, 1996 (UNAUDITED) (CONTINUED)
<TABLE>
<CAPTION>
COMMON STOCKHOLDERS' EQUITY (DEFICIT)
--------------------------------------------------
LESS
MAXIMUM
CASH
OBLIGATION
RELATED TO
401(K)
RETAINED PROFIT-
COMMON EARNINGS SHARING
STOCK (DEFICIT) PLAN TOTAL
-------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1992........................... $500,000 $(1,108,974) $ -- $(608,974)
Issuance of 9,091 shares of common stock upon the
exercise of warrants............................. -- (91) -- (91)
Purchase of 40,909 shares of redeemable common
stock for retirement............................. -- -- -- --
Warrants cancelled or expired...................... -- 100,000 -- 100,000
Dividends ($.30 per share)......................... -- (245,455) -- (245,455)
Net income......................................... -- 666,350 -- 666,350
-------- ----------- ---------- ---------
Balance, December 31, 1993........................... 500,000 (588,170) -- (88,170)
Net income......................................... -- 401,634 -- 401,634
Increase in estimated redemption price............. -- (818,182) -- (818,182)
-------- ----------- ---------- ---------
Balance, December 31, 1994........................... 500,000 (1,004,718) -- (504,718)
Common stock contributed to 401(k) profit-sharing
plan, 10,685 shares (Note 4)..................... 53,425 -- -- 53,425
Issuance of 5,000 shares of common stock upon the
exercise of options (Note 4)..................... 5,500 -- -- 5,500
Net income......................................... -- 464,974 -- 464,974
Increase in estimated redemption price............. -- (613,637) -- (613,637)
Change related to 401(k) profit-sharing plan
shares........................................... -- -- (69,453) (69,453)
-------- ----------- ---------- ---------
Balance, December 31, 1995........................... 558,925 (1,153,381) (69,453) (663,909)
Common stock contributed to 401(k) profit-sharing
plan, 10,140 shares (unaudited) (Note 4)......... 65,909 -- -- 65,909
Issuance of 375 shares of common stock upon the
exercise of options (unaudited) (Note 4)......... 375 -- -- 375
Purchase of 1,221 shares of common stock for
retirement (unaudited)........................... (6,315) -- -- (6,315)
Net income (unaudited)............................. -- 331,022 -- 331,022
Increase in estimated redemption price
(unaudited)...................................... -- (204,545) -- (204,545)
Change related to 401(k) profit-sharing plan shares
(unaudited)...................................... -- -- (70,400) (70,400)
-------- ----------- ---------- ---------
Balance, June 30, 1996 (unaudited)................... $618,894 $(1,026,904) $ (139,853) $(547,863)
======== =========== ========== =========
</TABLE>
See Notes to Consolidated Financial Statements.
F-36
<PAGE> 129
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
-------------------------------------------- ----------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash Flows from Operating Activities
Net income...................................... $ 666,350 $ 401,634 $ 464,974 $ 265,352 $ 331,022
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation.................................. 173,251 213,725 304,255 142,516 182,649
Amortization.................................. -- 99,774 171,041 85,521 86,632
Provision for doubtful accounts............... -- 38,072 -- -- --
(Gain) loss on sale of equipment.............. -- 10,761 (3,942) (3,942) --
Deferred income taxes......................... (6,000) -- 52,000 -- --
Changes in assets and liabilities:
Other receivables........................... (541,671) (869,041) (47,451) 626,797 (540,761)
(Increase) decrease in income taxes
receivable................................ (18,042) (4,121) (1,737) 22,163 23,900
(Increase) decrease in prepaid expenses..... (15,008) (42,726) 20,434 (158,999) 14,807
Increase (decrease) in accounts payable and
accrued expenses.......................... 253,107 411,916 (43,337) (392,739) 416,759
Increase (decrease) in income tax payable... (28,452) -- -- 38,445 36,953
Increase (decrease) in customer deposits.... (42,141) 16,086 631,543 7,650 (232,130)
----------- ----------- ----------- ----------- -----------
NET CASH PROVIDED BY OPERATING
ACTIVITIES.............................. 441,394 276,080 1,547,780 632,764 319,831
----------- ----------- ----------- ----------- -----------
Cash Flows from Investing Activities
Proceeds from sale of equipment................. -- 5,000 52,000 52,000 --
Purchase of equipment and leasehold
improvements.................................. (146,220) (784,985) (568,660) (302,641) (246,471)
Purchase of intangibles......................... -- (483,596) (49,378) -- (104,397)
----------- ----------- ----------- ----------- -----------
NET CASH (USED IN) INVESTING ACTIVITIES... (146,220) (1,263,581) (566,038) (250,641) (350,868)
----------- ----------- ----------- ----------- -----------
Cash Flows from Financing Activities
Proceeds from notes payable..................... 1,065,000 3,510,000 6,120,000 3,080,000 3,135,000
Principal payments on notes payable............. (1,080,000) (2,960,000) (6,570,000) (3,480,000) (3,035,000)
Proceeds from long-term borrowings.............. -- 600,000 -- 204,104 --
Principal payments on long-term borrowings...... (40,525) (254,155) (345,845) (58,890) --
Proceeds from issuance of common stock upon the
exercise of options........................... -- -- 5,500 -- 375
Proceeds from issuance of redeemable common
stock......................................... 9,000 -- -- -- --
Purchase of redeemable common stock for
retirement.................................... (122,727) -- -- -- --
Purchase of common stock for retirement......... -- -- -- -- (6,315)
Cash dividends paid............................. -- (245,455) -- -- --
Increase (decrease) in checks issued not yet
presented for payment......................... -- 207,773 (191,397) (127,337) (16,376)
----------- ----------- ----------- ----------- -----------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES.............................. (169,252) 858,163 (981,742) (382,123) 77,684
----------- ----------- ----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................. 125,922 (129,338) -- -- 46,647
Cash and cash equivalents:
Beginning....................................... 3,416 129,338 -- -- --
----------- ----------- ----------- ----------- -----------
Ending.......................................... $ 129,338 $ -- $ -- $ -- $ 46,647
=========== =========== =========== =========== ===========
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest...................................... $ 3,262 $ 39,183 $ 125,530 $ 61,862 $ 14,237
Income taxes.................................. 400,702 235,517 223,472 82,392 133,146
Supplemental Schedule of Noncash Investing and
Financing Activities
Common stock contributed to 401(k)
profit-sharing plan (Note 4).................. $ 53,425 $ 53,425 $ 65,909
=========== =========== ===========
Increase in estimated redemption price of
redeemable common stock and warrants.......... $ 818,182 $ 613,637
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-37
<PAGE> 130
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business: The Company provides telemarketing services and
systems to businesses and nonprofit entities throughout the United States.
Accounting estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
A summary of the Company's significant accounting policies follows:
Principles of consolidation: The accompanying consolidated financial
statements include Ruffalo, Cody & Associates, Inc. and its subsidiary,
Campus-Call, Inc., which is wholly-owned. All material intercompany transactions
and balances have been eliminated.
The results of operations of the subsidiary have been reported since the
inception date of June 2, 1994.
Cash and cash equivalents: For purposes of reporting cash flows, the
Company considers all highly liquid debt instruments purchased with a maturity
of three months or less to be cash equivalents.
Equipment and leasehold improvements and depreciation: Equipment and
leasehold improvements are carried at cost. Depreciation is computed by the
straight-line method over the following estimated useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Technical equipment.................................. 3-5
Office equipment..................................... 5
Leasehold improvements............................... 5-10
In-house phones...................................... 5
</TABLE>
Software costs: Costs incurred to develop software products are charged to
expense as research and development costs until technological feasibility for
the product is established. Thereafter, software production costs are
capitalized and, once the product is available for sale, are amortized by the
greater of (a) the ratio that current gross revenues for the product bear to the
total current and anticipated future gross revenues for that product and (b) the
straight-line method over the remaining estimated economic life of the product
including the period being reported on. If management's estimate of the future
gross revenues or the remaining economic life of the product are reduced
significantly, the carrying amount of software costs would be affected.
Revenue recognition: Fees from telemarketing contracts are recognized as
revenue in the period the services are performed.
Revenue on software license fees and sales that require installation is
recognized upon installation. Revenue on hardware sales is recognized upon
delivery and installation. Training and consulting fees are recognized as the
services are performed. Upon installation of a system, the Company records as
deferred revenue the charge for software maintenance. Revenue is then recognized
on the straight-line basis over the term of the contract.
F-38
<PAGE> 131
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Income taxes: Deferred taxes are provided on a liability method, whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of
the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.
Stock options issued to employees and directors: Compensation expense for
stock issued through stock option plans is accounted for using the intrinsic
value based method of accounting prescribed by APB Opinion No. 25, "Accounting
for Stock Issued for Employees." Under this method, compensation is measured as
the difference between the estimated market value of the stock at the date of
award less the amount required to be paid for the stock. The difference, if any,
is charged to expense over the periods of service.
The estimated market value used for the stock options granted is determined
on a periodic basis by the Company's Board of Directors.
Common stock held by 401(k) profit-sharing plan: The Company's maximum
cash obligation related to these shares is classified outside stockholders'
equity because the shares are not readily traded and could be put to the Company
for cash.
Earnings (loss) per common and common equivalent share: Earnings (loss)
per common and common equivalent share are determined by dividing net income,
less the increase in the estimated redemption price of redeemable common stock
and warrants, by the weighted average number of common and common equivalent
shares outstanding during each of the periods presented. Dilutive common stock
equivalents related to the stock options discussed in Note 4 were determined
using the treasury stock method. The estimated fair market value of the
Company's common stock used to calculate the common stock equivalents under the
treasury stock method for the periods presented has been estimated by management
or determined by an independent appraisal. Earnings (loss) per common and common
equivalent share assuming full dilution are the same as earnings (loss) per
common and common equivalent share.
Recently issued accounting standards: In March 1995, the Financial
Accounting Standards Board (FASB) issued SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
which will require the Company to account for the impairment of long-lived
assets and certain identifiable intangibles to be held and used by the Company
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Adoption of SFAS No. 121 is required in fiscal
1996.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which establishes a fair value based method for financial
accounting and reporting for stock-based employee compensation plans. However,
the new standard allows compensation to continue to be measured by using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," but requires
expanded disclosures. SFAS No. 123 is effective in fiscal year 1996. The Company
has elected to continue to apply the intrinsic value based method of accounting
for stock options.
F-39
<PAGE> 132
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
While the Company does not know precisely the impact that will result from
adopting SFAS No. 121 and SFAS No. 123, the Company does not expect the adoption
of SFAS No. 121 or SFAS No. 123 to have a material effect on the Company's
consolidated financial statements.
Fair value of financial instruments: The carrying amount of current notes
payable approximates fair value because these obligations bear interest at
current rates.
Interim financial information (unaudited): The financial statements and
notes related thereto as of June 30, 1996, and for the six-month periods ended
June 30, 1995 and 1996, are unaudited, but in the opinion of management include
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the financial position and results of operations. The
operating results for the interim periods are not indicative of the operating
results to be expected for a full year or for other interim periods. Not all
disclosures required by generally accepted accounting principles necessary for a
complete presentation have been included.
NOTE 2. PLEDGED ASSETS, CURRENT NOTES PAYABLE AND LONG-TERM DEBT
At June 30, 1996, the Company had a line of credit agreement with a bank
under which they may borrow up to 80% of eligible trade receivables up to a
maximum of $2,500,000. The Company has $200,000 outstanding under this agreement
at June 30, 1996. Borrowings under this agreement are collateralized by
substantially all of the Company's assets and bear interest at the bank's prime
rate (the current effective rate is 8.25%). The agreement contains a covenant
requiring the Company to maintain a certain amount of tangible net worth. The
covenant was waived as of June 30, 1996. Additional available borrowings under
the agreement totaled approximately $2,300,000 at June 30, 1996. The agreement
expires May 2, 1997.
NOTE 3. INCOME TAX MATTERS
Net deferred tax assets consist of the following components as of December
31, 1994 and 1995:
<TABLE>
<CAPTION>
1994 1995
--------- --------
<S> <C> <C>
Deferred tax assets:
Receivable allowances............................. $ 35,000 $ 20,000
Equipment and leasehold improvements.............. 5,000 17,000
Intangibles....................................... 21,000 9,000
Accrued expenses.................................. 32,000 50,000
Deferred rent..................................... 35,000 --
--------- --------
128,000 96,000
Deferred tax liabilities:
Capitalized software costs........................ -- 20,000
--------- --------
$ 128,000 $ 76,000
========= ========
</TABLE>
F-40
<PAGE> 133
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 3. INCOME TAX MATTERS -- (CONTINUED)
The deferred income tax amounts mentioned above have been classified on the
accompanying balance sheets as of December 31, 1994 and 1995 as follows:
<TABLE>
<CAPTION>
1994 1995
--------- --------
<S> <C> <C>
Current assets......................................... $ 115,000 $ 70,000
Noncurrent assets...................................... 13,000 6,000
--------- --------
$ 128,000 $ 76,000
========= ========
</TABLE>
Income tax expense is composed of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1993 1994 1995
--------- --------- ---------
<S> <C> <C> <C>
Current tax expense........................ $ 346,532 $ 223,380 $ 221,735
Deferred tax expense....................... (6,000) -- 52,000
--------- --------- ---------
$ 340,532 $ 223,380 $ 273,735
========= ========= =========
</TABLE>
The income tax provision differs from the amount of income tax determined
by applying the U.S. Federal income tax rate to pretax income for 1993, 1994 and
1995 due to the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1993 1994 1995
--------- --------- ---------
<S> <C> <C> <C>
Computed "expected" tax.................... $ 342,340 $ 212,505 $ 251,161
Increase (decrease) in income taxes
resulting from:
Nondeductible expenses................ 1,674 6,072 9,774
State income taxes, net of federal
income tax benefit.................. 1,393 1,864 4,691
Other................................. (4,875) 2,939 8,109
--------- --------- ---------
$ 340,532 $ 223,380 $ 273,735
========= ========= =========
</TABLE>
NOTE 4. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) profit sharing plan for eligible employees.
Contributions to the plan are at the discretion of the Company's Board of
Directors. The amount of contribution included in operating expenses for the
years ended December 31, 1993, 1994 and 1995 is $30,802, $52,473 and $59,494,
respectively. The contributions for 1994 and 1995 have been made with company
stock.
In the event a terminated plan participant desires to sell his or her
shares of the Company stock, or if certain employees elect to diversify their
account balances, the Company may be required to purchase the shares from the
participant at their fair market value. To the extent that shares of common
stock held by the 401(k) profit-sharing plan are not readily traded, a sponsor
must reflect the maximum cash obligation related to those securities outside of
stockholders' equity. As of June 30, 1996, 19,979 shares held by the 401(k)
profit-sharing plan, at a fair value of $7.00 per share, have been reclassified
from stockholders' equity to liabilities.
F-41
<PAGE> 134
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 4. EMPLOYEE BENEFIT PLANS -- (CONTINUED)
The Company pays bonuses to its officers at the discretion of the Board of
Directors. The amount of these bonuses charged to operating expenses for the
years ended December 31, 1993, 1994 and 1995 is $288,665, $179,165 and $186,466,
respectively.
The Company has established employee and director stock option plans for
the benefit of eligible employees and directors under which options for the
issuance of up to 295,000 shares of common stock may be granted. Under the
employee and director plans, all options vest over a period of up to ten years
as determined by the Board of Directors at the time of grant.
Other pertinent information related to the plan is as follows:
<TABLE>
<CAPTION>
SHARES OPTION PRICE
-------- ------------
<S> <C> <C>
Outstanding at January 1, 1993.............................. 154,000 $ 1.00-$1.10
Granted................................................ 67,000 3.00- 3.30
Forfeited.............................................. (15,000) 1.00- 3.00
--------
Outstanding at December 31, 1993............................ 206,000 1.00- 3.30
Granted................................................ 32,500 6.00
--------
Outstanding at December 31, 1994............................ 238,500 1.00- 6.00
Exercised.............................................. (5,000) 1.10
--------
Outstanding at December 31, 1995............................ 233,500 1.00- 6.00
Granted................................................ 26,500 6.50
Exercised.............................................. (375) 1.00
Forfeited.............................................. (1,875) 1.00- 6.00
--------
Under option, June 30, 1996................................. 257,750 $ 1.00-$6.50
========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, JUNE
--------------------------- 30,
1993 1994 1995 1996
------ ------ ------- -------
NUMBER OF SHARES
--------------------------------------
<S> <C> <C> <C> <C>
Available for grant, end of year............... 69,000 56,500 56,500 31,875
====== ====== ======== ========
Options exercisable, end of year............... -- 72,500 135,500 170,000
====== ====== ======== ========
</TABLE>
NOTE 5. LEASE COMMITMENTS AND TOTAL RENT EXPENSE
The Company leases its main office space under an agreement which expires
on April 30, 2005. This lease requires monthly rent payments totaling $29,851
and increasing to $32,429 in later years plus the payment of property taxes and
maintenance.
The Company also leases other office space and office equipment under
various leases which require various minimum rental payments through July 1997.
F-42
<PAGE> 135
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 5. LEASE COMMITMENTS AND TOTAL RENT EXPENSE -- (CONTINUED)
The total minimum lease commitment at December 31, 1995 under the operating
leases mentioned above is $3,620,229 which is due as follows:
<TABLE>
<S> <C>
During the year ending December 31:
1996...................................................... $ 438,644
1997...................................................... 399,992
1998...................................................... 358,215
1999...................................................... 358,215
2000...................................................... 378,839
Later years............................................... 1,686,324
-----------
$ 3,620,229
===========
</TABLE>
The total rent expense for the years ended December 31, 1993, 1994 and 1995
is approximately $241,500, $293,200 and $353,800, respectively.
NOTE 6. REDEEMABLE COMMON STOCK AND WARRANTS
In connection with an Investment Agreement covering the issuance of 350,000
shares of the Company's common stock, warrants were issued which entitle the
holders to purchase one share of common stock in exchange for $1 and one
warrant. At December 31, 1995 and June 30, 1996, a total of 90,909 warrants are
outstanding. All of the outstanding warrants expire on October 2, 2001.
At anytime after October 2, 1997, the shareholders covered by the
Investment Agreement may, at their option, put the common stock and warrants to
the Company and require the Company to immediately pay in cash, in the case of
the common stock, the fair market value of the common stock as determined by an
independent appraiser and, in the case of the warrants, the fair market value of
the common stock less the exercise price of the warrants.
The Company is increasing the carrying amount of the redeemable common
stock and warrants so that the carrying amount will equal the estimated
redemption amount. The estimated redemption amount at each year end was
determined by an independent appraiser. For interim periods, the amount was
estimated by management.
NOTE 7. MAJOR CUSTOMER
Telemarketing revenue for the years ended December 31, 1993, 1994 and 1995
includes approximately $2,750,000, $3,465,000 and $5,600,000, respectively, from
a major customer. Trade receivables from this customer totaled $382,928,
$579,943 and $522,544 at December 31, 1993, 1994 and 1995, respectively.
In October 1996, the Company was informed by the major customer that it
intends to terminate its contract with the Company effective December 31, 1996.
NOTE 8. EVENTS SUBSEQUENT TO DECEMBER 31, 1995
On July 15, 1996, McLeod, Inc. consummated the acquisition (the
"Acquisition") of the Company, from the shareholders of the Company by means of
a forward triangular merger pursuant to an Agreement and Plan of Reorganization,
dated as of July 12, 1996 (the "Agreement"), by and
F-43
<PAGE> 136
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1996 IS
UNAUDITED.)
NOTE 8. EVENTS SUBSEQUENT TO DECEMBER 31, 1995 -- (CONTINUED)
among McLeod, Inc., the Company and certain shareholders of the Company.
Pursuant to the Agreement, (i) McLeod Merging Co., a newly incorporated Iowa
corporation and a wholly-owned subsidiary of McLeod, Inc., was merged with and
into the Company, with McLeod Merging Co. (which has been renamed "Ruffalo, Cody
& Associates, Inc.") being the surviving corporation, (ii) the outstanding
shares of the Company's common stock were converted into the right to receive
cash and/or shares of McLeod, Inc.'s Class A Common Stock (the "Class A Common
Stock"), and (iii) the outstanding options to purchase shares of the Company's
common stock were converted into options to purchase shares of the Class A
Common Stock (the "Substitute Options"). Under the Agreement, each issued and
outstanding share of the Company's common stock was converted into the right to
receive a maximum of approximately 0.7 of a share of the Class A Common Stock.
McLeod, Inc. agreed to purchase the Company for a maximum aggregate
purchase price of approximately $19.9 million (based on the average market price
of the Class A Common Stock during the five business days before and after the
Acquisition). The purchase price consisted of approximately $4.9 million in
cash, 474,807 shares of Class A Common Stock issuable in exchange for the
Company's common stock, and 158,009 shares of Class A Common Stock issuable upon
the exercise of the Substitute Options. On July 15, 1996, McLeod, Inc. paid an
aggregate of approximately $4.8 million in cash and issued 361,420 shares of
Class A Common Stock to the shareholders of the Company, and granted to the
Company's option holders Substitute Options to purchase 158,009 shares of Class
A Common Stock. An additional $50,782 in cash and 113,387 shares of McLeod,
Inc.'s Class A Common Stock were placed into escrow and will be delivered (if at
all) to certain of the shareholders of the Company over a period of 18 months,
contingent upon certain conditions relating to the Company's ongoing revenues.
F-44
<PAGE> 137
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Telecom*USA Publishing Group, Inc.
Cedar Rapids, Iowa
We have audited the accompanying consolidated balance sheets of Telecom*USA
Publishing Group, Inc. and subsidiaries as of August 31, 1995 and 1996, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended August 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Telecom*USA
Publishing Group, Inc. and subsidiaries as of August 31, 1995 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended August 31, 1996 in conformity with generally accepted
accounting principles.
McGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
September 27, 1996
F-45
<PAGE> 138
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AUGUST 31,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
ASSETS (NOTE 4)
Current Assets
Accounts receivable:
Billed........................................................................... $ 3,744,468 $ 5,543,874
Unbilled......................................................................... 6,493,122 8,555,438
----------- -----------
10,237,590 14,099,312
Less allowance for doubtful accounts and adjustments............................. 2,334,156 3,102,923
----------- -----------
7,903,434 10,996,389
Income taxes receivable............................................................ -- 54,710
Other receivables.................................................................. 553,447 828,345
Deferred expenses.................................................................. 7,896,840 9,078,470
Prepaid expenses................................................................... 723,031 380,903
Deferred income taxes, net (Note 6)................................................ 1,410,000 1,536,000
----------- -----------
TOTAL CURRENT ASSETS......................................................... 18,486,752 22,874,817
----------- -----------
Equipment and Furniture (Note 13).................................................... 5,502,530 7,129,908
Less accumulated depreciation...................................................... 2,316,912 3,433,755
----------- -----------
3,185,618 3,696,153
----------- -----------
Investments and Other Assets
Investment in Colorado Directory Company, L.L.C. (Note 3).......................... 1,000,000 --
Purchase option (Note 2)........................................................... 500,000 500,000
Deferred income taxes, net (Note 6)................................................ 920,000 704,000
Other investment................................................................... -- 100,000
----------- -----------
2,420,000 1,304,000
----------- -----------
Intangibles
Customer lists, at cost, less accumulated amortization
1995 $1,155,646; 1996 $1,489,634 (Note 12)....................................... 5,349,506 6,176,196
Noncompete agreements, at cost, less accumulated amortization 1995 $1,094,317;
1996 $1,947,662.................................................................. 6,900,246 6,955,720
Organization and loan costs, at cost, less accumulated depreciation 1995 $72,592;
1996 $109,087.................................................................... 230,597 185,947
----------- -----------
12,480,349 13,317,863
----------- -----------
$36,572,719 $41,192,833
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Note payable, bank (Note 4)........................................................ $ 1,532,000 $ 2,773,800
Current maturities of long-term debt (Note 4)...................................... 875,050 1,224,286
Payables for intangibles acquired, due within one year............................. 1,439,846 572,528
Accounts payable................................................................... 1,573,680 2,160,855
Checks issued not yet presented for payment........................................ 21,981 219,942
Accrued payroll and payroll related expenses....................................... 1,597,745 1,920,379
Other accrued expenses............................................................. 759,925 914,053
Income taxes payable............................................................... 172,524
Customer deposits.................................................................. 6,761,668 7,534,485
----------- -----------
TOTAL CURRENT LIABILITIES.................................................... 14,734,419 17,320,328
----------- -----------
Long-Term Debt, less current maturities (Note 4)..................................... 15,511,295 16,228,889
----------- -----------
Commitments and Contingencies (Notes 5, 7, 9, 10 and 13)
Minority Interests
Redeemable preferred stock, redeemed on September 2, 1995.......................... 200,000 --
Consolidated subsidiary............................................................ 484,043 352,816
----------- -----------
684,043 352,816
----------- -----------
Redeemable common stock held by 401(k) profit-sharing plan (Note 9).................. 125,595 220,070
----------- -----------
Stockholders' Equity (Notes 4 and 14)
Capital stock, common, no par or stated value; authorized 10,000,000 shares; issued
1995 2,533,124 shares; 1996 2,719,481 shares (Notes 9, 10 and 11)................ 3,968,357 4,194,075
Retained earnings.................................................................. 1,787,855 3,209,975
----------- -----------
5,756,212 7,404,050
Less cost of treasury stock, 37,750 shares......................................... 113,250 113,250
Less maximum cash obligation related to 401(k) profit-sharing plan (Note 9)........ 125,595 220,070
----------- -----------
5,517,367 7,070,730
----------- -----------
$36,572,719 $41,192,833
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-46
<PAGE> 139
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED AUGUST 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenue................................................................ $31,438,605 $38,620,274 $52,117,929
----------- ----------- -----------
Operating expenses:
Production and distribution.......................................... 12,568,411 15,022,983 22,340,587
Market sales......................................................... 9,244,961 10,940,711 13,798,321
Sales and marketing administrative................................... 1,761,103 2,279,484 2,294,370
General and administrative........................................... 4,322,338 5,020,000 7,249,349
Depreciation and amortization........................................ 1,167,458 1,891,198 2,348,490
Restructuring loss (Note 11)......................................... 524,670 -- --
----------- ----------- -----------
TOTAL OPERATING EXPENSES....................................... 29,588,941 35,154,376 48,031,117
----------- ----------- -----------
OPERATING INCOME............................................... 1,849,664 3,465,898 4,086,812
----------- ----------- -----------
Nonoperating (income) expense:
Interest income...................................................... (1,707) (93,997) (251,000)
Interest expense..................................................... 843,961 1,497,699 1,767,309
Loan inducement fee payoff (Note 7).................................. -- 1,330,000 --
Loss on disposal of investment (Note 3).............................. -- -- 500,000
----------- ----------- -----------
842,254 2,733,702 2,016,309
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST IN
CONSOLIDATED SUBSIDIARY...................................... 1,007,410 732,196 2,070,503
Federal and state income taxes (Note 6)................................ 137,190 302,586 975,610
----------- ----------- -----------
INCOME BEFORE MINORITY INTEREST IN NET (LOSS) IN CONSOLIDATED
SUBSIDIARY................................................... 870,220 429,610 1,094,893
Minority interest in net (loss) of consolidated subsidiary............. -- (15,959) (327,227)
----------- ----------- -----------
NET INCOME..................................................... $ 870,220 $ 445,569 $ 1,422,120
=========== =========== ===========
Earnings per common and common equivalent shares outstanding:
Primary.............................................................. $ 0.27 $ 0.14 $ 0.43
=========== =========== ===========
Fully diluted........................................................ $ 0.26 $ 0.14 $ 0.36
=========== =========== ===========
Weighted average common and common equivalent shares outstanding:
Primary.............................................................. 3,198,776 3,271,497 3,332,659
=========== =========== ===========
Fully diluted........................................................ 4,510,864 3,289,720 4,678,549
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-47
<PAGE> 140
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED AUGUST 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
LESS MAXIMUM
CASH OBLIGATION
RELATED TO
LESS 401(K)
COMMON RETAINED TREASURY PROFIT-SHARING
STOCK EARNINGS STOCK PLAN SHARES TOTAL
---------- ---------- --------- --------------- ----------
<S> <C> <C> <C> <C> <C>
Balance, August 31, 1993.......................... $3,868,400 $ 472,066 $(113,250) $ -- $4,227,216
Common stock contributed to 401(k) profit-
sharing plan, 15,179 shares (Note 9).......... 53,126 -- -- (53,126) --
Issuance of 925 shares of common stock upon the
exercise of options (Note 10)................. 925 -- -- -- 925
Purchase of 775 shares of common stock for
retirement.................................... (2,713) -- -- -- (2,713)
Net income...................................... -- 870,220 -- -- 870,220
---------- ---------- --------- --------- ----------
Balance, August 31, 1994.......................... 3,919,738 1,342,286 (113,250) (53,126) 5,095,648
Common stock contributed to 401(k) profit-
sharing plan, 12,945 shares (Note 9).......... 57,307 -- -- (57,307) --
Issuance of 14,175 shares of common stock upon
the exercise of options (Note 10)............. 19,775 -- -- -- 19,775
Purchase of 6,325 shares of common stock for
retirement.................................... (28,463) -- -- -- (28,463)
Change related to 401(k) profit-sharing plan
shares........................................ -- -- -- (15,162) (15,162)
Net income...................................... -- 445,569 -- -- 445,569
---------- ---------- --------- --------- ----------
Balance, August 31, 1995.......................... 3,968,357 1,787,855 (113,250) (125,595) 5,517,367
Common stock contributed to 401(k) profit-
sharing plan, 10,363 shares (Note 9).......... 57,470 -- -- (57,470) --
Issuance of 182,300 shares of common stock upon
the exercise of options (Note 10)............. 208,850 -- -- -- 208,850
Purchase of 6,306 shares of common stock for
retirement.................................... (40,602) -- -- -- (40,602)
Change related to 401(k) profit-sharing plan
shares........................................ -- -- -- (37,005) (37,005)
Net income...................................... -- 1,422,120 -- -- 1,422,120
---------- ---------- --------- --------- ----------
Balance, August 31, 1996.......................... $4,194,075 $3,209,975 $(113,250) $(220,070) $7,070,730
========== ========== ========= ========= ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-48
<PAGE> 141
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED AUGUST 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income.................................................................... $ 870,220 $ 445,569 $ 1,422,120
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation................................................................ 551,531 802,428 1,116,508
Amortization................................................................ 615,927 1,088,770 1,231,982
Deferred income taxes....................................................... (171,512) (813,000) 90,000
Provision for loan inducement fee payable
(Note 7).................................................................. -- 1,330,000 --
Restructuring loss (Note 11)................................................ 524,670 -- --
Loss on disposal of investment (Note 3)..................................... -- -- 500,000
Minority interest in net (loss) of consolidated subsidiary.................. -- (15,959) (327,227)
Provision for doubtful accounts and adjustments............................. 1,340,069 1,669,478 2,636,421
Change in assets and liabilities:
(Increase) in accounts receivable......................................... (2,235,749) (2,539,025) (5,729,376)
(Increase) in income taxes receivable..................................... -- -- (54,710)
(Increase) in deferred expenses........................................... (1,454,860) (1,769,831) (1,181,630)
Increase (decrease) in accounts payable and accrued expenses.............. 345,414 887,580 (163,439)
Increase in customer deposits............................................. 1,609,118 1,469,140 772,817
Increase (decrease) in income taxes payable............................... 209,224 115,524 (172,524)
Other..................................................................... (67,702) (94,998) 67,230
------------ ------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES............................... 2,136,350 2,575,676 208,172
------------ ------------ ------------
Cash Flows from Investing Activities
Purchase of equipment and furniture........................................... (809,908) (1,483,881) (1,598,290)
Purchase of customer lists.................................................... (583,522) (3,121,804) (457,276)
Purchase of noncompete agreements............................................. (684,828) (3,681,801) (204,692)
Investment in Colorado Directory Company, L.L.C. (Note 3)..................... -- (1,000,000) --
Proceeds received on disposal of investment................................... -- -- 500,000
Purchase option (Note 2)...................................................... -- (500,000) --
Organization and loan costs................................................... -- (158,332) --
Purchase of other investment.................................................. -- -- (100,000)
------------ ------------ ------------
NET CASH (USED IN) INVESTING ACTIVITIES................................. (2,078,258) (9,945,818) (1,860,258)
------------ ------------ ------------
</TABLE>
F-49
<PAGE> 142
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows from Financing Activities
Increase (decrease) in checks issued not yet presented for payment............ $ (3,493) $ (83,223) $ 197,961
Borrowings on revolving credit agreements..................................... 12,906,000 10,109,500 21,211,000
Payments on revolving credit agreements....................................... (12,853,000) (9,103,500) (17,733,200)
Proceeds from long-term debt.................................................. -- 9,330,500 --
Principal payments on long-term debt.......................................... (105,811) (3,374,447) (2,187,923)
Proceeds from issuance of common stock upon the exercise of options........... 925 19,775 208,850
Purchase of common stock for retirement....................................... (2,713) (28,463) (40,602)
Payment on redemption of preferred stock...................................... -- -- (200,000)
Capital contribution received from minority owner in consolidated
subsidiary.................................................................. -- 500,000 196,000
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES..................... (58,092) 7,370,142 1,652,086
------------ ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS............................... -- -- --
Cash and cash equivalents:
Beginning..................................................................... -- -- --
------------ ------------ ------------
Ending........................................................................ $ -- $ -- $ --
============ ============ ============
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest.................................................................... $ 793,609 $ 1,247,048 $ 1,767,309
Income taxes, net of refunds................................................ 99,478 1,000,062 1,115,250
Supplemental Schedules of Noncash Investing and Financing Activities
Customer list acquired by issuance
payables.................................................................... $ 669,000 $ 464,923 $ 829,022
Noncompete agreement acquired by issuance
payables.................................................................... 669,000 974,923 578,506
Common stock contributed to 401(k) profit-sharing plan (Note 9)............... 53,126 57,307 57,470
Reclassification of intangibles to deferred income taxes (Note 6)............. 1,188,488
Equipment acquired by contracts payable....................................... 552,612 28,753
Current note payable converted to long-term debt (Note 4)..................... 2,236,000
</TABLE>
See Notes to Consolidated Financial Statements.
F-50
<PAGE> 143
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business: Telecom*USA Publishing Group, Inc. and subsidiaries
(the "Company") are publishers of telephone directories in a fifteen-state area
primarily in the midwestern United States. Revenues are principally derived from
advertising in such publications.
Accounting estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
A summary of the Company's significant accounting policies follows:
Principles of consolidation: The consolidated financial statements include
the accounts of Telecom*USA Publishing Group, Inc. and its wholly-owned
subsidiaries, Telecom*USA Publishing Company and Telecom*USA Neighborhood
Directories, Inc. (liquidated in January 1996) and its 51% owned subsidiary,
OakTel Directory, L.C. (OakTel). All significant intercompany accounts and
transactions have been eliminated in consolidation.
OakTel was formed to publish a directory for the Lincoln, Nebraska area and
its first publication was in November 1995. The Company provides directory
services to OakTel at specified prices.
Revenue and expense recognition: Revenue and expenses are recognized on
the accrual basis. Revenues are recorded upon publication of directories.
Deferred expenses consist of production and selling costs on unpublished
directory advertising orders. They are expensed when the related directory is
published and the related revenue of the directory is recognized.
Customer deposits consist of cash received from customers at the time a
sales contract is signed. They are recorded as revenue when the related
directory is published.
Advertising revenue and market sales expense includes contracts for trading
advertising space with various other media companies. These revenues are
recognized in the month of publication and the related prepaid expenses are
recorded at estimated net realizable value. These revenues totaled approximately
$548,000, $600,000, and $950,000 for the years ended August 31, 1994, 1995, and
1996, respectively.
Accounts receivable: In accordance with industry practice, accounts
receivable includes certain unbilled revenue from installment contracts. It is
anticipated that a substantial portion of all such amounts at August 31, 1996
will be collected within one year.
Equipment and furniture and depreciation: Equipment and furniture is
carried at cost. Depreciation expense is computed by the straight-line method
over primarily five or seven years.
Investment in Colorado Directory Company, L.L.C. ("CDC"): The Company is
accounting for its 12.5% investment in CDC by the cost method.
Income tax matters: Deferred taxes are provided on a liability method
whereby deferred tax assets are recognized for deductible temporary differences
and operating loss and tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of
the deferred tax assets will not be
F-51
<PAGE> 144
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
realized. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.
Intangible assets: Intangible assets are being amortized by the
straight-line method over the following periods:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Customer lists (See Note 13)......................... 15
Noncompete agreements................................ 3-10
Organization and loan costs.......................... 1-6
</TABLE>
Intangible assets are periodically reviewed for impairment based upon an
assessment of future operations to ensure that they are appropriately valued.
The Company entered into noncompete agreements and acquired customer lists
for forty and eight directories during the years ended August 31, 1995 and 1996,
respectively.
Stock options: Compensation expense for stock issued through stock options
plans is accounted for using the intrinsic value based method of accounting
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Under this method, compensation is measured as the difference between the
estimated market value of the stock at the date of award less the amount
required to be paid for the stock. The difference, if any, is charged to expense
over the periods of service.
Common stock held by 401(k) profit-sharing plan: The Company's maximum
cash obligation related to these shares is classified outside stockholders'
equity because the shares are not readily traded and could be put to the Company
for cash.
Earnings per common and common equivalent share: Earnings per common and
common equivalent share, assuming no dilution, are determined by dividing net
income by the weighted average number of common and common equivalent shares
outstanding during each of the periods presented. Dilutive common stock
equivalents related to the stock options and warrants discussed in Note 10 were
determined using the treasury stock method. The convertible debentures are not
common stock equivalents. The estimated fair market value of the Company's
common stock used to calculate the common stock equivalents under the treasury
stock method for the periods presented has been estimated by management or
determined by an independent appraisal. Earnings per common and common
equivalent share, assuming full dilution, assumes conversion of the dilutive
convertible debentures since the date of issuance.
Recently issued accounting standards: In March 1995, the Financial
Accounting Standards Board (FASB) issued SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of,"
which will require the Company to account for the impairment of long-lived
assets and certain identifiable intangibles to be held and used by the Company
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Adoption of SFAS No. 121 is required in fiscal
1997.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which establishes a fair value based method for financial
accounting and reporting for stock-based employee compensation plans. However,
the new standard allows compensation to continue to be measured by using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," but requires
F-52
<PAGE> 145
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
expanded disclosures. SFAS No. 123 is effective in fiscal year 1997. The Company
has elected to continue to apply the intrinsic value based method of accounting
for stock options.
While the Company does not know precisely the impact that will result from
adopting SFAS No. 121 and SFAS No. 123, the Company does not expect the adoption
of SFAS No. 121 or SFAS No. 123 to have a material effect on the Company's
consolidated financial statements.
Fair value of financial instruments: The carrying amount of long-term debt
approximates fair value because these obligations bear interest at current
rates.
NOTE 2. OPTION TO PURCHASE DIRECTORIES
The Company loaned $500,000 to another directory publisher in consideration
of an option to purchase nine of its directories. The note is noninterest
bearing, nonrecourse, and collateralized by the publishing rights to one of the
directories. The option price of the directories is determined based on revenue
of the directories at the time of exercise and other factors. The Company may
exercise the option anytime between June 1, 1997 and June 1, 1999. If the
Company does not exercise its option, the loan is forgiven. If the option is
exercised, the amount of the loan is applied to the option price.
NOTE 3. INVESTMENT IN COLORADO DIRECTORY COMPANY L.L.C.
The Company's investment in Colorado Directory Company, L.L.C. (CDC), a
Colorado limited liability company that publishes directories in Denver and
Boulder, Colorado, consists of the following:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Convertible debenture which is noninterest bearing, due
December 1, 2004, and collateralized by the publishing
rights to the Boulder directory....................... $ 500,000 $ --
Members' equity, represents 12.5% ownership in CDC...... 500,000 --
---------- ----------
$1,000,000 $ --
========== ==========
</TABLE>
In June 1996, the Company recognized a $500,000 loss on the disposition of
the CDC investment as a result of selling all of its interest in CDC to an
affiliate of another member of CDC for $500,000.
NOTE 4. PLEDGED ASSETS, CURRENT NOTES PAYABLE AND LONG-TERM DEBT
The Company has a $9,764,000 revolving line of credit with a bank, which
expires January 31, 1997. As of August 31, 1995 and 1996, the Company had
$1,532,000 and $2,773,800, respectively, outstanding on the line of credit. The
borrowings bear interest at prime (current effective rate is 8.25% at August 31,
1996), and are collateralized by substantially all of the Company's assets. If
borrowings are in excess of $6,000,000 the interest rate is prime plus 3/4%. To
the extent that the line of credit is used to finance acquisitions that cost
more than $1,000,000, the amount borrowed for the acquisition is converted to a
term loan. The amount of the term loan reduces the line of credit on a dollar
for dollar basis. The term loan will be repaid in quarterly installments of
principal and monthly installments of interest over a five-year period and will
bear interest at prime, unless over $6,000,000 is borrowed, then the rate shall
be prime plus 3/4%. The other terms and conditions of the term loan are the
same as the line of credit. As of August 31, 1996, there is a $2,012,400 term
loan outstanding under this agreement.
F-53
<PAGE> 146
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PLEDGED ASSETS, CURRENT NOTES PAYABLE AND LONG-TERM DEBT -- (CONTINUED)
The loan agreement contains covenants concerning various financial ratios,
additional acquisition and debt restrictions, and prohibition of any cash
dividends. As of August 31, 1996, the Company was either in compliance with the
restrictive covenants or had obtained waivers for noncompliance.
Long-term debt consists of:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
The Company has convertible unsecured debentures payable to
various individuals and corporations. The convertible
debentures are payable in quarterly payments of interest only
until maturity at which time the debentures will be converted
to common stock of the Company or paid in full, at the option
of the holder. The debentures may be converted to common
stock of the Company, at the option of the holder, upon the
earlier of (i) the expiration of two years from the date of
issuance (applies only to debentures issued April 1992), (ii)
upon a public offering of common stock of the Company, or
(iii) upon receipt of notice of redemption from the Company.
The Company may only redeem the convertible debentures in
connection with or as a precondition to a public offering of
common stock of the Company. The terms of these debentures
are due as follows:
9%, due April 1998, convertible at $4.00 per share of common
stock, issued April 1992.* ............................... $ 5,214,000 $ 5,214,000
11%, due November 2000 through January 2001, convertible at
$8.00 per share of common stock, issued November 1994
through January 1995.* ................................... 8,450,000 8,450,000
Note payable, bank, principal due in quarterly payments of
$111,800 through January 31, 2001, interest is due monthly at
prime (currently 8.25% at August 31, 1996), collateralized by
substantially all of the Company's assets. .................. -- 2,012,400
Noncompete agreement, due in monthly payments of $5,250,
including interest at 8 5/8%, through May 1996. ............. 41,980 --
Note payable, due $500,000 on January 1, 1996 and 1997,
including interest at 6 5/8%. Collateralized by a second lien
on publishing rights to purchased directories. .............. 905,377 465,377
Note payable, due in annual installments of $123,000 to
$189,000, including interest at 8.25%, through 2006.
Collateralized by publishing rights to purchased
directories.................................................. -- 990,000
Contracts payable, to finance company, due in various monthly
payments, including interest at 8.5% to 8 5/8%, through
November 1998, collateralized by equipment with a depreciated
cost of $348,053. ........................................... 444,988 321,398
Loan inducement fee payable (See Note 8)....................... 1,330,000 --
----------- -----------
16,386,345 17,453,175
Less current maturities........................................ 875,050 1,224,286
----------- -----------
$15,511,295 $16,228,889
=========== ===========
</TABLE>
- ---------------
* All debentures were converted into Common Stock prior to the acquisition of
the company by McLeod, Inc. on September 20, 1996. (See Note 14)
F-54
<PAGE> 147
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. PLEDGED ASSETS, CURRENT NOTES PAYABLE AND LONG-TERM DEBT -- (CONTINUED)
Principal payments required on the long-term debt at August 31, 1996 are as
follows:
<TABLE>
<S> <C>
1997.................................................. $ 1,224,286
1998.................................................. 5,874,780
1999.................................................. 573,309
2000.................................................. 550,200
2001.................................................. 8,773,600
Later years........................................... 457,000
-----------
$17,453,175
===========
</TABLE>
NOTE 5. LEASE COMMITMENTS AND TOTAL RENT EXPENSE
The Company has an operating lease for its corporate headquarters, which
expires August 31, 2005. In addition to minimum annual rentals, the lease
requires the payment of operating costs of the building based on its pro rata
share of the building. The Company also leases other office facilities and
equipment under various operating leases.
The total minimum rental commitment at August 31, 1996 under the operating
leases is as follows:
<TABLE>
<S> <C>
During the year ending August 31:
1997................................................ $ 1,412,000
1998................................................ 1,290,000
1999................................................ 1,130,000
2000................................................ 1,078,000
2001................................................ 891,000
Thereafter.......................................... 5,631,000
-----------
$11,432,000
===========
</TABLE>
The total rental expense for 1994, 1995, and 1996 was approximately
$1,225,000, $1,312,000, and $1,528,000, respectively.
F-55
<PAGE> 148
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. INCOME TAXES
Net deferred tax assets consist of the following components as of August
31, 1995 and 1996:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Deferred tax assets:
Accounts receivable..................................... $ 934,000 $1,219,000
Intangibles............................................. 679,000 664,000
Deferred expenses....................................... 101,000 --
Accrued expenses........................................ 444,000 513,000
Capital loss carryforward............................... -- 200,000
Loan inducement fee payable............................. 532,000 --
---------- ----------
2,690,000 2,596,000
Less valuation allowance................................ -- --
---------- ----------
2,690,000 2,596,000
---------- ----------
Deferred tax liabilities:
Equipment and furniture................................. 191,000 185,000
Accounts receivable..................................... 169,000 171,000
---------- ----------
360,000 356,000
---------- ----------
$2,330,000 $2,240,000
========== ==========
</TABLE>
The components giving rise to the net deferred tax assets described above
have been included in the accompanying balance sheets as of August 31, 1995 and
1996 as follows:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Current assets............................................ $1,410,000 $1,536,000
Noncurrent assets......................................... 920,000 704,000
---------- ----------
$2,330,000 $2,240,000
========== ==========
</TABLE>
No valuation allowance is required on the deferred tax assets as of August
31, 1996 and 1995. The valuation allowance for deferred tax assets decreased
$1,110,000 during 1994, due to the utilization of the acquired operating loss
carryforwards and management's belief that deferred tax assets will ultimately
be realized.
The provision for income taxes charged to operations for 1994, 1995, and
1996 consists of the following:
<TABLE>
<CAPTION>
1994 1995 1996
--------- ---------- --------
<S> <C> <C> <C>
Current tax expense........................... $ 308,702 $1,115,586 $885,610
Deferred tax expense.......................... (171,512) (813,000) 90,000
--------- ---------- --------
$ 137,190 $ 302,586 $975,610
========= ========== ========
</TABLE>
F-56
<PAGE> 149
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. INCOME TAXES -- (CONTINUED)
The income tax provision differs from the amount of income tax determined
by applying the U.S. Federal income tax rate to pretax income for 1994, 1995,
and 1996 due to the following:
<TABLE>
<CAPTION>
1994 1995 1996
------------------ ------------------ -----------------
% OF % OF % OF
DOLLAR PRETAX DOLLAR PRETAX DOLLAR PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
--------- ------ --------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Computed "expected" federal
income tax expense........ $ 352,593 35% $ 256,269 35% $724,676 35%
Increase (decrease) in
income taxes resulting
from:
State income taxes, net of
federal tax benefit.... 60,445 6 96,866 13 71,656 3
Meals and entertainment... 20,920 2 59,767 8 74,724 4
Minority interest in net
loss of consolidated
limited liability
subsidiary............. -- -- 5,586 1 114,529 6
Additional deferred income
taxes after
reclassification of
intangibles to deferred
income taxes........... (396,907) (39) -- -- -- --
Other.................. 100,139 10 (115,902) (16) (9,975) (1)
--
--------- --- --------- --- --------
$ 137,190 14% $ 302,586 41% $975,610 47%
========= === ========= === ======== ==
</TABLE>
NOTE 7. LOAN INDUCEMENT FEE
The Company had previously agreed to pay a fee of 1/2% of cash revenues to
three individuals on a monthly basis as compensation for previous financing
provided such individuals. Two of these individuals are stockholders of the
Company and one of these individuals is on the Company's Board of Directors. The
fee was to be paid through October 31, 2000. For 1994, 1995, and 1996, the loan
inducement fee expense was approximately $153,000, $190,000, and none,
respectively, which is included in interest expense.
In August 1995, the Company's Board of Directors adopted a resolution to
prepay the fee according to a formula contained in the original agreement.
Therefore, the remaining liability of $1,330,000 was recorded at August 31,
1995. The payment of the remaining liability was made during the year ended
August 31, 1996.
NOTE 8. STOCKHOLDER AGREEMENTS
The common stockholders of the Company have entered into a stockholder
agreement that provides for the following:
- The stockholders may not sell, transfer, or pledge their stock without
first offering it to the Company, and secondly to the other stockholders,
at fair market value.
F-57
<PAGE> 150
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. STOCKHOLDER AGREEMENTS -- (CONTINUED)
- Any gift of the stock must be approved by the Company and will be subject
to the terms of the stockholder agreement. The gift may be made to a
spouse, child of the stockholder or to a charitable organization or
private foundation.
- Upon the death of a stockholder, any transferee of the stock will be
subject to the terms of the stockholder agreement.
- Each stockholder has co-sale rights.
- Each stockholder has piggyback rights upon a registration of the stock.
- Written action of 51% of the stock may amend or cancel the agreement.
NOTE 9. RETIREMENT AND BONUS PLAN
The Company has a 401(k) Profit Sharing Plan for those employees who have
completed one year of service and who are at least 18 years of age. The plan
provides for contributions in such amounts as the Board of Directors may
annually determine. The amount charged to expense during 1994, 1995, and 1996
was approximately $56,000, $80,000, and $117,500, respectively. The
contributions for 1994 and 1995 have been made with the Company's common stock.
The Company plans to make the 1996 contribution with cash.
In the event a terminated plan participant desires to sell his or her
shares of the Company's stock, or if certain employees elect to diversify their
account balances, the Company may be required to purchase the shares from the
participant at their fair market value. To the extent that shares of common
stock held by the 401(k) profit-sharing plan are not readily traded, a sponsor
must reflect the maximum cash obligation related to those securities outside of
stockholders' equity. As of August 31, 1996, 38,273 shares held by the 401(k)
profit-sharing plan, at a fair value of $5.75 per share, have been reclassified
from stockholder's equity to liabilities.
The Company has bonus plans for substantially all of its nonsales personnel
based on obtaining certain profitability goals. These bonuses totaled
approximately $362,000, $471,000, and $720,000 for 1994, 1995, and 1996,
respectively.
NOTE 10. STOCK OPTION PLAN AND STOCK PURCHASE WARRANTS
The Company has adopted a qualified stock option plan with 800,000 shares
of common stock reserved for the grant of options to key employees and
directors. Option prices will be the fair market value of the common stock on
the date options are granted. The options primarily vest over a
F-58
<PAGE> 151
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. STOCK OPTION PLAN AND STOCK PURCHASE WARRANTS -- (CONTINUED)
54-month period and must be exercised within seven years from the date of grant.
The following table summarizes the options to purchase shares of the Company's
common stock:
<TABLE>
<CAPTION>
SHARES OPTION PRICE
-------- ------------
<S> <C> <C>
Outstanding, August 31, 1993.................... 490,800 $1.00-$3.00
Granted 18,900 1.00- 3.30
Exercised..................................... (925) 1.00
Cancelled..................................... (9,925) 1.00- 3.00
--------
Outstanding, August 31, 1994.................... 498,850 1.00- 3.50
Granted....................................... 265,600 4.50- 4.95
Exercised..................................... (14,175) 1.00- 3.00
Cancelled..................................... (20,775) 1.00- 4.50
--------
Outstanding, August 31, 1995.................... 729,500 1.00- 4.95
Granted....................................... 28,050 5.75
Exercised..................................... (182,300) 1.00- 4.50
Cancelled..................................... (21,400) 3.00- 5.75
--------
Outstanding, August 31, 1996.................... 553,850 1.00- 5.75
========
</TABLE>
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Options exercisable, end of year.... 245,325 384,300 251,900
======= ======= =======
Available for grant, end of year.... 625 55,400 48,750
======= ======= =======
</TABLE>
In connection with previous financing provided by three individuals (see
Note 7), the Company issued three stock purchase warrants enabling the holders
to purchase 488,650 shares of common stock at an exercise price of $.01 per
share. The stock purchase warrants are exercisable through November 20, 2000.
All vested options and stock purchase warrants were exercised prior to the
acquisition of the Company by McLeod, Inc. on September 20, 1996. (See Note 14).
NOTE 11. RESTRUCTURING LOSS
In January 1994, the Company restructured Telecom*USA Neighborhood
Directories, Inc. Previously it published eleven neighborhood directories in the
Chicago, Illinois area. The Company has decided to keep certain market areas and
produce two directories similar to the Company's other products. The expense
included in 1994 includes previously deferred expenses on books which will no
longer be published and a write-down of the purchased customer list and
agreement not-to-compete.
NOTE 12. CHANGE IN ACCOUNTING ESTIMATE
During the year ended August 31, 1996, the Company evaluated the turnover
of its customer lists and determined that a 15-year life was more appropriate
than the 3-10 year life it was presently using. The effect of this change was to
increase net income for 1996 by approximately $781,000, equal to $0.23 per
average common share outstanding.
F-59
<PAGE> 152
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13. COMMITMENT TO PURCHASE EQUIPMENT
During the year ended August 31, 1996, the Company has capitalized
approximately $200,000 related to a telephone sales force automation project.
The Company estimates it will cost approximately $1,100,000 to complete the
project.
NOTE 14. REORGANIZATION OF COMPANY AND SUBSEQUENT EVENTS
On September 20, 1996 the Company was acquired by McLeod, Inc. pursuant to
an Agreement and Plan of Reorganization. Under the Agreement, the Company was
merged into McLeod Reverse Merging Co., a wholly owned subsidiary of McLeod, Inc
with the Company as the surviving corporation. Immediately after the merger each
share of the Company was converted into the right to receive $12.75 in cash.
This acquisition resulted in a total purchase price of approximately $75.7
million. This purchase price consisted of approximately $74.1 million in cash
and $1.6 million resulting from McLeod, Inc. entering into a deferred
compensation program with all holders of non-vested options to purchase shares
of the Company's common stock. Prior to the acquisition all debentures discussed
in Note 4 were converted into common stock and all vested stock options and
stock purchase warrants discussed in Note 10 were exercised.
F-60
<PAGE> 153
<TABLE>
<S> <C>
DEALER, SALESPERSON OR ANY OTHER PERSON HAS 5,200,000 SHARES
BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE
ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN
OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE
UNDERWRITERS. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, MCLEOD, INC.
UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF
THE COMPANY SINCE THE DATES AS OF WHICH
INFORMATION IS GIVEN IN THIS PROSPECTUS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR
SOLICITATION BY ANYONE IN ANY JURISDICTION IN
WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED
OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY
PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH CLASS A COMMON STOCK
SOLICITATION. ($.01 PAR VALUE)
------------------------------
(*MCLEOD LOGO)
TABLE OF CONTENTS
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary................... 1
Risk Factors......................... 8
Use of Proceeds...................... 21 SALOMON BROTHERS INC
Price Range of Class A Common Stock BEAR, STEARNS & CO. INC.
and Dividend Policy................ 21 MORGAN STANLEY & CO.
Capitalization....................... 22 INCORPORATED
Selected Consolidated Financial
Data............................... 23
Pro Forma Financial Data............. 25
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 27
Business............................. 35
Management........................... 61
Certain Transactions................. 76
Principal and Selling Stockholders... 77
Description of Capital Stock......... 79
Shares Eligible for Future Sale...... 82
Underwriting......................... 84
Validity of Securities............... 85
Experts.............................. 86
Available Information................ 86
Glossary............................. G-1 PROSPECTUS
Index to Consolidated Financial
Statements......................... F-1 DATED NOVEMBER 15, 1996
</TABLE>
<PAGE> 154
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following are the estimated expenses payable by the Company in
connection with the distribution of the securities hereunder. The Selling
Stockholders are not paying any portion of such expenses.
<TABLE>
<S> <C>
SEC registration fee.................................................... $ 67,955
NASD filing fee......................................................... 22,925
Nasdaq National Market listing fee...................................... 17,500
Accounting fees and expenses............................................ 175,000
Legal fees and expenses................................................. 500,000
Printing and engraving expenses......................................... 195,000
Blue Sky fees and expenses.............................................. 15,000
Transfer Agent fees and expenses........................................ 6,620
-----------
Total......................................................... $ 1,000,000
===========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under Section 145 of the Delaware General Corporation Law ("DGCL"), a
corporation may indemnify its directors, officers, employees and agents and its
former directors, officers, employees and agents and those who serve, at the
corporation's request, in such capacities with another enterprise, against
expenses (including attorneys' fees), as well as judgments, fines and
settlements in nonderivative lawsuits, actually and reasonably incurred in
connection with the defense of any action, suit or proceeding in which they or
any of them were or are made parties or are threatened to be made parties by
reason of their serving or having served in such capacity. The DGCL provides,
however, that such person must have acted in good faith and in a manner such
person reasonably believed to be in (or not opposed to) the best interests of
the corporation and, in the case of a criminal action, such person must have had
no reasonable cause to believe his or her conduct was unlawful. In addition, the
DGCL does not permit indemnification in an action or suit by or in the right of
the corporation, where such person has been adjudged liable to the corporation,
unless, and only to the extent that, a court determines that such person fairly
and reasonably is entitled to indemnity for costs the court deems proper in
light of liability adjudication. Indemnity is mandatory to the extent a claim,
issue or matter has been successfully defended.
The Restated Certificate contains provisions that provide that no director
of the Company shall be liable for breach of fiduciary duty as a director except
for (1) any breach of the directors' duty of loyalty to the Company or its
stockholders; (2) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of the law; (3) liability under
Section 174 of the DGCL; or (4) any transaction from which the director derived
an improper personal benefit. The Restated Certificate contains provisions that
further provide for the indemnification of directors and officers to the fullest
extent permitted by the DGCL. Under the Bylaws of the Company, the Company is
required to advance expenses incurred by an officer or director in defending any
such action if the director or officer undertakes to repay such amount if it is
determined that the director or officer is not entitled to indemnification. In
addition, the Company has entered into indemnity agreements with each of its
directors pursuant to which the Company has agreed to indemnify the directors as
permitted by the DGCL. The Company has obtained directors and officers liability
insurance against certain liabilities, including liabilities under the
Securities Act.
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The Underwriting Agreement provides for indemnification by the Underwriters
of the directors, officers and controlling persons of the Company against
certain liabilities, including liabilities under the Securities Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
From the Company's inception on June 6, 1991 through September 30, 1996,
the Company has issued and sold the following securities (as adjusted to give
effect to the 3.75-for-one stock split of the Company's Class A Common Stock and
Class B Common Stock, effective May 2, 1996 (the "Recapitalization")):
(1) In July 1991, the Company issued 18,750 shares of Class A Common
Stock to its founder, Clark E. McLeod. The price per share was $.27, for an
aggregate consideration of $5,000.
(2) In September 1992, the Company granted stock options to five of
its employees to purchase an aggregate of 832,096 shares of Class A Common
Stock pursuant to the 1992 Plan at an exercise price of $.27 per share and
granted Clark E. McLeod stock options to purchase an aggregate of 172,298
shares of Class A Common Stock pursuant to the 1992 Plan at an exercise
price of $.29 per share.
(3) In January 1993, the Company issued an aggregate of 6,356,256
shares of Class A Common Stock to Clark E. McLeod (2,462,334), Mary E.
McLeod (2,481,080), Holly A. McLeod (34,459), James L. Cram (153,548),
Virginia A. Cram (153,548), William A. Cram (18,750), Kristin J. Cram
(18,750), Stephen C. and Sally W. Gray (86,149), Scott L. and Julie A.
Goldberg (68,918), Kirk E. Kaalberg (17,232), and Bruce A. and Susan M.
Thayer (861,488). The price per share was $.27, for an aggregate
consideration of $1,695,000.
(4) Between March and November 1993, the Company granted stock options
to 35 of its employees to purchase an aggregate of 1,193,438 shares of
Class A Common Stock pursuant to the 1992 Plan (198,750) and the 1993 Plan
(994,688), at an exercise price of $.80 per share and granted Clark E.
McLeod stock options to purchase an aggregate of 180,000 shares of Class A
Common Stock pursuant to the 1992 Plan (56,250) and the 1993 Plan
(123,750), at an exercise price of $.88 per share.
(5) In April 1993, the Company issued an aggregate of 5,618,754 shares
of Class A Common Stock to Mary E. McLeod (1,249,999), Clark E. McLeod
(1,250,003), Allsop (2,500,002), David C. Stanard (123,750), Judith A.
Stanard (56,250), Douglas McGowan (153,750), Stephen C. and Sally W. Gray
(18,750), James L. Cram (18,750), Virginia A. Cram (18,750), John D. and
Karleen M. Hagan (18,750), Scott L. and Julie A. Goldberg (18,750), Robert
C. and Deborah B. Taylor (18,750), Mernat & Co. f/b/o Henry Royer IRA
(37,500), Gene L. Hassman (41,250), Stephen Samuel Gray Irrevocable Trust
(3,750), Mernat & Co. f/b/o Joanne H. Collins Trust (45,000), and Mernat &
Co. f/b/o Thomas M. Collins (45,000). The price per share was $.80, for an
aggregate consideration of $4,495,002.
(6) In April 1993, the Company issued 5,625,000 shares of Class B
Common Stock to IES. The price per share was $.80, for an aggregate
consideration of $4,500,000.
(7) In May 1993, the Company granted to four of its directors,
pursuant to the Director Plan, stock options to purchase an aggregate of
150,000 shares of Class A Common Stock at an exercise price of $.80 per
share.
(8) In December 1993, the Company issued an aggregate of 307,096
shares of Class A Common Stock to William A. Cram (14,063), Kristin J. Cram
(14,063), James L. Cram (139,485) and Virginia A. Cram (139,485) in
exchange for 307,096 shares of Class A Common Stock previously issued to
James L. Cram (153,548) and Virginia A. Cram (153,548).
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<PAGE> 156
(9) In December 1993, the Company granted to 44 of its employees,
pursuant to the 1993 Plan, stock options to purchase an aggregate of 40,976
shares of Class A Common Stock at an exercise price of $1.07 per share.
(10) Between January and June 1994, the Company granted to 47 of its
employees, pursuant to the 1993 Plan, stock options to purchase an
aggregate of 535,314 shares of Class A Common Stock at an exercise price of
$1.47 per share.
(11) In February 1994, the Company issued 2,045,457 shares of Class B
Common Stock to IES. The price per share was $1.47, for an aggregate
consideration of $3,000,003.
(12) In February 1994, the Company issued an aggregate of 2,484,720
shares of Class A Common Stock to Allsop (1,022,727), Clark E. McLeod
(511,365), Mary E. McLeod (511,362), Mernat & Co. f/b/o John D. Hagan IRA
(76,875), Bruce A. and Susan M. Thayer (68,183), Judith A. Stanard
(67,500), Mernat & Co. f/b/o Thomas M. Collins (102,274), Mernat & Co.
f/b/o Henry Royer IRA (37,500), Casey D. Mahon (34,092), Dain Bosworth,
Custodian for Casey D. Mahon IRA (34,092), Stephen C. and Sally W. Gray
(15,000), and Robert C. and Deborah B. Taylor (3,750). The price per share
was $1.47, for an aggregate consideration of $3,644,250.
(13) In May 1994, the Company issued an aggregate of 14,478,480 shares
of Class A Common Stock to all existing holders of Class A Common Stock and
an aggregate of 7,670,457 shares of Class B Common Stock to all existing
holders of Class B Common Stock in connection with the reincorporation of
the Company from Iowa to Delaware in August 1993 and in exchange for all
shares of Class A Common Stock and Class B Common Stock previously issued
to such stockholders.
(14) In May 1994, the Company granted to IES, in consideration of the
guaranty executed by IES in connection with the Credit Facility, stock
options to purchase an aggregate of 1,875,000 shares of Class B Common
Stock at an exercise price of $1.47 per share.
(15) Between August 1994 and January 1995, the Company granted to 235
of its employees, pursuant to the 1993 Plan, stock options to purchase an
aggregate of 569,503 shares of Class A Common Stock at an exercise price of
$1.73 per share and granted Clark E. McLeod stock options to purchase an
aggregate of 18,750 shares of Class A Common Stock pursuant to the 1993
Plan at an exercise price of $1.91 per share.
(16) In December 1994, the Company issued an aggregate of 2,482,602
shares of Class A Common Stock to Joni Thornton (3,750), Al and Delores
Lyon (3,750), Aaron McLeod (3,750), Holly McLeod (3,750), Dave and Karen
Lindberg (3,750), Ted McLeod (3,750), Clark E. McLeod (7,500) and Mary E.
McLeod (2,452,602), in exchange for 2,482,602 shares of Class A Common
Stock previously issued to Clark E. McLeod (18,750) and Mary E. McLeod
(2,463,852).
(17) In December 1994, the Company issued an aggregate of 278,972*
shares of Class A Common Stock to William A. Cram (4,688), Kristin J. Cram
(4,688), James L. Cram (134,798) and Virginia A. Cram (134,798) in exchange
for 278,970* shares of Class A Common Stock previously issued to James L.
Cram (139,485) and Virginia A. Cram (139,485).
(18) In January 1995, the Company issued 22,500 shares of Class A
Common Stock to Mernat & Co. f/b/o Stephen C. Gray. The price per share was
$1.73, for an aggregate consideration of $39,000.
- ---------------
* Differences between the number of shares originally issued and the number of
shares exchanged therefor in the described transaction are due to the rounding
up of all fractional shares resulting from the Recapitalization.
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<PAGE> 157
(19) In January 1995, the Company granted to four of its directors,
pursuant to the Director Plan, stock options to purchase an aggregate of
75,000 shares of Class A Common Stock at an exercise price of $1.73 per
share.
(20) Between March and October 1995, the Company granted stock options
to 452 of its employees to purchase an aggregate of 1,339,474 shares of
Class A Common Stock pursuant to the 1992 Plan (105,000), the 1993 Plan
(953,224) and the 1995 Plan (281,250), at an exercise price of $2.27 per
share, and granted Clark E. McLeod stock options to purchase an aggregate
of 56,250 shares of Class A Common Stock pursuant to the 1995 Plan at an
exercise price of $2.49 per share.
(21) In April 1995, the Company issued 3,676,058 shares of Class B
Common Stock to Midwest Capital Group Inc. The price per share was $2.27,
for an aggregate consideration of $8,332,397.
(22) In April 1995, the Company granted to IES, in consideration of
the guaranty executed by IES in connection with the Credit Facility, stock
options to purchase an aggregate of 1,912,500 shares of Class B Common
Stock at an exercise price of $2.27 per share.
(23) In June 1995, the Company issued 3,529,414 shares of Class B
Common Stock to MWR Investments Inc. The price per share was $2.27, for an
aggregate consideration of $8,000,005.
(24) In June 1995, the Company issued 750,000 shares of Class B Common
Stock to IES. The price per share was $2.27, for an aggregate consideration
of $1,700,000.
(25) In June 1995, the Company issued 3,676,058 shares of Class B
Common Stock to MWR Investments Inc., in exchange for 3,676,058 shares of
Class B Common Stock previously issued to Midwest Capital Group Inc.
(26) In June 1995, the Company issued an aggregate of 929,670* shares
of Class A Common Stock to Bruce A. Thayer (464,835) and Susan M. Thayer
(464,835) in exchange for 929,671* shares of Class A Common Stock
previously issued to Bruce A. and Susan M. Thayer.
(27) In June 1995, the Company issued an aggregate of 1,897,068 shares
of Class A Common Stock to Allsop (171,188), Frank N. and Marilyn Y. Magid
(44,119), Fred L. Wham, III, Trustee, Fred L. Wham, III Profit Sharing U/A
dated 1/1/89 f/b/o Fred L. Wham, III (88,238), Scott G. Byers Partnership
(44,119), Craig M. and Susan M. Byers (44,119), Richard C. Young (44,119),
Ross D. Christensen (44,119), William C. Knapp as trustee of the William C.
Knapp Revocable Trust (88,238), Nelson Investment Company (44,119), John W.
Aalfs (44,119), John D. Hagan (44,119), William J. Stevens (11,625), Tami
Young (22,062), Merrill Lynch f/b/o Michael J. Brown IRA (13,238), Ann
Vermeer Stienstra (13,238), Keith R. Molof (2,250), Central Iowa Energy
Cooperative (330,885), Trust for the Benefit of the Children of Frank Magid
(44,119), Iowa Capital Corporation (154,414), Dain Bosworth f/b/o Thomas M.
Brown IRA (32,363), Thomas M. Brown (8,813), Karen Jacobi (450), Philip
Thrasher Kennedy (6,619), IPC Development Co. (45,000), Trusty (44,119),
S.K.E. Investment Partnership (44,119), Thomas M. Hoyt (44,119), James S.
Cownie (88,238), Mernat & Co. f/b/o Stephen C. Gray IRA (3,750), Stephen C.
Gray (26,352), Gregg D. Miller (44,119), Theodore G. Schwartz (44,119),
Clark E. McLeod (64,163), Mary E. McLeod (64,159), Ibak & Company f/b/o
John W. Colloton (25,875), and John W. Colloton (18,244). The price per
share was $2.27, for an aggregate consideration of $4,299,997.
- ---------------
* Differences between the number of shares originally issued and the number of
shares exchanged therefor in the described transaction are due to the rounding
up of all fractional shares resulting from the Recapitalization.
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<PAGE> 158
(28) In July 1995, the Company issued an aggregate of 26,352 shares of
Class A Common Stock to Stephen C. Gray (22,602) and Elizabeth Mary
Fletcher Gray Education Trust (3,750) in exchange for 26,352 shares of
Class A Common Stock previously issued to Stephen C. Gray.
(29) In July 1995, the Company granted to six of its directors,
pursuant to the Director Plan, stock options to purchase an aggregate of
112,500 shares of Class A Common Stock at an exercise price of $2.27 per
share.
(30) In October 1995, the Company issued 282 shares of Class A Common
Stock to Kathleen Sanders. The price per share was $1.06, for an aggregate
consideration of $300.
(31) In October 1995, the Company issued an aggregate of 269,596
shares of Class A Common Stock to William A. Cram (3,750), Kristin J. Cram
(3,750), James L. Cram (131,048) and Virginia A. Cram (131,048) in exchange
for 269,596 shares of Class A Common Stock previously issued to James L.
Cram (134,798) and Virginia A. Cram (134,798).
(32) In December 1995, the Company issued an aggregate of 2,462,330
shares of Class A Common Stock to Joni Thornton (3,750), Dave and Karen
Lindberg (3,750), Aaron McLeod (3,750), Holly McLeod (3,750), Clark E.
McLeod (2,437,602) and Mary E. McLeod (9,728), in exchange for 2,462,330
shares of Class A Common Stock previously issued to Clark E. McLeod
(2,445,102) and Mary E. McLeod (17,228).
(33) In December 1995, the Company issued 11,250 shares of Class A
Common Stock to James L. Cram. The price per share was $.27, for an
aggregate consideration of $3,000.
(34) Between December 1995 and February 1996, the Company granted
stock options to 239 of its employees to purchase an aggregate of 1,514,263
shares of Class A Common Stock pursuant to the 1992 Plan (39,752) and the
1993 Plan (1,474,511), at an exercise price of $2.67 per share and granted
Clark E. McLeod stock options to purchase an aggregate of 112,500 shares of
Class A Common Stock pursuant to the 1993 Plan at an exercise price of
$2.93 per share.
(35) In January 1996, the Company granted to six of its directors,
pursuant to the Director Plan, stock options to purchase an aggregate of
112,500 shares of Class A Common Stock at an exercise price of $2.67 per
share.
(36) In February 1996, the Company issued an aggregate of 262,096
shares of Class A Common Stock to William A. Cram (5,625), Kristin J. Cram
(5,625), Thomas W. Burns (3,750), Rita M. Burns (3,750), James L. Cram
(121,673) and Virginia A. Cram (121,673) in exchange for 262,096 shares of
Class A Common Stock previously issued to James L. Cram (131,048) and
Virginia A. Cram (131,048).
(37) In February 1996, the Company issued 23,438 shares of Class A
Common Stock to Blake O. Fisher, Jr. The price per share was $.99, for an
aggregate consideration of $23,125.
(38) In April 1996, as partial consideration for the execution of
employment, confidentiality and non-competition agreements, the Company
granted to the 37 employees signing such agreements options to purchase an
aggregate of 540,500 shares of Class A Common Stock, effective upon
consummation of the Company's initial public offering of Class A Common
Stock, at exercise prices ranging from $20.00 to $22.00.
(39) In June 1996, the Company granted to 176 of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of
223,550 shares of Class A Common Stock at an exercise price of $20.00 per
share.
(40) In June 1996, the Company granted to seven of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of 6,800
shares of Class A Common Stock at an exercise price of $23.75 per share.
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<PAGE> 159
(41) In July 1996, the Company issued an aggregate of 474,807 shares
of Class A Common Stock to Allsop (194,476), Albert P. Ruffalo (73,600),
Joseph P. Cunningham (40,301), Laura L. Dement (37,386), Randy A. Snyder
(18,763), Brian P. Donnelley (18,763), Clark E. McLeod (38,609), Mary E.
McLeod (38,609), Eric Hender (7,150), and Julie Hender (7,150). The 474,807
shares were exchanged for all the shares of Ruffalo, Cody common stock held
by such persons.
(42) In July 1996, in connection with the acquisition of Ruffalo, Cody
and pursuant to the 1996 Plan, the Company granted stock options to
purchase an aggregate of 88,436 shares of Class A Common Stock at an
exercise price of $1.43 to 19 Ruffalo, Cody employees, an aggregate of
29,537 shares of Class A Common Stock at an exercise price of $4.29 to 9
Ruffalo, Cody employees, an aggregate of 14,684 shares of Class A Common
Stock at an exercise price of $8.58 to 14 Ruffalo, Cody employees, an
aggregate of 11,370 shares of Class A Common Stock at an exercise price of
$9.30 to 31 Ruffalo, Cody employees, an aggregate of 6,991 shares of Class
A Common Stock at an exercise price of $8.58 to 1 Ruffalo, Cody independent
contractor, and an aggregate of 6,991 shares of Class A Common Stock at an
exercise price of $9.30 to 1 Ruffalo, Cody independent contractor.
(43) In July 1996, as partial consideration for the execution of
employment, confidentiality and non-competition agreements, the Company
granted to 11 employees signing such agreements options to purchase an
aggregate of 167,000 shares of Class A Common Stock at an exercise price of
$25.25 per share.
(44) In July 1996, the Company granted to two of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of 11,500
shares of Class A Common Stock at an exercise price of $25.25 per share.
(45) In July 1996, the Company granted to 81 of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of 34,100
shares of Class A Common Stock at an exercise price of $24.75 per share.
(46) In August 1996, the Company granted to 62 of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of
129,855 shares of Class A Common Stock at an exercise price of $30.125 per
share.
(47) In September 1996, as partial consideration for the execution of
employment, confidentiality and non-competition agreements, the Company
granted to six employees signing such agreements options to purchase an
aggregate of 225,000 shares of Class A Common Stock at an exercise price of
$33.375 per share.
(48) In September 1996, the Company granted to 541 of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of
191,700 shares of Class A Common Stock at an exercise price of $33.375 per
share.
(49) In September 1996, as partial consideration for the execution of
an employment, confidentiality and non-competition agreement, the Company
granted to one employee signing such agreement options to purchase 10,000
shares of Class A Common Stock at an exercise price of $33.875 per share.
(50) In September 1996, the Company granted to 29 of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of 35,975
shares of Class A Common Stock at an exercise price of $33.875 per share.
(51) In October 1996, the Company granted to 50 of its employees,
pursuant to the 1996 Plan, stock options to purchase an aggregate of 41,600
shares of Class A Common Stock at an exercise price of $30.25 per share.
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Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as a
transaction by an issuer not involving any public offering. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transactions. All recipients had adequate access,
through their relationships with the Company, to information about the Company.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
1.1 -- Form of Underwriting Agreement among McLeod, Inc., Salomon Brothers Inc, Bear,
Stearns & Co. Inc., Morgan Stanley & Co. Incorporated, and certain stockholders
of the Company.
2.1 -- Agreement and Plan of Reorganization dated April 28, 1995 among Midwest Capital
Group Inc., MWR Telecom, Inc. and McLeod Inc. (Filed as Exhibit 2.1 to
Registration Statement on Form S-1, File No. 333-3112 ("Initial Form S-1"), and
incorporated herein by reference.)
2.2 -- Agreement and Plan of Reorganization dated July 12, 1996 among Ruffalo, Cody &
Associates, Inc., certain shareholders of Ruffalo, Cody & Associates, Inc. and
McLeod, Inc. (Filed as Exhibit 2 to Current Report on Form 8-K, File No.
0-20763, and incorporated herein by reference.)
2.3 -- Agreement and Plan of Reorganization dated August 15, 1996 among Telecom*USA
Publishing Group, Inc. and McLeod, Inc. (Filed as Exhibit 2 to Current Report on
Form 8-K, File No. 0-20763, and incorporated herein by reference.)
3.1 -- Amended and Restated Certificate of Incorporation of McLeod, Inc. (Filed as
Exhibit 3.1 to Initial Form S-1, and incorporated herein by reference.)
**3.2 -- Amended and Restated Bylaws of McLeod, Inc.
4.1 -- Form of Class A Common Stock Certificate of McLeod, Inc. (Filed as Exhibit 4.1
to Initial Form S-1, and incorporated herein by reference.)
4.2 -- Investor Agreement dated as of April 1, 1996 among McLeod, Inc., IES Investments
Inc., Midwest Capital Group Inc., MWR Investments Inc., Clark and Mary McLeod,
and certain other stockholders. (Filed as Exhibit 4.8 to Initial Form S-1, and
incorporated herein by reference.)
**4.3 -- Amendment No. 1 to Investor Agreement dated as of October 23, 1996 by and among
McLeod, Inc., IES Investments Inc., Midwest Capital Group Inc., MWR Investments
Inc., Clark E. McLeod and Mary E. McLeod.
**5.1 -- Opinion of Hogan & Hartson L.L.P.
10.1 -- Credit Agreement dated as of May 16, 1994 among McLeod, Inc., McLeod Network
Services, Inc., McLeod Telemanagement, Inc., McLeod Telecommunications, Inc. and
The First National Bank of Chicago. (Filed as Exhibit 10.1 to Initial Form S-1,
and incorporated herein by reference.)
10.2 -- First Amendment to Credit Agreement dated as of June 17, 1994 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.2 to Initial Form S-1, and incorporated herein by reference.)
</TABLE>
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<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
10.3 -- Second Amendment to Credit Agreement dated as of December 1, 1994 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.3 to Initial Form S-1, and incorporated herein by reference.)
10.4 -- Third Amendment to Credit Agreement dated as of May 31, 1995 among McLeod, Inc.,
McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc., MWR Telecom, Inc. and The First National Bank of
Chicago. (Filed as Exhibit 10.4 to Initial Form S-1, and incorporated herein by
reference.)
10.5 -- Fourth Amendment to Credit Agreement dated as of July 28, 1995 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc., MWR Telecom, Inc. and The First National Bank of
Chicago. (Filed as Exhibit 10.5 to Initial Form S-1, and incorporated herein by
reference.)
10.6 -- Fifth Amendment to Credit Agreement dated as of October 18, 1995 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc., MWR Telecom, Inc. and The First National Bank of
Chicago. (Filed as Exhibit 10.6 to Initial Form S-1, and incorporated herein by
reference.)
10.7 -- Sixth Amendment to Credit Agreement dated as of March 29, 1996 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telecommunications, Inc., MWR
Telecom, Inc. and The First National Bank of Chicago. (Filed as Exhibit 10.7 to
Initial Form S-1, and incorporated herein by reference.)
10.8 -- Security Agreement dated as of May 16, 1994 among McLeod, Inc., McLeod Network
Services, Inc., McLeod Telemanagement, Inc., McLeod Telecommunications, Inc. and
The First National Bank of Chicago. (Filed as Exhibit 10.8 to Initial Form S-1,
and incorporated herein by reference.)
10.9 -- First Amendment to Security Agreement dated as of December 1, 1994 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.9 to Initial Form S-1, and incorporated herein by reference.)
10.10 -- Support Agreement dated as of December 1, 1994 among IES Diversified Inc.,
McLeod, Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.10 to Initial Form S-1, and incorporated herein by reference.)
10.11 -- Agreement Regarding Support Agreement dated December 1994 between McLeod, Inc.
and IES Diversified Inc. (Filed as Exhibit 10.11 to Initial Form S-1, and
incorporated herein by reference.)
10.12 -- Agreement Regarding Guarantee dated May 16, 1994 between McLeod, Inc. and IES
Diversified Inc. (Filed as Exhibit 10.12 to Initial Form S-1, and incorporated
herein by reference.)
10.13 -- Joinder to and Assumption of Credit Agreement dated as of April 28, 1995 between
McLeod Merging Co. and The First National Bank of Chicago. (Filed as Exhibit
10.13 to Initial Form S-1, and incorporated herein by reference.)
10.14 -- Joinder to and Assumption of Security Agreement dated as of April 28, 1995
between McLeod Merging Co. and The First National Bank of Chicago. (Filed as
Exhibit 10.14 to Initial Form S-1, and incorporated herein by reference.)
10.15 -- Letter from The First National Bank of Chicago to James L. Cram dated April 28,
1995 regarding extension of the termination date under the Credit Agreement.
(Filed as Exhibit 10.15 to Initial Form S-1, and incorporated herein by
reference.)
</TABLE>
II-8
<PAGE> 162
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
10.16 -- Credit Agreement dated as of March 29, 1996 among McLeod, Inc., McLeod Network
Services, Inc., McLeod Telemanagement, Inc., McLeod Telecommunications, Inc. MWR
Telecom, Inc. and The First National Bank of Chicago. (Filed as Exhibit 10.16 to
Initial Form S-1, and incorporated herein by reference.)
10.17 -- Agreement for Construction Related Services dated as of October 17, 1995 between
City Signal Fiber Services, Inc. and McLeod Network Services, Inc. (Filed as
Exhibit 10.17 to Initial Form S-1, and incorporated herein by reference.)
10.18 -- Construction Services Agreement dated March 27, 1996 between City Signal Fiber
Services, Inc. and McLeod Network Services, Inc. (Filed as Exhibit 10.18 to
Initial Form S-1, and incorporated herein by reference.)
10.19 -- Fiber Optic Use Agreement dated as of February 14, 1996 between McLeod Network
Services, Inc. and Galaxy Telecom, L.P. (Filed as Exhibit 10.19 to Initial Form
S-1, and incorporated herein by reference.)
10.20 -- Agreement dated as of July 11, 1994 between McLeod Network Services, Inc. and
KLK Construction. (Filed as Exhibit 10.20 to Initial Form S-1, and incorporated
herein by reference.)
10.21 -- Lease Agreement dated September 5, 1995 between State of Iowa and MWR Telecom,
Inc. (Filed as Exhibit 10.21 to Initial Form S-1, and incorporated herein by
reference.)
10.22 -- Lease Agreement dated September 5, 1995 between State of Iowa and McLeod Network
Services, Inc. (Filed as Exhibit 10.22 to Initial Form S-1, and incorporated
herein by reference.)
10.23 -- Contract dated September 5, 1995 between Iowa Telecommunications and Technology
Commission and MWR Telecom, Inc. (Filed as Exhibit 10.23 to Initial Form S-1,
and incorporated herein by reference.)
10.24 -- Contract dated June 27, 1995 between Iowa National Guard and McLeod Network
Services, Inc. (Filed as Exhibit 10.24 to Initial Form S-1, and incorporated
herein by reference.)
10.25 -- Addendum Number One to Contract dated September 5, 1995 between Iowa National
Guard and McLeod Network Services, Inc. (Filed as Exhibit 10.25 to Initial Form
S-1, and incorporated herein by reference.)
10.26 -- U S WEST Centrex Plus Service Rate Stability Plan dated October 15, 1993 between
McLeod Telemanagement, Inc. and U S WEST Communications, Inc. (Filed as Exhibit
10.26 to Initial Form S-1, and incorporated herein by reference.)
10.27 -- U S WEST Centrex Plus Service Rate Stability Plan dated July 17, 1993 between
McLeod Telemanagement, Inc. and U S WEST Communications, Inc. (Filed as Exhibit
10.27 to Initial Form S-1, and incorporated herein by reference.)
10.28 -- Ameritech Centrex Service Confirmation of Service Orders dated various dates in
1994, 1995 and 1996 between McLeod Telemanagement, Inc. and Ameritech
Information Industry Services. (Filed as Exhibit 10.28 to Initial Form S-1, and
incorporated herein by reference.)
10.29 -- Lease Agreement dated as of December 28, 1993 between 2060 Partnership and
McLeod Telemanagement, Inc., as amended by Amendments First to Ninth dated as of
July 3, 1994, March 25, 1994, June 22, 1994, August 12, 1994, September 12,
1994, September 20, 1994, November 16, 1994, September 20, 1995 and January 6,
1996, respectively. (Filed as Exhibit 10.29 to Initial Form S-1, and
incorporated herein by reference.)
</TABLE>
II-9
<PAGE> 163
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
10.30 -- Lease Agreement dated as of May 24, 1995 between 2060 Partnership and McLeod
Telemanagement, Inc. (Filed as Exhibit 10.30 to Initial Form S-1, and
incorporated herein by reference.)
10.31 -- Lease Agreement dated October 31, 1995 between I.R.F.B. Joint Venture and McLeod
Telemanagement, Inc. (Filed as Exhibit 10.31 to Initial Form S-1, and
incorporated herein by reference.)
10.32 -- First Amendment to Lease Agreement dated as of November 20, 1995 between
I.R.F.B. Joint Venture and McLeod Telemanagement, Inc. (Filed as Exhibit 10.32
to Initial Form S-1, and incorporated herein by reference.)
10.33 -- Uniform Purchase Agreement dated July 22, 1993 between McLeod, Inc. and Hill's
Maple Crest Farms Partnership. (Filed as Exhibit 10.33 to Initial Form S-1, and
incorporated herein by reference.)
10.34 -- Master Right-of-Way Agreement dated July 27, 1994 between McLeod Network
Services, Inc. and IES Industries Inc. (Filed as Exhibit 10.34 to Initial Form
S-1, and incorporated herein by reference.)
10.35 -- Master Right-of-Way and Tower Use Agreement dated February 13, 1996 between IES
Industries Inc. and McLeod, Inc. (Filed as Exhibit 10.35 to Initial Form S-1,
and incorporated herein by reference.)
10.36 -- Master Pole, Duct and Tower Use Agreement dated February 20, 1996 between
MidAmerican Energy Company and McLeod, Inc. (Iowa and South Dakota). (Filed as
Exhibit 10.36 to Initial Form S-1, and incorporated herein by reference.)
10.37 -- Master Pole, Duct and Tower Use Agreement dated February 20, 1996 between
MidAmerican Energy Company and McLeod, Inc. (Illinois). (Filed as Exhibit 10.37
to Initial Form S-1, and incorporated herein by reference.)
10.38 -- Settlement Agreement dated March 18, 1996 between U S WEST Communications, Inc.
and McLeod Telemanagement, Inc. (Filed as Exhibit 10.38 to Initial Form S-1, and
incorporated herein by reference.)
10.39 -- Agreement dated August 4, 1995 between Vadacom, Inc. and McLeod Telemanagement,
Inc. (Filed as Exhibit 10.39 to Initial Form S-1, and incorporated herein by
reference.)
10.40 -- McLeod Telecommunications, Inc. 1992 Incentive Stock Option Plan. (Filed as
Exhibit 10.40 to Initial Form S-1, and incorporated herein by reference.)
10.41 -- McLeod, Inc. 1993 Incentive Stock Option Plan. (Filed as Exhibit 10.41 to
Initial Form S-1, and incorporated herein by reference.)
10.42 -- McLeod, Inc. 1995 Incentive Stock Option Plan. (Filed as Exhibit 10.42 to
Initial Form S-1, and incorporated herein by reference.)
10.43 -- McLeod Telecommunications, Inc. Director Stock Option Plan. (Filed as Exhibit
10.43 to Initial Form S-1, and incorporated herein by reference.)
10.44 -- Promissory Note dated July 18, 1995 between Kirk E. Kaalberg and McLeod, Inc.
(Filed as Exhibit 10.44 to Initial Form S-1, and incorporated herein by
reference.)
10.45 -- Promissory Note dated March 29, 1996 between Stephen K. Brandenburg and McLeod,
Inc. (Filed as Exhibit 10.45 to Initial Form S-1, and incorporated herein by
reference.)
10.46 -- Agreement dated April 28, 1995 among McLeod, Inc., McLeod Telecommunications,
Inc., McLeod Telemanagement, Inc., McLeod Network Services, Inc. and Clark E.
McLeod. (Filed as Exhibit 10.46 to Initial Form S-1, and incorporated herein by
reference.)
</TABLE>
II-10
<PAGE> 164
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
+10.47 -- Telecommunications Services Agreement dated March 14, 1994 between WilTel, Inc.
and McLeod Telemanagement, Inc., as amended. (Filed as Exhibit 10.47 to Initial
Form S-1, and incorporated herein by reference.)
10.48 -- Amendment to Contract Addendum A to Contract No. 2102 dated March 31, 1993
between the Iowa Department of General Services and McLeod Telecommunications,
Inc. (Filed as Exhibit 10.48 to Initial Form S-1, and incorporated herein by
reference.)
10.49 -- Construction Services Agreement dated June 30, 1995 between MFS Network
Technologies, Inc. and MWR Telecom, Inc. (Filed as Exhibit 10.49 to Initial Form
S-1, and incorporated herein by reference.)
10.50 -- First Amendment to Agreement Regarding Support Agreement dated May 14, 1996
among McLeod, Inc., IES Diversified Inc. and IES Investments Inc. (Filed as
Exhibit 10.50 to Initial Form S-1, and incorporated herein by reference.)
10.51 -- First Amendment to Agreement Regarding Guarantee dated May 14, 1996 among
McLeod, Inc., IES Diversified Inc. and IES Investments Inc. (Filed as Exhibit
10.51 to Initial Form S-1, and incorporated herein by reference.)
10.52 -- Amended and Restated Directors Stock Option Plan of McLeod, Inc. (Filed as
Exhibit 10.52 to Initial Form S-1, and incorporated herein by reference.)
10.53 -- Forms of Employment, Confidentiality and Non-Competition Agreement between
McLeod, Inc. and certain employees of McLeod, Inc. (Filed as Exhibit 10.53 to
Initial Form S-1, and incorporated herein by reference.)
10.54 -- Form of Change-of-Control Agreement between McLeod, Inc. and certain employees
of McLeod, Inc. (Filed as Exhibit 10.54 to Initial Form S-1, and incorporated
herein by reference.)
**10.55 -- McLeod, Inc. 1996 Employee Stock Option Plan, as amended.
10.56 -- McLeod, Inc. Employee Stock Purchase Plan. (Filed as Exhibit 10.56 to Initial
Form S-1, and incorporated herein by reference.)
10.57 -- Form of Indemnity Agreement between McLeod, Inc. and certain officers and
directors of McLeod, Inc. (Filed as Exhibit 10.57 to Initial Form S-1, and
incorporated herein by reference.)
10.58 -- License Agreement dated April 24, 1996 between PageMart, Inc. and MWR Telecom,
Inc. (Filed as Exhibit 10.58 to Initial Form S-1, and incorporated herein by
reference.)
**10.59 -- Assignment of Purchase Agreement dated August 15, 1996 by and between Ryan
Properties, Inc. and McLeod, Inc.
**10.60 -- Assignment of Purchase Agreement dated August 14, 1996 by and between Ryan
Properties, Inc. and McLeod, Inc.
**10.61 -- Asset Purchase Agreement dated September 4, 1996 by and between Total
Communication Services, Inc. and McLeod Telemanagement, Inc.
**10.62 -- First Amendment to Asset Purchase Agreement dated September 30, 1996 by and
between Total Communication Services, Inc. and McLeod Telemanagement, Inc.
**10.63 -- McLeod, Inc. Incentive Plan.
**10.64 -- Amended and Restated Credit Agreement dated as of May 5, 1996 by and between
Telecom*USA Publishing Group, Inc., Telecom*USA Publishing Company and
Telecom*USA Neighborhood Directories, Inc. and Norwest Bank Iowa, National
Association.
</TABLE>
II-11
<PAGE> 165
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
**10.65 -- First Amendment to Amended and Restated Credit Agreement dated as of January 31,
1996 by and between Telecom*USA Publishing Group, Inc., Telecom*USA Publishing
Company and Telecom*USA Neighborhood Directories, Inc. and Norwest Bank Iowa,
National Association.
**10.66 -- Lease Agreement dated as of September 26, 1994 between Ryan Properties, Inc. and
Ruffalo, Cody & Associates, Inc.
**10.67 -- First Lease Amendment dated as of April 12, 1995 between Ryan Properties, Inc.
and Ruffalo, Cody & Associates, Inc.
**10.68 -- Lease Agreement dated as of July 18, 1995 between 2060 Partnership, L.P. and
Telecom*USA Publishing Company.
**10.69 -- Lease Agreement dated April 26, 1995 by and between A.M. Henderson and
Telecom*USA Publishing Company.
**10.70 -- License Agreement dated as of April 19, 1994, between Ameritech Information
Industry Services and Telecom*USA Publishing Company.
**10.71 -- License Agreement dated September 13, 1993 between U S WEST Communications, Inc.
and Telecom*USA Publishing Company.
**10.72 -- Form of McLeod, Inc. Directors Stock Option Plan Stock Option Agreement.
**10.73 -- Forms of McLeod, Inc. 1996 Employee Stock Option Plan Incentive Stock Option
Agreement.
**10.74 -- Forms of McLeod, Inc. 1996 Employee Stock Option Plan Non-Incentive Stock Option
Agreement.
**10.75 -- Option Agreement dated April 27, 1995 between Fronteer Directory Company, Inc.
and Telecom*USA Publishing Company.
**10.76 -- Promissory Note dated May 5, 1995 between Telecom*USA Publishing Company and
Fronteer Directory Company, Inc.
**10.77 -- Security Agreement dated May 5, 1995 between Telecom*USA Publishing Company and
Fronteer Directory Company, Inc.
**10.78 -- Design/Build Construction Contract dated September 17, 1996 by and between Ryan
Construction Company of Minnesota, Inc. and McLeod, Inc.
**10.79 -- Guaranty Agreement dated as of October 17, 1996 by McLeod, Inc. in favor of
Kirkwood Community College.
**10.80 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod Telemanagement, Inc.
**10.81 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod Telecommunications, Inc.
**10.82 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod Network Services, Inc.
**10.83 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod, Inc.
**10.84 -- Change Order No. 1 to the Construction Services Agreement dated November 22,
1995 by and between MWR Telecom, Inc. and MFS Network Technologies, Inc.
**10.85 -- Change Order No. 2 to the Construction Services Agreement dated August 14, 1996
by and between MWR Telecom, Inc. and MFS Network Technologies, Inc.
**10.86 -- Change Order No. 3 to the Construction Services Agreement dated October 31, 1996
by and between MWR Telecom, Inc. and MFS Network Technologies, Inc.
**10.87 -- Independent Contractor Sales Agreement dated May , 1995 by and between Sprint
Communications Company L.P. and Ruffalo, Cody & Associates, Inc.
</TABLE>
II-12
<PAGE> 166
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
**10.88 -- Second Amendment to Asset Purchase Agreement dated October 31, 1996 between
Total Communication Services, Inc. and McLeod Telemanagement, Inc.
**10.89 -- Escrow Agreement dated July 15, 1996 among McLeod, Inc., certain shareholders of
Ruffalo, Cody & Associates, Inc., Albert P. Ruffalo and Norwest Bank N.A.
**11.1 -- Statement regarding Computation of Per Share Earnings.
**21.1 -- Subsidiaries of McLeod, Inc.
23.1 -- Consents of McGladrey & Pullen, LLP.
**23.2 -- Consent of Hogan & Hartson L.L.P. (included in Exhibit 5.1 to this Registration
Statement on Form S-1).
**24.1 -- Power of Attorney (included on signature page).
**27.1 -- Financial Data Schedule.
**99.1 -- Purchase Agreement dated as of August 15, 1996 between Iowa Land and Building
Company and Ryan Properties, Inc.
**99.2 -- Purchase Agreement dated as of June 28, 1996 between Donald E. Zvacek, Dennis E.
Zvacek and Robert J. Zvacek and Ryan Properties, Inc.
</TABLE>
- ---------------
** Previously filed.
+ Confidential treatment has been granted. The copy filed as an exhibit omits
the information subject to the confidential treatment request.
(b) FINANCIAL STATEMENT SCHEDULES.
The following financial statement schedule is filed herewith:
Schedule II -- Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are inapplicable
or the information required to be set forth therein is provided in the Financial
Statements or notes thereto.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-13
<PAGE> 167
The undersigned registrant hereby further undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-14
<PAGE> 168
SIGNATURES
Pursuant to the requirements of the Securities Act, the Company has duly
caused this Amendment to Registration Statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Cedar Rapids, Iowa,
on this 15th day of November, 1996.
McLEOD, INC.
By /s/ CLARK E. MCLEOD
------------------------------------
Clark E. McLeod
Chairman and Chief Executive Officer
------------------------
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons, in the capacities indicated
below, on this 15th day of November, 1996.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------- ---------------------------------------------
<S> <C>
/s/ CLARK E. MCLEOD Chairman, Chief Executive Officer and
- --------------------------------------------- Director (Principal Executive Officer)
Clark E. McLeod
* President, Chief Operating Officer and
- --------------------------------------------- Director
Stephen C. Gray
* Chief Financial Officer, Executive Vice
- --------------------------------------------- President, Corporate Administration,
Blake O. Fisher, Jr. Treasurer and Director (Principal Financial
Officer)
* Chief Accounting Officer (Principal
- --------------------------------------------- Accounting Officer)
James L. Cram
* Director
- ---------------------------------------------
Russell E. Christiansen
* Director
- ---------------------------------------------
Thomas M. Collins
* Director
- ---------------------------------------------
Paul D. Rhines
* Director
- ---------------------------------------------
Lee Liu
*By: /s/ CLARK E. MCLEOD
- ---------------------------------------------
Clark E. McLeod
Attorney-in-Fact
</TABLE>
II-15
<PAGE> 169
INDEPENDENT AUDITOR'S REPORT
ON THE FINANCIAL STATEMENT SCHEDULES
To the Board of Directors
McLeod, Inc.
Cedar Rapids, Iowa
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated
supplemental schedule II is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not a part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in our audits of the basic consolidated financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic consolidated financial statements taken as a whole.
McGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
March 28, 1996
<PAGE> 170
MCLEOD, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
ADDITIONS
---------------------
BALANCE CHARGED CHARGED BALANCE
AT TO TO AT
BEGINNING COST AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ------------------------------------ ---------- ---------- -------- --------- ----------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1993:
Allowance for uncollectible
accounts and discounts......... $ -- $ -- $ -- $ -- $ --
Valuation reserve on deferred
tax assets..................... -- 789,000 -- -- 789,000
---------- ---------- -------- --------- ----------
$ -- $ 789,000 $ -- $ -- $ 789,000
========== ========== ======== ========= ==========
Year Ended December 31, 1994:
Allowance for uncollectible
accounts and discounts......... $ -- $ 84,000 $ -- $ -- $ 84,000
Valuation reserve on deferred
tax assets..................... 789,000 4,622,000 -- -- 5,411,000
---------- ---------- ------- --------- ----------
$ 789,000 $4,706,000 $ -- $ -- $5,495,000
========== ========== ======= ========= ==========
Year Ended December 31, 1995:
Allowance for doubtful accounts
and discounts.................. $ 84,000 $ 135,000 $ -- $ -- $ 219,000
Valuation reserve on deferred
tax assets..................... 5,411,000 3,007,000 -- -- 8,418,000
---------- ---------- ------- --------- ----------
$5,495,000 $3,142,000 $ -- $ -- $8,637,000
========== ========== ======= ========= ==========
</TABLE>
<PAGE> 171
INDEPENDENT AUDITOR'S REPORT
ON THE FINANCIAL STATEMENT SCHEDULES
To the Board of Directors
Ruffalo, Cody & Associates, Inc.
Cedar Rapids, Iowa
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated
supplemental schedule II is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not a part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in our audits of the basic consolidated financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic consolidated financial statements taken as a whole.
McGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
February 9, 1996
<PAGE> 172
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
ADDITIONS
-------------------
BALANCE CHARGED CHARGED BALANCE
AT TO TO AT
BEGINNING COST AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ---------------------------------------------- --------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1993:
Allowance for doubtful accounts............. $50,000 $ -- $ -- $ -- $50,000
======== ======= ======== ======= =======
Year Ended December 31, 1994:
Allowance for doubtful accounts............. $50,000 $38,072 $ -- $ -- $88,072
======== ======= ======== ======= =======
Year Ended December 31, 1995:
Allowance for doubtful accounts............. $88,072 $ -- $ -- $38,072 $50,000
======== ======= ======== ======= =======
</TABLE>
<PAGE> 173
INDEPENDENT AUDITOR'S REPORT
ON THE FINANCIAL STATEMENT SCHEDULES
To the Board of Directors
Telecom*USA Publishing Group, Inc.
Cedar Rapids, Iowa
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated
supplemental schedule II is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not a part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in our audits of the basic consolidated financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic consolidated financial statements taken as a whole.
McGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
September 27, 1996
<PAGE> 174
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
ADDITIONS
---------------------
BALANCE CHARGED CHARGED BALANCE
AT TO TO AT
BEGINNING COST AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ---------------------------------- ---------- ---------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year Ended August 31, 1994:
Allowance for doubtful
accounts and adjustments..... $1,662,481 $1,340,069 $ -- $1,131,470 $1,871,080
========== ========== ======== ========== ==========
Year Ended August 31, 1995:
Allowance for doubtful
accounts and adjustments..... $1,871,080 $1,669,478 $ -- $1,206,402 $2,334,156
========== ========== ======== ========== ==========
Year Ended August 31, 1996:
Allowance for doubtful accounts
and adjustments.............. $2,334,156 $2,636,421 $ -- $1,867,654 $3,102,923
========== ========== ======== ========== ==========
</TABLE>
<PAGE> 175
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
1.1 -- Form of Underwriting Agreement among McLeod, Inc., Salomon Brothers Inc, Bear,
Stearns & Co. Inc., Morgan Stanley & Co. Incorporated, and certain stockholders
of the Company.
2.1 -- Agreement and Plan of Reorganization dated April 28, 1995 among Midwest Capital
Group Inc., MWR Telecom, Inc. and McLeod Inc. (Filed as Exhibit 2.1 to
Registration Statement on Form S-1, File No. 333-3112 ("Initial Form S-1"), and
incorporated herein by reference.)
2.2 -- Agreement and Plan of Reorganization dated July 12, 1996 among Ruffalo, Cody &
Associates, Inc., certain shareholders of Ruffalo, Cody & Associates, Inc. and
McLeod, Inc. (Filed as Exhibit 2 to Current Report on Form 8-K, File No.
0-20763, and incorporated herein by reference.)
2.3 -- Agreement and Plan of Reorganization dated August 15, 1996 among Telecom*USA
Publishing Group, Inc. and McLeod, Inc. (Filed as Exhibit 2 to Current Report on
Form 8-K, File No. 0-20763, and incorporated herein by reference.)
3.1 -- Amended and Restated Certificate of Incorporation of McLeod, Inc. (Filed as
Exhibit 3.1 to Initial Form S-1, and incorporated herein by reference.)
**3.2 -- Amended and Restated Bylaws of McLeod, Inc.
4.1 -- Form of Class A Common Stock Certificate of McLeod, Inc. (Filed as Exhibit 4.1
to Initial Form S-1, and incorporated herein by reference.)
4.2 -- Investor Agreement dated as of April 1, 1996 among McLeod, Inc., IES Investments
Inc., Midwest Capital Group Inc., MWR Investments Inc., Clark and Mary McLeod,
and certain other stockholders. (Filed as Exhibit 4.8 to Initial Form S-1, and
incorporated herein by reference.)
**4.3 -- Amendment No. 1 to Investor Agreement dated as of October 23, 1996 by and among
McLeod, Inc., IES Investments Inc., Midwest Capital Group Inc., MWR Investments
Inc., Clark E. McLeod and Mary E. McLeod.
**5.1 -- Opinion of Hogan & Hartson L.L.P.
10.1 -- Credit Agreement dated as of May 16, 1994 among McLeod, Inc., McLeod Network
Services, Inc., McLeod Telemanagement, Inc., McLeod Telecommunications, Inc. and
The First National Bank of Chicago. (Filed as Exhibit 10.1 to Initial Form S-1,
and incorporated herein by reference.)
10.2 -- First Amendment to Credit Agreement dated as of June 17, 1994 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.2 to Initial Form S-1, and incorporated herein by reference.)
10.3 -- Second Amendment to Credit Agreement dated as of December 1, 1994 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.3 to Initial Form S-1, and incorporated herein by reference.)
10.4 -- Third Amendment to Credit Agreement dated as of May 31, 1995 among McLeod, Inc.,
McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc., MWR Telecom, Inc. and The First National Bank of
Chicago. (Filed as Exhibit 10.4 to Initial Form S-1, and incorporated herein by
reference.)
</TABLE>
<PAGE> 176
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
10.5 -- Fourth Amendment to Credit Agreement dated as of July 28, 1995 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc., MWR Telecom, Inc. and The First National Bank of
Chicago. (Filed as Exhibit 10.5 to Initial Form S-1, and incorporated herein by
reference.)
10.6 -- Fifth Amendment to Credit Agreement dated as of October 18, 1995 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc., MWR Telecom, Inc. and The First National Bank of
Chicago. (Filed as Exhibit 10.6 to Initial Form S-1, and incorporated herein by
reference.)
10.7 -- Sixth Amendment to Credit Agreement dated as of March 29, 1996 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telecommunications, Inc., MWR
Telecom, Inc. and The First National Bank of Chicago. (Filed as Exhibit 10.7 to
Initial Form S-1, and incorporated herein by reference.)
10.8 -- Security Agreement dated as of May 16, 1994 among McLeod, Inc., McLeod Network
Services, Inc., McLeod Telemanagement, Inc., McLeod Telecommunications, Inc. and
The First National Bank of Chicago. (Filed as Exhibit 10.8 to Initial Form S-1,
and incorporated herein by reference.)
10.9 -- First Amendment to Security Agreement dated as of December 1, 1994 among McLeod,
Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.9 to Initial Form S-1, and incorporated herein by reference.)
10.10 -- Support Agreement dated as of December 1, 1994 among IES Diversified Inc.,
McLeod, Inc., McLeod Network Services, Inc., McLeod Telemanagement, Inc., McLeod
Telecommunications, Inc. and The First National Bank of Chicago. (Filed as
Exhibit 10.10 to Initial Form S-1, and incorporated herein by reference.)
10.11 -- Agreement Regarding Support Agreement dated December 1994 between McLeod, Inc.
and IES Diversified Inc. (Filed as Exhibit 10.11 to Initial Form S-1, and
incorporated herein by reference.)
10.12 -- Agreement Regarding Guarantee dated May 16, 1994 between McLeod, Inc. and IES
Diversified Inc. (Filed as Exhibit 10.12 to Initial Form S-1, and incorporated
herein by reference.)
10.13 -- Joinder to and Assumption of Credit Agreement dated as of April 28, 1995 between
McLeod Merging Co. and The First National Bank of Chicago. (Filed as Exhibit
10.13 to Initial Form S-1, and incorporated herein by reference.)
10.14 -- Joinder to and Assumption of Security Agreement dated as of April 28, 1995
between McLeod Merging Co. and The First National Bank of Chicago. (Filed as
Exhibit 10.14 to Initial Form S-1, and incorporated herein by reference.)
10.15 -- Letter from The First National Bank of Chicago to James L. Cram dated April 28,
1995 regarding extension of the termination date under the Credit Agreement.
(Filed as Exhibit 10.15 to Initial Form S-1, and incorporated herein by
reference.)
10.16 -- Credit Agreement dated as of March 29, 1996 among McLeod, Inc., McLeod Network
Services, Inc., McLeod Telemanagement, Inc., McLeod Telecommunications, Inc. MWR
Telecom, Inc. and The First National Bank of Chicago. (Filed as Exhibit 10.16 to
Initial Form S-1, and incorporated herein by reference.)
10.17 -- Agreement for Construction Related Services dated as of October 17, 1995 between
City Signal Fiber Services, Inc. and McLeod Network Services, Inc. (Filed as
Exhibit 10.17 to Initial Form S-1, and incorporated herein by reference.)
</TABLE>
<PAGE> 177
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
10.18 -- Construction Services Agreement dated March 27, 1996 between City Signal Fiber
Services, Inc. and McLeod Network Services, Inc. (Filed as Exhibit 10.18 to
Initial Form S-1, and incorporated herein by reference.)
10.19 -- Fiber Optic Use Agreement dated as of February 14, 1996 between McLeod Network
Services, Inc. and Galaxy Telecom, L.P. (Filed as Exhibit 10.19 to Initial Form
S-1, and incorporated herein by reference.)
10.20 -- Agreement dated as of July 11, 1994 between McLeod Network Services, Inc. and
KLK Construction. (Filed as Exhibit 10.20 to Initial Form S-1, and incorporated
herein by reference.)
10.21 -- Lease Agreement dated September 5, 1995 between State of Iowa and MWR Telecom,
Inc. (Filed as Exhibit 10.21 to Initial Form S-1, and incorporated herein by
reference.)
10.22 -- Lease Agreement dated September 5, 1995 between State of Iowa and McLeod Network
Services, Inc. (Filed as Exhibit 10.22 to Initial Form S-1, and incorporated
herein by reference.)
10.23 -- Contract dated September 5, 1995 between Iowa Telecommunications and Technology
Commission and MWR Telecom, Inc. (Filed as Exhibit 10.23 to Initial Form S-1,
and incorporated herein by reference.)
10.24 -- Contract dated June 27, 1995 between Iowa National Guard and McLeod Network
Services, Inc. (Filed as Exhibit 10.24 to Initial Form S-1, and incorporated
herein by reference.)
10.25 -- Addendum Number One to Contract dated September 5, 1995 between Iowa National
Guard and McLeod Network Services, Inc. (Filed as Exhibit 10.25 to Initial Form
S-1, and incorporated herein by reference.)
10.26 -- U S WEST Centrex Plus Service Rate Stability Plan dated October 15, 1993 between
McLeod Telemanagement, Inc. and U S WEST Communications, Inc. (Filed as Exhibit
10.26 to Initial Form S-1, and incorporated herein by reference.)
10.27 -- U S WEST Centrex Plus Service Rate Stability Plan dated July 17, 1993 between
McLeod Telemanagement, Inc. and U S WEST Communications, Inc. (Filed as Exhibit
10.27 to Initial Form S-1, and incorporated herein by reference.)
10.28 -- Ameritech Centrex Service Confirmation of Service Orders dated various dates in
1994, 1995 and 1996 between McLeod Telemanagement, Inc. and Ameritech
Information Industry Services. (Filed as Exhibit 10.28 to Initial Form S-1, and
incorporated herein by reference.)
10.29 -- Lease Agreement dated as of December 28, 1993 between 2060 Partnership and
McLeod Telemanagement, Inc., as amended by Amendments First to Ninth dated as of
July 3, 1994, March 25, 1994, June 22, 1994, August 12, 1994, September 12,
1994, September 20, 1994, November 16, 1994, September 20, 1995 and January 6,
1996, respectively. (Filed as Exhibit 10.29 to Initial Form S-1, and
incorporated herein by reference.)
10.30 -- Lease Agreement dated as of May 24, 1995 between 2060 Partnership and McLeod
Telemanagement, Inc. (Filed as Exhibit 10.30 to Initial Form S-1, and
incorporated herein by reference.)
10.31 -- Lease Agreement dated October 31, 1995 between I.R.F.B. Joint Venture and McLeod
Telemanagement, Inc. (Filed as Exhibit 10.31 to Initial Form S-1, and
incorporated herein by reference.)
</TABLE>
<PAGE> 178
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
10.32 -- First Amendment to Lease Agreement dated as of November 20, 1995 between
I.R.F.B. Joint Venture and McLeod Telemanagement, Inc. (Filed as Exhibit 10.32
to Initial Form S-1, and incorporated herein by reference.)
10.33 -- Uniform Purchase Agreement dated July 22, 1993 between McLeod, Inc. and Hill's
Maple Crest Farms Partnership. (Filed as Exhibit 10.33 to Initial Form S-1, and
incorporated herein by reference.)
10.34 -- Master Right-of-Way Agreement dated July 27, 1994 between McLeod Network
Services, Inc. and IES Industries Inc. (Filed as Exhibit 10.34 to Initial Form
S-1, and incorporated herein by reference.)
10.35 -- Master Right-of-Way and Tower Use Agreement dated February 13, 1996 between IES
Industries Inc. and McLeod, Inc. (Filed as Exhibit 10.35 to Initial Form S-1,
and incorporated herein by reference.)
10.36 -- Master Pole, Duct and Tower Use Agreement dated February 20, 1996 between
MidAmerican Energy Company and McLeod, Inc. (Iowa and South Dakota). (Filed as
Exhibit 10.36 to Initial Form S-1, and incorporated herein by reference.)
10.37 -- Master Pole, Duct and Tower Use Agreement dated February 20, 1996 between
MidAmerican Energy Company and McLeod, Inc. (Illinois). (Filed as Exhibit 10.37
to Initial Form S-1, and incorporated herein by reference.)
10.38 -- Settlement Agreement dated March 18, 1996 between U S WEST Communications, Inc.
and McLeod Telemanagement, Inc. (Filed as Exhibit 10.38 to Initial Form S-1, and
incorporated herein by reference.)
10.39 -- Agreement dated August 4, 1995 between Vadacom, Inc. and McLeod Telemanagement,
Inc. (Filed as Exhibit 10.39 to Initial Form S-1, and incorporated herein by
reference.)
10.40 -- McLeod Telecommunications, Inc. 1992 Incentive Stock Option Plan. (Filed as
Exhibit 10.40 to Initial Form S-1, and incorporated herein by reference.)
10.41 -- McLeod, Inc. 1993 Incentive Stock Option Plan. (Filed as Exhibit 10.41 to
Initial Form S-1, and incorporated herein by reference.)
10.42 -- McLeod, Inc. 1995 Incentive Stock Option Plan. (Filed as Exhibit 10.42 to
Initial Form S-1, and incorporated herein by reference.)
10.43 -- McLeod Telecommunications, Inc. Director Stock Option Plan. (Filed as Exhibit
10.43 to Initial Form S-1, and incorporated herein by reference.)
10.44 -- Promissory Note dated July 18, 1995 between Kirk E. Kaalberg and McLeod, Inc.
(Filed as Exhibit 10.44 to Initial Form S-1, and incorporated herein by
reference.)
10.45 -- Promissory Note dated March 29, 1996 between Stephen K. Brandenburg and McLeod,
Inc. (Filed as Exhibit 10.45 to Initial Form S-1, and incorporated herein by
reference.)
10.46 -- Agreement dated April 28, 1995 among McLeod, Inc., McLeod Telecommunications,
Inc., McLeod Telemanagement, Inc., McLeod Network Services, Inc. and Clark E.
McLeod. (Filed as Exhibit 10.46 to Initial Form S-1, and incorporated herein by
reference.)
+10.47 -- Telecommunications Services Agreement dated March 14, 1994 between WilTel, Inc.
and McLeod Telemanagement, Inc., as amended. (Filed as Exhibit 10.47 to Initial
Form S-1, and incorporated herein by reference.)
</TABLE>
<PAGE> 179
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
10.48 -- Amendment to Contract Addendum A to Contract No. 2102 dated March 31, 1993
between the Iowa Department of General Services and McLeod Telecommunications,
Inc. (Filed as Exhibit 10.48 to Initial Form S-1, and incorporated herein by
reference.)
10.49 -- Construction Services Agreement dated June 30, 1995 between MFS Network
Technologies, Inc. and MWR Telecom, Inc. (Filed as Exhibit 10.49 to Initial Form
S-1, and incorporated herein by reference.)
10.50 -- First Amendment to Agreement Regarding Support Agreement dated May 14, 1996
among McLeod, Inc., IES Diversified Inc. and IES Investments Inc. (Filed as
Exhibit 10.50 to Initial Form S-1, and incorporated herein by reference.)
10.51 -- First Amendment to Agreement Regarding Guarantee dated May 14, 1996 among
McLeod, Inc., IES Diversified Inc. and IES Investments Inc. (Filed as Exhibit
10.51 to Initial Form S-1, and incorporated herein by reference.)
10.52 -- Amended and Restated Directors Stock Option Plan of McLeod, Inc. (Filed as
Exhibit 10.52 to Initial Form S-1, and incorporated herein by reference.)
10.53 -- Forms of Employment, Confidentiality and Non-Competition Agreement between
McLeod, Inc. and certain employees of McLeod, Inc. (Filed as Exhibit 10.53 to
Initial Form S-1, and incorporated herein by reference.)
10.54 -- Form of Change-of-Control Agreement between McLeod, Inc. and certain employees
of McLeod, Inc. (Filed as Exhibit 10.54 to Initial Form S-1, and incorporated
herein by reference.)
**10.55 -- McLeod, Inc. 1996 Employee Stock Option Plan, as amended.
10.56 -- McLeod, Inc. Employee Stock Purchase Plan. (Filed as Exhibit 10.56 to Initial
Form S-1, and incorporated herein by reference.)
10.57 -- Form of Indemnity Agreement between McLeod, Inc. and certain officers and
directors of McLeod, Inc. (Filed as Exhibit 10.57 to Initial Form S-1, and
incorporated herein by reference.)
10.58 -- License Agreement dated April 24, 1996 between PageMart, Inc. and MWR Telecom,
Inc. (Filed as Exhibit 10.58 to Initial Form S-1, and incorporated herein by
reference.)
**10.59 -- Assignment of Purchase Agreement dated August 15, 1996 by and between Ryan
Properties, Inc. and McLeod, Inc.
**10.60 -- Assignment of Purchase Agreement dated August 14, 1996 by and between Ryan
Properties, Inc. and McLeod, Inc.
**10.61 -- Asset Purchase Agreement dated September 4, 1996 by and between Total
Communication Services, Inc. and McLeod Telemanagement, Inc.
**10.62 -- First Amendment to Asset Purchase Agreement dated September 30, 1996 by and
between Total Communication Services, Inc. and McLeod Telemanagement, Inc.
**10.63 -- McLeod, Inc. Incentive Plan.
</TABLE>
<PAGE> 180
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
**10.64 -- Amended and Restated Credit Agreement dated as of May 5, 1996 by and between
Telecom*USA Publishing Group, Inc., Telecom*USA Publishing Company and
Telecom*USA Neighborhood Directories, Inc. and Norwest Bank Iowa, National
Association.
**10.65 -- First Amendment to Amended and Restated Credit Agreement dated as of January 31,
1996 by and between Telecom*USA Publishing Group, Inc., Telecom*USA Publishing
Company and Telecom*USA Neighborhood Directories, Inc. and Norwest Bank Iowa,
National Association.
**10.66 -- Lease Agreement dated as of September 26, 1994 between Ryan Properties, Inc. and
Ruffalo, Cody & Associates, Inc.
**10.67 -- First Lease Amendment dated as of April 12, 1995 between Ryan Properties, Inc.
and Ruffalo, Cody & Associates, Inc.
**10.68 -- Lease Agreement dated as of July 18, 1995 between 2060 Partnership, L.P. and
Telecom*USA Publishing Company.
**10.69 -- Lease Agreement dated April 26, 1995 by and between A.M. Henderson and
Telecom*USA Publishing Company.
**10.70 -- License Agreement dated as of April 19, 1994, between Ameritech Information
Industry Services and Telecom*USA Publishing Company.
**10.71 -- License Agreement dated September 13, 1993 between U S WEST Communications, Inc.
and Telecom*USA Publishing Company.
**10.72 -- Form of McLeod, Inc. Directors Stock Option Plan Option Agreement.
**10.73 -- Forms of McLeod, Inc. 1996 Employee Stock Option Plan Incentive Stock Option
Agreement.
**10.74 -- Forms of McLeod, Inc. 1996 Employee Stock Option Plan Non-Incentive Stock Option
Agreement.
**10.75 -- Option Agreement dated April 27, 1995 between Fronteer Directory Company, Inc.
and Telecom*USA Publishing Company.
**10.76 -- Promissory Note dated May 5, 1995 between Telecom*USA Publishing Company and
Fronteer Directory Company, Inc.
**10.77 -- Security Agreement dated May 5, 1995 between Telecom*USA Publishing Company and
Fronteer Directory Company, Inc.
**10.78 -- Design/Build Construction Contract dated September 17, 1996 by and between Ryan
Construction Company of Minnesota, Inc. and McLeod, Inc.
**10.79 -- Guaranty Agreement dated as of October 17, 1996 by McLeod, Inc. in favor of
Kirkwood Community College.
**10.80 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod Telemanagement, Inc.
**10.81 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod Telecommunications, Inc.
**10.82 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod Network Services, Inc.
**10.83 -- Industrial New Jobs Training Agreement dated as of October 31, 1996 between
Kirkwood Community College and McLeod, Inc.
**10.84 -- Change Order No. 1 to the Construction Services Agreement dated November 22,
1995 by and between MWR Telecom, Inc. and MFS Network Technologies, Inc.
</TABLE>
<PAGE> 181
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C>
**10.85 -- Change Order No. 2 to the Construction Services Agreement dated August 14, 1996
by and between MWR Telecom, Inc. and MFS Network Technologies, Inc.
**10.86 -- Change Order No. 3 to the Construction Services Agreement dated October 31, 1996
by and between MWR Telecom, Inc. and MFS Network Technologies, Inc.
**10.87 -- Independent Contractor Sales Agreement dated May , 1995 by and between Sprint
Communications Company L.P. and Ruffalo, Cody & Associates, Inc.
**10.88 -- Second Amendment to Asset Purchase Agreement dated October 31, 1996 between
Total Communication Services, Inc. and McLeod Telemanagement, Inc.
**10.89 -- Escrow Agreement dated July 15, 1996 among McLeod, Inc., certain shareholders of
Ruffalo, Cody & Associates, Inc., Albert P. Ruffalo and Norwest Bank N.A.
**11.1 -- Statement regarding Computation of Per Share Earnings.
**21.1 -- Subsidiaries of McLeod, Inc.
23.1 -- Consents of McGladrey & Pullen, LLP.
**23.2 -- Consent of Hogan & Hartson L.L.P. (included in Exhibit 5.1 to this Registration
Statement on Form S-1).
**24.1 -- Power of Attorney (included on signature page).
**27.1 -- Financial Data Schedule.
**99.1 -- Purchase Agreement dated as of August 15, 1996 between Iowa Land and Building
Company and Ryan Properties, Inc.
**99.2 -- Purchase Agreement dated as of June 28, 1996 between Donald E. Zvacek, Dennis E.
Zvacek and Robert J. Zvacek and Ryan Properties, Inc.
</TABLE>
- ---------------
** Previously filed.
+ Confidential treatment has been granted. The copy filed as an exhibit omits
the information subject to the confidential treatment request.
<PAGE> 1
Exhibit 1.1
MCLEOD, INC.
4,307,143 Shares
Class A Common Stock
($.01 par value)
Underwriting Agreement
November 14, 1996
Salomon Brothers Inc
Bear, Stearns & Co. Inc.
Morgan Stanley & Co. Incorporated
As Representatives of the several Underwriters
c/o Salomon Brothers Inc
Seven World Trade Center
New York, New York 10048
Dear Sirs:
McLeod, Inc., a Delaware corporation (the "Company"), proposes to sell
to the underwriters named in Schedule I hereto (the "Underwriters"), for whom
you (the "Representatives") are acting as representatives, 3,876,046 shares of
Class A Common Stock, $.01 par value (the "Common Stock") of the Company, and
the persons named in Schedule II hereto (the "Selling Stockholders") propose to
sell to the Underwriters 431,097 shares of Common Stock (the shares to be
issued and sold by the Company and the shares to be sold by the Selling
Stockholders collectively being hereinafter called the "Underwritten
Securities"). The Company also proposes to grant to the Underwriters an option
to purchase up to 780,000 additional shares of Common Stock (the "Option
Securities"; the Option Securities, together with the Underwritten Securities,
being hereinafter called the "Securities").
1. Representations and Warranties.
(a) The Company represents and warrants to, and agrees with, each
Underwriter as set forth below in this Section 1. Certain terms used in this
Section 1 are defined in paragraph (iii) hereof.
(i) The Company has filed with the Securities and
Exchange Commission (the "Commission") a registration statement (file
number 333-13885) on Form S-1, including a related preliminary
prospectus, for the registration under the Securities Act of 1933 (the
"Act") of the offering and sale of the Securities. The Company may
have filed one or
<PAGE> 2
2
more amendments thereto, including the related preliminary prospectus,
each of which have previously been furnished to you. The Company will
next file with the Commission either (A) prior to effectiveness of
such registration statement, a further amendment to such registration
statement (including the form of final prospectus) or (B) after
effectiveness of such registration statement, a final prospectus in
accordance with Rules 430A and 424(b)(1) or (4) or (C) after
effectiveness of such registration statement, a post-effective
amendment to such registration statement (including a final
prospectus). In the case of clause (B), the Company has included in
such registration statement, as amended at the Effective Date, all
information (other than Rule 430A Information) required by the Act
and the rules thereunder to be included in the Prospectus with
respect to the Securities and the offering thereof. As filed, such
amendment and form of final prospectus, such final prospectus, or
such post-effective amendment and final prospectus, shall contain
all Rule 430A Information, together with all other such required
information, with respect to the Securities and the offering thereof
and, except to the extent the Representatives shall agree in writing
to a modification, shall be in all substantive respects in the form
furnished to you prior to the Execution Time or, to the extent not
completed at the Execution Time, shall contain only such specific
additional information and other changes (beyond that contained in
the latest Preliminary Prospectus) as the Company has advised you,
prior to the Execution Time, will be included or made therein.
(ii) On the Effective Date, the Registration Statement did
or will, and when the Prospectus is first filed (if required) in
accordance with Rule 424(b) and on the Closing Date, the Prospectus
(and any supplements thereto) will, comply in all material respects
with the applicable requirements of the Act and the rules thereunder;
on the Effective Date, the Registration Statement did not or will not
contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to
make the statements therein not misleading; and, on the Effective
Date, the Prospectus, if not filed pursuant to Rule 424(b), did not or
will not, and on the date of any filing pursuant to Rule 424(b), the
Prospectus will not, and on the Closing Date, the Prospectus (together
with any supplement thereto) will not, include any untrue statement of
a material fact or omit to state a material fact necessary in order to
make the statements therein, in the light of the circumstances under
which they were made, not misleading; provided, however, that the
Company makes no representations or warranties as to the information
contained in or omitted from the Registration Statement or the
Prospectus (or any supplement thereto) in reliance upon
<PAGE> 3
3
and in conformity with information furnished in writing to the Company
by or on behalf of any Underwriter through the Representatives or any
Selling Stockholders specifically for inclusion in the Registration
Statement or the Prospectus (or any supplement thereto).
(iii) The terms which follow, when used in this Agreement,
shall have the meanings indicated. "Effective Date" shall mean each
date that the Registration Statement and any post-effective amendment
or amendments thereto became or become effective. "Execution Time"
shall mean the date and time that this Agreement is executed and
delivered by the parties hereto. "Preliminary Prospectus" shall mean
any preliminary prospectus referred to in paragraph (i) above and any
preliminary prospectus included in the Registration Statement at the
Effective Date that omits Rule 430A Information. "Prospectus" shall
mean the prospectus relating to the Securities that is first filed
pursuant to Rule 424(b) after the Execution Time or, if no filing
pursuant to Rule 424(b) is required, shall mean the form of final
prospectus relating to the Securities included in the Registration
Statement at the Effective Date. "Registration Statement" shall mean
the registration statement referred to in paragraph (i) above,
including exhibits and financial statements, as amended at the
Execution Time (or, if not effective at the Execution Time, in the
form in which it shall become effective) and, in the event any
post-effective amendment thereto becomes effective prior to the
Closing Date (as hereinafter defined), shall also mean such
registration statement as so amended. Such term shall include any
Rule 430A Information deemed to be included therein at the Effective
Date as provided by Rule 430A. "Rule 424" and "Rule 430A" refer to
such rules under the Act. "Rule 430A Information" means information
with respect to the Securities and the offering thereof permitted to
be omitted from the Registration Statement when it becomes effective
pursuant to Rule 430A.
(iv) Since the date of the most recent financial statements
included in the Prospectus (exclusive of any supplement thereto),
there has been no material adverse change, or any development which
could reasonably be expected to result in a material adverse change,
in the condition (financial or other), earnings, business, prospects
or properties of the Company and its subsidiaries, whether or not
arising from transactions in the ordinary course of business, except
as set forth in the Prospectus (exclusive of any supplement thereto);
and, since the respective dates as of which information is given in
the
<PAGE> 4
4
Registration Statement and the Prospectus, there has not been any
change in the capital stock (other than grants of options and
issuances of common stock pursuant to existing employee stock option
plans, stock ownership plans or stock purchase plans, repurchases by
the Company of its common stock in the ordinary course of business or
conversions of outstanding convertible securities) or long-term debt
(other than changes as a result of borrowings under the Telecom Credit
Facility (as defined in the Prospectus) in the ordinary course of
business, maturities, regularly scheduled payments and payments
contemplated as a result of the application of proceeds of the
offering of the Securities as described in the Prospectus,
amortization of debt discount or currency fluctuations) of the Company
or any of its subsidiaries.
(v) Each of (a) the Company and (b) McLeod Telemanagement,
Inc., MWR Telecom, Inc., McLeod Network Services, Inc., MWR Wireless,
Inc., McLeod Transit, Inc., McLeod Telecommunications, Inc.,
Telecom*USA Publishing Group, Inc., Telecom*USA Publishing Company and
Ruffalo, Cody & Associates, Inc. (individually a "Subsidiary" and
collectively the "Subsidiaries") has been duly incorporated and is
validly existing as a corporation in good standing under the laws of
the jurisdiction in which it is chartered or organized, with full
corporate power and authority to own its properties and conduct its
business as described in the Prospectus, and is duly qualified to do
business as a foreign corporation and is in good standing under the
laws of each jurisdiction which requires such qualification, except
where the failure to be so qualified could not reasonably be expected
to have a material adverse effect on the Company and the Subsidiaries.
Except for the Subsidiaries, the Company has no subsidiaries which,
considered in the aggregate as a single subsidiary, would constitute a
"significant subsidiary" as defined in Rule 1-02(w) of Regulation S-X
promulgated under the Act.
(vi) All the outstanding shares of capital stock of each
Subsidiary have been duly and validly authorized and issued and are
fully paid and nonassessable, and, except as otherwise set forth in
the Prospectus, all outstanding shares of capital stock of the
Subsidiaries are owned by the Company either directly or through
wholly owned subsidiaries free and clear of any security interests,
claims, liens or encumbrances.
(vii) The Company's authorized equity capitalization is as
set forth in the Prospectus; the capital stock of the
<PAGE> 5
5
Company conforms in all material respects to the description thereof
contained in the Prospectus; the outstanding shares of Common Stock
have been duly and validly authorized and issued and are fully paid
and nonassessable; the Securities have been duly and validly
authorized, and, when issued and delivered to and paid for by the
Underwriters pursuant to this Agreement, will be fully paid and
nonassessable; the Securities are duly authorized for listing, subject
to official notice of issuance, on the Nasdaq National Market; the
certificates for the Securities are in valid and sufficient form; and
the holders of outstanding shares of capital stock of the Company are
not entitled to statutory preemptive or similar contractual rights to
subscribe for the Securities being sold by the Company in connection
with the issuance and sale thereof by the Company.
(viii) There is no pending or, to the Company's knowledge,
threatened action, suit or proceeding before any court or governmental
agency, authority or body or any arbitrator involving the Company or
any of its subsidiaries of a character required to be disclosed in the
Registration Statement which is not adequately disclosed in the
Prospectus, and there is no franchise, contract or other document of a
character required to be described in the Registration Statement or
Prospectus, or to be filed as an exhibit, which is not described or
filed as required; and the statements in the Prospectus under the
headings "Risk Factors - Dependence on Regional Bell Operating
Companies; US West Centrex Action," "Business - Legal Proceedings,"
"Management - Investor Agreement," "Management - Compensation
Committee Interlocks and Insider Participation," "Certain
Transactions" and, with respect to the Telecom Credit Facility (as
defined in the Prospectus), "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources" fairly summarize the franchises, contracts or other
documents therein described.
(ix) This Agreement has been duly authorized, executed and
delivered by the Company.
(x) No consent, approval, authorization or order of any court
or governmental agency or body is required for the consummation by the
Company of the transactions contemplated herein, except such as have
been or will be obtained under the Act and such as may be required
under all applicable state securities and blue sky laws of any
jurisdiction in connection with the purchase and distribution of the
<PAGE> 6
6
Securities by the Underwriters and such other approvals as have been
obtained.
(xi) Neither the issue and sale of the Securities, the
consummation of any other of the transactions herein contemplated nor
the fulfillment of the terms hereof, in each case by the Company, will
conflict with, result in a breach or violation of, or constitute a
default under the charter or by-laws of the Company or the terms of
any indenture or other agreement or instrument to which the Company or
any of its Subsidiaries is a party or bound or (assuming compliance
with all applicable state securities and blue sky laws and that the
Registration Statement has been declared effective and, if required,
that the Prospectus has been filed pursuant to Rule 424(b)(1) or
424(b)(4)) any law, rule or regulation applicable to the Company or
any of the Subsidiaries or any judgement, order or decree applicable
to the Company or any of its subsidiaries of any court, regulatory
body, administrative agency, governmental body or arbitrator having
jurisdiction over the Company or any of its subsidiaries.
(xii) No holders of securities of the Company have rights to
the registration of such securities under the Registration Statement
that have not been duly waived.
(xiii) McGladrey & Pullen, LLP, who are reporting upon the
audited financial statements and schedules included in the
Registration Statement, are independent public accountants as required
by the Act and the rules and regulations of the Commission thereunder.
(xiv) The consolidated financial statements included in the
Registration Statement present fairly the financial position of the
Company and its subsidiaries as of the dates indicated and the
consolidated results of the operations and cash flows of the Company
and its subsidiaries for the periods specified. Such financial
statements (except as disclosed in the notes thereto or otherwise
stated therein) have been prepared in conformity with generally
accepted accounting principles applied on a consistent basis
throughout the entire period involved. The financial statement
schedules, if any, included in the Registration Statement present
fairly the information stated therein. The selected financial data
included in the Prospectus present fairly the information shown
therein and have been compiled on a basis consistent with that of the
audited consolidated financial statements included in the Registration
Statement. The pro forma financial statements
<PAGE> 7
7
and other pro forma financial information, if any, included in the
Registration Statement present fairly the information shown therein,
have been prepared in accordance with the Commission's rules and
guidelines with respect to pro forma financial statements, have been
properly compiled on the pro forma bases described therein, and, in
the opinion of the Company, the assumptions used in the preparation
thereof are reasonable and the adjustments used therein are
appropriate to give effect to the transactions or circumstances
referred to therein.
(xv) Neither the Company nor any of the Subsidiaries is in
violation of its charter or in default in the performance or
observance of any obligation, agreement, covenant or condition
contained in any indenture or other agreement or instrument to which
the Company or any of the Subsidiaries is a party or by which it or
any of them may be bound, or to which any of the property or assets of
the Company or any of the Subsidiaries is subject, other than defaults
(considered in the aggregate) which could not reasonably be expected
to have a material adverse effect on the condition (financial or
other), earnings, business, prospects or properties of the Company and
its subsidiaries.
(xvi) The Company and the Subsidiaries possess adequate
certificates, authorities or permits issued by the appropriate state,
federal or foreign regulatory agencies or bodies necessary to conduct
the business now operated by them and are in compliance in all
material respects with all such certificates, authorities and permits.
Neither the Company nor any of its subsidiaries has received any
notice of proceedings relating to the revocation or modification of
any such certificate, authority or permit, with such exceptions as
could not reasonably be expected to, singly or in the aggregate, have
a material adverse effect on the condition (financial or other),
earnings, business, prospects or properties of the Company and its
subsidiaries.
(xvii) The Company and its subsidiaries have timely filed all
United States federal income tax returns and all other material tax
returns which are required to be filed by them and have paid all taxes
due and payable (other than taxes, the payment of which are being
contested in good faith), and no tax liens have been filed and no
claims are being asserted with respect to any such taxes, which could
reasonably be expected to have a material adverse effect on the
condition (financial or other), earnings, business, prospects or
properties of the Company and its subsidiaries. The provisions for
taxes on the books of the Company are
<PAGE> 8
8
adequate in all material respects for all open years and for its
current fiscal period.
(xviii) The Company and the Subsidiaries (A) are in
compliance with all applicable federal, state, local and foreign and
other laws and regulations relating to the protection of human health
and safety, the environment or hazardous or toxic substances or
wastes, pollutants or contaminants ("Environmental Laws"), (B) have
received all permits, licenses and other approvals required of them
under applicable Environmental Laws to conduct their respective
businesses and (C) are in compliance with all terms and conditions of
any such permit, license and approval, except, in each case, where
such noncompliance with Environmental Law, failure to receive required
permits, licenses or other approvals or failure to comply with the
terms and conditions of such permits, licenses or approvals could not
reasonably be expected, singly or in the aggregate, to have a material
adverse effect on the condition (financial or other), earnings,
business, prospects or properties of the Company and its subsidiaries.
(xix) The Company and the Subsidiaries have good and
marketable title to all real property and good and valid title to all
personal property owned by them, in each case free and clear of all
liens, encumbrances and defects, and any real property and buildings
held under lease by the Company and the Subsidiaries are held by them
under valid, subsisting and enforceable leases, except, in each case,
for such exceptions as are set forth in the Prospectus or which could
not reasonably be expected to have a material adverse effect on the
condition (financial or other), earnings, business, prospects or
properties of the Company and its subsidiaries.
(xx) The Company together with its subsidiaries own and
possess all right, title and interest in and to, or have duly licensed
from third parties a valid, enforceable right to use, all patents,
patent rights, licenses, inventions, copyrights, know-how (including
trade secrets and other unpatented or unpatentable proprietary or
confidential information, systems or procedures), trademarks, service
marks and trade names currently employed by the Company and its
subsidiaries in connection with the business conducted by them
(collectively, "Patent and Proprietary Rights") and neither the
Company nor any of its subsidiaries has received notice of
infringement or misappropriation of or conflict with asserted rights
of others with respect to any Patent and Proprietary Rights, or of any
facts which would render
<PAGE> 9
9
any Patent and Proprietary Rights invalid or inadequate to protect the
interest of the Company or of its subsidiaries therein, and which
infringement, misappropriation or conflict or invalidity or
inadequacy, individually or in the aggregate, could reasonably be
expected to result in a material adverse effect on the condition
(financial or other), earnings, business, prospects or properties of
the Company and its subsidiaries.
(xxi) The Company has complied with all provisions of Section
1 of Laws of Florida, Chapter 92-198 Securities-Business with Cuba.
(b) Each Selling Stockholder represents and warrants to, and
agrees with, each Underwriter that:
(i) Such Selling Stockholder is the lawful owner of the
Securities to be sold by such Selling Stockholder hereunder and upon
sale and delivery of, and payment for, such Securities, as provided
herein, such Selling Stockholder will convey good and marketable title
to such Securities, free and clear of all liens, encumbrances,
equities and claims whatsoever.
(ii) Such Selling Stockholder has no reason to believe
that the representations and warranties of the Company contained in
this Section 1 are not true and correct, is familiar with the
Registration Statement and has no knowledge of any material fact,
condition or information not disclosed in the Prospectus or any
supplement thereto which has adversely affected or may adversely
affect the business of the Company or any of its subsidiaries; and the
sale of Securities by such Selling Stockholder pursuant hereto is not
prompted by any information concerning the Company or any of its
subsidiaries which is not set forth in the Prospectus or any
supplement thereto.
(iii) Such Selling Stockholder has not taken and will not
take, directly or indirectly, any action designed to or which has
constituted or which might reasonably be expected to cause or result,
under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), or otherwise, in stabilization or manipulation of the price of
any security of the Company to facilitate the sale or resale of the
Securities and has not effected any sales of shares of Common Stock
which, if effected by the issuer, would be required to be disclosed in
response to Item 701 of Regulation S-K.
<PAGE> 10
10
(iv) Certificates in negotiable form for such Selling
Stockholder's Securities have been placed in custody, for delivery
pursuant to the terms of this Agreement, under a Custody Agreement and
Power of Attorney duly executed and delivered by such Selling
Stockholders, in the form heretofore furnished to you (the "Custody
Agreement") with Norwest Bank Minnesota, N.A., as Custodian (the
"Custodian"); the Securities represented by the certificates so held in
custody for such Selling Stockholder are subject to the interests
hereunder of the Underwriters, the arrangements for custody and
delivery of such certificates, made by such Selling Stockholder
hereunder and under the Custody Agreement, are not subject to
termination by any acts of such Selling Stockholder, or by operation of
law, whether by the death or incapacity of such Selling Stockholder or
the occurrence of any other event; and if any such death, incapacity or
any other such event shall occur before the delivery of such Securities
hereunder, certificates for the Securities will be delivered by the
Custodian in accordance with the terms and conditions of this Agreement
and the Custody Agreement as if such death, incapacity or other event
had not occurred, regardless of whether or not the Custodian shall have
received notice of such death, incapacity or other event.
(v) No consent, approval, authorization or order of any court
or governmental agency or body is required for the consummation by
such Selling Stockholder of the transactions contemplated herein,
except such as may have been obtained under the Act and such as may be
required under the blue sky laws of any jurisdiction in connection
with the purchase and distribution of the Securities by the
Underwriters and such other approvals as have been obtained.
(vi) Neither the sale of the Securities being sold by such
Selling Stockholder nor the consummation of any other of the
transactions herein contemplated by such Selling Stockholder or the
fulfillment of the terms hereof by such Selling Stockholder will
conflict with, result in a breach or violation of, or constitute a
default under any law or the terms of any indenture or other agreement
or instrument to which such Selling Stockholder is a party or bound,
or any judgement, order or decree applicable to such Selling
Stockholder of any court, regulatory body, administrative agency,
governmental body or arbitrator having jurisdiction over such Selling
Stockholder.
In respect of any statements in or omissions from the Registration Statement or
the Prospectus or any supplements
<PAGE> 11
11
thereto made in reliance upon and in conformity with written information
furnished to the Company by any Selling Stockholder specifically for use in
connection with the preparation thereof, such Selling Stockholder hereby makes
the same representations and warranties to each Underwriter as the Company
makes to such Underwriter under paragraph (a)(ii) of this Section.
2. Purchase and Sale. (a) Subject to the terms and conditions
and in reliance upon the representations and warranties herein set forth: (i)
the Company agrees to sell to the Underwriters 3,876,046 shares of Class A
Common Stock and each Underwriter agrees, severally and not jointly, to
purchase from the Company, at a purchase price of $26.74 per share (the
"Purchase Price"), that proportion of the number of shares of Underwritten
Securities to be sold by the Company which the number of shares of Underwritten
Securities set forth in Schedule I opposite the name of the Underwriter bears
to the total number of shares of Underwritten Securities, subject, in each
case, to adjustments as the Representatives in their discretion shall make to
eliminate any sales or purchases of fractional shares; and (ii) each Selling
Stockholder agrees to sell to the Underwriters the number of shares of
Underwritten Securities set forth in Schedule II opposite the name of such
Selling Stockholder, and each Underwriter agrees, severally and not jointly, to
purchase from each Selling Stockholder, at the Purchase Price, that proportion
of the number of shares of Underwritten Securities set forth in Schedule II
opposite the name of each Selling Stockholder which the number of shares of
Underwritten Securities set forth in Schedule I opposite the name of the
Underwriter bears to the total number of Underwritten Securities, subject, in
each case, to adjustments as the Representatives in their discretion shall make
to eliminate any sales or purchases of fractional shares.
(b) Subject to the terms and conditions and in reliance upon the
representations and warranties herein set forth, the Company hereby grants an
option to the several Underwriters to purchase, severally and not jointly, up
to 780,000 shares of the Option Securities at the same purchase price per share
as the Underwriters shall pay for the Underwritten Securities. Said option may
be exercised only to cover over-allotments in the sale of the Underwritten
Securities by the Underwriters. Said option may be exercised in whole or in
part at any time on or before the 30th day after the date of the Prospectus
upon written notice by the Representatives to the Company setting forth the
number of shares of the Option Securities as to which the several
<PAGE> 12
12
Underwriters are exercising the option and the settlement date. The number of
shares of the Option Securities to be purchased by each Underwriter shall be
the same percentage of the total number of shares of the Option Securities to
be purchased by the several Underwriters as such Underwriter is purchasing of
the Underwritten Securities, subject to such adjustments as the Representatives
in their absolute discretion shall make to eliminate any fractional shares.
3. Delivery and Payment. Delivery of and payment for the
Underwritten Securities and the Option Securities (if the option provided for
in Section 2(b) hereof shall have been exercised on or before the third
business day prior to the Closing Date) shall be made at 10:00 AM, New York
City time, on November 20, 1996, which date and time may be postponed by
agreement among the Representatives and the Company or as provided in Section 9
hereof (such date and time of delivery and payment for the Securities being
herein called the "Closing Date"). Delivery of the Securities shall be made to
the Representatives for the respective accounts of the several Underwriters
against payment by the several Underwriters through the Representatives of the
respective aggregate purchase prices of the Securities being sold by the
Company and the Selling Stockholders to or upon the order of the Company and
the Selling Stockholders by Federal Funds check or checks payable in same day
funds or by wire transfer of same day funds to an account or accounts specified
by the Company and the Selling Stockholders at least one business day in
advance of the Closing Date. Delivery of the Securities shall be made at such
location as the Representatives shall reasonably designate at least one
business day in advance of the Closing Date and payment for such Securities
shall be made at the offices of Hogan & Hartson L.L.P., 555 Thirteenth Street,
N.W., Washington, D.C. 20004. Certificates for the Securities shall be
registered in such names and in such denominations as the Representatives may
request not less than three full business days in advance of the Closing Date.
The Company and the Selling Stockholders agree to have the
certificates for the Securities available for inspection, checking and
packaging by the Representatives in New York, New York, not later than 1:00 PM
on the business day prior to the Closing Date.
<PAGE> 13
13
Each Selling Stockholder will pay all applicable state transfer taxes,
if any, involved in the transfer to the several Underwriters of the Securities
to be purchased by them from such Selling Stockholder and the respective
Underwriters will pay any additional stock transfer taxes involved in further
transfers.
If the option provided for in Section 2(b) hereof is exercised after
the third business day prior to the Closing Date, the Company will deliver (at
the expense of the Company) to the Representatives, at One New York Plaza, New
York, New York, on the date specified by the Representatives (which shall be
within three business days after exercise of said option), certificates for the
Option Securities in such names and denominations as the Representatives shall
have requested at least three full business days in advance of the settlement
date against payment of the purchase price thereof to or upon the order of the
Company by Federal Funds check or checks payable in same day funds or by wire
transfer of same day funds to an account specified by the Company at least one
business day in advance of the settlement date. The Company agrees to have the
certificates for the Option Securities available for inspection, checking and
packaging by the Representatives in New York, New York, not later than 1:00
p.m. on the business day prior to the settlement date. If settlement for the
Option Securities occurs after the Closing Date, the Company will deliver to
the Representatives on the settlement date for the Option Securities, and the
obligation of the Underwriters to purchase the Option Securities shall be
conditioned upon receipt of, supplemental opinions, certificates and letters
confirming as of such date the opinions, certificates and letters delivered on
the Closing Date pursuant to Section 6 hereof.
4. Offering by Underwriters. It is understood that the several
Underwriters propose to offer the Securities for sale to the public as set
forth in the Prospectus.
5. Agreements.
(a) The Company agrees with the several Underwriters that:
(i) The Company will use its best efforts to cause the
Registration Statement, if not effective at the Execution Time, and
any amendment thereof to become effective. Prior to the termination
of the offering of the Securities, the Company will not file any
amendment of the Registration Statement or supplement to the
Prospectus without the prior consent of the Representatives (which
consent shall not be unreasonably delayed or withheld). Subject to
the foregoing sentence, if the Registration Statement has become or
<PAGE> 14
14
becomes effective pursuant to Rule 430A, or filing of the Prospectus
is otherwise required under Rule 424(b), the Company will cause the
Prospectus, properly completed, and any supplement thereto to be filed
with the Commission pursuant to the applicable paragraph of Rule
424(b) within the time period prescribed and will provide evidence
satisfactory to the Representatives of such timely filing. The
Company will promptly advise the Representatives (A) when the
Registration Statement, if not effective at the Execution Time, and
any amendment thereto, shall have become effective, (B) when the
Prospectus, and any supplement thereto, shall have been filed (if
required) with the Commission pursuant to Rule 424(b), (C) when, prior
to termination of the offering of the Securities, any amendment to the
Registration Statement shall have been filed or become effective, (D)
of any request by the Commission for any amendment of the Registration
Statement or supplement to the Prospectus or for any additional
information with respect to the Registration Statement or the
Prospectus, (E) of the issuance by the Commission of any stop order
suspending the effectiveness of the Registration Statement or the
institution or threatening of any proceeding for that purpose and (F)
of the receipt by the Company of any notification with respect to the
suspension of the qualification of the Securities for sale in any
jurisdiction or the initiation or threatening of any proceeding for
such purpose. The Company will use its best efforts to prevent the
issuance of any such stop order and, if issued, to obtain as soon as
possible the withdrawal thereof.
(ii) If, at any time when a prospectus relating to the
Securities is required to be delivered under the Act, any event occurs
as a result of which the Prospectus as then supplemented would include
any untrue statement of a material fact or omit to state any material
fact necessary to make the statements therein in the light of the
circumstances under which they were made not misleading, or if it
shall be necessary to amend the Registration Statement or supplement
the Prospectus to comply with the Act or the rules thereunder, the
Company promptly will prepare and file with the Commission, subject to
the second sentence of paragraph (a) (i) of this Section 5, an
amendment or supplement which will correct such statement or omission
or effect such compliance.
(iii) As soon as reasonably practicable, the Company will
make generally available to its security holders and to the
Representatives an earnings statement or statements of the Company and
its subsidiaries which will satisfy the
<PAGE> 15
15
provisions of Section 11(a) of the Act and Rule 158 under the Act.
(iv) The Company will furnish to the Representatives and
counsel for the Underwriters, without charge, signed copies of the
Registration Statement (including exhibits thereto) and to each other
Underwriter a copy of the Registration Statement (without exhibits
thereto) and, so long as delivery of a prospectus by an Underwriter or
dealer may be required by the Act, as many copies of each Preliminary
Prospectus and the Prospectus and any supplement thereto as the
Representatives may reasonably request. The Company will pay the
expenses of printing or other production of all documents relating to
the offering.
(v) The Company will cooperate with the Representatives
and counsel for the Underwriters in order to register or qualify the
Securities for sale under the laws of such jurisdictions as the
Representatives may designate, will maintain such registrations or
qualifications in effect so long as required for the distribution of
the Securities and will pay the fee of the National Association of
Securities Dealers, Inc. in connection with its review of the
offering; provided, however, that in no event shall the Company be
obligated to register or qualify as a foreign corporation or to take
any action that would subject it to general service of process in any
jurisdiction where it is not now so subject.
(vi) The Company will not, for a period of 120 days following
the Execution Time, without the prior written consent of Salomon
Brothers Inc ("Salomon Brothers"), offer, sell or contract to sell, or
otherwise dispose of, directly or indirectly, or announce the offering
of, any other shares of Common Stock or any securities convertible
into, or exchangeable for, shares of Common Stock; provided, however,
that the Company may grant options and issue and sell Common Stock
pursuant to any employee stock option plan, stock ownership plan or
stock purchase plan of the Company in effect at the Execution Time and
the Company may issue Common Stock issuable upon the conversion of
securities or the exercise of warrants outstanding at the Execution
Time.
(b) Each Selling Stockholder agrees with the several Underwriters
that they will not during the period of 120 days following the Execution Time,
without the prior written consent of Salomon Brothers, offer, sell or contract
to sell, or otherwise dispose of, directly or indirectly, or announce the
offering of, any other shares of Common Stock beneficially owned by such
<PAGE> 16
16
person, or any securities convertible into, or exchangeable for, shares of
Common Stock, other than shares of Common Stock disposed of as bona fide gifts
or pledges where the recipients of such gifts or the pledgees, as the case may
be, agree in writing with the Underwriters to be bound by the terms of this
paragraph (b).
6. Conditions to the Obligations of the Underwriters. The
obligations of the Underwriters to purchase the Underwritten Securities and the
Option Securities, as the case may be, shall be subject to the accuracy of the
representations and warranties on the part of the Company and the Selling
Stockholders contained herein as of the Execution Time, the Closing Date and
any settlement date pursuant to Section 3 hereof, to the accuracy of the
statements of the Company and the Selling Stockholders made in any certificates
pursuant to the provisions hereof, to the performance by the Company and the
Selling Stockholders of their respective obligations hereunder and to the
following additional conditions:
(a) A post-effective amendment to the registration
statement, in the form approved by Salomon Brothers Inc, on behalf of
the Representatives, shall have become effective and Salomon Brothers
Inc shall have been notified by telephone of such effectiveness by the
Company or its counsel prior to the earlier of (i) the time that
trading in the Company's Common Stock commences on the Nasdaq National
Market on the day following the Execution Time and (ii) 10:30 AM
New York City time on such date; if filing of the Prospectus, or any
supplement thereto, is required pursuant to Rule 424(b), the
Prospectus, and any such supplement, will be filed in the manner and
within the time period required by Rule 424(b); and no stop order
suspending the effectiveness of the Registration Statement shall have
been issued and no proceedings for that purpose shall have been
instituted or threatened.
(b) The Company shall have furnished to the
Representatives the opinion of counsel for the Company, dated the
Closing Date, substantially in the form of Exhibit A.
(c) The Company shall have furnished to the
Representatives the opinion of Swidler & Berlin, special counsel to
the Company on regulatory matters, dated the Closing Date, to the
effect that:
<PAGE> 17
17
(i) the statements in the Prospectus under the
headings "Prospectus Summary - Business Strategy," "Risk
Factors - Wireline Competition," "Risk Factors - Regulation,"
"Business - Business Strategy," "Business-Market Potential,"
"Business - Expansion of Certain Facilities-based Services,"
"Business - Wireless Services," "Business - Competition" and
"Business - Regulation" fairly and accurately summarize the
laws, case law, rules and regulations and orders of the Federal
Communications Commission ("FCC") and the comparable state
regulatory agencies or bodies with direct regulatory
jurisdiction over telecommunications matters in the states in
which the Company and any of the Subsidiaries provide
intrastate services (the "State Regulatory Agencies") and, to
the best knowledge of such counsel, the statements in the
Prospectus under the headings "Risk Factors - Dependence on
Regional Bell Operating Companies; US West Centrex Action,"
"Risk Factors - Refusal of US West to Improve its Process of
Service Orders" and "Business - Legal Proceedings" fairly and
accurately summarize the legal proceedings set forth therein
with respect to the US West Centrex Action (as defined in the
Prospectus) and the action against U S West Communications,
Inc. concerning the processing of orders;
(ii) the Company and the Subsidiaries possess all
material certificates, authorities and permits required by the
FCC and State Regulatory Agencies for the provision of the
telecommunications services currently provided by the Company
and the Subsidiaries, except where the failure to possess such
certificates, authorities or permits could not reasonably be
expected to have a material adverse effect in the Company and
its subsidiaries; and the Company and the Subsidiaries are in
compliance in all material respects with such certificates,
authorities and permits;
(iii) to the best knowledge of such counsel, neither
the Company nor any of the Subsidiaries is subject to any
pending or threatened action, suit or proceeding before the
FCC or any State Regulatory Agency or (with respect to federal
or state telecommunications laws) any court of a character
required to be disclosed in the Registration Statement, which
is not described as required;
(iv) no consent, approval, authorization or order of
the FCC or any State Regulatory Agency is required for the
issuance and sale of the Securities or the consummation of the
transactions contemplated hereby; and
(v) neither the issuance and sale of the Securities
nor the consummation of the transactions contemplated hereby
will result in a breach or
<PAGE> 18
18
violation of any law, rule, regulation, judgment, order or
decree of the FCC or any State Regulatory Agency applicable to
the Company or any of the Subsidiaries.
In rendering such opinion, such counsel may rely as to matters of
fact, to the extent they deem proper and reasonable, on certificates
of public officials and responsible officers of the Company, including
certificates that define the scope of the telecommunications services
provided by the Company and the Subsidiaries.
(d) The Selling Stockholder shall have furnished to the
Representatives the opinion of Shuttleworth & Ingersoll P.C., their
counsel, dated the Closing Date, to the effect that:
(i) this Agreement and the Custody Agreement have
been duly executed and delivered by the Selling Stockholders,
the Custody Agreement is valid and binding on the Selling
Stockholders and each Selling Stockholder has full legal right
and authority to sell, transfer and deliver in the manner
provided in this Agreement and the Custody Agreement the
Securities being sold by such Selling Stockholder hereunder;
(ii) the delivery by each Selling Stockholder to
the several Underwriters of certificates for the Securities
being sold hereunder by such Selling Stockholder against
payment therefor as provided herein, will pass good and
marketable title to such Securities to the several
Underwriters, free and clear of all liens, encumbrances,
equities and claims whatsoever;
(iii) no consent, approval, authorization or order
of any court or governmental agency or body is required for
the consummation by any Selling Stockholder of the
transactions contemplated herein, except such as may have been
obtained under the Act and such as may be required under the
blue sky laws of any jurisdiction in connection with the
purchase and distribution of the Securities by the
Underwriters and such other approvals (specified in such
opinion) as have been obtained; and
(iv) neither the sale of the Securities being sold
by any Selling Stockholder nor the consummation of any other
of the transactions herein contemplated by any Selling
Stockholder or the fulfillment of the terms
<PAGE> 19
19
hereof by any Selling Stockholder will conflict with, result
in a breach or violation of, or constitute a default under any
law or the terms of any indenture or other agreement or
instrument known to such counsel and to which any Selling
Stockholder is a party or bound, or any judgement, order or
decree known to such counsel to be applicable to any Selling
Stockholder of any court, regulatory body, administrative
agency, governmental body or arbitrator having jurisdiction
over any Selling Stockholder.
In rendering such opinion, such counsel may rely as to matters of
fact, to the extent they deem proper and reasonable, on certificates
of the Selling Stockholders and public officials.
(e) The Representatives shall have received from Mayer,
Brown & Platt, counsel for the Underwriters, such opinion or opinions,
dated the Closing Date, with respect to the issuance and sale of the
Securities, the Registration Statement, the Prospectus (together with
any supplement thereto) and other related matters as the
Representatives may reasonably require, and the Company and the
Selling Stockholders shall have furnished to such counsel such
documents as they may reasonably request for the purpose of enabling
them to pass upon such matters.
(f) The Company shall have furnished to the
Representatives a certificate of the Company, signed by the Chairman
of the Board or the President and the principal financial or
accounting officer of the Company, dated the Closing Date, to the
effect that the signers of such certificate have carefully examined
the Registration Statement, the Prospectus, any supplements to the
Prospectus and this Agreement and that:
(i) the representations and warranties of the
Company in this Agreement are true and correct in all material
respects on and as of the Closing Date with the same effect as
if made on the Closing Date and the Company has complied in
all material respects with all the agreements and satisfied
all the conditions on its part to be performed or satisfied at
or prior to the Closing Date;
(ii) the Registration Statement has become effective
under the Act; any required filing of the Prospectus, and any
supplement thereto, pursuant to Rule 424(b) has been made in
the manner and within the
<PAGE> 20
20
time period required by Rule 424(b); and no stop order
suspending the effectiveness of the Registration Statement has
been issued and no proceedings for that purpose have been
instituted or, to the Company's knowledge, threatened; and
(iii) since the date of the most recent audited
financial statements included in the Prospectus (exclusive of
any supplement thereto), there has been no material adverse
change in the condition (financial or other), earnings,
business, prospects or properties of the Company and its
subsidiaries, whether or not arising from transactions in the
ordinary course of business, except as set forth in or
contemplated in the Prospectus (exclusive of any supplement
thereto).
(g) Each Selling Stockholder shall have furnished to the
Representatives a certificate, signed by such Selling Stockholder,
dated the Closing Date, to the effect that the signer of such
certificate has carefully examined the Registration Statement, the
Prospectus, any supplement to the Prospectus and this Agreement and
that the representations and warranties of such Selling Stockholder in
this Agreement are true and correct in all material respects on and as
of the Closing Date with the same effect as if made on the Closing
Date.
(h) At the Execution Time and at the Closing Date, McGladrey
& Pullen, LLP shall have furnished to the Representatives a letter or
letters, dated respectively as of the Execution Time and as of the
Closing Date, in form and substance satisfactory to the
Representatives, confirming that they are independent accountants
within the meaning of the Act and the applicable published rules and
regulations thereunder and stating in effect that:
(i) in their opinion the audited financial
statements and financial statement schedules included in the
Registration Statement and the Prospectus and reported on by
them, as applicable, comply in form in all material respects
with the applicable accounting requirements of the Act and the
related published rules and regulations;
(ii) on the basis of a reading of the latest
unaudited financial statements made available by the Company
and its subsidiaries; carrying out certain specified
procedures (but not an examination in accordance with
generally accepted auditing standards)
<PAGE> 21
21
which would not necessarily reveal matters of significance with
respect to the comments set forth in such letter; a reading of the
minutes of the meetings of the stockholders and directors of the
Company; and inquiries of certain officials of the Company who have
responsibility for financial and accounting matters of the Company and
its subsidiaries as to transactions and events subsequent to December
31, 1995, nothing came to their attention which caused them to believe
that:
(1) any unaudited financial statements
included in the Registration Statement and the
Prospectus do not comply in form in all material
respects with applicable accounting requirements of
the Act and with the published rules and regulations
of the Commission with respect to registration
statements on Form S-1; and said unaudited financial
statements are not in conformity with generally
accepted accounting principles applied on a basis
substantially consistent with that of the audited
financial statements included in the Registration
Statement and the Prospectus; or
(2) with respect to the period
subsequent to September 30, 1996, there were any
changes, at a specified date not more than five
business days prior to the date of the letter, in the
long-term debt of the Company and its subsidiaries or
capital stock of the Company or decreases in the
stockholders' equity of the Company and its
subsidiaries as compared with the amounts shown on
the September 30, 1996 consolidated balance sheet
included in the Registration Statement and the
Prospectus, or for the period from October 1, 1996 to
such specified date as compared with the
corresponding period in the preceding year, there
were any decreases in telecommunications revenue or
increases in operating loss or net loss of the
Company and its subsidiaries, except in all instances
for such changes, decreases or increases set forth in
such letter, in which case the letter shall be
accompanied by an explanation by the Company as to
the significance thereof unless said explanation is
not deemed necessary by the Representatives;
(iii) they have performed certain other specified
procedures as a result of which they determined that
<PAGE> 22
22
certain information of an accounting, financial or statistical
nature (which is limited to accounting, financial or
statistical information derived from the general accounting
records of the Company and its subsidiaries) set forth in the
Registration Statement and the Prospectus agrees with the
accounting records of the Company and its subsidiaries,
excluding any questions of legal interpretation; and
(iv) on the basis of a reading of the unaudited pro
forma financial statements included in the Registrations
Statement and the Prospectus (the "pro forma financial
statements"); carrying out certain specified procedures;
inquiries of certain officials of the Company who have
responsibility for financial and accounting matters; and
proving the arithmetic accuracy of the application of the pro
forma adjustments to the historical amounts in the pro forma
financial statements, nothing came to their attention which
caused them to believe that the pro forma financial statements
do not comply in form in all material respects with the
applicable accounting requirements of Rule 11-02 of Regulation
S-X or that the pro forma adjustments have not been properly
applied to the historical amounts in the compilation of such
statements.
References to the Prospectus in this paragraph (h) includes
any supplement thereto at the date of the letter.
(i) Subsequent to the Execution Time or, if earlier, the
dates as of which information is given in the Registration Statement
(exclusive of any amendment thereof) and the Prospectus (exclusive of
any supplement thereto), there shall not have been (i) any change,
decrease or increase specified in the letter or letters referred to in
paragraph (f)(ii)(2) of this Section 6 or (ii) any change, or any
development involving a prospective change, in or affecting the
business, prospects or properties of the Company and its subsidiaries
the effect of which, in any case referred to in clause (i) or (ii)
above, is, in the judgment of the Representatives, so material and
adverse as to make it impractical or inadvisable to proceed with the
offering or delivery of the Securities as contemplated by the
Registration Statement (exclusive of any amendment thereof) and the
Prospectus (exclusive of any supplement thereto).
(j) At the Execution Time, the Company shall have furnished
to the Representatives a letter substantially in
<PAGE> 23
23
the form of Exhibit B hereto from Allsop Venture Partners III L.P.,
two irrevocable trusts founded by Theodore G. Schwartz, and each
director and officer of the Company, addressed to the Representatives,
in which each such person or entity agrees not to offer, sell or
contract to sell or otherwise dispose of, directly or indirectly, or
announce an offering of, any shares of Common Stock beneficially owned
by such person or entity or any securities convertible into, or
exchangeable for, shares of Common Stock for a period of 120 days
following the Execution Time without the prior written consent of
Salomon Brothers, except in the case of each of such persons and
entities, shares of Common Stock disposed of as bona fide gifts or
pledges where the recipients of such gifts or the pledgees, as the
case may be, agree in writing with the Underwriters to be bound by the
terms of this paragraph (j).
(k) Prior to the Closing Date, the Company shall have
furnished to the Representatives such further information,
certificates and documents as the Representatives may reasonably
request.
If any of the conditions specified in this Section 6 shall not have
been fulfilled in all material respects when and as provided in this Agreement,
or if any of the opinions and certificates mentioned above or elsewhere in this
Agreement shall not be in all material respects reasonably satisfactory in form
and substance to the Representatives and counsel for the Underwriters, this
Agreement and all obligations of the Underwriters hereunder may be canceled at,
or at any time prior to, the Closing Date by the Representatives. Notice of
such cancellation shall be given to the Company and each Selling Stockholder in
writing or by telephone confirmed in writing.
7. Reimbursement of Underwriters' Expenses. If the sale of the
Securities provided for herein is not consummated because any condition to the
obligations of the Underwriters set forth in Section 6 hereof is not satisfied
or because of any refusal, inability or failure on the part of the Company or
any Selling Stockholder to perform any agreement herein or comply with any
provision hereof other than by reason of a default by any of the Underwriters,
the Company will reimburse the Underwriters severally upon demand for all
reasonable out-of-pocket expenses (including reasonable fees and disbursements
of counsel) that shall have been incurred by them in connection with the
proposed purchase and sale of the Securities.
8. Indemnification and Contribution. (a) The Company agrees to
indemnify and hold harmless each Underwriter, the directors, officers,
employees and agents of each Underwriter and
<PAGE> 24
24
each person who controls any Underwriter within the meaning of either the Act
or the Exchange Act against any and all losses, claims, damages or liabilities,
joint or several, to which they or any of them may become subject under the
Act, the Exchange Act or other Federal or state statutory law or regulation, at
common law or otherwise, insofar as such losses, claims, damages or liabilities
(or actions in respect thereof) arise out of or are based upon any untrue
statement or alleged untrue statement of a material fact contained in the
registration statement for the registration of the Securities as originally
filed or in any amendment thereof, or in any Preliminary Prospectus or the
Prospectus, or in any amendment thereof or supplement thereto, or arise out of
or are based upon the omission or alleged omission to state therein a material
fact required to be stated therein or necessary to make the statements therein
not misleading, and agrees to reimburse each such indemnified party, as
incurred, for any legal or other expenses reasonably incurred by them in
connection with investigating or defending any such loss, claim, damage,
liability or action; provided, however, that the Company will not be liable in
any such case to the extent that any such loss, claim, damage or liability
arises out of or is based upon any such untrue statement or alleged untrue
statement or omission or alleged omission made therein in reliance upon and in
conformity with written information furnished to the Company by or on behalf of
any Underwriter through the Representatives or any Selling Stockholder
specifically for inclusion therein; and provided, further, that the foregoing
indemnity agreement with respect to any Preliminary Prospectus or Prospectus
shall not inure to the benefit of any Underwriter from whom the person
asserting or causing any such losses, claims, damages or liabilities purchased
Securities (or to the benefit of any person controlling such Underwriter or any
directors, officers, employees and agents of each Underwriter), if a copy of
the Preliminary Prospectus or the Prospectus (as amended or supplemented, if
the Company shall have timely furnished the Underwriters with sufficient copies
thereof) was not sent or given by or on behalf of such Underwriter to such
person, if required by law so to have been delivered, at or prior to the
written confirmation of the sale of the Securities to such person and if the
Preliminary Prospectus or the Prospectus (as so amended or supplemented) would
have cured the defect giving rise to such loss, claim, damage or liability.
This indemnity agreement will be in addition to any liability which the Company
may otherwise have.
(b) Each Selling Stockholder severally agrees to indemnify and
hold harmless the Company, each of its directors, each of its officers who
signs the Registration Statement, each Underwriter, the directors, officers,
employees and agents of each Underwriter
<PAGE> 25
25
and each person who controls the Company or any Underwriter within the meaning
of either the Act or the Exchange Act and each other Selling Stockholder to the
same extent as the foregoing indemnity from the Company to each Underwriter,
but only with reference to information furnished in writing to the Company by
or on behalf of such Selling Stockholder specifically for inclusion in the
documents referred to in the foregoing indemnity. This indemnity agreement
will be in addition to any liability which any Selling Stockholder may
otherwise have.
(c) Each Underwriter severally agrees to indemnify and hold
harmless the Company, each of its directors, each of its officers who signs the
Registration Statement, and each person who controls the Company within the
meaning of either the Act or the Exchange Act and each Selling Stockholder, to
the same extent as the foregoing indemnity from the Company to each
Underwriter, but only with reference to written information relating to such
Underwriter furnished to the Company by or on behalf of such Underwriter
through the Representatives specifically for inclusion in the documents
referred to in the foregoing indemnity. This indemnity agreement will be in
addition to any liability which any Underwriter may otherwise have. The
Company and each Selling Stockholder acknowledge that the statements set forth
in the last paragraph of the cover page and in the [first through sixth]
paragraphs under the heading "Underwriting" in any Preliminary Prospectus and
the Prospectus constitute the only information furnished in writing by or on
behalf of the several Underwriters for inclusion in any Preliminary Prospectus
or the Prospectus, and you, as the Representatives, confirm that such
statements are correct.
(d) Promptly after receipt by an indemnified party under this
Section 8 of notice of the commencement of any action, such indemnified party
will, if a claim in respect thereof is to be made against the indemnifying
party under this Section 8, notify the indemnifying party in writing of the
commencement thereof; but the failure so to notify the indemnifying party (i)
will not relieve it from liability under paragraph (a), (b) or (c) above unless
and to the extent it did not otherwise learn of such action and such failure
results in the forfeiture by the indemnifying party of substantial rights and
defenses and (ii) will not, in any event, relieve the indemnifying party from
any obligations to any indemnified party other than the indemnification
obligation provided in paragraph (a), (b) or (c) above. The indemnifying
party shall be entitled to appoint counsel of the indemnifying party's choice
at the indemnifying party's expense to represent the indemnified party in any
action for which indemnification is sought (in which case the indemnifying
party shall not thereafter be responsible for the
<PAGE> 26
26
fees and expenses of any separate counsel retained by the indemnified party or
parties except as set forth below); provided, however, that such counsel shall
be reasonably satisfactory to the indemnified party. Notwithstanding the
indemnifying party's election to appoint counsel to represent the indemnified
party in an action, the indemnified party shall have the right to employ
separate counsel (including local counsel), and the indemnifying party shall
bear the reasonable fees, costs and expenses of such separate counsel if (i)
the use of counsel chosen by the indemnifying party to represent the
indemnified party would present such counsel with a conflict of interest, (ii)
the actual or potential defendants in, or targets of, any such action include
both the indemnified party and the indemnifying party and the indemnified party
shall have reasonably concluded that there may be legal defenses available to
it and/or other indemnified parties which are different from or additional to
those available to the indemnifying party, (iii) the indemnifying party shall
not have employed counsel satisfactory to the indemnified party to represent
the indemnified party within a reasonable time after notice of the institution
of such action or (iv) the indemnifying party shall authorize the indemnified
party to employ separate counsel at the expense of the indemnifying party. An
indemnifying party will not, without the prior written consent of the
indemnified parties, settle or compromise or consent to the entry of any
judgment with respect to any pending or threatened claim, action, suit or
proceeding in respect of which indemnification or contribution may be sought
hereunder (whether or not the indemnified parties are actual or potential
parties to such claim or action) unless such settlement, compromise or consent
includes an unconditional release of each indemnified party from all liability
arising out of such claim, action, suit or proceeding.
(e) In the event that the indemnity provided in paragraph (a), (b)
or (c) of this Section 8 is unavailable to or insufficient to hold harmless an
indemnified party for any reason, the Company, the Selling Stockholders and the
Underwriters agree to contribute to the aggregate losses, claims, damages and
liabilities (including legal or other expenses reasonably incurred in
connection with investigating or defending same) (collectively "Losses") to
which the Company, one or more of the Selling Stockholders and one or more of
the Underwriters may be subject in such proportion as is appropriate to reflect
the relative benefits received by the Company, by the Selling Stockholders and
by the Underwriters from the offering of the Securities; provided, however,
that in no case shall any Underwriter (except as may be provided in any
agreement among underwriters relating to the offering of the Securities) be
responsible for any amount in excess of the underwriting discount
<PAGE> 27
27
or commission applicable to the Securities purchased by such Underwriter
hereunder. If the allocation provided by the immediately preceding sentence is
unavailable for any reason, the Company, the Selling Stockholders and the
Underwriters shall contribute in such proportion as is appropriate to reflect
not only such relative benefits but also the relative fault of the Company, of
the Selling Stockholders and of the Underwriters in connection with the
statements or omissions which resulted in such Losses as well as any other
relevant equitable considerations. Benefits received by the Company and by the
Selling Stockholders shall be deemed to be equal to the total net proceeds from
the offering (before deducting expenses) received by each of them, and benefits
received by the Underwriters shall be deemed to be equal to the total
underwriting discounts and commissions, in each case as set forth on the cover
page of the Prospectus. Relative fault shall be determined by reference to
whether any alleged untrue statement or omission relates to information
provided by the Company, the Selling Stockholders or the Underwriters. The
Company, the Selling Stockholders and the Underwriters agree that it would not
be just and equitable if contribution were determined by pro rata allocation or
any other method of allocation which does not take account of the equitable
considerations referred to above. Notwithstanding the provisions of this
paragraph (e), no person guilty of fraudulent misrepresentation (within the
meaning of Section 11(f) of the Act) shall be entitled to contribution from any
person who was not guilty of such fraudulent misrepresentation. For purposes
of this Section 8, each person who controls an Underwriter within the meaning
of either the Act or the Exchange Act and each director, officer, employee and
agent of an Underwriter shall have the same rights to contribution as such
Underwriter, and each person who controls the Company within the meaning of
either the Act or the Exchange Act, each director of the Company and each
officer who shall have signed the Registration Statement shall have the same
rights to contribution as the Company, subject in each case to the applicable
terms and conditions of this paragraph (e).
9. Default by an Underwriter. If any one or more Underwriters
shall fail to purchase and pay for any of the Securities agreed to be purchased
by such Underwriter or Underwriters hereunder and such failure to purchase
shall constitute a default in the performance of its or their obligations under
this Agreement, the remaining Underwriters shall be obligated severally to take
up and pay for (in the respective proportions which the amount of Underwritten
Securities set forth opposite their names in Schedule I hereto bears to the
aggregate amount of Underwritten Securities set forth opposite the names of all
the remaining Underwriters) the
<PAGE> 28
28
Securities which the defaulting Underwriter or Underwriters agreed but failed
to purchase; provided, however, that in the event that the aggregate amount of
Securities which the defaulting Underwriter or Underwriters agreed but failed
to purchase shall exceed 10% of the aggregate amount of Underwritten Securities
set forth in Schedule I hereto, the remaining Underwriters shall have the right
to purchase all, but shall not be under any obligation to purchase any, of such
Securities, and if such nondefaulting Underwriters do not purchase all such
Securities, this Agreement will terminate without liability to any
nondefaulting Underwriter, the Selling Stockholders or the Company. In the
event of a default by any Underwriter as set forth in this Section 9, the
Closing Date shall be postponed for such period, not exceeding seven days, as
the Representatives shall determine in order that the required changes in the
Registration Statement and the Prospectus or in any other documents or
arrangements may be effected. Nothing contained in this Agreement shall
relieve any defaulting Underwriter of its liability, if any, to the Company,
the Selling Stockholders and any nondefaulting Underwriter for damages
occasioned by its default hereunder.
10. Termination. This Agreement shall be subject to termination
in the absolute discretion of the Representatives, by notice given to the
Company prior to delivery of and payment for the Securities, if prior to such
time (i) trading in the Company's Common Stock shall have been suspended by the
Commission or the Nasdaq National Market or trading in securities generally on
the New York Stock Exchange or the Nasdaq National Market shall have been
suspended or limited or minimum prices shall have been established on either of
such Exchange or Market, (ii) a banking moratorium shall have been declared
either by Federal or New York State authorities or (iii) there shall have
occurred any outbreak or escalation of hostilities, declaration by the United
States of a national emergency or war or other calamity or crisis the effect of
which on financial markets is such as to make it, in the judgment of the
Representatives, impracticable or inadvisable to proceed with the offering or
delivery of the Securities as contemplated by the Prospectus (exclusive of any
supplement thereto).
11. Representations and Indemnities to Survive. The respective
agreements, representations, warranties, indemnities and other statements of
the Company or its officers, of each Selling Stockholder and of the
Underwriters set forth in or made pursuant to this Agreement will remain in
full force and effect, regardless of any investigation made by or on behalf of
any Underwriter, any Selling Stockholder or the Company or any of the officers,
directors or controlling persons referred to in Section
<PAGE> 29
29
8 hereof, and will survive delivery of and payment for the Securities. The
provisions of Sections 7 and 8 hereof shall survive the termination or
cancellation of this Agreement.
12. Notices. All communications hereunder will be in writing and
effective only on receipt, and, if sent to the Representatives, will be mailed,
delivered or sent by facsimile transmission and confirmed to them, care of
Salomon Brothers Inc, at Seven World Trade Center, New York, New York, 10048;
or, if sent to the Company, will be mailed, delivered or sent by facsimile
transmission and confirmed to it at McLeod, Inc., Town Centre, 221 Third
Avenue, S.E., Suite 500, Cedar Rapids, Iowa 52401, attention of the legal
department; or if sent to the Selling Stockholders, will be mailed, delivered
or sent by facsimile transmission and confirmed to them at the addresses set
forth on Schedule II hereto.
13. Successors. This Agreement will inure to the benefit of and
be binding upon the parties hereto and their respective successors and the
officers and directors and controlling persons referred to in Section 8 hereof,
and no other person will have any right or obligation hereunder.
14. Applicable Law. This Agreement will be governed by and
construed in accordance with the laws of the State of New York.
If the foregoing is in accordance with your understanding of our
agreement, please sign and return to us the enclosed duplicate hereof,
whereupon this letter and your acceptance shall represent a binding agreement
among the Company, the Selling Stockholders and the several Underwriters.
Very truly yours,
MCLEOD, INC.
By:
------------------------------------------
Blake O. Fisher, Jr.
Chief Financial Officer
<PAGE> 30
30
The foregoing Agreement is hereby
confirmed and accepted as of the
date first above written.
Salomon Brothers Inc
Bear, Stearns & Co. Inc.
Morgan Stanley & Co. Incorporated
By: Salomon Brothers Inc
By:
------------------------------------------
Charles K. Bobrinskoy
Managing Director
For themselves and the other
several Underwriters named in
Schedule I to the foregoing
Agreement.
<PAGE> 31
31
The foregoing Agreement is hereby
confirmed and accepted as of the
date first written.
- -----------------------------------------------
James L. Cram
- -----------------------------------------------
Virginia Cram
- -----------------------------------------------
Stephen C. Gray
- -----------------------------------------------
Sally Gray
- -----------------------------------------------
Kirk E. Kaalberg
- -----------------------------------------------
Casey D. Mahon
- -----------------------------------------------
Albert P. Ruffalo
- -----------------------------------------------
Michael J. Brown
- -----------------------------------------------
Laura L. Dement
- -----------------------------------------------
Joseph P. Cunningham
The Selling Stockholders as named in
Schedule II to the foregoing Agreement.
<PAGE> 32
SCHEDULE I
<TABLE>
<CAPTION>
Number of Shares of
Underwritten Securities
Underwriters To Be Purchased
- ------------ -----------------------
<S> <C>
Salomon Brothers Inc 935,977
Bear, Stearns & Co. Inc. 935,976
Morgan Stanley & Co. Incorporated 935,976
Donaldson, Lufkin & Jenrette Securities Corporation 120,103
A.G. Edwards & Sons, Inc. 120,103
Lehman Brothers Inc. 120,103
Merrill Lynch, Pierce, Fenner & Smith Incorporated 120,103
Smith Barney Inc. 120,103
William Blair & Company, L.L.C. 86,971
Dain Bosworth Incorporated 86,971
Everen Securities, Inc. 86,971
McDonald & Company Securities, Inc. 86,971
Principal Financial Securities, Inc. 86,971
The Robinson-Humphrey Company, Inc. 86,971
Robert W. Baird & Co. Incorporated 53,839
Gerard Klauer Mattison & Co., LLC 53,839
Edward D. Jones & Co., L.P. 53,869
Kirkpatrick, Pettis, Smith, Polian Inc. 53,839
Brad Peery Inc. 53,839
Pennsylvania Merchant Group Ltd 53,839
Securities Corporation of Iowa 53,839
_______________________
Total . . . . . . . . . . . . . . . . . . 4,307,143
</TABLE>
<PAGE> 33
SCHEDULE II
<TABLE>
Caption>
Number of Shares of
Underwritten Securities
To Be Sold
-----------------------
<S> <C>
Stephen C. Gray . . . . . . . . . . . . . . . . . . . . . . . . . . 30,101
312 Nassau Street SE
Cedar Rapids, Iowa 52403
Stephen C. Gray &
Sally Gray as Tenants in Common . . . . . . . . . . . . . . . . . . 95,705
312 Nassau Street SE
Cedar Rapids, Iowa 52403
James L. Cram . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,291
R.R. #1, Box 180C
Vinton, Iowa 52349
Virginia Cram . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,290
R.R. #1, Box 180C
Vinton, Iowa 52349
Casey D. Mahon . . . . . . . . . . . . . . . . . . . . . . . . . . 50,323
226 McLean Street
Iowa City, Iowa 52246
Kirk E. Kaalberg . . . . . . . . . . . . . . . . . . . . . . . . . . 33,548
1455 Butternut Court NE
Swisher, Iowa 52238
Michael Brown . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,935
1935 Southridge Knoll Ct. SE
Cedar Rapids, Iowa 52403
Albert P. Ruffalo . . . . . . . . . . . . . . . . . . . . . . . . . 16,774
3181 Eagle Court NE
Cedar Rapids, Iowa 52402
Laura L. Dement . . . . . . . . . . . . . . . . . . . . . . . . . . 10,065
3963 Sally Drive NE
Cedar Rapids, Iowa 52402
Joseph P. Cunningham . . . . . . . . . . . . . . . . . . . . . . . 10,065
7150 Bettsy Court NE
Cedar Rapids, Iowa 52411
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 431,097
</TABLE>
<PAGE> 34
EXHIBIT B
[Letterhead of Stockholder]
McLeod, Inc.
------------
Public Offering of Class A Common Stock
---------------------------------------
, 1996
Salomon Brothers Inc
Bear, Stearns & Co. Inc.
Morgan Stanley & Co. Incorporated
As Representatives of the several Underwriters
c/o Salomon Brothers Inc
Seven World Trade Center
New York, New York 10048
Dear Sirs:
This letter is being delivered to you in connection with the
proposed Underwriting Agreement (the "Underwriting Agreement"), between McLeod,
Inc., a Delaware corporation (the "Company"), certain Selling Stockholders
named therein and each of you as Representatives of a group of Underwriters
named therein, relating to an underwritten public offering of Class A Common
Stock, $.01 par value (the "Common Stock"), of the Company.
In order to induce you and the other Underwriters to enter
into the Underwriting Agreement, the undersigned agrees not to offer, sell or
contract to sell, or otherwise dispose of, directly or indirectly, or announce
an offering of, any shares of Common Stock beneficially owned by the
undersigned or any securities convertible into, or exchangeable for, shares of
Common Stock for a period of 120 days following the day on which the
Underwriting Agreement is executed without the prior written consent of the
Representatives, except shares of Common Stock disposed of as bona fide gifts
or pledges where the recipients of such gifts or the pledgees, as the case may
be, agree in writing with the Underwriters to be bound by the terms of this
letter.
If for any reason the Underwriting Agreement shall be
terminated prior to the Closing Date (as defined in the Underwriting
Agreement), the agreement set forth above shall likewise be terminated.
Yours very truly,
<PAGE> 1
[MCGLADREY & PULLEN, LLP LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
McLeod, Inc.
Cedar Rapids, Iowa
We hereby consent to the use in this Registration Statement of our report,
dated March 28, 1996, except for Note 11, as to which the date is May 29, 1996,
relating to the consolidated financial statements of McLeod, Inc. and
subsidiaries, and to the reference to our Firm under the caption "Experts" and
"Selected Consolidated Financial Data" in the Prospectus.
/s/ MCGLADREY & PULLEN, LLP
-----------------------------
MCGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
November 15, 1996
<PAGE> 2
[MCGLADREY & PULLEN, LLP LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
MWR Telecom Inc.
Cedar Rapids, Iowa
We hereby consent to the use in this Registration Statement of our report,
dated March 15, 1996, relating to the financial statements of MWR Telecom Inc.,
and to the reference to our Firm under the caption "Experts" in the Prospectus.
/s/ MCGLADREY & PULLEN, LLP
-------------------------------
MCGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
November 15, 1996
<PAGE> 3
[MCGLADREY & PULLEN, LLP LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Ruffalo, Cody & Associates, Inc.
Cedar Rapids, Iowa
We hereby consent to the use in this Registration Statement of our report,
dated February 9, 1996, except for Note 8, as to which the date is July 15,
1996, relating to the consolidated financial statements of Ruffalo, Cody &
Associates, Inc. and subsidiary, and to the reference to our Firm under the
caption "Experts" in the Prospectus.
/s/ MCGLADREY & PULLEN, LLP
--------------------------------
MCGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
November 15, 1996
<PAGE> 4
[MCGLADREY & PULLEN, LLP LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Telecom*USA Publishing Group, Inc.
Cedar Rapids, Iowa
We hereby consent to the use in this Registration Statement of our report,
dated September 27, 1996, relating to the consolidated financial statements of
Telecom*USA Publishing Group, Inc. and subsidiaries, and to the reference to
our Firm under the caption "Experts" in the Prospectus.
/s/ MCGLADREY & PULLEN, LLP
-----------------------------
MCGLADREY & PULLEN, LLP
Cedar Rapids, Iowa
November 15, 1996
