<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 3, 1997
REGISTRATION NO. 333-27647
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 1 TO FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
MCLEODUSA INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 4813 42-1407240
(PRIMARY STANDARD (I.R.S. EMPLOYER
(STATE OR OTHER INDUSTRIAL IDENTIFICATION NUMBER)
JURISDICTION OF CLASSIFICATION CODE
INCORPORATION OR NUMBER)
ORGANIZATION) MCLEODUSA TECHNOLOGY PARK
6400 C STREET, SW, P.O. BOX 3177
CEDAR RAPIDS, IA 52406-3177
(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
MCLEODUSA INCORPORATED
MCLEODUSA TECHNOLOGY PARK
6400 C STREET, SW, P.O. BOX 3177
CEDAR RAPIDS, IA 52406-3177
(319) 364-0000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
----------------
COPIES TO:
JOSEPH G. CONNOLLY, JR., ESQ.
NANCY J. KELLNER, ESQ.
HOGAN & HARTSON L.L.P.
555 THIRTEENTH STREET, N.W.
WASHINGTON, D.C. 20004
(202) 637-5600
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
----------------
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance
with General Instruction G, check the following box. [_]
----------------
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED PROPOSED
MAXIMUM MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED PRICE PER UNIT(1) OFFERING PRICE(1) REGISTRATION FEE(2)
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<S> <C> <C> <C> <C>
10 1/2% Senior Discount
Notes Due March 1,
2007.................. $500,000,000 61.386% $306,931,616 $93,010
</TABLE>
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(1) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(f) under the Securities Act of 1933, as amended.
(2) Calculated pursuant to Rule 457(f) based on the book value, calculated as
of May 20, 1997, of the outstanding 10 1/2% Senior Discount Notes Due 2007
of McLeodUSA Incorporated to be cancelled in the exchange transaction
hereunder. Such amount was previously paid.
----------------
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>
SUBJECT TO COMPLETION
DATED JULY 3, 1997
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS
$500,000,000
MCLEODUSA INCORPORATED
OFFER TO EXCHANGE ALL OUTSTANDING 10 1/2% SENIOR DISCOUNT NOTES DUE MARCH 1,LOGO
2007
FOR 10 1/2% SENIOR DISCOUNT NOTES DUE MARCH 1, 2007 OF MCLEODUSA INCORPORATED
INTEREST PAYABLE MARCH 1 AND SEPTEMBER 1, COMMENCING SEPTEMBER 1, 2002
THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P.M., NEW YORK
CITY TIME, ON , 1997, UNLESS EXTENDED.
McLeodUSA Incorporated (the "Company") hereby offers, upon the terms and
subject to the conditions set forth in this Prospectus (as the same may be
amended or supplemented from time to time) and in the accompanying Letter of
Transmittal (the "Letter of Transmittal") (which together constitute the
"Exchange Offer"), to exchange $1,000 principal amount at maturity of its 10
1/2% Senior Discount Notes due March 1, 2007 (the "Exchange Notes") which have
been registered under the Securities Act of 1933, as amended (the "Securities
Act"), for each $1,000 principal amount at maturity of its outstanding
unregistered 10 1/2% Senior Discount Notes due March 1, 2007, of which $500
million in aggregate principal amount at maturity is outstanding as of the date
hereof (the "Senior Notes" and, together with the Exchange Notes, the "Notes").
The form and terms of the Exchange Notes are identical in all material respects
to the form and terms of the Senior Notes, except that (i) the Exchange Notes
will have been registered under the Securities Act and therefore will not be
subject to certain restrictions on transfer applicable to the Senior Notes and
(ii) holders of the Exchange Notes will not be entitled to certain rights of
holders of the Senior Notes under the Registration Agreement dated March 4,
1997 (the "Registration Agreement") among the Company and Salomon Brothers Inc
and Morgan Stanley & Co. Incorporated (the "Initial Purchasers"). The Exchange
Notes evidence the same indebtedness as the Senior Notes (which they replace)
and will be issued pursuant to, and entitled to the benefits of, an indenture
dated as of March 4, 1997 between the Company and the United States Trust
Company of New York, as trustee (the "Trustee"), governing the Senior Notes and
the Exchange Notes (the "Indenture").
The Exchange Notes will mature on March 1, 2007. Interest will not accrue on
the Exchange Notes prior to March 1, 2002. Thereafter, interest on the Exchange
Notes will accrue at a rate of 10 1/2% per annum and will be payable in cash
semi-annually on March 1 and September 1 of each year, commencing September 1,
2002. See "Description of the Exchange Notes." The Exchange Notes will be
redeemable, at the option of the Company, in whole or in part, at any time on
or after March 1, 2002, at the redemption prices set forth herein, plus accrued
and unpaid interest, if any, to the date of redemption. In the event of a
Strategic Equity Investment (as defined herein) before March 1, 2000,
(Continued on next page.)
SEE "RISK FACTORS" COMMENCING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS
WHICH INVESTORS SHOULD CONSIDER IN CONNECTION WITH THE EXCHANGE OFFER AND AN
INVESTMENT IN THE EXCHANGE NOTES.
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.
The date of this Prospectus is , 1997
<PAGE>
the Company may, at its option, use all or a portion of the net proceeds
therefrom to redeem up to an aggregate amount equal to 33 1/3% of the original
principal amount of the Exchange Notes at a redemption price of 110.5% of the
Accreted Value (as defined herein) thereof. In addition, in the event of a
Change of Control (as defined herein), each holder of Exchange Notes will have
the right to require the Company to repurchase all or any part of such
holder's Exchange Notes at a repurchase price equal to 101% of the Accreted
Value thereof prior to March 1, 2002, or 101% of the principal amount thereof
plus accrued and unpaid interest, if any, on or after March 1, 2002. See
"Description of the Exchange Notes--Repurchase at the Option of Holders upon a
Change of Control." There can be no assurance that the Company will have the
financial resources necessary to repurchase the Exchange Notes in such
circumstances.
The Exchange Notes are senior unsecured obligations of the Company. The
Exchange Notes rank pari passu in right of payment with the Senior Notes and
all other existing and future senior unsecured indebtedness of the Company and
rank senior in right of payment to all existing and future subordinated
indebtedness of the Company. The Exchange Notes are effectively subordinated
to any existing and future secured indebtedness of the Company and its
subsidiaries to the extent of the value of the assets securing such
indebtedness. The Exchange Notes also are effectively subordinated to all
existing and future third-party indebtedness and other liabilities of the
Company's subsidiaries. As of March 31, 1997, the total secured indebtedness
of the Company and its subsidiaries was approximately $2.9 million and the
total liabilities of the Company's subsidiaries (after elimination of loans
and advances by the Company to its subsidiaries) were approximately $54.2
million.
The Senior Notes were originally issued and sold on March 4, 1997 in a
transaction not registered under the Securities Act (the "Offering").
Accordingly, the Senior Notes may not be offered for resale, resold or
otherwise transferred unless so registered or unless an applicable exemption
from the registration requirements of the Securities Act is available. Based
on interpretations by the staff of the Securities and Exchange Commission (the
"Commission"), as set forth in no-action letters issued to third parties
unrelated to the Company, the Company believes that the Exchange Notes issued
pursuant to the Exchange Offer may be offered for resale, resold or otherwise
transferred by holders thereof (other than any holder that is (i) a broker-
dealer that acquired Senior Notes as a result of market-making activities or
other trading activities, or (ii) a broker-dealer that acquired Senior Notes
directly from the Company for resale pursuant to Rule 144A under the
Securities Act ("Rule 144A") or another available exemption under the
Securities Act) without compliance with the registration or prospectus
delivery provisions of the Securities Act, provided that such Exchange Notes
are acquired in the ordinary course of such holders' business, such holders
have no arrangement or understanding with any person to participate in the
distribution of such Exchange Notes and such holders are not "affiliates" of
the Company (within the meaning of Rule 405 under the Securities Act).
However, the staff of the Commission has not considered the Exchange Offer in
the context of a no-action letter, and there can be no assurance that the
staff of the Commission would make a similar determination with respect to the
Exchange Offer as in such other circumstances.
By tendering Senior Notes in exchange for Exchange Notes, each holder will
represent to the Company, among other things, that: (i) any Exchange Notes to
be received by such holder will be acquired in the ordinary course of such
holder's business; (ii) at the time of the commencement of the Exchange Offer,
such holder has no arrangement or understanding with any person to participate
in the distribution (within the meaning of the Securities Act) of the Exchange
Notes; and (iii) such holder is not an "affiliate" of the Company (within the
meaning of Rule 405 under the Securities Act). Each broker-dealer that
receives Exchange Notes for its own account in exchange for Senior Notes,
where such Senior Notes were acquired by such broker-dealer as a result of
marketing-making activities or other trading activities, must acknowledge that
it will deliver a prospectus in connection with any resale of such Exchange
Notes. The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it
is an "underwriter" within the meaning of the Securities Act. This Prospectus,
as it may be amended or supplemented from time to time, may
<PAGE>
be used by a broker-dealer in connection with resales of Exchange Notes
received in exchange for Senior Notes where such Senior Notes were acquired by
such broker-dealer as a result of market-making activities or other trading
activities. The Company has agreed that, starting on the Expiration Date (as
defined herein) and ending on the close of business on the first anniversary
of the Expiration Date, it will make this Prospectus available to any broker-
dealer for use in connection with any such resale. See "Plan of Distribution."
The Company does not intend to apply for listing of the Exchange Notes for
trading on any securities exchange or for inclusion of the Exchange Notes in
any automated quotation system. The Senior Notes, however, have been
designated for trading in the Private Offerings, Resales and Trading through
Automatic Linkages ("PORTAL") Market of the National Association of Securities
Dealers, Inc. Any Senior Notes not tendered and accepted in the Exchange Offer
will remain outstanding. To the extent that Senior Notes remain outstanding, a
holder's ability to sell such Senior Notes could be adversely affected.
Following consummation of the Exchange Offer, the holders of Senior Notes will
continue to be subject to the existing restrictions on transfer thereof and
the Company will have no further obligation to such holders to provide for the
registration under the Securities Act of the Senior Notes, except under
limited circumstances. See "Description of the Exchange Notes--Exchange Offer;
Registration Rights." No assurance can be given as to the liquidity of either
the Senior Notes or the Exchange Notes.
THIS PROSPECTUS AND THE RELATED LETTER OF TRANSMITTAL CONTAIN IMPORTANT
INFORMATION. HOLDERS OF SENIOR NOTES ARE URGED TO READ THIS PROSPECTUS AND THE
RELATED LETTER OF TRANSMITTAL CAREFULLY BEFORE DECIDING WHETHER TO TENDER
THEIR SENIOR NOTES PURSUANT TO THE EXCHANGE OFFER.
Senior Notes may be tendered for exchange prior to 5:00 p.m., New York City
time, on , 1997 (such time on such date being hereinafter called the
"Expiration Date"), unless the Exchange Offer is extended by the Company (in
which case the term "Expiration Date" shall mean the latest date and time to
which the Exchange Offer is extended). Tenders of Senior Notes may be
withdrawn at any time prior to the Expiration Date. The Exchange Offer is not
conditioned upon any minimum aggregate principal amount of Senior Notes being
tendered for exchange. The Exchange Offer is, however, subject to certain
events and conditions and to the terms of the Registration Agreement. Senior
Notes may be tendered only in integral multiples of aggregate principal amount
at maturity of $1,000. The Company has agreed to pay all expenses of the
Exchange Offer. This Prospectus, together with the Letter of Transmittal, is
being sent to all registered holders of Senior Notes as of , 1997.
The Company will not receive any cash proceeds from the issuance of the
Exchange Notes offered hereby. No underwriter is being used in connection with
the Exchange Offer. See "Use of Proceeds" and "Plan of Distribution."
<PAGE>
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.
Potential participants in the Exchange Offer should carefully consider the
factors set forth herein under the caption "Risk Factors" and are urged to read
this Prospectus and the Letter of Transmittal in their 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, 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, (iv) the sale of advertising space in
telephone directories, and (v) ancillary services, including direct marketing
and telemarketing services and the sale of business telephone systems. As of
March 31, 1997, the Company served over 27,400 telecommunications customers in
138 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
offers a variety of special access and private line services to large
businesses, institutional customers and interexchange carriers, primarily in
Des Moines, Iowa. 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 subscribing to the Company's
integrated telecommunications services 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
generally are most popular with the Company's business customers, and, in
certain cases, rates specifically identified by a
1
<PAGE>
business customer and agreed to by the Company. The Company also provides voice
mail, paging and Internet access services. See "Business--Current Products and
Services."
The Company completed its initial public offering of Class A Common Stock,
$.01 par value per share (the "Class A Common Stock"), in June 1996 and
completed an additional public offering of Class A Common Stock in November
1996. Since its initial public offering of Class A Common Stock, the Company
has actively pursued its strategy of increasing market penetration and
expanding into new markets in the following ways: (i) the Company now offers to
residential customers in 15 cities and towns in Iowa and in ten cities and
towns in Illinois 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 now offers integrated telecommunications
services in markets in Minnesota and Wisconsin in addition to its Iowa and
Illinois markets; (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
TelecomwUSA Publishing Group, Inc. (now known as McLeodUSA Media Group, Inc.
("McLeodUSA Publishing")), which publishes and distributes "white page" and
"yellow page" telephone directories in nineteen 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 2,200 new route miles of
fiber optic network at a cost of approximately $50.5 million; (vi) in May 1997,
the Company acquired 25 personal communications services ("PCS") licenses as
part of its strategy to increase the range of integrated telecommunications
services provided to customers in its target markets; and (vii) in June 1997,
the Company entered into an agreement to acquire Consolidated Communications
Inc. ("CCI"), which offers a variety of communications services including local
exchange services.
BUSINESS STRATEGY
The Company's objective is to become a leading provider of integrated
wireline and wireless telecommunications services in Iowa, Illinois, Minnesota,
Wisconsin, South Dakota, North Dakota, Colorado, Wyoming, Montana, Utah, Idaho
and Nebraska. 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 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 wireline and wireless
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. The Company intends to add PCS
services to its current array of integrated telecommunications services over
the next several years.
BUILD MARKET SHARE THROUGH BRANDING AND CUSTOMER SERVICE. The Company
believes that, by branding its telecommunications services with the trade name
wMcLeodUSA in combination with the distinctive black-and-yellow motif of the
McLeodUSA 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
2
<PAGE>
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, and will permit the Company to include additional
services, such as PCS, when available. 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 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). As of
March 31, 1997, the Company owned approximately 2,600 route miles of fiber
optic network and, subject to the foregoing factors, expects to construct
approximately 4,900 additional route miles of fiber optic network during the
next three years. Through its strategic relationships with its electric utility
stockholders and its contracts to build the final links of the Iowa
Communications Network and lease a portion of the capacity on those links 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, during 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
3
<PAGE>
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 and one
utility in Wisconsin provide it with access to rights-of-way and other
resources on favorable terms. The Company believes that its acquisitions of
Ruffalo, Cody and McLeodUSA Publishing during 1996 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. In June 1997, the Company
entered into an agreement to acquire CCI. 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. Seven of the nine 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 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 McLeodUSA Technology Park, 6400 C
Street, SW, P.O. Box 3177, Cedar Rapids, Iowa 52406-3177, and its phone number
is (319) 364-0000.
RECENT DEVELOPMENTS
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 56,177 shares of Class A Common Stock were delivered to
certain of the shareholders of Ruffalo, Cody upon the fulfillment of certain
conditions relating to Ruffalo, Cody's ongoing revenues from a material
agreement with a major long distance carrier to provide telemarketing services.
The major long distance carrier terminated this agreement, effective December
31, 1996. Ruffalo, Cody specializes in direct marketing and telemarketing
services, including telecommunications sales. The Company uses Ruffalo, Cody's
information database to identify attractive sales opportunities and pursues
those opportunities through a variety of methods, including calls from Ruffalo,
Cody's telemarketing personnel.
On September 20, 1996, the Company acquired McLeodUSA Publishing for
approximately $74.1 million in cash and an additional amount estimated as of
the date hereof to be approximately $1.6 million to be paid to certain
employees of McLeodUSA Publishing as part of an incentive plan. At the time of
the acquisition, McLeodUSA Publishing had outstanding debt of approximately
$6.6 million. McLeodUSA Publishing publishes and distributes "white page" and
"yellow page" telephone directories in nineteen states in the midwestern and
Rocky Mountain regions of the United States. In its fiscal year 1996, McLeodUSA
Publishing published and distributed over 7 million directories and
4
<PAGE>
had revenues of $52.1 million, primarily from the sale of advertising space in
its telephone directories to approximately 85,000 advertisers. The Company
believes that the acquisition of McLeodUSA 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 integrated telecommunications
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 McLeodUSA 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 McLeodUSA
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 wMcLeodUSA will create
and strengthen brand awareness in all of the Company's markets. See "Risk
Factors--Risks Associated with Acquisitions," "Business--Recent Transactions"
and "Business--Sales and Marketing."
On April 28, 1997, the FCC granted the Company 25 "D" and "E" block frequency
PCS licenses in 23 markets covering areas of Iowa, Illinois, Minnesota,
Nebraska and South Dakota. The Company paid the FCC approximately $32 million
for these PCS licenses. The PCS licenses encompass approximately 100,000 square
miles and a population of approximately 6.3 million. The Company is beginning
to design and engineer its proposed PCS system. The Company expects to begin
constructing its PCS network and offering PCS services as part of its
integrated telecommunications services over the next several years. See "Risk
Factors--PCS System Implementation Risks," "Risk Factors--Regulation" and
"Business--Wireless Services."
On May 29, 1997, the stockholders of the Company approved an amendment to the
Company's Amended and Restated Certificate of Incorporation (the "Restated
Certificate") changing the name of the Company from McLeod, Inc. to McLeodUSA
Incorporated.
On June 10, 1997, the Company acquired substantially all of the assets of ESI
Communications, Inc. and related entities (collectively, "ESI Communications")
for an aggregate of approximately $15.2 million. ESI Communications sells,
installs and services telephone systems in Minnesota.
On June 14, 1997, the Company entered into an Agreement and Plan of
Reorganization with CCI pursuant to which the Company agreed, subject to
certain conditions, to acquire CCI for an aggregate of 8,488,613 shares of
Class A Common Stock and $155 million in cash. CCI is a communications company
that offers a variety of communications services, including local exchange
services, primarily in Illinois, Missouri and Indiana. See "Risk Factors--Risks
Associated with Acquisitions" and "Business--Recent Transactions."
THE EXCHANGE OFFER
The Exchange Offer..........
Up to $500 million aggregate principal amount at
maturity of Exchange Notes are being offered in
exchange for a like aggregate principal amount at
maturity of Senior Notes. Senior Notes may be
tendered for exchange in whole or in part in
integral multiples of $1,000 principal amount at
5
<PAGE>
maturity. The Company is making the Exchange
Offer in order to satisfy its obligations under
the Registration Agreement relating to the Senior
Notes. For a description of the procedures for
tendering Senior Notes, see "The Exchange Offer--
Procedures for Tendering Senior Notes."
Expiration Date............. 5:00 p.m., New York City time, on , 1997
unless the Exchange Offer is extended by the
Company (in which case the term "Expiration Date"
shall mean the latest date and time to which the
Exchange Offer is extended). See "The Exchange
Offer--Expiration Date; Extensions; Amendments."
Conditions to the Exchange
Offer....................... The Exchange Offer is subject to certain
conditions, which may be waived by the Company in
its sole discretion. The Exchange Offer is not
conditioned upon any minimum aggregate principal
amount at maturity of Senior Notes being
tendered. See "The Exchange Offer--Conditions to
the Exchange Offer."
The Company reserves the right in its sole and
absolute discretion, subject to applicable law,
at any time and from time to time, (i) to delay
the acceptance of the Senior Notes, (ii) to
terminate the Exchange Offer if certain specified
conditions have not been satisfied, (iii) to
extend the Expiration Date of the Exchange Offer
and retain all Senior Notes tendered pursuant to
the Exchange Offer, subject, however, to the
right of holders of Senior Notes to withdraw
their tendered Senior Notes, and (iv) to waive
any condition or otherwise amend the terms of the
Exchange Offer in any respect. See "The Exchange
Offer--Expiration Date; Extensions; Amendments."
Withdrawal Rights........... Tenders of Senior Notes may be withdrawn at any
time prior to the Expiration Date by delivering a
written notice of such withdrawal to the Exchange
Agent (as defined herein) in conformity with
certain procedures as set forth below under "The
Exchange Offer--Withdrawal Rights."
Procedures for Tendering
Senior Notes................ Tendering holders of Senior Notes must complete
and sign a Letter of Transmittal in accordance
with the instructions contained therein and
forward the same by mail, facsimile transmission
or hand delivery, together with any other
required documents, to the Exchange Agent, either
with the Senior Notes to be tendered or in
compliance with the specified procedures for
guaranteed delivery of Senior Notes. Certain
brokers, dealers, commercial banks, trust
companies and other nominees may also effect
tenders by book-entry transfer. Holders of Senior
Notes registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
are urged to contact such person promptly if they
wish to tender Senior Notes pursuant to the
Exchange Offer. See "The Exchange Offer--
Procedures for Tendering Senior Notes."
6
<PAGE>
Letters of Transmittal and certificates
representing Senior Notes should not be sent to
the Company. Such documents should only be sent
to the Exchange Agent. Questions regarding how to
tender and requests for information should be
directed to the Exchange Agent. See "The Exchange
Offer--Exchange Agent."
Resales of Exchange Notes... Based on interpretations by the staff of the
Commission, as set forth in no-action letters
issued to third parties, the Company believes
that holders of Senior Notes (other than any
holder that is (i) a broker-dealer that acquired
Senior Notes as a result of market-making
activities or other trading activities, or (ii) a
broker-dealer that acquired Senior Notes directly
from the Company for resale pursuant to Rule 144A
or another available exemption under the
Securities Act) who exchange their Senior Notes
for Exchange Notes pursuant to the Exchange Offer
may offer for resale, resell and otherwise
transfer such Exchange Notes without compliance
with the registration and prospectus delivery
provisions of the Securities Act, provided that
such Exchange Notes are acquired in the ordinary
course of such holders' business, such holders
have no arrangement or understanding with any
person to participate in the distribution of such
Exchange Notes and such holders are not
"affiliates" of the Company (within the meaning
of Rule 405 under the Securities Act). However,
the staff of the Commission has not considered
the Exchange Offer in the context of a no-action
letter, and there can be no assurance that the
staff of the Commission would make a similar
determination with respect to the Exchange Offer.
Each broker-dealer that receives Exchange Notes
for its own account in exchange for Senior Notes,
where such Senior Notes were acquired by such
broker-dealer as a result of market-making
activities or other trading activities, must
acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange
Notes. See "Plan of Distribution."
Exchange Agent.............. The exchange agent with respect to the Exchange
Offer is United States Trust Company of New York
(the "Exchange Agent"). The address, telephone
number and facsimile number of the Exchange Agent
are set forth in "The Exchange Offer--Exchange
Agent" and in the Letter of Transmittal.
Use of Proceeds............. The Company will not receive any cash proceeds
from the issuance of the Exchange Notes offered
hereby. See "Use of Proceeds."
Certain United States
Federal Income Tax
Consequences................ The exchange of the Exchange Notes for the Senior
Notes will not be a taxable exchange for federal
income tax purposes, and holders of Senior Notes
should not recognize any taxable
7
<PAGE>
gain or loss or any interest income as a result
of such exchange. See "Certain United States
Federal Income Tax Consequences--The Exchange."
THE EXCHANGE NOTES
Securities Offered.......... $500 million aggregate principal amount at
maturity of 10 1/2% Senior Discount Notes due
March 1, 2007. The terms of the Exchange Notes
are identical in all material respects to the
terms of the Senior Notes, except that (i) the
Exchange Notes will have been registered under
the Securities Act and therefore will not be
subject to certain restrictions on transfer
applicable to the Senior Notes and (ii) holders
of the Exchange Notes will not be entitled to
certain rights of holders of the Senior Notes
under the Registration Agreement. The Exchange
Notes evidence the same debt as the Senior Notes
and will be issued pursuant to and entitled to
the benefits of the Indenture.
Maturity.................... March 1, 2007.
Interest.................... The Exchange Notes will accrete from March 4,
1997 at a rate of 10 1/2% per annum, compounded
semi-annually, to an aggregate principal amount
of $500 million by March 1, 2002 (assuming all of
the Senior Notes are exchanged for Exchange Notes
in the Exchange Offer). Interest will not accrue
on the Exchange Notes prior to March 1, 2002.
Thereafter, interest on the Exchange Notes will
accrue at the rate of 10 1/2% per annum and will
be payable in cash semi-annually on March 1 and
September 1, commencing September 1, 2002.
Yield....................... 10 1/2% per annum, computed on a semi-annual
bond-equivalent basis and calculated from March
4, 1997.
Ranking..................... The Exchange Notes rank pari passu in right of
payment with the Senior Notes and all other
existing and future senior unsecured indebtedness
of the Company and rank senior in right of
payment to all existing and future subordinated
indebtedness of the Company. As of March 31,
1997, the Company had no outstanding subordinated
indebtedness and, other than the Senior Notes,
had no outstanding indebtedness that would rank
pari passu with the Exchange Notes. The Exchange
Notes are not secured by any assets and are
effectively subordinated to any existing and
future secured indebtedness of the Company and
its subsidiaries, including any Senior Credit
Facility (as defined herein) or Qualified
Receivable Facility (as defined herein), to the
extent of the value of the assets securing such
indebtedness. As of March 31, 1997, the Company
and its subsidiaries had approximately $2.9
million outstanding of secured
8
<PAGE>
indebtedness. The Exchange Notes also are
effectively subordinated to all existing and
future third-party indebtedness (including any
Senior Credit Facility or any applicable
Qualified Receivable Facility) and other
liabilities of the Company's subsidiaries
(including trade payables). As of March 31, 1997,
the total liabilities of the Company's
subsidiaries (after the elimination of loans and
advances by the Company to its subsidiaries) were
approximately $54.2 million. Of that amount,
approximately $202,000 in indebtedness was
secured by first priority liens on certain assets
of the borrowing subsidiaries. See "Description
of the Exchange Notes--General."
Optional Redemption......... The Exchange Notes are subject to redemption at
the option of the Company, in whole or in part,
at any time on or after March 1, 2002 at the
redemption prices set forth herein, plus accrued
and unpaid interest thereon (if any) to the date
of redemption. In addition, in the event of a
sale by the Company of its Common Stock (as
defined herein) in a Strategic Equity Investment
before March 1, 2000, the Company may, at its
option, use all or a portion of the net proceeds
from such sale to redeem Exchange Notes in a
principal amount of up to an aggregate amount
equal to 33 1/3% of the original principal amount
of the Exchange Notes at a redemption price of
110.5% of the Accreted Value of the Exchange
Notes. See "Description of the Exchange Notes--
Optional Redemption."
Change of Control........... Upon the occurrence of a Change of Control, each
holder of Exchange Notes shall have the right to
require the Company to repurchase all or any part
of such holder's Exchange Notes at a purchase
price equal to 101% of the Accreted Value thereof
on any Change of Control Payment Date (as defined
herein) prior to March 1, 2002, or 101% of the
principal amount thereof plus accrued and unpaid
interest, if any, to any Change of Control
Payment Date on or after March 1, 2002. There can
be no assurance that the Company will have the
financial resources necessary to repurchase the
Exchange Notes upon a Change of Control. See
"Description of the Exchange Notes--Repurchase at
the Option of Holders upon a Change of Control."
Original Issue Discount..... The Exchange Notes bear original issue discount
for federal income tax purposes. Thus, although
interest will not accrue on the Exchange Notes
prior to March 1, 2002, and there will be no
periodic payments of interest on the Exchange
Notes prior to September 1, 2002, original issue
discount (that is, the difference between the
stated redemption price at maturity and the issue
price of the Senior Notes) will accrue from
the issue date and will be includible as interest
income
9
<PAGE>
periodically in a holder's gross income for
federal income tax purposes in advance of receipt
of the cash payments to which the income is
attributable. See "Certain United States Federal
Income Tax Consequences."
Certain Covenants........... The Indenture contains certain covenants which,
among other things, restrict the ability of the
Company and certain of its subsidiaries to incur
additional indebtedness, pay dividends or make
distributions in respect of the Company's or such
subsidiaries' capital stock, make other
restricted payments, enter into sale and
leaseback transactions, create liens, enter into
transactions with affiliates or related persons,
sell assets, or consolidate, merge or sell all or
substantially all of their assets. These
covenants are subject to important exceptions and
qualifications. See "Description of the Exchange
Notes--Certain Covenants."
RISK FACTORS
POTENTIAL PARTICIPANTS IN THE EXCHANGE OFFER SHOULD CONSIDER CAREFULLY
CERTAIN FACTORS SET FORTH UNDER THE CAPTION "RISK FACTORS." SEE "RISK FACTORS."
10
<PAGE>
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 Ruffalo, Cody and McLeodUSA Publishing on July 15, 1996 and
September 20, 1996, respectively, using the purchase method of accounting, and
also reflects the issuance of the Senior Notes on March 4, 1997, assuming, for
purposes of the pro forma statement of operations data, that such transactions
were consummated at the beginning of the periods presented. The unaudited pro
forma information should be read in conjunction with the Financial Statements
of Ruffalo, Cody and McLeodUSA 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, Ruffalo, Cody and McLeodUSA
Publishing.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------------------------------- -----------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996(4)(5) 1996 1997(6) 1997(4)(7)
---- ---- ---- ---------- ---------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT DATA:
Revenue................ $ 250 $ 1,550 $ 8,014 $ 28,998 $ 81,323 $128,624 $12,488 $ 35,747 $ 35,747
----- ------- -------- -------- -------- -------- ------- -------- --------
Operating expenses:
Cost of service....... 262 1,528 6,212 19,667 52,624 71,634 9,250 21,200 21,200
Selling, general and
administrative....... 219 2,390 12,373 18,054 46,044 67,416 6,345 23,985 23,985
Depreciation and
amortization......... 6 235 772 1,835 8,485 12,756 969 4,122 4,122
Other................. -- -- -- -- 2,380 4,968 -- 1,608 1,608
----- ------- -------- -------- -------- -------- ------- -------- --------
Total operating
expenses............. 487 4,153 19,357 39,556 109,533 156,774 16,564 50,915 50,915
----- ------- -------- -------- -------- -------- ------- -------- --------
Operating loss......... (237) (2,603) (11,343) (10,558) (28,210) (28,150) (4,076) (15,168) (15,168)
Interest income
(expense), net........ -- 163 (73) (771) 5,369 (12,242) (264) 1,806 (2,148)
Other non-operating
income................ -- -- -- -- 495 6 -- 7 7
Income taxes........... -- -- -- -- -- -- -- -- --
----- ------- -------- -------- -------- -------- ------- -------- --------
Net loss............... $(237) $(2,440) $(11,416) $(11,329) $(22,346) $(40,386) $(4,340) $(13,355) $(17,309)
===== ======= ======== ======== ======== ======== ======= ======== ========
Loss per common and
common equivalent
share................. $(.02) $ (.08) $ (.31) $ (.31) $ (.52) $ (.93) $ (.12) $ (.26) $ (.33)
===== ======= ======== ======== ======== ======== ======= ======== ========
Ratio of earnings to
fixed charges(8)...... -- -- -- -- -- -- -- -- --
===== ======= ======== ======== ======== ======== ======= ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------- MARCH 31,
1992 1993 1994 1995(1)(9) 1996(1)(10) 1997(6)
---------- ---------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets................................ $ 544 $ 7,077 $ 4,862 $ 8,507 $224,401 $481,940
Working capital (deficit)..................... $ (440) $ 5,962 $ 1,659 $(1,208) $185,968 $409,874
Property and equipment, net................... $ 135 $ 1,958 $ 4,716 $16,119 $ 92,123 $115,512
Total assets.................................. $ 694 $ 9,051 $ 10,687 $28,986 $452,994 $779,654
Long-term debt................................ -- -- $ 3,500 $ 3,600 $ 2,573 $304,304
Stockholders' equity (deficit)................ $ (290) $ 7,936 $ 3,291 $14,958 $403,429 $394,227
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------------------------------- -----------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996(4)(5) 1996 1997(6) 1997(4)(7)
---- ---- ---- ---------- ---------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures,
including business
acquisitions.......... $ 138 $ 2,052 $ 3,393 $ 14,697 $173,782 $175,346 $ 4,390 $ 42,876 $ 42,876
EBITDA(11)............. $(231) $(2,368) $(10,571) $ (8,723) $(17,345) $(10,426) $(3,107) $ (9,438) $ (9,438)
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- MARCH 31,
1994 1995 1996 1997
------ ------ ------ ---------
<S> <C> <C> <C> <C>
OTHER OPERATING DATA:
Local lines.................................... 17,112 35,795 65,367 77,228
Number of telecommunications customers......... 5,137 8,776 17,872 27,405
Cities and towns served........................ 25 77 102 138
Route miles.................................... 8 218 2,352 2,576
Employees...................................... 302 419 2,077 2,362
</TABLE>
- --------
(1) The acquisitions of MWR Telecom, Inc. ("MWR") (now part of McLeodUSA
Network Services, Inc. ("McLeodUSA Network Services")), Ruffalo, Cody and
McLeodUSA 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.
(2) Includes operations of MWR from April 29, 1995 to December 31, 1995.
(3) Includes operations of Ruffalo, Cody from July 16, 1996 to December 31,
1996 and operations of McLeodUSA Publishing from September 21, 1996 to
December 31, 1996.
(4) The acquisitions of Ruffalo, Cody and McLeodUSA Publishing in July 1996
and September 1996, respectively, and the issuance of the Senior Notes in
March 1997, affect the comparability of the pro forma data presented to
the data for prior periods shown.
(5) Includes operations of Ruffalo, Cody and McLeodUSA Publishing from January
1, 1996 to December 31, 1996 and certain adjustments attributable to the
acquisitions of Ruffalo, Cody and McLeodUSA Publishing by the Company.
Also reflects certain adjustments attributable to the issuance of the
Senior Notes computed as if the Senior Notes had been issued on January 1,
1996.
(6) Reflects the issuance of the Senior Notes on March 4, 1997.
(7) Reflects certain adjustments attributable to the issuance of the Senior
Notes computed as if the Senior Notes had been issued on January 1, 1997.
(8) For the purpose of calculating the ratio of earnings to fixed charges,
earnings consist of net loss before income taxes plus fixed charges
(excluding capitalized interest). Fixed charges consist of interest on all
debt (including capitalized interest), amortization of debt discount and
deferred loan costs and the portion of rental expense that is
representative of the interest component of rental expense (deemed to be
one-third of rental expense which management believes is a reasonable
approximation of the interest component). For each of the years ended
December 31, 1992, 1993, 1994, 1995 and 1996 earnings were insufficient to
cover fixed charges by $237,000, $2.4 million, $11.4 million, $11.4
million and $22.6 million, respectively. For the three months ended March
31, 1996 and 1997, earnings were insufficient to cover fixed charges by
$4.4 million and $13.6 million, respectively. On a pro forma basis
computed as if the acquisitions by the Company of Ruffalo, Cody and
McLeodUSA Publishing and the issuance of the Senior Notes were consummated
at the beginning of the periods presented, earnings would not have been
sufficient to cover fixed charges by $41.8 million and $18.1 million for
the year ended December 31, 1996 and the three months ended March 31,
1997, respectively.
(9) Includes MWR, which was acquired by the Company on April 28, 1995.
(10) Includes Ruffalo, Cody and McLeodUSA Publishing, which were acquired by
the Company on July 15, 1996 and September 20, 1996, respectively.
(11) EBITDA consists of operating loss before depreciation, amortization and
other nonrecurring operating expenses. 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.
12
<PAGE>
RISK FACTORS
In addition to the other information contained in this Prospectus, holders
of Senior Notes should consider carefully the following factors before
tendering their Senior Notes for Exchange Notes.
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 to 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 1994, 1995, 1996
and the three months ended March 31, 1997 were approximately $11.4 million,
$11.3 million, $22.3 million and $13.4 million, respectively. At March 31,
1997, the Company had an accumulated deficit of $61.2 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 activities during the next several
years, while it develops its businesses, constructs, installs and expands its
fiber optic network and develops and constructs a PCS system. 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 service the Notes or to meet its other 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 March 31, 1997, the Company
estimates that its aggregate capital requirements for the remainder of 1997,
1998 and 1999 will be approximately $413 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)
acquiring the PCS licenses awarded to the Company in the FCC's recent "D" and
"E" block frequency PCS license auction, (iv) developing, constructing and
operating a PCS system, and (v) constructing its new corporate headquarters
and associated buildings. These capital requirements are expected to be
funded, in large part, out of the net proceeds from the Offering
(approximately $289.8 million), the net proceeds remaining from the Company's
public offerings of Class A Common Stock in June and November 1996
(approximately $184.3 million as of March 31, 1997), 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 $413
million. In June 1997, the Company entered into an agreement to acquire CCI
pursuant to which the Company will be required to pay $155 million in cash
upon consummation of the transaction. See "Business--Recent Transactions."
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
13
<PAGE>
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 respective 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") acquired MFS Communications Company, Inc., a competitive access
provider, in December 1996. 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. 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. Three other small telecommunications
companies also hold such certificates in Iowa. On July 26, 1996, the Iowa
Utilities Board approved AT&T's application to offer local service in Iowa on
both a resale and facilities-based basis, subject to certain additional filing
requirements. During the past twelve months, AT&T has received certification
to provide local service in all of the Company's current and target markets.
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.
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
14
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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 August 1996, the FCC released the Interconnection Decision implementing the
interconnection portions of the Telecommunications Act. Certain provisions of
the Interconnection Decision have been appealed in proceedings currently
pending before the U.S. Eighth Circuit Court of Appeals. In October 1996, the
U.S. Eighth Circuit Court of Appeals temporarily stayed the effectiveness of
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,
pending a decision on the merits. 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 do so. The U.S. Eighth Circuit Court of Appeals heard oral arguments on the
merits of the challenges to the Interconnection Decision on January 17, 1997,
but has not yet ruled in the case. 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. See "Business--
Competition."
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. As of the
date hereof, U S WEST and Ameritech are 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.
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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.
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.
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 entered into 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
and affirmed by the Iowa District Court for Polk County on February 21, 1997.
In Minnesota, U S WEST's initial filing was rejected on procedural grounds
by the Public Utilities Commission. 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. On December 23, 1996, an
administrative law judge ruled that U S WEST must continue to offer Centrex
service in Minnesota. U S WEST filed exceptions to this ruling. The Minnesota
Public Utilities Commission denied U S WEST's exceptions on February 20, 1997.
U S WEST has filed a petition for rehearing with the Minnesota Public
Utilities Commission. As of the date hereof, the Minnesota Public Utilities
Commission had not yet ruled on the petition for rehearing.
In South Dakota, the Public Utilities Commission rejected the U S WEST
Centrex Action on August 22, 1996. U S WEST appealed the unfavorable decision
of the Public Utilities Commission in South Dakota state court. On December 2,
1996, the South Dakota state court hearing the appeal affirmed the decision of
the Public Utilities Commission.
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. U S WEST appealed the unfavorable
decision by the Public Service Commission in North Dakota state
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court. On January 24, 1997, the North Dakota state court hearing the appeal
affirmed the decision of the Public Service Commission.
In Nebraska, on November 25, 1996, the Public Service Commission rejected
complaints by the Company and other parties objecting to the U S WEST Centrex
Action. On February 3, 1997, the Company and other parties appealed the order
of the Public Service Commission to the Nebraska Court of Appeals. The appeal
remains pending.
In Idaho, on November 14, 1996, the Public Utilities Commission rejected
complaints by AT&T and MCI objecting to the U S WEST Centrex Action. On
January 31, 1997, the Company filed its own complaint with the Idaho Public
Utilities Commission. As of the date hereof, the Idaho Public Utilities
Commission has not yet ruled on the Company's complaint.
In Utah, 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 on September 26, 1996. Upon rehearing, however, the Utah Public Service
Commission issued an order on April 29, 1997 including restrictions on Centrex
resale. The Company is preparing to appeal such order.
The Company anticipates that U S WEST will continue to appeal unfavorable
decisions by public utilities commissions with respect to the U S WEST Centrex
Action.
In addition to the U S WEST Centrex Action, U S WEST has taken other
measures that may impede the Company's ability to use Centrex service to
provide its competitive local exchange services. In Colorado, U S WEST filed
new tariffs in July 1996 that, as interpreted by U S WEST, would prohibit the
Company from consolidating telephone lines of separate customers into leased
common blocks in U S WEST's central office switches, thereby significantly
increasing the cost of serving customers in Colorado through resale of Centrex
services. The Company filed a complaint with the Colorado Public Utilities
Commission on February 12, 1997, alleging that U S WEST's tariffs, as
interpreted by U S WEST, unlawfully create a barrier to the Company's ability
to compete in Colorado. The Company's complaint was suspended to allow the
Colorado Public Utilities Commission to rule on the same issues in a U S WEST
tariff proceeding, which ruling is expected in June 1997.
In January 1997, U S WEST proposed to implement certain interconnection
surcharges in each of the states in its service region. On February 20, 1997,
the Company and several other parties filed a petition with the FCC objecting
to U S WEST's proposal. The petition was based on Section 252(d) of the
Telecommunications Act, which governs the pricing of interconnection and
network elements. The Company believes that U S WEST's proposal is an unlawful
attempt to recover costs associated with the upgrading of U S WEST's network,
in violation of Section 252 of the Telecommunications Act. U S WEST filed an
opposition to the Company's petition with the FCC on March 3, 1997. The matter
remains pending before the FCC.
There can be no assurance that the Company will ultimately succeed in its
legal challenges to the U S WEST Centrex Action or other actions by U S WEST
that may have the effect of preventing or deterring the Company from using
Centrex service, or that these actions by U S WEST, or similar actions by
other Regional Bell Operating Companies, will not have a material adverse
effect on the Company. In any jurisdiction where U S WEST prevails, the
Company's ability to offer integrated telecommunications services would be
impaired, which could have a material adverse effect on the Company. See
"Business--Legal Proceedings."
The Company also anticipates that U S WEST will seek various legislative
initiatives in states within the Company's target market area in an effort to
reduce state regulatory oversight over its rates and operations. There can be
no assurance that U S WEST will not succeed in such efforts or that
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any such state legislative initiatives, if adopted, will not have a material
adverse effect on the Company.
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 had imposed a limit of processing one
new local service order of the Company per hour for each U S WEST central
office, creating a significant backlog of local service orders of the Company.
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. On October 21, 1996, in accordance with the Iowa Utilities Board's
order, the Company and U S WEST jointly filed supplemental evidence regarding
a potential modification of order processing practices that would increase U S
WEST's rate of processing service orders. However, since implementing the new
process, U S WEST has not significantly increased its overall order processing
rate. On December 23, 1996, the Company filed a report with the Iowa Utilities
Board requesting further direction. On February 14, 1997, the Iowa Utilities
Board clarified that U S WEST must eliminate all numerical limitations on the
Company's residential and business orders. There can be no assurance, however,
that the decision of or any further action by 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. See "Business--Legal
Proceedings."
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 these
services. 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. Absent such
verification, the Company does not bill its customers for the call. These call
detail omissions typically occur in connection with new customers of the
Company.
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 years ended December 31, 1995 and December 31, 1996, the Company
estimates that it was unable to bill approximately $126,000 and $92,000,
respectively, in long distance calls due to this situation.
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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 99.3% of the
requisite call detail records for February 1996 through March 1997. There can
be no assurance, however, that U S WEST will not continue to experience
difficulties in furnishing complete call detail 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.
SUBORDINATION OF NOTES; HOLDING COMPANY STRUCTURE
The Company is a holding company that derives all of its operating income
from its subsidiaries. The holders of the Exchange Notes will have no direct
claim against the subsidiaries for payment under the Exchange Notes. The
Company must rely on dividends and other payments from its subsidiaries or
must raise funds in a public or private equity or debt offering or sell assets
to generate the funds necessary to meet its obligations, including the payment
of principal and interest on the Exchange Notes. There can be no assurance
that the Company would be able to obtain such funds on acceptable terms or at
all. The Indenture contains covenants that restrict the ability of the
Company's subsidiaries to enter into any agreement limiting certain
distributions and transfers, including dividends to the Company.
The Exchange Notes are effectively subordinated in right of payment to all
existing and future indebtedness and liabilities of the Company's
subsidiaries. The total liabilities of the Company's subsidiaries (after the
elimination of loans and advances by the Company to its subsidiaries) as of
March 31, 1997 were $54.2 million, of which approximately $202,000 was
indebtedness secured by first priority liens on certain assets of the
borrowing subsidiaries. In addition, the Indenture will permit the Company and
its subsidiaries to incur additional indebtedness. Consequently, in the event
of a bankruptcy, liquidation, dissolution, reorganization or similar
proceeding with respect to the Company's subsidiaries, the holders of any
indebtedness of the Company's subsidiaries will be entitled to payment thereof
from the assets of such subsidiaries prior to the holders of any general
unsecured obligation of the Company, including the Exchange Notes.
The Exchange Notes also are unsecured and are effectively subordinated to
any secured indebtedness of the Company to the extent of the value of the
assets securing such indebtedness. As of March 31, 1997, the Company and its
subsidiaries had approximately $2.9 million of secured indebtedness. The
Indenture permits the Company and its subsidiaries to incur additional secured
indebtedness, including purchase money indebtedness in unlimited amounts, and
indebtedness of up to $250 million pursuant to one or more credit facilities.
Consequently, in the event of a bankruptcy, liquidation, dissolution,
reorganization or similar proceeding with respect to the Company, the holders
of any secured indebtedness will be entitled to proceed against the collateral
that secures such secured indebtedness and such collateral will not be
available for satisfaction of any amounts owed under the Exchange Notes. See
"Description of the Exchange Notes--Certain Covenants--Limitation on
Consolidated Indebtedness."
WIRELESS COMPETITION
The Company does not currently offer PCS or cellular services. On April 28,
1997, the FCC granted the Company 25 "D" and "E" block frequency PCS licenses
covering areas of Iowa, Illinois, Minnesota, Nebraska and South Dakota. See
"--Regulation" and "Business--Regulation."
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 wireline communications (similar to
cellular telephone services in use today),
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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 proposed PCS markets: two existing cellular providers, five other PCS
providers and Nextel Communications Inc., an enhanced specialized mobile radio
("ESMR") provider. Principal cellular providers in the Company's proposed PCS
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 proposed
PCS markets include AT&T Wireless PCS, Inc., PRIMECO Personal Communications,
L.P., WirelessCo, d/b/a Sprint PCS, American Portable Telecommunications,
Inc., d/b/a Aerial Communications, Inc., Western PCS Corp., Cox
Communications, Inc., DCR PCS, Inc., d/b/a Pocket Communication Corp.,
Wireless PCS, Inc., d/b/a Airadigm Communications, Inc., SprintCom, Inc., BRK
Wireless Co. Inc., Western PCS BTA I Corp., OPCSE-Galloway Consortium,
Northcoast Operating Co. Inc., Minnesota PCS Limited Partnership, Northeast
Nebraska Telephone Company, Triad Cellular Corp., Iowa L.P. 136, Redwood
Wireless Corp., Polycell Communications Inc., CM-PCS Partners, and U S WEST.
Competition with these or other providers of wireless telecommunications
services may be intense. Many of the Company's potential wireless competitors
have substantially greater financial, technical, marketing, sales,
manufacturing and distribution resources than those of the Company and have
significantly greater experience than the Company in testing new or improved
wireless telecommunications products and services. Some competitors are
expected to market other services, such as cable television access, with their
wireless telecommunications service offerings. The Company does not offer
cable television access. In addition, several of the Company's potential
wireless competitors are operating or planning to operate, through joint
ventures and affiliation arrangements, wireless telecommunications systems
that encompass most of the United States. There can be no assurance that the
Company will be able to compete successfully in this environment or that new
technologies and products that are more commercially effective than the
Company's technologies and products will not be developed. See "Business--
Wireless Services" and "Business--Competition."
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 and
substantial expenditures. There can be no assurance that the Company will
succeed in developing a PCS system or that, after expending substantial
amounts to develop such a system, the Company will achieve or sustain
profitability or positive cash flows from PCS operations. The ownership,
development, construction and operation of a PCS system could have a material
adverse effect on the Company.
In the absence of FCC mandated technology protocols, the Company will be
required to choose from among several competing and potentially incompatible
digital protocol technologies in order to build and operate a PCS system. The
selection of a particular digital protocol technology could adversely affect
the ability of the Company to successfully offer PCS service. See "Business--
Wireless Services."
The Company does not own or operate any facilities for providing wireless
telecommunication services to the public. The successful implementation of a
PCS system will require the Company to, among other things, lease or acquire
sites for base stations, construct the base stations, install the necessary
equipment and conduct system testing. The Company believes that the successful
implementation of a PCS system will also require that the Company enter into
"roaming" arrangements with PCS operators in other markets to enable future
subscribers to the Company's proposed PCS services to receive seamless call
transmission and reception throughout the United States. While the
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Company is currently exploring possible roaming arrangements, the Company
cannot predict when, or whether, it will be able to enter into any such
arrangement with other PCS operators. 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 encounters delays or other
problems, the Company's plans for providing PCS services could be adversely
affected.
The Company's success in the implementation and operation of a PCS system
also is subject to other factors beyond the Company's control. These factors
include, without limitation, (i) changes in general and local economic
conditions, (ii) availability of equipment necessary to operate the PCS
system, (iii) changes in communications service rates charged by others, (iv)
changes in the supply and demand for PCS and the commercial viability of PCS
systems as a result of competing with wireline and wireless operators in the
same geographic area, (v) demographic changes that might negatively affect the
potential market for PCS, (vi) changes in the federal and state regulatory
scheme affecting the operation of PCS systems (including the enactment of new
statutes and the promulgation of changes in the interpretation or enforcement
of existing or new rules and regulations) and (vii) changes in PCS or
competing wireless technologies that have the potential of rendering obsolete
the technology and equipment that the Company intends to use to construct its
PCS system. In addition, the extent of the potential demand for PCS cannot be
estimated with any degree of certainty and may be less than the Company
anticipates. See "--Rapid Technological Changes" and "Business--Wireless
Services." There can be no assurance that one or more of these factors will
not have a material adverse effect on the Company's ownership, development,
construction or operation of a PCS system.
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 directly owned or voted by non-U.S. citizens, by a
foreign government or by a foreign corporation to 20%, and limiting indirect
foreign ownership to 25%, absent waiver by the FCC. See "--Regulation."
Furthermore, certain of the FCC rules require all PCS licensees to meet
certain buildout and population coverage requirements. Failure to comply with
such requirements could result in the imposition of fines on the Company by
the FCC or cause revocation or forfeiture of the Company's PCS licenses, even
after the Company has expended substantial amounts to develop a PCS system.
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 deploying adequate systems,
procedures and controls in a timely manner) could have a material adverse
effect on the Company.
RELOCATION OF FIXED MICROWAVE LICENSEES
Following the grant of a PCS license, existing licensees that operate
certain fixed microwave systems within the PCS license area retain the right
to continue to operate their systems until 2005. To secure a sufficient amount
of unencumbered spectrum to operate a PCS system efficiently, the Company may
need to relocate many of these incumbent licensees. In an effort to balance
the competing interests of existing microwave users and newly authorized PCS
licensees, the FCC has adopted a transition plan to relocate such microwave
operators to other spectrum blocks. This transition plan allows most microwave
users to operate in the PCS spectrum for a one-year voluntary negotiation
period and an additional one-year mandatory negotiation period. For public
safety entities dedicating a majority of their system communications for
police, fire or emergency medical services operations, the voluntary
negotiation period is three years. Parties unable to reach agreement within
these time periods may refer the matter to the FCC for resolution, but the
incumbent microwave user is permitted to continue its operations until final
FCC resolution of the matter. There can be no
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assurance that the Company will be successful in reaching timely agreements
with the existing microwave licensees or that any such agreements will be on
terms favorable to the Company. Any delay in the relocation of such licensees
may adversely affect the Company's ability to commence timely commercial
operation of a PCS system. Furthermore, depending on the terms of such
agreements, if any, the Company's ability to operate a PCS system profitably
may be adversely affected. In connection with its proposed PCS system, the
Company estimates that it may be required to relocate approximately 50
microwave links operated by approximately 19 different microwave licensees.
See "Business--Regulation."
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. As of the date hereof, the Company does not 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 million, and on Mr. Gray, in the amount of
$1 million.
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. McLeodUSA Telecommunications Services, Inc., a wholly owned
subsidiary of the Company ("McLeodUSA Telecommunications"), is currently
required to file interstate and international tariffs with the FCC and
intrastate tariffs with the relevant state public utilities commissions
listing the rates, terms and conditions of certain services provided. In most
states, McLeodUSA Telecommunications also is required to obtain certification
from the relevant state public utilities commission prior to the initiation of
intrastate 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. McLeodUSA Telecommunications also has obtained
authority from the FCC to provide international services. The FCC's rules may,
under certain conditions, limit the size of investments in the Company by
foreign telecommunications carriers.
The licensing, construction, operation, sale and interconnection
arrangements of wireless telecommunications systems are regulated to varying
degrees by the FCC. On January 15, 1997, the FCC notified the Company that it
was the successful bidder for 26 "D" and "E" block frequency PCS licenses
covering areas of Iowa, Illinois, Minnesota, Nebraska and South Dakota. The
Company filed an application for such PCS licenses on January 30, 1997. On
April 28, 1997, the FCC granted 25 of these PCS licenses to the Company. The
Company's application for the remaining license, an "E" block frequency PCS
license covering Rochester, Minnesota, has been challenged by a third party
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based on alleged interference of the "E" block frequency with frequencies used
by such third party. Although the Company expects that the FCC will ultimately
issue the remaining PCS license to the Company, there can be no assurance that
the Company will succeed in obtaining such PCS license.
FCC licenses to provide PCS services are subject to renewal and revocation.
The PCS licenses that the Company has been awarded will expire in 2007. There
can be no assurance that such licenses will be renewed. PCS licenses may also
be revoked by the FCC in certain circumstances. Furthermore, the
Communications Act of 1934, as amended (the "Communications Act"), limits the
ownership by non-U.S. citizens, foreign governments, and corporations
organized under the laws of a foreign country of interests in companies
holding a common carrier radio license.
The Company, through its wholly owned subsidiary McLeodUSA Network Services,
provides certain competitive access services as a private carrier on a non-
regulated basis. The Company believes that McLeodUSA Network Services' 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 McLeodUSA Network Services' 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 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."
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."
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 $3.4 million, $4.9 million and $5.9 million in 1994, 1995
and 1996, respectively, or 42%, 17% and 7%, of the Company's total revenues in
1994, 1995 and 1996, respectively. Revenue from these contracts totaled $1.4
million and $1.5 million, respectively, or 11% and 4% of the Company's total
revenues during the three months ended March 31, 1996 and 1997, 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 Communications Network Maintenance Contract
or that the State of Iowa currently intends to do so. However, termination of
the
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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, relocate microwave licensees and obtain
rights-of-way, building access, antenna sites 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 assurance 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 employees. 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 acquired Ruffalo, Cody and
McLeodUSA Publishing, has agreed to acquire CCI 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. 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 McLeodUSA
Publishing or 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."
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 Holdings Company
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(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. The Company has entered into a similar long-term agreement with
Wisconsin Power and Light Company for access to rights-of-way, poles and
towers primarily located in Wisconsin. IES has entered into a definitive
agreement of merger with WPL Holdings, Inc., the parent of Wisconsin Power and
Light Company, and with Interstate Power Company, which merger is subject to
certain regulatory and other approvals. There can be no assurance that IES,
MidAmerican, Wisconsin Power and Light Company or the Company will be able to
maintain existing franchises, permits and rights-of-way or that the Company
will be able 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.
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
acquisition of PCS licenses and the development, construction and operation of
a PCS system, 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."
CONTROL OF THE COMPANY; CONFLICTS OF INTEREST
As of June 26, 1997, IES, MidAmerican, Allsop Venture Partners III, L.P.
("Allsop") and Clark and Mary McLeod owned, directly or indirectly, in the
aggregate approximately 57% of the outstanding Class A Common Stock and voting
power of the Company. Accordingly, such stockholders collectively are 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"). IES,
MidAmerican and Mr. and Mrs. McLeod also have entered into a voting agreement
with respect to the election of directors. 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
and Stockholders' Agreement" and "Principal Stockholders."
Certain decisions concerning the operations or financial structure of the
Company may present conflicts of interest between the Company's stockholders
and the holders of the Notes. For example, if the Company encounters financial
difficulties or is unable to pay its debts as they mature, the interests of
the Company's stockholders might conflict with those of the holders of the
Notes. In addition, the Company's stockholders may have an interest in
pursuing acquisitions, divestitures, financings or other
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transactions that, in their judgment, could enhance their equity investment,
even though such transactions might involve risk to the holders of the Notes.
Because certain significant stockholders of the Company are able to control
the management policy of the Company and all fundamental corporate actions,
any such conflict of interest may be resolved in favor of the Company's
stockholders to the detriment of the holders of the Notes.
INCREASED LEVERAGE; RESTRICTIVE COVENANTS
As of March 31, 1997, the Company's total amount of indebtedness outstanding
was $311.9 million and the Company had stockholder's equity of $394.2 million.
The level of the Company's indebtedness could adversely affect the Company in
a number of ways, including the following: (i) the ability of the Company to
obtain any necessary financing in the future for working capital, capital
expenditures, debt service requirements or other purposes may be limited; (ii)
the Company's level of indebtedness could limit its flexibility in planning
for, or reacting to, changes in its business; (iii) the Company may be more
highly leveraged than some of its competitors, which may place it at a
competitive disadvantage; and (iv) the Company's degree of indebtedness may
make it more vulnerable to a downturn in its business or in the economy
generally.
The Indenture imposes operating and financial restrictions on the Company
and its subsidiaries. These restrictions affect, and in certain cases
significantly limit or prohibit, among other things, the ability of the
Company and its subsidiaries to incur additional indebtedness, pay dividends
or make distributions in respect of the Company's or such subsidiaries'
capital stock, make other restricted payments, enter into sale and leaseback
transactions, create liens upon assets, enter into transactions with
affiliates or related persons, sell assets, or consolidate, merge or sell all
or substantially all of their assets. There can be no assurance that such
covenants will not adversely affect the Company's ability to finance its
future operations or capital needs or to engage in other business activities
that may be in the interest of the Company. See "Description of the Exchange
Notes."
ABSENCE OF PUBLIC MARKET
The Senior Notes have been designated for trading by qualified buyers in the
PORTAL Market. The Senior Notes have not been registered under the Securities
Act, however, and will continue to be subject to restrictions on
transferability to the extent that they are not exchanged for Exchange Notes.
Furthermore, the Exchange Offer will not be conditioned upon any minimum or
maximum aggregate principal amount of Senior Notes being tendered for
exchange. No assurance can be given as to the liquidity of the trading market
of the Senior Notes following the Exchange Offer.
Although the Exchange Notes will generally be permitted to be resold or
otherwise transferred by the holders thereof (other than any holder that is
(i) an "affiliate" of the Company within the meaning of Rule 405 under the
Securities Act, (ii) a broker-dealer that acquired Senior Notes as a result of
market-making activities or other trading activities, or (iii) a broker-dealer
that acquired Senior Notes directly from the Company for resale pursuant to
Rule 144A or another available exemption under the Securities Act) without
compliance with the registration requirements under the Securities Act, they
will constitute a new issue of securities for which there is currently no
established trading market. If the Exchange Notes are traded after their
initial issuance, they may trade at a discount, depending upon prevailing
interest rates, the market for similar securities, the financial condition of
the Company and other factors beyond the control of the Company, including
general economic conditions. The Company does not intend to apply for a
listing or quotation of the Exchange Notes. The Initial Purchasers have
informed the Company that they currently intend to make a market in the
Exchange Notes. However, the Initial Purchasers are not obligated to do so,
and any such market making may be discontinued at any time without notice. No
assurance can be given as to the development or liquidity of any trading
market for the Exchange Notes.
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Notwithstanding the registration of the Exchange Notes in the Exchange
Offer, holders who are "affiliates" of the Company (within the meaning of Rule
405 under the Securities Act) may publicly offer for sale or resell the
Exchange Notes only in compliance with the provisions of Rule 144 under the
Securities Act or any other available exemptions under the Securities Act.
Each broker-dealer that receives Exchange Notes for its own account in
exchange for Senior Notes, where such Senior Notes were acquired by such
broker-dealer as a result of market-making activities or other trading
activities, must acknowledge that it will deliver a prospectus in connection
with any resale of such Exchange Notes. See "Plan of Distribution."
ORIGINAL ISSUE DISCOUNT; POSSIBLE UNFAVORABLE TAX AND OTHER LEGAL CONSEQUENCES
FOR HOLDERS OF NOTES AND THE COMPANY
The Senior Notes were issued at a substantial discount from the stated
principal amount at maturity. Consequently, potential participants in the
Exchange Offer should be aware that, although interest will not accrue on the
Exchange Notes prior to March 1, 2002, and there will be no periodic payments
of cash interest on the Exchange Notes prior to September 1, 2002, original
issue discount (that is, the difference between the stated redemption price at
maturity and the issue price of the Senior Notes) will accrue from March 4,
1997 and will be includible as interest income periodically (including for
periods ending prior to March 1, 2002) in a holder's gross income for U.S.
federal income tax purposes in advance of receipt of the cash payments to
which the income is attributable. Similar results may apply under state and
other tax laws.
If a bankruptcy case is commenced by or against the Company under U.S.
bankruptcy laws, the claim of a holder of Exchange Notes with respect to the
principal amount thereof may be limited to an amount equal to the sum of (i)
the initial offering price of the Senior Notes and (ii) that portion of the
original issue discount that is not deemed to constitute "unmatured interest"
for purposes of the U.S. bankruptcy laws. Any original issue discount that was
not amortized as of any such bankruptcy filing would constitute "unmatured
interest."
See "Certain United States Federal Income Tax Consequences" for a more
detailed discussion of the federal income tax consequences to the holders of
the Notes regarding the purchase, ownership and disposition of the Notes.
CONSEQUENCES OF A FAILURE TO EXCHANGE SENIOR NOTES
The Senior Notes have not been registered under the Securities Act or any
state securities laws and therefore may not be offered, sold or otherwise
transferred except in compliance with the registration requirements of the
Securities Act and any other applicable securities laws, or pursuant to an
exemption therefrom or in a transaction not subject thereto, and in each case
in compliance with certain other conditions and restrictions. Senior Notes
which remain outstanding after consummation of the Exchange Offer will
continue to bear a legend reflecting such restrictions on transfer. In
addition, upon consummation of the Exchange Offer, holders of Senior Notes
which remain outstanding will not be entitled to any rights to have such
Senior Notes registered under the Securities Act, except under certain limited
circumstances. The Company does not intend to register under the Securities
Act any Senior Notes which remain outstanding after consummation of the
Exchange Offer. See "The Exchange Offer."
To the extent that Senior Notes are tendered and accepted in the Exchange
Offer, the principal amount at maturity of outstanding Senior Notes will
decrease, which will result in a decrease in the
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<PAGE>
liquidity of the Senior Notes. Any trading market for Senior Notes which
remain outstanding after the Exchange Offer could be adversely affected.
EXCHANGE OFFER PROCEDURES
Issuance of the Exchange Notes in exchange for Senior Notes pursuant to the
Exchange Offer will be made only after a timely receipt by the Exchange Agent
of (i) such Senior Notes or a book-entry confirmation of a book-entry transfer
of the Senior Notes into the Exchange Agent's account at DTC Trust Company
("DTC"), (ii) the Letter of Transmittal (or a facsimile thereof), properly
completed and duly executed, with any required signature guarantees, and (iii)
any other documents required by the Letter of Transmittal. Holders of the
Senior Notes desiring to tender such Senior Notes in exchange for Exchange
Notes should allow sufficient time to ensure timely delivery. The Company and
the Exchange Agent are under no duty to give notification of defects or
irregularities with respect to the tenders of Senior Notes for exchange. See
"The Exchange Offer."
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THE EXCHANGE OFFER
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
In connection with the sale of the Senior Notes, the Company entered into
the Registration Agreement with the Initial Purchasers, pursuant to which the
Company agreed to file and to use its best efforts to cause to become
effective with the Commission a registration statement with respect to the
exchange of the Senior Notes for Exchange Notes with terms identical in all
material respects to the terms of the Senior Notes. A copy of the Registration
Agreement has been filed as an exhibit to the Registration Statement of which
this Prospectus is a part (the "Registration Statement"). The Exchange Offer
is being made to satisfy the contractual obligations of the Company under the
Registration Agreement.
By tendering Senior Notes in exchange for Exchange Notes, each holder will
represent to the Company that: (i) any Exchange Notes to be received by such
holder are being acquired in the ordinary course of such holder's business;
(ii) such holder has no arrangement or understanding with any person to
participate in a distribution (within the meaning of the Securities Act) of
Exchange Notes; (iii) such holder is not an "affiliate" of the Company (within
the meaning of Rule 405 under the Securities Act), or if such holder is an
affiliate, that such holder will comply with the registration and prospectus
delivery requirements of the Securities Act to the extent applicable; (iv)
such holder has full power and authority to tender, exchange, sell, assign and
transfer the tendered Senior Notes, (v) the Company will acquire good,
marketable and unencumbered title to the tendered Senior Notes, free and clear
of all liens, restrictions, charges and encumbrances; and (vi) the Senior
Notes tendered for exchange are not subject to any adverse claims or proxies.
Each tendering holder also will warrant and agree that such holder will, upon
request, execute and deliver any additional documents deemed by the Company or
the Exchange Agent to be necessary or desirable to complete the exchange,
sale, assignment, and transfer of the Senior Notes tendered pursuant to the
Exchange Offer. Each broker-dealer that receives Exchange Notes for its own
account in exchange for Senior Notes, where such Senior Notes were acquired by
such broker-dealer as a result of market-making activities or other trading
activities, must acknowledge that it will deliver a prospectus in connection
with any resale of such Exchange Notes. See "Plan of Distribution."
The Exchange Offer is not being made to, nor will the Company accept tenders
for exchange from, holders of Senior Notes in any jurisdiction in which the
Exchange Offer or the acceptance thereof would not be in compliance with the
securities or blue sky laws of such jurisdiction.
Unless the context requires otherwise, the term "holder" with respect to the
Exchange Offer means any person in whose name the Senior Notes are registered
on the books of the Company or any other person who has obtained a properly
completed bond power from the registered holder, or any participant in DTC
whose name appears on a security position listing as a holder of Senior Notes
(which, for purposes of the Exchange Offer, include beneficial interests in
the Senior Notes held by direct or indirect participants in DTC and Senior
Notes held in definitive form).
TERMS OF THE EXCHANGE OFFER
The Company hereby offers, upon the terms and subject to the conditions set
forth in this Prospectus and in the accompanying Letter of Transmittal, to
exchange $1,000 principal amount at maturity of Exchange Notes for each $1,000
principal amount at maturity of Senior Notes properly tendered prior to the
Expiration Date and not properly withdrawn in accordance with the procedures
described below. Holders may tender their Senior Notes in whole or in part in
integral multiples of $1,000 principal amount at maturity.
The form and terms of the Exchange Notes are the same as the form and terms
of the Senior Notes except that (i) the Exchange Notes will have been
registered under the Securities Act and therefore will not be subject to
certain restrictions on transfer applicable to the Senior Notes and
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<PAGE>
(ii) holders of the Exchange Notes will not be entitled to certain rights of
holders of the Senior Notes under the Registration Agreement. The Exchange
Notes evidence the same indebtedness as the Senior Notes (which they replace)
and will be issued pursuant to, and entitled to the benefits of, the
Indenture.
The Exchange Offer is not conditioned upon any minimum aggregate principal
amount of Senior Notes being tendered for exchange. The Company reserves the
right in its sole discretion to purchase or make offers for any Senior Notes
that remain outstanding after the Expiration Date or, as set forth under "--
Conditions to the Exchange Offer," to terminate the Exchange Offer and, to the
extent permitted by applicable law, purchase Senior Notes in the open market,
in privately negotiated transactions or otherwise. The terms of any such
purchases or offers could differ from the terms of the Exchange Offer. As of
the date of this Prospectus, $500 million aggregate principal amount at
maturity of Senior Notes is outstanding.
Holders of Senior Notes do not have any appraisal or dissenters' rights in
connection with the Exchange Offer. Senior Notes which are not tendered for,
or are tendered but not accepted in connection with, the Exchange Offer will
remain outstanding. See "Risk Factors--Consequences of a Failure to Exchange
Senior Notes."
If any tendered Senior Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, certificates for any such unaccepted Senior Notes will be returned,
without expense, to the tendering holder thereof promptly after the Expiration
Date.
Holders who tender Senior Notes in connection with the Exchange Offer will
not be required to pay brokerage commissions or fees or, subject to the
instructions in the Letter of Transmittal, transfer taxes with respect to the
exchange of Senior Notes in connection with the Exchange Offer. The Company
will pay all charges and expenses, other than certain applicable taxes
described below, in connection with the Exchange Offer. See "--Fees and
Expenses."
THE BOARD OF DIRECTORS OF THE COMPANY MAKES NO RECOMMENDATION TO HOLDERS OF
SENIOR NOTES AS TO WHETHER TO TENDER OR REFRAIN FROM TENDERING ALL OR ANY
PORTION OF THEIR SENIOR NOTES PURSUANT TO THE EXCHANGE OFFER. IN ADDITION, NO
ONE HAS BEEN AUTHORIZED TO MAKE ANY SUCH RECOMMENDATION. HOLDERS OF SENIOR
NOTES MUST MAKE THEIR OWN DECISION WHETHER TO TENDER PURSUANT TO THE EXCHANGE
OFFER AND, IF SO, THE AGGREGATE AMOUNT OF SENIOR NOTES TO TENDER AFTER READING
THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL AND CONSULTING WITH THEIR
ADVISERS, IF ANY, BASED ON THEIR FINANCIAL POSITION AND REQUIREMENTS.
EXPIRATION DATE; EXTENSIONS, AMENDMENTS
The term "Expiration Date" means 5:00 p.m., New York City time, on ,
1997 unless the Exchange Offer is extended by the Company (in which case the
term "Expiration Date" shall mean the latest date and time to which the
Exchange Offer is extended).
The Company expressly reserves the right in its sole and absolute
discretion, subject to applicable law, at any time and from time to time, (i)
to delay the acceptance of the Senior Notes for exchange, (ii) to terminate
the Exchange Offer (whether or not any Senior Notes have theretofore been
accepted for exchange) if the Company determines, in its sole and absolute
discretion, that any of the events or conditions referred to under "--
Conditions to the Exchange Offer" has occurred or exists or has not been
satisfied, (iii) to extend the Expiration Date of the Exchange Offer and
retain all Senior Notes tendered pursuant to the Exchange Offer, subject,
however, to the right of holders of Senior Notes to withdraw their tendered
Senior Notes as described under "--Withdrawal Rights," and (iv) to waive any
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<PAGE>
condition or otherwise amend the terms of the Exchange Offer in any respect.
If the Exchange Offer is amended in a manner determined by the Company to
constitute a material change, or if the Company waives a material condition of
the Exchange Offer, the Company will promptly disclose such amendment by means
of a prospectus supplement that will be distributed to the registered holders
of the Senior Notes, and the Company will extend the Exchange Offer to the
extent required by Rule 14e-1 under the Exchange Act.
Any such delay in acceptance, termination, extension or amendment will be
followed promptly by oral or written notice thereof to the Exchange Agent (any
such oral notice to be promptly confirmed in writing) and by making a public
announcement thereof, and such announcement in the case of an extension will
be made no later than 9:00 a.m., New York City time, on the next business day
after the previously scheduled Expiration Date. Without limiting the manner in
which the Company may choose to make any public announcement, and subject to
applicable laws, the Company shall have no obligation to publish, advertise or
otherwise communicate any such public announcement other than by issuing a
release to an appropriate news agency.
ACCEPTANCE FOR EXCHANGE AND ISSUANCE OF EXCHANGE NOTES
Upon the terms and subject to the conditions of the Exchange Offer, the
Company will exchange, and will issue to the Exchange Agent, Exchange Notes
for Senior Notes validly tendered and not withdrawn (pursuant to the
withdrawal rights described under "--Withdrawal Rights") promptly after the
Expiration Date.
In all cases, delivery of Exchange Notes in exchange for Senior Notes
tendered and accepted for exchange pursuant to the Exchange Offer will be made
only after timely receipt by the Exchange Agent of (i) Senior Notes or a book-
entry confirmation of a book-entry transfer of Senior Notes into the Exchange
Agent's account at DTC, (ii) the Letter of Transmittal (or facsimile thereof),
properly completed and duly executed, with any required signature guarantees,
and (iii) any other documents required by the Letter of Transmittal.
Accordingly, the delivery of Exchange Notes might not be made to all tendering
holders at the same time, and will depend upon when Senior Notes, book-entry
confirmations with respect to Senior Notes and other required documents are
received by the Exchange Agent.
The term "book-entry confirmation" means a timely confirmation of a book-
entry transfer of Senior Notes into the Exchange Agent's account at DTC.
Subject to the terms and conditions of the Exchange Offer, the Company will
be deemed to have accepted for exchange, and thereby exchanged, Senior Notes
validly tendered and not withdrawn as, if and when the Company gives oral or
written notice to the Exchange Agent (any such oral notice to be promptly
confirmed in writing) of the Company's acceptance of such Senior Notes for
exchange pursuant to the Exchange Offer. The Company's acceptance for exchange
of Senior Notes tendered pursuant to any of the procedures described above
will constitute a binding agreement between the tendering holder and the
Company upon the terms and subject to the conditions of the Exchange Offer.
The Exchange Agent will act as agent for the Company for the purpose of
receiving tenders of Senior Notes, Letters of Transmittal and related
documents, and as agent for tendering holders for the purpose of receiving
Senior Notes, Letters of Transmittal and related documents and transmitting
Exchange Notes to holders who validly tendered Senior Notes. Such exchange
will be made promptly after the Expiration Date. If for any reason whatsoever
the acceptance for exchange or the exchange of any Senior Notes tendered
pursuant to the Exchange Offer is delayed (whether before or after the
Company's acceptance for exchange of Senior Notes), or the Company extends the
Exchange Offer or is unable to accept for exchange or exchange Senior Notes
tendered pursuant to the Exchange Offer, then, without prejudice to the
Company's rights set forth herein, the Exchange Agent may, nevertheless, on
behalf of the Company and subject to Rule 14e-1(c) under the Exchange Act,
retain
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<PAGE>
tendered Senior Notes and such Senior Notes may not be withdrawn except to the
extent tendering holders are entitled to withdrawal rights as described under
"--Withdrawal Rights."
PROCEDURES FOR TENDERING SENIOR NOTES
VALID TENDER. Except as set forth below, in order for Senior Notes to be
validly tendered pursuant to the Exchange Offer, either (i) (a) a properly
completed and duly executed Letter of Transmittal (or facsimile thereof), with
any required signature guarantees and any other required documents, must be
received by the Exchange Agent at the address set forth under "--Exchange
Agent" prior to the Expiration Date and (b) tendered Senior Notes must be
received by the Exchange Agent, or such Senior Notes must be tendered pursuant
to the procedures for book-entry transfer set forth below and a book-entry
confirmation must be received by the Exchange Agent, in each case prior to the
Expiration Date, or (ii) the guaranteed delivery procedures set forth below
must be complied with.
If less than all of the Senior Notes are tendered, a tendering holder should
fill in the amount of Senior Notes being tendered in the appropriate box on
the Letter of Transmittal. The entire amount of Senior Notes delivered to the
Exchange Agent will be deemed to have been tendered unless otherwise
indicated.
If any Letter of Transmittal, endorsement, bond power, power of attorney, or
any other document required by the Letter of Transmittal is signed by a
trustee, executor, administrator, guardian, attorney-in-fact, officer of a
corporation or other person acting in a fiduciary or representative capacity,
such person should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company, in its sole discretion, of such person's
authority to so act must be submitted.
Any beneficial owner of Senior Notes that are held by or registered in the
name of a broker, dealer, commercial bank, trust company or other nominee or
custodian is urged to contact such entity promptly if such beneficial holder
wishes to participate in the Exchange Offer.
THE METHOD OF DELIVERY OF SENIOR NOTES, THE LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS IS AT THE OPTION AND SOLE RISK OF THE TENDERING
HOLDER, AND DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE
EXCHANGE AGENT. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS
USE AN OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME
SHOULD BE ALLOWED TO ASSURE TIMELY DELIVERY AND PROPER INSURANCE SHOULD BE
OBTAINED. NO LETTER OF TRANSMITTAL OR SENIOR NOTES SHOULD BE SENT TO THE
COMPANY. HOLDERS MAY REQUEST THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL
BANKS, TRUST COMPANIES OR NOMINEES TO EFFECT THESE TRANSACTIONS FOR SUCH
HOLDERS.
BOOK-ENTRY TRANSFER. The Exchange Agent will make a request to establish an
account with respect to the Senior Notes at DTC for purposes of the Exchange
Offer within two business days after the date of this Prospectus. Any
financial institution that is a participant in DTC's book-entry transfer
facility system may make a book-entry delivery of the Senior Notes by causing
DTC to transfer such Senior Notes into the Exchange Agent's account at DTC in
accordance with DTC's procedures for transfers. However, although delivery of
Senior Notes may be effected through book-entry transfer into the Exchange
Agent's account at DTC, the Letter of Transmittal (or facsimile thereof),
properly completed and duly executed, with any required signature guarantees
and any other required documents, must in any case be delivered to and
received by the Exchange Agent at its address set forth under "--Exchange
Agent" prior to the Expiration Date, or the guaranteed delivery procedure set
forth below must be complied with.
32
<PAGE>
DELIVERY OF DOCUMENTS TO DTC DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE
AGENT.
SIGNATURE GUARANTEES. Certificates for Senior Notes need not be endorsed and
signature guarantees on a Letter of Transmittal or a notice of withdrawal, as
the case may be, are unnecessary unless (a) a certificate for Senior Notes is
registered in a name other than that of the person surrendering the
certificate or (b) a registered holder completes the box entitled "Special
Issuance Instructions" or "Special Delivery Instructions" in the Letter of
Transmittal. In the case of (a) or (b) above, such certificates for Senior
Notes must be duly endorsed or accompanied by a properly executed bond power,
with the endorsement or signature on the bond power and on the Letter of
Transmittal or the notice of withdrawal, as the case may be, guaranteed by a
firm or other entity identified in Rule 17Ad-15 under the Exchange Act as an
"eligible guarantor institution," including (as such terms are defined
therein) (i) a bank, (ii) a broker, dealer, municipal securities broker or
dealer or government securities broker or dealer, (iii) a credit union, (iv) a
national securities exchange, registered securities association or clearing
agency, or (v) a savings association that is a participant in a Securities
Transfer Association (each an "Eligible Institution"), unless surrendered on
behalf of such Eligible Institution. See Instruction 1 to the Letter of
Transmittal.
GUARANTEED DELIVERY. If a holder desires to tender Senior Notes pursuant to
the Exchange Offer and the certificates for such Senior Notes are not
immediately available or time will not permit all required documents to reach
the Exchange Agent before the Expiration Date, or the procedures for book-
entry transfer cannot be completed on a timely basis, such Senior Notes may
nevertheless be tendered, provided that all of the following guaranteed
delivery procedures are complied with:
(i) such tenders are made by or through an Eligible Institution;
(ii) prior to the Expiration Date, the Exchange Agent receives from such
Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery, substantially in the form accompanying the Letter of
Transmittal, setting forth the name and address of the holder of Senior
Notes and the amount of Senior Notes tendered, stating that the tender is
being made thereby and guaranteeing that within three New York Stock
Exchange trading days after the date of execution of the Notice of
Guaranteed Delivery, the certificates for all physically tendered Senior
Notes, in proper form for transfer, or a book-entry confirmation, as the
case may be, and any other documents required by the Letter of Transmittal
will be deposited by the Eligible Institution with the Exchange Agent. The
Notice of Guaranteed Delivery may be delivered by hand, or transmitted by
facsimile or mail to the Exchange Agent and must include a guarantee by an
Eligible Institution in the form set forth in the Notice of Guaranteed
Delivery; and
(iii) the certificates (or book-entry confirmation) representing all
tendered Senior Notes, in proper form for transfer, together with a
properly completed and duly executed Letter of Transmittal, with any
required signature guarantees and any other documents required by the
Letter of Transmittal, are received by the Exchange Agent within three New
York Stock Exchange trading days after the date of execution of the Notice
of Guaranteed Delivery.
DETERMINATION OF VALIDITY. All questions as to the form of documents,
validity, eligibility (including time of receipt) and acceptance for exchange
of any tendered Senior Notes will be determined by the Company, in its sole
discretion, which determination shall be final and binding on all parties. The
Company reserves the absolute right, in its sole and absolute discretion, to
reject any and all tenders determined by it not to be in proper form or the
acceptance for exchange of which may, in the view of counsel to the Company,
be unlawful. The Company also reserves the absolute right, subject to
applicable law, to waive any of the conditions of the Exchange Offer as set
forth under "--Conditions to the Exchange Offer" or any defect or irregularity
in any tender of Senior Notes of any particular holder whether or not similar
defects or irregularities are waived in the case of other holders.
33
<PAGE>
The Company's interpretation of the terms and conditions of the Exchange
Offer (including the Letter of Transmittal and the instructions thereto) will
be final and binding on all parties. No tender of Senior Notes will be deemed
to have been validly made until all defects or irregularities with respect to
such tender have been cured or waived. Neither the Company, any affiliates of
the Company, the Exchange Agent or any other person shall be under any duty to
give any notification of any defects or irregularities in tenders or incur any
liability for failure to give any such notification.
RESALES OF EXCHANGE NOTES
Based on interpretations by the staff of the Commission, as set forth in no-
action letters issued to third parties unrelated to the Company, the Company
believes that holders of Senior Notes (other than any holder that is (i) a
broker-dealer that acquired Senior Notes as a result of market-making
activities or other trading activities, or (ii) a broker-dealer that acquired
Senior Notes directly from the Company for resale pursuant to Rule 144A or
another available exemption under the Securities Act) who exchange their
Senior Notes for Exchange Notes pursuant to the Exchange Offer may offer for
resale, resell and otherwise transfer such Exchange Notes without compliance
with the registration and prospectus delivery provisions of the Securities
Act, provided that such Exchange Notes are acquired in the ordinary course of
such holders' business, such holders have no arrangement or understanding with
any person to participate in the distribution of such Exchange Notes and such
holders are not "affiliates" of the Company (within the meaning of Rule 405 of
the Securities Act). However, the staff of the Commission has not considered
the Exchange Offer in the context of a no-action letter, and there can be no
assurance that the staff of the Commission would make a similar determination
with respect to the Exchange Offer. Each broker-dealer that receives Exchange
Notes for its own account in exchange for Senior Notes, where such Senior
Notes were acquired by such broker-dealer as a result of market-making
activities or other trading activities, must acknowledge that it will deliver
a prospectus in connection with any resale of such Exchange Notes. See "Plan
of Distribution."
WITHDRAWAL RIGHTS
Except as otherwise provided herein, tenders of Senior Notes may be
withdrawn at any time prior to the Expiration Date.
In order for a withdrawal to be effective, a written, telegraphic or
facsimile transmission of such notice of withdrawal must be timely received by
the Exchange Agent at its address set forth under "--Exchange Agent" prior to
the Expiration Date. Any such notice of withdrawal must specify the name of
the person who tendered the Senior Notes to be withdrawn, the aggregate
principal amount of Senior Notes to be withdrawn, and (if certificates for
such Senior Notes have been tendered) the name of the registered holder of the
Senior Notes as set forth on the Senior Notes, if different from that of the
person who tendered such Senior Notes. If certificates for Senior Notes have
been delivered or otherwise identified to the Exchange Agent, the notice of
withdrawal must specify the serial numbers on the particular certificates for
the Senior Notes to be withdrawn and the signature on the notice of withdrawal
must be guaranteed by an Eligible Institution, except in the case of Senior
Notes tendered for the account of an Eligible Institution. If Senior Notes
have been tendered pursuant to the procedures for book-entry transfer set
forth in "--Procedures for Tendering Senior Notes," the notice of withdrawal
must specify the name and number of the account at DTC to be credited with the
withdrawal of Senior Notes and must otherwise comply with the procedures of
DTC. Withdrawals of tenders of Senior Notes may not be rescinded. Senior Notes
properly withdrawn will not be deemed validly tendered for purposes of the
Exchange Offer, but may be retendered at any subsequent time prior to the
Expiration Date by following any of the procedures described above under "--
Procedures for Tendering Senior Notes."
All questions as to the validity, form and eligibility (including time of
receipt) of such withdrawal notices will be determined by the Company, in its
sole discretion, which determination shall be final and binding on all
parties. Neither the Company, any affiliates of the Company, the Exchange
Agent
34
<PAGE>
or any other person shall be under any duty to give any notification of any
defects or irregularities in any notice of withdrawal or incur any liability
for failure to give any such notification. Any Senior Notes which have been
tendered but which are withdrawn will be returned to the holder thereof
promptly after withdrawal.
INTEREST ON THE EXCHANGE NOTES
The Senior Notes and the Exchange Notes will accrete from March 4, 1997 at a
rate of 10 1/2% per annum, compounded semi-annually, to an aggregate principal
amount of $500 million by March 1, 2002. Interest will not accrue on the
Exchange Notes prior to March 1, 2002. Thereafter, interest on the Exchange
Notes will accrue at the rate of 10 1/2% per annum and will be payable in cash
semi-annually on March 1 and September 1, commencing September 1, 2002.
CONDITIONS TO THE EXCHANGE OFFER
Notwithstanding any other provisions of the Exchange Offer or any extension
of the Exchange Offer, the Company will not be required to accept for
exchange, or to exchange, any Senior Notes for any Exchange Notes and will not
be required to issue Exchange Notes in exchange for any Senior Notes, and as
described below may, at any time and from time to time, terminate or amend the
Exchange Offer (whether or not any Senior Notes have theretofore been accepted
for exchange) or may waive any conditions to or amend the Exchange Offer, if
any of the following conditions have occurred or exists or have not been
satisfied prior to the Expiration Date:
(a) there shall occur a change in the current interpretation by the staff
of the Commission which permits the Exchange Notes issued pursuant to the
Exchange Offer in exchange for Senior Notes to be offered for resale,
resold and otherwise transferred by holders thereof (other than (i) broker-
dealers that acquired Senior Notes as a result of market-making activities
or other trading activities or (ii) broker-dealers that acquired Senior
Notes directlly from the Company for resale pursuant to Rule 144A or
another available exemption under the Securities Act) without compliance
with the registration and prospectus delivery provisions of the Securities
Act, provided that such Exchange Notes are acquired in the ordinary course
of such holders' business, such holders have no arrangement or
understanding with any person to participate in the distribution of such
Exchange Notes and such holders are not "affiliates" of the Company (within
the meaning of Rule 405 under the Securities Act);
(b) any action or proceeding shall have been instituted or threatened in
any court or by or before any governmental agency or body with respect to
the Exchange Offer which, in the Company's judgment, would reasonably be
expected to impair the ability of the Company to proceed with the Exchange
Offer;
(c) any law, statute, rule or regulation shall have been adopted or
enacted which, in the Company's judgment, would reasonably be expected to
impair the ability of the Company to proceed with the Exchange Offer;
(d) a stop order shall have been issued by the Commission or any state
securities authority suspending the effectiveness of the Registration
Statement, or proceedings shall have been initiated or, to the knowledge of
the Company, threatened for that purpose;
(e) any governmental approval has not been obtained, which approval the
Company shall, in its sole discretion, deem necessary for the consummation
of the Exchange Offer as contemplated hereby; or
(f) any change, or any development involving a prospective change, in the
business or financial affairs of the Company has occurred which, in the
sole judgment of the Company, might materially impair the ability of the
Company to proceed with the Exchange Offer.
If the Company determines in its sole and absolute discretion that any of
the foregoing events or conditions has occurred or exists or has not been
satisfied at any time prior to the Expiration Date, the Company may, subject
to applicable law, terminate the Exchange Offer (whether or not any Senior
Notes have theretofore been accepted for exchange) or may waive any such
condition or otherwise amend the terms of the Exchange Offer in any respect.
If such waiver or amendment constitutes a
35
<PAGE>
material change to the Exchange Offer, the Company will promptly disclose such
waiver by means of a prospectus supplement that will be distributed to the
registered holders of the Senior Notes, and the Company will extend the
Exchange Offer to the extent required by Rule 14e-1 under the Exchange Act.
EXCHANGE AGENT
United States Trust Company of New York has been appointed as Exchange Agent
for the Exchange Offer. Delivery of the Letters of Transmittal and any other
required documents, questions, requests for assistance, and requests for
additional copies of this Prospectus or of the Letter of Transmittal should be
directed to the Exchange Agent as follows:
By Mail
United States Trust Company of New York
P.O. Box 843
Cooper Station
New York, New York 10276
Attention: Corporate Trust Services
By Hand before 4:30 p.m.
United States Trust Company of New York
111 Broadway
New York, New York 10006
Attention: Lower Level Corporate Trust Window
By Overnight Courier and By Hand after 4:30 p.m.
United States Trust Company of New York
770 Broadway, 13th Floor
New York, New York 10003
By Facsimile
(212) 420-6152
Attention: Customer Service
Confirm by telephone: (800) 548-6565
DELIVERY TO OTHER THAN THE ABOVE ADDRESSES OR FACSIMILE NUMBER WILL NOT
CONSTITUTE A VALID DELIVERY.
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail. Additional solicitation may be
made personally or by telephone or other means by officers, directors or
employees of the Company.
The Company has not retained any dealer-manager or similar agent in
connection with the Exchange Offer and will not make any payments to brokers,
dealers or others soliciting acceptances of the Exchange Offer. The Company
has agreed to pay the Exchange Agent reasonable and customary fees for its
services and will reimburse it for its reasonable out-of-pocket expenses in
connection therewith. The Company will also pay brokerage houses and other
custodians, nominees and fiduciaries the reasonable out-of-pocket expenses
incurred by them in forwarding copies of this Prospectus and related documents
to the beneficial owners of Senior Notes, and in handling or tendering for
their customers.
Holders who tender their Senior Notes for exchange will not be obligated to
pay any transfer taxes in connection therewith, except that if Exchange Notes
are to be delivered to, or are to be issued in the name of, any person other
than the registered holder of the Senior Notes tendered, or if a transfer tax
is imposed for any reason other than the exchange of Senior Notes in
connection with the Exchange Offer, then the amount of any such transfer tax
(whether imposed on the registered holder or any other persons) will be
payable by the tendering holder. If satisfactory evidence of payment of such
transfer tax or exemption therefrom is not submitted with the Letter of
Transmittal, the amount of such transfer tax will be billed directly to such
tendering holder.
36
<PAGE>
USE OF PROCEEDS
The Exchange Offer is intended to satisfy certain obligations of the Company
under the Registration Agreement. The Company will not receive any proceeds
from the issuance of the Exchange Notes offered hereby. In consideration for
issuing the Exchange Notes as contemplated in this Prospectus, the Company will
receive, in exchange, an equal number of Senior Notes in like principal amount.
The form and terms of the Exchange Notes are identical in all material respects
to the form and terms of the Senior Notes, except as otherwise described herein
under "The Exchange Offer--Terms of the Exchange Offer." The Senior Notes
surrendered in exchange for Exchange Notes will be retired and cancelled and
cannot be reissued.
37
<PAGE>
CAPITALIZATION
The following table sets forth, as of March 31, 1997, the actual
capitalization of the Company, which reflects the application of the net
proceeds to the Company from the Offering. 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>
MARCH 31, 1997
--------------
(IN THOUSANDS)
(UNAUDITED)
<S> <C>
Short-term debt................................................. $ 7,550
--------
Long-term debt.................................................. 304,304
--------
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(1).............................. --
Class A Common Stock, $.01 par value, 75,000,000 shares
authorized; 36,919,930 shares issued and outstanding(2)...... 369
Class B Common Stock, convertible, $.01 par value, 22,000,000
shares authorized; 15,625,929 shares issued and
outstanding(3)............................................... 156
Additional paid-in capital.................................... 454,882
Accumulated deficit........................................... (61,180)
--------
Total stockholders' equity.................................. 394,227
--------
Total capitalization........................................ $706,081
========
</TABLE>
- --------
(1) On May 29, 1997, the Company's stockholders approved the cancellation of
the Class A Preferred Stock, $5.50 par value per share.
(2) On May 29, 1997, the Company's stockholders approved an increase in the
authorized shares of Class A Common Stock to 250,000,000 shares.
(3) The Class B Common Stock, $.01 par value per share (the "Class B Common
Stock"), is convertible on a one-for-one basis at any time at the option
of the holder into Class A Common Stock. As of June 13, 1997, all of the
outstanding shares of Class B Common Stock had been converted into shares
of Class A Common Stock.
38
<PAGE>
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 years ended December 31,
1992, 1993, 1994, 1995 and 1996 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 three month periods
ended March 31, 1996 and 1997 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 Ruffalo, Cody and McLeodUSA Publishing on July 15, 1996 and September 20,
1996, respectively, using the purchase method of accounting, and also reflects
the issuance of the Senior Notes on March 4, 1997, assuming, for purposes of
the pro forma statement of operations data, that such transactions were
consummated at the beginning of the periods presented. The unaudited pro forma
information should be read in conjunction with the Financial Statements of
Ruffalo, Cody and McLeodUSA 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, Ruffalo, Cody and McLeodUSA
Publishing.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
------------------------------------------------------------ -----------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996 (4)(5) 1996 1997(6) 1997(4)(7)
---- ---- ---- ---------- ---------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT
DATA:
Revenue............... $ 250 $ 1,550 $ 8,014 $ 28,998 $ 81,323 $128,624 $12,488 $ 35,747 $ 35,747
------ ------- -------- -------- -------- -------- ------- -------- --------
Operating expenses:
Cost of service...... 262 1,528 6,212 19,667 52,624 71,634 9,250 21,200 21,200
Selling, general and
administrative...... 219 2,390 12,373 18,054 46,044 67,416 6,345 23,985 23,985
Depreciation and
amortization........ 6 235 772 1,835 8,485 12,756 969 4,122 4,122
Other................ -- -- -- -- 2,380 4,968 -- 1,608 1,608
------ ------- -------- -------- -------- -------- ------- -------- --------
Total operating
expenses............ 487 4,153 19,357 39,556 109,533 156,774 16,564 50,915 50,915
------ ------- -------- -------- -------- -------- ------- -------- --------
Operating loss........ (237) (2,603) (11,343) (10,558) (28,210) (28,150) (4,076) (15,168) (15,168)
Interest income
(expense), net....... -- 163 (73) (771) 5,369 (12,242) (264) 1,806 (2,148)
Other non-operating
income............... -- -- -- -- 495 6 -- 7 7
Income taxes.......... -- -- -- -- -- -- -- -- --
------ ------- -------- -------- -------- -------- ------- -------- --------
Net loss.............. $ (237) $(2,440) $(11,416) $(11,329) $(22,346) $(40,386) $(4,340) $(13,355) $(17,309)
====== ======= ======== ======== ======== ======== ======= ======== ========
Loss per common and
common equivalent
share................ $ (.02) $ (.08) $ (.31) $ (.31) $ (.52) $ (.93) $ (.12) $ (.26) $ (.33)
====== ======= ======== ======== ======== ======== ======= ======== ========
Weighted average
common and common
equivalent shares
outstanding.......... 14,925 29,665 36,370 37,055 43,019 43,214 37,055 52,327 52,327
====== ======= ======== ======== ======== ======== ======= ======== ========
Ratio of earnings to
fixed charges(8)..... -- -- -- -- -- -- -- -- --
====== ======= ======== ======== ======== ======== ======= ======== ========
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------- MARCH 31,
1992 1993 1994 1995(1)(9) 1996(1)(10) 1997(6)
----- ------ ------- ---------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets........ $ 544 $7,077 $ 4,862 $ 8,507 $224,401 $481,940
Working capital
(deficit)............ $(440) $5,962 $ 1,659 $(1,208) $185,968 $409,874
Property and
equipment, net....... $ 135 $1,958 $ 4,716 $16,119 $ 92,123 $115,512
Total assets.......... $ 694 $9,051 $10,687 $28,986 $452,994 $779,654
Long-term debt........ -- -- $ 3,500 $ 3,600 $ 2,573 $304,304
Stockholders' equity
(deficit)............ $(290) $7,936 $ 3,291 $14,958 $403,429 $394,227
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------------------------------- -----------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996(4)(5) 1996 1997(6) 1997(4)(7)
---- ---- ---- ---------- ---------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures,
including business ac-
quisitions............ $ 138 $ 2,052 $ 3,393 $14,697 $173,782 $175,346 $ 4,390 $42,876 $42,876
EBITDA(11)............. $(231) $(2,368) $(10,571) $(8,723) $(17,345) $(10,426) $(3,107) $(9,438) $(9,438)
</TABLE>
- -------
(1) The acquisitions of MWR, Ruffalo, Cody and McLeodUSA 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.
(2) Includes operations of MWR from April 29, 1995 to December 31, 1995.
(3) Includes operations of Ruffalo, Cody from July 16, 1996 to December 31,
1996 and operations of McLeodUSA Publishing from September 21, 1996 to
December 31, 1996.
(4) The acquisitions of Ruffalo, Cody and McLeodUSA Publishing in July 1996
and September 1996, respectively, and the issuance of the Senior Notes in
March 1997, affect the comparability of the pro forma data presented to
the data for prior periods shown.
(5) Includes operations of Ruffalo, Cody and McLeodUSA Publishing from
January 1, 1996 to December 31, 1996 and certain adjustments attributable
to the acquisitions of Ruffalo, Cody and McLeodUSA Publishing by the
Company. Also reflects certain adjustments attributable to the issuance
of the Senior Notes computed as if the Senior Notes had been issued on
January 1, 1996.
(6) Reflects the issuance of the Senior Notes on March 4, 1997.
(7) Reflects certain adjustments attributable to the issuance of the Senior
Notes computed as if the Senior Notes had been issued on January 1, 1997.
(8) For the purpose of calculating the ratio of earnings to fixed charges,
earnings consist of net loss before income taxes plus fixed charges
(excluding capitalized interest). Fixed charges consist of interest on
all debt (including capitalized interest), amortization of debt discount
and deferred loan costs and the portion of rental expense that is
representative of the interest component of rental expense (deemed to be
one-third of rental expense which management believes is a reasonable
approximation of the interest component). For each of the years ended
December 31, 1992, 1993, 1994, 1995 and 1996, earnings were insufficient
to cover fixed charges by $237,000, $2.4 million, $11.4 million, $11.4
million and $22.6 million, respectively. For the three months ended March
31, 1996 and 1997, earnings were insufficient to cover fixed charges by
$4.4 million and $13.6 million, respectively. On a pro forma basis
computed as if the acquisitions by the Company of Ruffalo, Cody and
McLeodUSA Publishing and the issuance of the Senior Notes were
consummated at the beginning of the periods presented, earnings would not
have been sufficient to cover fixed charges by $41.8 million and $18.1
million for the year ended December 31, 1996 and the three months ended
March 31, 1997, respectively.
(9) Includes MWR, which was acquired by the Company on April 28, 1995.
(10) Includes Ruffalo, Cody and McLeodUSA Publishing, which were acquired by
the Company on July 15, 1996 and September 20, 1996, respectively.
(11) EBITDA consists of operating loss before depreciation, amortization and
other nonrecurring operating expenses. 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.
40
<PAGE>
PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial information has been prepared to
give effect to the acquisitions of Ruffalo, Cody and McLeodUSA Publishing by
the Company in July 1996 and September 1996, respectively, and also reflects
the issuance of the Senior Notes. The unaudited pro forma financial statements
reflect the acquisitions using the purchase method of accounting, and assume
that the acquisitions and the issuance of the Senior Notes 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 McLeodUSA
Publishing 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.
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.
MCLEODUSA INCORPORATED AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------------------------------------------------------
RUFFALO, CODY MCLEODUSA ADJUSTMENTS PRO FORMA ADJUSTMENTS PRO FORMA
MCLEODUSA & ASSOCIATES, MEDIA FOR FOR FOR FOR
INCORPORATED(1) INC.(2) GROUP, INC.(3) ACQUISITIONS ACQUISITIONS TRANSACTION TRANSACTION
--------------- ------------- -------------- ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS STATEMENT
DATA:
Revenue............... $ 81,323 $8,891(4) $38,410 $ -- $128,624 $ -- $128,624
-------- ------ ------- ------- --------- -------- --------
Operating expenses:
Cost of service....... 52,624 4,529 14,481 -- 71,634 -- 71,634
Selling, general and
administrative....... 46,044 3,550 17,822 -- 67,416 -- 67,416
Depreciation and
amortization......... 8,485 293 1,725 2,253(5) 12,756 -- 12,756
Other................. 2,380 -- -- 2,588(6) 4,968 -- 4,968
-------- ------ ------- ------- --------- -------- --------
Total operating
expenses............ 109,533 8,372 34,028 4,841 156,774 -- 156,774
-------- ------ ------- ------- --------- -------- --------
Operating income
(loss)............... (28,210) 519 4,382 (4,841) (28,150) -- (28,150)
Interest income
(expense), net....... 5,369 (6) (1,119) 1,011(7) 5,255 (17,497)(8) (12,242)
Other non-operating
expenses............. 495 -- (489) -- 6 -- 6
Income taxes.......... -- (182) (1,120) 1,302(9) -- -- --
-------- ------ ------- ------- --------- -------- --------
Net income (loss)..... $(22,346) 331 $ 1,654 $(2,528) $ (22,889) $(17,497) $(40,386)
======== ====== ======= ======= ========= ======== ========
Loss per common and
common equivalent
share................ $(0.52) $ (0.53) $ (0.93)
======== ========= ========
Weighted average
common and common
equivalent shares
outstanding.......... 43,019 43,214 43,214
======== ========= ========
OTHER FINANCIAL DATA:
EBITDA(10)............ $(17,345) $ 812 $ 6,107 $ -- $ (10,426) $ -- $(10,426)
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1997
------------------------------------------
MCLEODUSA ADJUSTMENTS FOR PRO FORMA FOR
INCORPORATED TRANSACTION TRANSACTION
------------ --------------- -------------
<S> <C> <C> <C>
OPERATIONS STATEMENT DATA:
Revenue........................... $ 35,747 $ -- $ 35,747
-------- ------- --------
Operating expenses:
Cost of service................... 21,200 -- 21,200
Selling, general and
administrative................... 23,985 -- 23,985
Depreciation and amortization..... 4,122 -- 4,122
Other............................. 1,608 -- 1,608
-------- ------- --------
Total operating expenses......... 50,915 -- 50,915
-------- ------- --------
Operating income (loss)........... (15,168) -- (15,168)
Interest income (expense), net.... 1,806 (3,954)(8) (2,148)
Other non-operating income........ 7 -- 7
Income taxes...................... -- -- --
-------- ------- --------
Net loss.......................... $(13,355) (3,954) $(17,309)
======== ======= ========
Loss per common and common
equivalent share ................ $ (0.26) $ (0.33)
======== ========
Weighted average common and common
equivalent shares outstanding.... 52,327 52,327
======== ========
OTHER FINANCIAL DATA:
EBITDA(10)........................ $ (9,438) $ -- $ (9,438)
</TABLE>
- -------
(1) Includes operations of Ruffalo, Cody from July 16, 1996 to December 31,
1996 and operations of McLeodUSA Publishing from September 21, 1996 to
December 31, 1996.
(2) Includes operations of Ruffalo, Cody from January 1, 1996 to July 15,
1996.
(3) Includes operations of McLeodUSA Publishing from January 1, 1996 to
September 20, 1996.
(4) Includes revenue from a material agreement with a major long distance
carrier to provide telemarketing services. Over 40% of Ruffalo, Cody's
revenues in 1996 were derived from this agreement. The major long distance
carrier terminated this agreement, effective December 31, 1996.
(5) To adjust depreciation and amortization to include amortization of
intangibles acquired in the Company's acquisitions of Ruffalo, Cody and
McLeodUSA Publishing. Intangibles acquired in these acquisitions are being
amortized over periods ranging from 5 years to 25 years.
(6) To recognize the costs associated with the directories in progress at the
time of the Company's acquisition of McLeodUSA Publishing.
(7) To eliminate the interest expense recorded on McLeodUSA Publishing
convertible debentures that were converted to shares of McLeodUSA
Publishing common stock immediately prior to the acquisition of McLeodUSA
Publishing by the Company.
(8) To record the interest expense on the Senior Notes at 10 1/2% compounded
semi-annually, reduced by an estimated annual yield of 5% on the net
proceeds from the Offering and estimated additional interest capitalization
of $1,280,000 and $537,000 for the year ended December 31, 1996 and the
three months ended March 31, 1997, respectively.
(9) 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.
(10) EBITDA consists of operating loss before depreciation, amortization and
other nonrecurring operating expenses. 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.
42
<PAGE>
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 the sale of
advertising space in telephone directories as a result of its acquisition of
McLeodUSA Publishing in September 1996, and from ancillary services as a
result of its acquisitions of Ruffalo, Cody and Digital Communications of
Iowa, Inc. ("Digital Communications") in July 1996 and January 1997,
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 began deriving revenue from the sale of advertising
space in telephone directories published by McLeodUSA Publishing on September
20, 1996, the date the Company acquired McLeodUSA Publishing. The Company
began deriving revenue from the sale, installation and service of business
telephone systems on January 30, 1997, the date the Company acquired Digital
Communications. 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 THREE MONTHS
DECEMBER 31, ENDED MARCH 31,
---------------- ---------------
1994 1995 1996 1996 1997
---- ---- ---- ------- -------
<S> <C> <C> <C> <C> <C>
Local and long distance
telecommunications services............. 58% 74% 51% 67% 42%
Telecommunications network maintenance
services................................ 42 17 7 11 4
Special access and private line
services................................ -- 9 13 22 7
Telephone directory advertising.......... -- -- 19 -- 40
Ancillary services....................... -- -- 10 -- 7
--- --- --- ------- -------
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 has expanded its PrimeLine(R) service to
13 additional cities and towns in Iowa and ten cities and towns in Illinois in
1997. 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 McLeodUSA Publishing, which publishes and distributes
"white page" and "yellow page" telephone directories in nineteen 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
43
<PAGE>
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
April 1995.
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 of
printing and distributing the telephone directories published by McLeodUSA
Publishing, costs associated with maintaining the Iowa Communications Network
and costs associated with operating the Company's network. 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, customer
lists and noncompete agreements related to the Company's acquisitions;
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 is being 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, installs and expands its fiber
optic network and develops and constructs its proposed PCS system. 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 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.
44
<PAGE>
THREE MONTHS ENDED MARCH 31, 1997 COMPARED WITH THREE MONTHS ENDED MARCH 31,
1996
Revenue increased from $12.5 million for the three months ended March 31,
1996 to $35.7 million for the three months ended March 31, 1997, representing
an increase of $23.2 million or 186%. Revenue from the sale of local and long
distance telecommunications services accounted for $6.5 million of this
increase. In addition, revenues from Ruffalo, Cody, which was acquired in July
1996, McLeodUSA Publishing, which was acquired in September 1996, and Digital
Communications, which was acquired in January 1997, contributed $2.3 million,
$14.2 million and $521,000, respectively, to the increase.
Cost of service increased from $9.3 million for the three months ended March
31, 1996, to $21.2 million for the three months ended March 31, 1997,
representing an increase of $11.9 million or 129%. This increase in cost of
service was due primarily to the growth in the Company's local and long
distance telecommunications services and to the acquisitions of Ruffalo, Cody
and McLeodUSA Publishing, which contributed $1 million and $5.4 million,
respectively, to the increase. Cost of service as a percentage of revenue
decreased from 74% for the three months ended March 31, 1996 to 59% for the
three months ended March 31, 1997, primarily as a result of these
acquisitions. The cost of providing local and long distance services as a
percentage of local and long distance telecommunications revenue increased
from 70% for the three months ended March 31, 1996 to 76% for the three months
ended March 31, 1997, primarily as a result of increased line costs associated
with the Company's accelerated expansion into new markets.
SG&A increased from $6.3 million for the three months ended March 31, 1996
to $24 million for the three months ended March 31, 1997, an increase of $17.7
million or 277%. The acquisitions of Ruffalo, Cody and McLeodUSA Publishing
contributed $963,000 and $6.6 million, respectively, to this increase.
Increased costs of $10.1 million related to expansion of selling, customer
support and administration activities to support the Company's growth also
contributed to this increase.
Depreciation and amortization expenses increased from $969,000 for the three
months ended March 31, 1996 to $4.1 million for the three months ended March
31, 1997, representing an increase of $3.1 million or 325%. This increase
consisted of $1.7 million related to the acquisitions of Ruffalo, Cody and
McLeodUSA Publishing; an increase in amortization expense of $252,000 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; and $1.1 million due primarily to the growth
of the Company's network.
Other operating expenses during the three-month period ended March 31, 1997
represented the realization of a purchase accounting adjustment related to the
capitalization of costs associated with directories in progress at the time
the Company acquired McLeodUSA Publishing.
Interest income increased from $1,000 for the three-month period ended March
31, 1996 to $4.3 million for the same period in 1997. This increase resulted
from earnings on investments made with a portion of the proceeds from the
Company's public offerings of Class A Common Stock in June and November 1996
and from the Offering in March 1997.
Gross interest expense increased from $265,000 for the three months ended
March 31, 1996 to $2.7 million for the three months ended March 31, 1997. This
increase was primarily a result of $2.6 million of accretion of the Senior
Notes. Interest expense of approximately $290,000 during the three-month
period ended March 31, 1997 was capitalized as part of the Company's
construction of fiber optic network.
Net loss increased from $4.3 million for the three months ended March 31,
1996 to $13.4 million for the three months ended March 31, 1997, an increase
of $9.1 million. This increase resulted
45
<PAGE>
primarily from the expansion of the Company's central office operations, the
opening of new sales offices and costs related to the acquisition of Ruffalo,
Cody, McLeodUSA Publishing and Digital Communications. 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.
YEAR ENDED 1996 COMPARED WITH YEAR ENDED 1995
Revenue increased from $29 million for the year ended December 31, 1995 to
$81.3 million for the year ended December 31, 1996, representing an increase
of $52.3 million or 180%. Revenue from the sale of local and long distance
telecommunications services accounted for $19.9 million of this increase.
Total local and long-distance customers increased 103% from 8,776 at December
31, 1995 to 17,872 at December 31, 1996. Local lines under the Company's
management increased 83% from 35,795 at December 31, 1995 to 65,367 at
December 31, 1996. Average lines per customer decreased from 4.31 at December
31, 1995 to 3.95 at December 31, 1996, due to the increase in residential
customers. Average monthly revenue per line decreased from $62.68 for the
month ended December 31, 1995 to $59.90 for the month ended December 31, 1996,
also due to the increase in residential customers.
Included in the year ended December 31, 1996 revenue was $8.6 million of
revenue from Ruffalo Cody, which was acquired on July 15, 1996, and $15.1
million in revenue from McLeodUSA Publishing, which was acquired on September
20, 1996. Excluding these acquisitions, 1996 revenue would have been $57.6
million.
Cost of service increased from $19.7 million for the year ended December 31,
1995 to $52.6 million for the year ended December 31, 1996, an increase of
$32.9 million or 168%. This increase in cost of service was due primarily to
the growth in the Company's local and long distance telecommunications
services and to the acquisitions of Ruffalo, Cody and McLeodUSA Publishing,
which contributed $4.5 million and $6.7 million, respectively, to the
increase. Cost of service as a percentage of revenue decreased from 68% to
65%, primarily as a result of the effect of these acquisitions. The cost of
providing local and long-distance services as a percentage of local and long
distance telecommunications revenue increased from 68% for the year ended
December 31, 1995 to 70% for the year ended December 31, 1996, 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.
SG&A increased from $18.1 million for the year ended December 31, 1995 to
$46 million for the year ended December 31, 1996, an increase of $27.9 million
or 155%. The acquisitions of Ruffalo Cody and McLeodUSA Publishing contributed
$3.3 million and $7.3 million, respectively, to the increase. Increased costs
of $17.3 million related to expansion of selling, customer support and
administration activities to support the Company's growth also contributed to
this increase.
Depreciation and amortization expenses increased from $1.8 million for the
year ended December 31, 1995 to $8.5 million for the year ended December 31,
1996, an increase of $6.7 million or 362%. This increase consisted of $2.1
million related to the acquisitions of Ruffalo, Cody and McLeodUSA Publishing;
amortization expense of $2 million 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; and $2.6 million due primarily to the growth of the Company's
network in 1996.
Other operating expense in 1996 represented the realization of a purchase
accounting adjustment related to the capitalization of costs associated with
directories in progress at the time the Company acquired McLeodUSA Publishing.
46
<PAGE>
The Company had net interest income of $5.4 million for the year ended
December 31, 1996 compared to net interest expense of $771,000 for the year
ended December 31, 1995 as a result of earnings on investments made with a
portion of the proceeds of the Company's public offerings of Class A Common
Stock during 1996 and decreased interest expense on reduced borrowings as a
result of the Company's payment of all amounts outstanding under a bank credit
facility maintained by the Company from May 1994 until June 1996 (the "Credit
Facility") 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 $495,000 for the year ended December 31, 1996.
Net loss increased from $11.3 million for the year ended December 31, 1995
to $22.3 million for the year ended December 31, 1996, an increase of $11
million. This increase resulted primarily from the expansion of the local and
long distance businesses, amortization and other operating expenses related to
the acquisitions of Ruffalo, Cody and McLeodUSA Publishing 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, amortization and other nonrecurring
operating expenses ("EBITDA") decreased from a negative $8.7 million for the
year ended December 31, 1995 to a negative $17.3 million for the year ended
December 31, 1996, a decrease of $8.6 million. The change reflected the
increase in the operating 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 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 costs of $1.3 million required to handle the growth experienced
primarily in local and long distance revenues.
47
<PAGE>
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.
48
<PAGE>
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.
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.
LIQUIDITY AND CAPITAL RESOURCES
Since the inception of the Company in June 1991, the Company's total assets
have grown to $754.2 million at March 31, 1997. At March 31, 1997, $115.5
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, net proceeds of approximately $396.2 million from public
offerings of Class A Common Stock, and net proceeds of approximately $289.8
million from the Offering. At March 31, 1997, the Company's current assets of
$481.9 million exceeded its current liabilities of $46.7 million, providing
working capital of $435.2 million, which represents an increase of $249.2
million compared to December 31, 1996, primarily attributable to the Company's
completion of the Offering in March 1997. At December 31, 1996, the Company's
current assets of $224.4 million exceeded its current liabilities of $38.4
million, providing working capital of $186 million, which represents an
improvement of $187.2 million compared to December 31, 1995, primarily
attributable to the Company's completion of its public offerings of Class A
Common Stock in June and November 1996. At December 31, 1995, the Company's
current liabilities of $9.7 million exceeded current assets of $8.5 million,
resulting in a working capital deficit of $1.2 million. 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 $5.9 million, $11.8
million and $9.5 million for the three months ended March 31, 1997 and the
years ended December 31, 1996 and 1995, respectively. During the three months
ended March 31, 1997 and the year ended December 31, 1996, cash for operating
activities was used primarily to fund the Company's net loss of $13.4 million
and $22.3 million, respectively, for such periods. During the three months
ended March 31, 1997, the Company also required cash to fund the growth in
line installation costs of $2.1 million as a result of the expansion of the
Company's local and long distance telecommunications services. During the year
ended December 31, 1996, the Company also required cash to fund the growth in
trade receivables of $9.3 million offset by a decrease in other current assets
of $675,000. The increase in accounts receivable was a result of the growth in
local and long distance telecommunications services and special access and
private line services. This use of cash was partially offset by an increase in
accounts payable and accrued expenses of $3.2 million due to the costs
associated with the increase in telecommunications revenue, an increase in
deferred revenue of $9.5 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 $13.1 million during the
three months ended March 31, 1997, $283.1 million during the year ended
December 31, 1996 and $5.5 million during the
49
<PAGE>
year ended December 31, 1995. The significant use of cash for investing
activities for the year ended December 31, 1996 consisted of the purchase of
available-for-sale securities with certain of the net proceeds from the
Company's public offerings of Class A Common Stock, the purchase of Ruffalo,
Cody and McLeodUSA 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 expansion of the Company's local and long distance
telecommunications services, the continued development and expansion of its
fiber optic telecommunications network and other capital expenditures resulted
in purchases of equipment, fiber optic cable and other property and equipment
totaling $24.5 million, $70.3 million and $5.3 million during the three months
ended March 31, 1997 and the years ended December 31, 1996 and 1995,
respectively.
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 56,177 shares of Class A Common Stock were delivered to certain of the
shareholders of Ruffalo, Cody upon the fulfillment of certain conditions
relating to Ruffalo, Cody's ongoing revenues from a material agreement with a
major long distance carrier to provide telemarketing services. The major long
distance carrier terminated 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 McLeodUSA Publishing for
approximately $74.1 million in cash and an additional amount estimated as of
the date hereof to be approximately $1.6 million to be paid to certain
employees of McLeodUSA Publishing as part of an incentive plan. At the time of
the acquisition, McLeodUSA Publishing had outstanding debt of approximately
$6.6 million. The Company recorded the McLeodUSA Publishing acquisition as a
purchase for accounting purposes.
On January 30, 1997, the Company acquired Digital Communications in a stock
transaction valued at approximately $2.3 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. The Company issued 84,430 shares of Class A Common
Stock to the shareholders of Digital Communications and recorded the
acquisition as a purchase for accounting purposes.
On February 25, 1997, McLeodUSA Publishing acquired six telephone
directories from Fronteer Financial Holdings, Ltd. ("Fronteer"). As of the
date hereof, McLeodUSA Publishing has paid approximately $1.5 million for
these directories. The balance of the cash purchase price is to be determined
based on the sum of the revenues derived from the last Fronteer editions of
the directories and is estimated as of the date hereof to be approximately
$1.7 million.
On March 31, 1997, McLeodUSA Publishing acquired 26 telephone directories
published by Indiana Directories, Inc. McLeodUSA Publishing paid approximately
$10 million for these directories.
The Company used a portion of the net proceeds from the Company's initial
public offering of Class A Common Stock to fund the Indiana Directories, Inc.,
Fronteer and McLeodUSA Publishing
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acquisitions and the cash portion of the Ruffalo, Cody acquisition. The uses
of cash for investing activities during the three months ended March 31, 1997
were partially offset by net proceeds of $20.8 million from the sales and
maturities of available-for-sale securities.
On April 28, 1997, the FCC granted the Company 25 "D" and "E" block
frequency PCS licenses in 23 markets covering areas of Iowa, Illinois,
Minnesota, Nebraska and South Dakota. The Company paid the FCC an aggregate of
approximately $32 million for these PCS licenses. The Company made a $4.8
million deposit with the FCC at the beginning of the bidding process in 1996,
made an additional $1.8 million deposit in January 1997 and paid the balance
of $25.4 million for these PCS licenses on May 12, 1997. The Company will be
required to make significant additional expenditures to develop, construct and
operate a PCS system.
On June 10, 1997, the Company acquired substantially all of the assets of
ESI Communications for an aggregate of approximately $15.2 million.
Cash received from net financing activities was $289.6 million during the
three months ended March 31, 1997, primarily as a result of the Offering. Cash
received from net financing activities was $391.4 million during the year
ended December 31, 1996, primarily as a result of the Company's public
offerings of Class A Common Stock in June and November 1996. The Company paid
off and canceled the Credit Facility in June 1996 with a portion of the net
proceeds from its initial public offering of Class A Common Stock. Cash
received from financing activities during 1995 was $15 million and was
primarily obtained through the issuance of Class A 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 March 4, 1997, the Company received net proceeds of approximately $289.8
million from the Offering. The Notes will accrete to an aggregate principal
amount of $500 million by March 1, 2002. Interest will not accrue on the Notes
prior to March 1, 2002. Thereafter, interest will accrue at a rate of 10 1/2%
per annum and will be payable semi-annually on March 1 and September 1 of each
year, commencing September 1, 2002. See "Description of the Exchange Notes."
The Indenture imposes operating and financial restrictions on the Company
and its subsidiaries. These restrictions affect, and in certain cases
significantly limit or prohibit, among other things, the ability of the
Company and its subsidiaries to incur additional indebtedness, pay dividends
or make distributions in respect of the Company's or such subsidiaries'
capital stock, make other restricted payments, enter into sale and leaseback
transactions, create liens upon assets, enter into transactions with
affiliates or related persons, sell assets, or consolidate, merge or sell all
or substantially all of their assets. See "Description of the Exchange Notes."
There can be no assurance that such covenants will not adversely affect the
Company's ability to finance its future operations or capital needs or to
engage in other business activities that may be in the interest of the
Company.
At March 31, 1997, the Company had no actual contractual capital commitments
for costs associated with the construction of fiber optic networks.
As of March 31, 1997, the Company estimates that its aggregate capital
requirements for the remainder of 1997, 1998 and 1999 will be approximately
$413 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) acquiring the PCS licenses awarded to
the Company in the FCC's recent "D" and "E" block frequency PCS license
auction, (iv) developing, constructing and operating a PCS system, and (v)
constructing its new corporate headquarters and associated buildings. These
capital requirements are expected to be funded, in large part, out of the net
proceeds from the Offering (approximately $289.8 million), the net proceeds
remaining from the Company's public offerings of Class A Common Stock in June
and November 1996 (approximately $184.3 million as of March 31, 1997), 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
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operating deficits and net losses. These activities could require significant
additional capital not included in the foregoing estimated aggregate capital
requirements of $413 million. In June 1997, the Company entered into an
agreement to acquire CCI pursuant to which the Company will be required to pay
$155 million in cash upon consummation of the transaction. See "Business--
Recent Transactions."
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 plans to obtain one or more lines of credit, although,
as of the date hereof, 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 February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
(SFAS 128), and SFAS No. 129, "Disclosure of Information about Capital
Structure" (SFAS 129). SFAS 128 specifies the computation, presentation and
disclosure requirements for earnings per share for entities with publicly held
common stock. Its objective is to simplify the computation of earnings per
share and to make the U.S. standard for computing earnings per share more
compatible with the standards of other countries and with that of the
International Accounting Standards Committee. SFAS 129 incorporates related
disclosure requirements from APB Opinion No. 10, "Disclosure of Long-Term
Obligations," and SFAS No. 47, "Disclosure of Long-Term Obligations," for
entities that were subject to the requirements for those standards. Both
statements are effective for fiscal years beginning after December 15, 1997.
The Company will adopt the statements effective January 1, 1998 and does not
expect adoption of the statements to have a significant impact on its current
earnings per share calculation and disclosures.
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, (iv) the sale of advertising space in
telephone directories, and (v) ancillary services, including direct marketing
and telemarketing services and the sale of business telephone systems. As of
March 31, 1997, the Company served over 27,400 telecommunications customers in
138 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 offers a variety of special access and private line
services to large businesses, institutional customers and interexchange
carriers, primarily in Des Moines, Iowa. 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. McLeodUSA Telecommunications
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, September 1996 and January 1997,
respectively, the Company acquired MWR, a competitive access provider in Des
Moines, Iowa, Ruffalo, Cody, a telemarketing company, McLeodUSA Publishing, a
publisher of telephone directories, and Digital Communications, a telephone
equipment company.
The Company is organized as a holding company and operates primarily through
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.
As of the date hereof, the Company is offering integrated telecommunications
services to business and residential customers located primarily in Iowa and
Illinois. The Company has recently begun sales of integrated
telecommunications services in a number of markets in Minnesota and Wisconsin.
The Company plans to begin offering integrated telecommunications services in
markets in South Dakota, North Dakota, Colorado and Wyoming in 1997. Over the
next several years, depending on competitive and other factors, the Company
also intends to offer integrated telecommunications services in Montana,
Idaho, Utah and Nebraska. The Company also offers long distance service in 45
states in the continental United States.
On April 28, 1997, the FCC granted the Company 25 "D" and "E" block
frequency PCS licenses in 23 markets covering areas of Iowa, Illinois,
Minnesota, Nebraska and South Dakota. The Company paid the FCC approximately
$32 million for these PCS licenses. The PCS licenses encompass approximately
100,000
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square miles and a population of approximately 6.3 million. The Company is
assessing its technological options and beginning to design and engineer its
proposed PCS system. The Company expects to begin constructing its PCS network
and offering PCS services as part of its integrated telecommunications
services over the next several years. See "Risk Factors--PCS System
Implementation Risks."
The statements in the foregoing paragraphs about the Company's expansion
plans and proposed PCS services 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 and wireless services 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; (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.
On April 28, 1997, the FCC informed the Company that it was also the
successful bidder for four Wireless Communications Service ("WCS") licenses in
the Major Economic Areas of Milwaukee, Wisconsin, Minneapolis-St. Paul,
Minnesota, Des Moines-Quad Cities, Iowa/Illinois and Omaha, Nebraska. The
Company filed an application for such licenses on May 12, 1997. If the Company
receives such WCS licenses, the Company intends to use the frequency blocks
covered by such licenses to provide certain fixed services, such as wireless
local loop, Internet access or meter reading. There can be no assurance that
the Company will be successful in acquiring any WCS licenses.
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 subscribing to the Company's integrated
telecommunications services receives the lowest long distance rate available
each month from among the pricing plans of AT&T, MCI and Sprint that generally
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 voice mail, 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) the
Company now offers to residential customers in 15 cities and towns in Iowa and
in ten cities and towns in Illinois 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 now offers
integrated telecommunications services in markets in Minnesota and Wisconsin
in addition to its Iowa and Illinois markets; (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
McLeodUSA Publishing, which publishes and distributes "white page" and "yellow
page" telephone directories in nineteen 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 2,200 new route miles of fiber optic
network at a cost of approximately $50.5 million; (vi) in May 1997, the
Company acquired 25 PCS licenses as part of its strategy to increase the range
of integrated telecommunications services provided to customers in its target
markets; and (vii) in June 1997, the Company entered into an agreement to
acquire CCI, which offers a variety of communications services including local
exchange services.
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RECENT TRANSACTIONS
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 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 56,177 shares of Class A Common Stock were delivered to
certain of the shareholders of Ruffalo, Cody upon the fulfillment of certain
conditions relating to Ruffalo, Cody's ongoing revenues from a material
agreement with a major long distance carrier to provide telemarketing
services. The major long distance carrier terminated 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 September 20, 1996, the Company acquired McLeodUSA Publishing by means of
a merger of a newly formed wholly owned subsidiary of the Company with and
into McLeodUSA Publishing. As consideration for the acquisition, the Company
paid approximately $74.1 million in cash and an additional amount estimated as
of the date hereof to be approximately $1.6 million to be paid to certain
employees of McLeodUSA Publishing as part of an incentive plan. At the time of
the acquisition, McLeodUSA Publishing had outstanding debt of approximately
$6.6 million.
McLeodUSA Publishing publishes and distributes "white page" and "yellow
page" telephone directories in nineteen states in the midwestern and Rocky
Mountain regions of the United States, including most of the Company's target
markets. McLeodUSA Publishing derives its revenues primarily from the sale of
advertising space in its telephone directories.
On December 9, 1996, the Company, through McLeodUSA Telecommunications,
acquired the customer base of Total Communication Systems, Inc. ("TCSI") for
an aggregate cash purchase price of approximately $534,000. TCSI is an Iowa
corporation that offered local and long distance service in Iowa by
partitioning of U S WEST's central office switches. TCSI managed approximately
1,600 local and long distance lines in Iowa prior to the acquisition.
On February 25, 1997, McLeodUSA Publishing acquired six telephone
directories published by Fronteer at a purchase price to be determined based
on the sum of the revenues derived from the last Fronteer editions of the
directories. The purchase price is estimated as of the date hereof to be
approximately $3.7 million.
On January 30, 1997, the Company acquired Digital Communications by means of
a merger of a newly formed wholly owned subsidiary of the Company with and
into Digital Communications. As consideration for the acquisition, the Company
issued an aggregate of 84,430 shares of Class A Common Stock to the
shareholders of Digital Communications. Digital Communications sells, installs
and services telephone systems primarily to small businesses in eastern Iowa.
On March 31, 1997, McLeodUSA Publishing acquired 26 telephone directories
published by Indiana Directories, Inc. at a purchase price of $10 million.
On June 10, 1997, the Company acquired substantially all of the assets of
ESI Communications for an aggregate of approximately $15.2 million. ESI
Communications sells, installs and services telephone systems in Minnesota.
On June 14, 1997, the Company entered into an Agreement and Plan of
Reorganization with CCI pursuant to which the Company agreed, subject to
certain conditions, to acquire CCI for an aggregate of 8,488,613 shares of
Class A Common Stock and $155 million in cash. CCI is a communications company
that offers a variety of communications services, including local exchange
services, primarily in Illinois, Missouri and Indiana.
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BUSINESS STRATEGY
The Company's objective is to become a leading provider of integrated
wireline and wireless telecommunications services in Iowa, Illinois,
Minnesota, Wisconsin, South Dakota, North Dakota, Colorado, Wyoming, Montana,
Utah, Idaho and Nebraska. 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 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 wireline
and wireless 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. The Company intends to add PCS services to
its current array of integrated telecommunications services over the
next several years.
. BUILD MARKET SHARE THROUGH BRANDING AND CUSTOMER SERVICE. The Company
believes that, by branding its telecommunications services with the
trade name McLeodUSA in combination with the distinctive black-and-
yellow motif of the McLeodUSA 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, and will permit
the Company to include additional services, such as PCS, when available.
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). As of
March 31, 1997, the Company owned approximately 2,600 route miles of
fiber optic network and, subject to the foregoing factors, expects to
construct approximately 4,900 additional route miles of fiber optic
network during the next three years. Through its strategic relationships
with its electric
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utility stockholders and its contracts to build the final links of the
Iowa Communications Network and lease a portion of the capacity on those
links 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 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 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 of the U.S. Eighth Circuit Court of Appeals.
On November 12, 1996, the U.S. Supreme Court refused to vacate the
judicial stay of the U.S. Eighth Circuit Court of Appeals. The
Interconnection Decision 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, during 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 and one utility in Wisconsin provide it with access to rights-
of-way and other resources on favorable terms. The Company believes that
its acquisitions of Ruffalo, Cody and McLeodUSA Publishing during 1996
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. In June 1997, the Company
entered into an agreement to acquire CCI. 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. Seven of the nine 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 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.
WIRELINE SERVICES. The market for local exchange services consists of a
number of distinct service components. These service components are defined by
specific regulatory tariff classifications
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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 and the
sale of business telephone equipment. 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.
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
poles, 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
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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.
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 optic 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, was 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
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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 of the U.S. Eighth
Circuit Court of Appeals. On November 12, 1996, the U.S. Supreme Court refused
to vacate the judicial stay of the U.S. Eighth Circuit Court of Appeals. The
Interconnection Decision 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 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 March 31, 1997, 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, Idaho
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.
WIRELESS SERVICES. Demand for wireless communications has grown rapidly over
the past decade. According to the Cellular Telecommunications Industry
Association ("CTIA"), the number of wireless telephone subscribers nationwide
has grown from approximately 680,000 in 1986 to an estimated 38.2 million as
of June 30, 1996, with a compound annual growth rate in excess of 45% from
1990 through 1995. Wireless communication revenues for the 12-month period
ended June 30, 1996 are estimated by CTIA to have totaled over $21 billion, a
31% increase over the prior 12-month period. The Company believes that the
demand for wireless communications will continue to grow dramatically, and
that PCS will capture a significant share of the wireless market, due to
anticipated declines in costs of service, increased function versatility, and
increased awareness of the productivity, convenience and safety benefits
associated with such services. The Company also believes the rapid growth of
notebook computers and personal digital assistants, combined with emerging
software applications for wireless delivery of electronic mail, fax and
database searching, will further stimulate demand for wireless service. BIA
Consulting, Inc. estimates that the number of wireless service subscriptions
will reach 90.5 million by the year 2000, with PCS accounting for
approximately 23.1 million of such subscriptions.
CURRENT PRODUCTS AND SERVICES
The Company derives revenue from: (i) the sale of local and long distance
telecommunications services, (ii) special access and private line services,
(iii) telecommunications network maintenance services, (iv) the sale of
advertising space in telephone directories, and (v) ancillary services,
including direct marketing and telemarketing services and the sale of business
telephone systems. For the three months ended March 31, 1997, these services
represented 42%, 7%, 4%, 40% and 7%, respectively, of the Company's total
revenues. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Overview."
INTEGRATED TELECOMMUNICATIONS SERVICES. As of March 31, 1997, the Company
was providing service, on a retail basis, to approximately 77,000 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 revenue approximately 800% from the sale of local and long
distance telecommunications services from $4.6 million for the year ended
December 31, 1994 to $41.4 million
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for the year ended December 31, 1996. 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 and Minnesota
customers and Ameritech for its Illinois and Wisconsin 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 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." As of the date hereof, the Company is purchasing Centrex service
in Minnesota from U S WEST on a month-to-month basis while negotiating a term
agreement. The Company has seven-year Centrex agreements with Ameritech that
extend through 2001 or 2002 in Illinois and 2003 in Wisconsin. These
agreements 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
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. The
Company has consistently met the minimum purchase requirements under its
agreement with WilTel. 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
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,
and will permit the Company to include additional services, such as PCS, when
available. 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 cities and
towns in which the Company offers its integrated telecommunications services
as of the date hereof 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
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required and the fixed costs associated with maintaining a PBX network
infrastructure. The Company's telemanagement services allow small to medium-
sized business customers, which may lack the resources to support their own
PBX, to benefit from a sophisticated telecommunications system managed by
industry experts.
Business customers subscribing to the Company's integrated
telecommunications services generally receive 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 such 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 generally 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 commitment
to use the Company's services. As of the date hereof, the Company compares the
monthly calls of business customers subscribing to the Company's integrated
telecommunications services 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 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. As of March 31, 1997, the
Company's average integrated telecommunications service contract for business
customers had an approximately 38.9-month term.
The Company also offers other long distance rates to certain business
customers, based on the customer's particular needs. Furthermore, in certain
states, including states outside of its target markets, the Company offers
business customers long distance service only, in order to enhance the
Company's ability to attract business customers that have offices outside of
the Company's target markets. In the markets in which the Company offers long
distance service only, business customers generally receive flat-rate long
distance pricing at rates ranging from $.085 to $.395 per minute as of the
date hereof.
Residential Services. In June 1996, the Company introduced its PrimeLine(R)
service to residential and certain small business customers in the Cedar
Rapids, and Iowa City, Iowa markets. The Company has expanded its PrimeLine(R)
service to 13 additional cities and towns in Iowa and ten cities and towns in
Illinois in 1997. The Company intends to begin offering PrimeLine(R) service
in all of its Iowa and Illinois markets and in Wisconsin in the remainder of
1997. 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. As of the date
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hereof, PrimeLine(R) customers may choose from five integrated
telecommunications service packages generally ranging in price from $16.95 to
$39.95 per month in Iowa and $11.40 to $39.95 in Illinois. 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.
SPECIAL ACCESS AND PRIVATE LINE SERVICES. The Company provides, on a private
carrier basis, a wide range of special access and private line services to its
interexchange carrier, cable television and other end-user 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 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 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. As of the date hereof,
a single pair of fibers on the Company's network can transmit 32,256
simultaneous voice conversations, whereas a typical pair of copper wires can
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 the initial fiber optic links of the Iowa Communications
Network (the "Part I and II segments"). The Part I and II segments, 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
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Company maintains the Part I and II segments 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 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 capacity on the Part I and II segments to
provide telecommunications services to customers.
OTHER SERVICES. Through McLeodUSA Publishing, the Company publishes and
distributes annual "white page" and "yellow page" telephone directories to
local telephone subscribers in nineteen states in the midwestern and Rocky
Mountain regions of the United States, including most of the Company's target
markets. In its fiscal year 1996, McLeodUSA Publishing published and
distributed an aggregate of over 7 million copies of 80 telephone directories
and had revenues of $52.1 million, primarily from the sale of advertising
space in its telephone directories to approximately 85,000 advertisers.
In addition, the Company provides direct marketing and telemarketing
services through Ruffalo, Cody. Such services include 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 approximately 40% of its revenues in 1996 from an
agreement with a major long distance carrier to provide telemarketing
services. The major long distance carrier terminated this agreement, effective
December 31, 1996. As a result, the Company has redirected 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 McLeodUSA
Publishing's sales force of 410 direct sales personnel and telemarketers as
of May 31, 1997 to sell both advertising space in the Company's telephone
directories and, where available, the Company's telecommunications services.
Furthermore, all of the Company's 162 full-time telemarketing sales personnel
at its Ruffalo, Cody subsidiary as of March 31, 1997 were engaged in sales of
the Company's PrimeLine(R) residential services. See "--Sales and Marketing."
The Company also sells, installs and services telephone systems, primarily
to small businesses in eastern Iowa, through Digital Communications, which the
Company acquired in January 1997. The Company believes that these services
will provide valuable expertise for and complement its telecommunications
services offerings.
EXPANSION OF CERTAIN FACILITIES-BASED SERVICES
The Company is constructing a fiber optic network that will enable it, when
certain judicial and regulatory proceedings are resolved, 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 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
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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
planned 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 ultimately plans 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 August 1996, the FCC released the Interconnection Decision implementing the
interconnection portions of the Telecommunications Act. Certain provisions of
the Interconnection Decision have been appealed in proceedings before the U.S.
Eighth Circuit Court of Appeals. In October 1996, the U.S. Eighth Circuit
Court of Appeals temporarily stayed the effectiveness of 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, pending a decision
on the merits. 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 do so. The U.S. Eighth Circuit Court
of Appeals heard oral arguments on the merits of the challenges to the
Interconnection Decision on January 17, 1997, but as of the date hereof had
not ruled in the case. 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), among other places. The Company then 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" within the meaning of 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
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increasingly will offer, in addition to products that supplement a customer's
wireline 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 proposed PCS markets: two existing cellular providers, five other PCS
providers and one ESMR provider.
Wireless telecommunications networks use a variety of radio frequencies to
transmit voice and data in place of, or in addition to, standard wireline
telephone networks. Wireless telecommunications technologies include one-way
radio applications, such as paging or beeper services, and two-way radio
applications, such as cellular and PCS telephone networks. In 1993, the FCC
allocated 140 MHz of the radio spectrum (and subsequently allocated an
additional 10 MHz of spectrum) for the provision of a new wireless
communications service, commonly known as PCS. PCS differs from traditional
cellular telephone service principally in that PCS systems will operate at a
higher frequency band and employ advanced digital technology. Relative to
existing cellular service, these features are expected to enable PCS system
operators to offer customers lower cost service options, lighter handsets with
longer battery lives, and new and enhanced service offerings.
To accommodate a wide range of services and technologies with different
spectrum requirements and to facilitate the entry of small business and rural
telephone companies, the FCC divided the 150 MHz of PCS spectrum into three 10
MHz blocks, three 30 MHz blocks and 30 MHz of unlicensed spectrum. The FCC
adopted the following frequency plan.
Block A: 30 MHz (1850-1865/1930-1945 MHz)
Block B: 30 MHz (1870-1885/1950-1965 MHz)
Block C: 30 MHz (1895-1910/1975-1990 MHz)
Block D: 10 MHz (1865-1870/1945-1950 MHz)
Block E: 10 MHz (1885-1890/1965-1970 MHz)
Block F: 10 MHz (1890-1895/1970-1975 MHz)
The FCC divided service areas based upon the 51 Major Trading Areas ("MTA")
and the 493 Basic Trading Areas ("BTA"), as defined by Rand McNally Commercial
Atlas and Marketing Guide. Two 30 MHz frequency blocks were designated for MTA
operation, and one 30 MHz frequency block was designated for BTA operation.
The FCC determined that providing two frequency blocks on an MTA basis will
provide economies of scale and scope necessary for the development of low-cost
PCS equipment. The remaining three 10 MHz frequency blocks are designated for
BTA operation. The FCC concluded that a combination of these frequency blocks
and BTA service areas will minimize the start-up costs likely to result from
competitive bidding, and therefore provide greater opportunity for
participation by small businesses, rural telephone companies and others.
On January 15, 1997, the FCC notified the Company that it was the successful
bidder for 26 "D" and "E" block frequency PCS licenses in 24 BTAs covering all
of Iowa, seven cities in Illinois, three cities in southern Minnesota, Omaha,
Nebraska and Sioux Falls, South Dakota. The Company bid an aggregate of
approximately $32.8 million for these PCS licenses. On January 30, 1997, the
Company filed an application for such PCS licenses with the FCC. On April 28,
1997, the FCC granted 25 of these PCS licenses to the Company. The Company
paid the FCC approximately $32 million for these PCS licenses. The Company's
application for the remaining license, an "E" block frequency PCS license
covering Rochester, Minnesota, has been challenged by a third party based on
alleged interference of the "E" block frequency with frequencies used by such
third party. Although the Company expects that the FCC will ultimately issue
the remaining PCS license to the Company, there can be no assurance that the
Company will succeed in obtaining such PCS license. The Company does not
believe that a delay in receiving, or a failure to receive, the remaining
license would have a material adverse effect on its ability to own, develop,
construct and operate its proposed PCS system.
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The Company is assessing its technological options and beginning to design
and engineer its proposed PCS system. The Company expects to begin
constructing its PCS network and offering PCS services as part of its
integrated telecommunications services over the next several years.
The infrastructure of a PCS system generally consists of digital switches,
base station transmitters and receivers, and related equipment. Additional
costs are attributable to site acquisition and preparation, and installation
services. The Company expects to begin selecting and acquiring sites for
transmitters by the end of 1997. Sites will be selected on the basis of their
coverage of targeted customers and on frequency propagation characteristics.
In many cases, the Company may be required to obtain zoning approval or other
permits. The use of existing towers and other facilities occupied by other
telecommunications service providers and utility companies is also expected to
facilitate this process. The Company has entered into long-term agreements
with its electric utility stockholders (MidAmerican and IES) and with
Wisconsin Power and Light Company, and may negotiate similar agreements with
other companies, that will enable the Company to install PCS base stations and
other equipment on such companies' towers. See "--Network Facilities." For new
sites, the Company estimates that the site acquisition process may take three
to twelve months. Once sites are acquired and the requisite governmental
approvals are obtained, the Company estimates that preparation of each site,
including grounding, ventilation and air conditioning, equipment installation,
testing and optimization, generally will require an additional two to four
months. In addition to system design and site acquisitions, the implementation
of the proposed PCS system will require frequency planning, construction and
equipment procurement, installation and testing. The Company will be required
to make significant expenditures to develop, construct and operate a PCS
system.
In order to build and operate a PCS system, the Company will be required to
select from among competing and potentially incompatible technologies. Digital
signal transmission is accomplished through the use of frequency management
technologies, or "protocols." These protocols "manage" the radio channel
either by dividing it into distinct time slots (a method known as Time
Division Multiple Access, or "TDMA") or by assigning specific coding
instructions to each packet of digitized data that comprises a signal (a
method known as Code Division Multiple Access, or "CDMA"). While the FCC has
established compatible analog signaling protocols for licensed cellular
systems in the U.S., there is no required universal digital signaling
protocol. As of the date hereof, three principal competing, incompatible
signaling protocols have been proposed by various vendors for use in PCS
systems: Global System for Mobile Communications ("GSM") (a TDMA-based
protocol), IS-136 (also a TDMA-based protocol) and CDMA. Because these
protocols are incompatible, a subscriber of a system that relies on GSM
technology, for example, will be unable to use a GSM handset when traveling in
an area served only by CDMA-based wireless operators, unless it is a dual-mode
handset that permits the subscriber to use the cellular system in that area.
For this reason, the success of each protocol will depend both on its ability
to offer enhanced wireless service and on the extent to which its users will
be able to use their handsets when roaming outside their service area. Each of
the three principal PCS signaling protocols have been adopted by at least one
PCS licensee, and each offers certain advantages and disadvantages.
The Company has not yet selected one of the digital signaling protocols for
its planned PCS network. The Company anticipates that its decision will be
based primarily on an assessment of the signaling protocols selected by PCS
licensees in the markets in which the Company wishes to offer roaming services
as well as the technical advantages and disadvantages of each protocol.
The Company intends to provide roaming service in its proposed PCS markets
by establishing suitable roaming arrangements with other PCS operators in
other markets constructing systems compatible with the digital protocol
technology to be selected by the Company. The Company cannot predict when, or
whether, it will be able to enter into such roaming agreements with local
providers. Future subscribers to the Company's proposed PCS services will not
be able to roam in markets without at least one PCS licensee using the
protocol selected by the Company unless the subscriber
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uses a dual-mode telephone that would permit the subscriber to use the
existing cellular wireless system in such other market. Such dual-mode phones
are heavier and more expensive than single-mode phones.
The Company plans to operate a fully digital PCS system. As of the date
hereof, most cellular services transmit voice and data signals over analog-
based systems, which use one continuous electronic signal that varies in
amplitude or frequency over a single radio channel. Digital systems, on the
other hand, convert voice or data signals into a stream of digits that is
compressed before transmission, enabling a single radio channel to carry
multiple simultaneous signal transmissions. The Company believes that this
enhanced capacity, along with improvements in digital protocols, will allow
the Company's proposed PCS system to offer new and enhanced services,
including:
. Secure Communications. Sophisticated encryption algorithms provide
increased call security, encouraging users to make private professional
and personal calls that they might otherwise have made only on wireline
telephones.
. Sophisticated Call Management. The Company expects that it will be able
to offer call screening, routing and forwarding, caller I.D., message
waiting, call hold, call transfer, voice activated dialing and selective
call screening, rejection and forwarding through a digital PCS system.
. Enhanced Battery Performance. While analog handsets transmit continuous
electronic signals, digital handsets transmit messages in segments,
turning the handset off between transmissions. (Because the handset is
turned on and off hundreds of times each second, this switching is not
noticed by the user.) As a result, the handset is effectively turned off
for almost 90 percent of each call, thereby extending the amount of time
a battery can be used without having to be recharged. Digital handsets
are also capable of entering into "sleep" and "hibernation" modes when
not in use, which will significantly extend the handset's battery life.
. Single Number Service. This service provides subscribers with a
convenient way to transfer all incoming calls between primary wireline
and wireless locations automatically. When a subscriber's handset is
activated, the network will route all incoming calls to the subscriber's
wireless number. When the handset is deactivated, all calls will be
directed to the subscriber's primary wireline location. Such service will
enable subscribers to direct their incoming calls to one of several
alternative locations (wireline telephone, paging system handset,
mailbox, etc.) on an ongoing basis.
. Enhanced Wireless Data Transmission. Digital networks will offer
simultaneous voice and data communications. The Company believes that, as
data transmission technologies develop, a number of potential uses for
such services will merge, including short message service, "mobile
office" applications (e.g., facsimile, electronic mail and connecting
notebook computers with computer/data networks), access to stock quote
services, transmission of text such as maps and manuals, transmission of
photographs, connections of wireless point-of-sale terminals to host
computers, monitoring of alarm systems, automation of meter reading and
monitoring of status and inventory levels of vending machines.
. Integrated Wireless/Wireline Features. The Company intends to bundle its
PCS services with its wireline products, enabling subscribers to have one
integrated voice mailbox, with message waiting indicators, for home,
office and wireless telephones.
The Company intends to offer a variety of wireless telecommunications
services, ranging from wireline enhancement services that supplement the
customer's wireline telephone (much like cellular) to wireline replacement
services that will serve as the customer's primary mode of communication. An
example of the latter service is "enhanced cordless" handsets, which operate
as cordless wireline telephones when used in or near the customer's home and
operate as wireless PCS handsets when used elsewhere.
On April 28, 1997, the FCC informed the Company that it was also the
successful bidder for four WCS licenses in the Major Economic Areas of
Milwaukee, Wisconsin, Minneapolis-St. Paul,
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Minnesota, Des Moines-Quad Cities, Iowa/Illinois and Omaha, Nebraska. The
Company filed an application for such licenses on May 12, 1997. If the Company
receives such WCS licenses, the Company intends to use the frequency blocks
covered by such licenses to provide certain fixed services, such as wireless
local loop, Internet access or meter reading. There can be no assurance that
the Company will be successful in acquiring any WCS licenses.
As the wireline and wireless markets converge, the Company believes that it
can also identify other opportunities to generate revenues from the wireless
industry on both a retail and a wholesale basis. 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.
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. The Company has entered into agreements with
five wireless companies to provide access to several of the towers controlled
by the Company.
The statements in the foregoing paragraphs about the Company's plans to own,
develop, construct and operate a PCS system are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
These plans may be revised, and the Company's actual wireless services 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; (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. See "Risk Factors--Wireless Competition"
and "Risk Factors--PCS System Implementation Risks."
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, which is now part of McLeodUSA Network
Services, is a competitive access provider which owns and operates a fiber
optic network and offers special access and private line services to 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
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 the Part I and II segments 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 of Iowa, the Company is 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.
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The Company has reached agreements with its electric utility stockholders
(MidAmerican and IES) and with Wisconsin Power and Light Company 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 companies 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 and Wisconsin for installation of the Company's wireline
and wireless 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 networks. 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.
As of March 31, 1997, the Company owned approximately 2,600 route miles of
fiber optic network and expects to construct approximately 4,900 additional
route miles of fiber optic network during the next three years. The Company
expects that approximately half 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 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 integrated 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 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.
As of March 31, 1997, marketing of the Company's integrated
telecommunications services to business customers was conducted by 265 direct
sales personnel, located at the Company's headquarters in Cedar Rapids, Iowa
and in 44 branch sales offices in Iowa, Illinois, Minnesota, Wisconsin, South
Dakota, North Dakota and Colorado. 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 integrated telecommunications services to
residential customers was conducted as of March 31, 1997 by 162 telemarketers
from the Company's Ruffalo, Cody subsidiary.
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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 uses Ruffalo, Cody's information database to identify attractive sales
opportunities and pursues those opportunities through a variety of methods,
including calls from Ruffalo, Cody's telemarketing personnel.
The Company believes that its acquisition of McLeodUSA 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 integrated telecommunications
service but expects to do so in the future (such as South Dakota, North
Dakota, 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 McLeodUSA 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 McLeodUSA
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 *McLeodUSA will create
and strengthen brand awareness in all of the Company's markets.
In 1997, the Company expects to expand its telecommunications sales and
marketing efforts primarily by opening new branch sales offices in Minnesota,
Wisconsin, South Dakota, North Dakota and Colorado, 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 Wyoming. Over the next several years, depending
on competitive and other factors, the Company also intends to begin sales and
marketing efforts in Montana, Idaho, Utah and Nebraska. 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. 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.
Sales and marketing of the Company's competitive access services are handled
as of the date hereof by a small sales staff located in Des Moines, Iowa.
These sales people work closely with the Company's network engineers to design
and market special access and private line services.
COMPETITION
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 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
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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.
The Company's plans to provide local switched services are dependent upon
obtaining favorable interconnection agreements with local exchange carriers.
In August 1996, the FCC released the Interconnection Decision implementing the
interconnection portions of the Telecommunications Act. 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. On November 12, 1996, the U.S. Supreme
Court refused to vacate the decision of the U.S. Eighth Circuit Court of
Appeals. 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. See "Risk
Factors--Regulation" and "--Regulation."
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
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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 subscribing to the
Company's integrated telecommunications services receives the lowest long
distance rate available each month from among the pricing plans of AT&T, MCI
and Sprint that generally 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.
WIRELESS COMPETITION. The wireless telecommunications industry is
experiencing significant technological change, as evidenced by the increasing
pace of improvements in the capacity and quality of digital technology,
shorter cycles for new products and enhancements, and changes in consumer
preferences and expectations. 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 wireline
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. Accordingly, the Company expects
competition in the wireless telecommunications business to be dynamic and
intense as a result of the entrance of new competitors and the development of
new technologies, products and services. The Company anticipates that in the
future there could potentially be eight wireless competitors in each of its
proposed PCS markets: two existing cellular providers, five other PCS
providers and Nextel Communications Inc., an ESMR provider. Principal cellular
providers in the Company's proposed PCS 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 proposed PCS markets
include AT&T Wireless PCS, Inc., PRIMECO Personal Communications, L.P.,
WirelessCo, d/b/a Sprint PCS, American Portable Telecommunications, Inc.,
d/b/a Aerial Communications, Inc., Western PCS Corp., Cox Communications,
Inc., DCR PCS, Inc., d/b/a Pocket Communication Corp., Wireless PCS, Inc.,
d/b/a Airadigm Communications, Inc., SprintCom, Inc., BRK Wireless Co. Inc.,
Western PCS BTA I Corp., OPCSE-Galloway Consortium, Northcoast Operating Co.
Inc., Minnesota PCS Limited Partnership, Northeast Nebraska Telephone Company,
Triad Cellular Corp., Iowa L.P. 136, Redwood Wireless Corp., Polycell
Communications Inc., CM-PCS Partners, and U S WEST.
Competition with these or other providers of wireless telecommunications
services may be intense. Many of the Company's potential wireless competitors
have substantially greater financial, technical, marketing, sales,
manufacturing and distribution resources than those of the Company and have
significantly greater experience than the Company in testing new or improved
wireless telecommunications products and services. Some competitors are
expected to market other services, such as cable television access, with their
wireless telecommunications service offerings. The Company does not offer
cable television access. In addition, several of the Company's potential
wireless competitors are operating or planning to operate, through joint
ventures and affiliation arrangements, wireless telecommunications systems
that encompass most of the United States. There can be no assurance that the
Company will be able to compete successfully in this environment or that new
technologies and products that are more commercially effective than the
Company's technologies and products will not be developed. See "Risk Factors--
Wireless Competition" and "--Wireless Services."
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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. In addition, the licensing, construction, operation, sale and
interconnection arrangements of wireless telecommunications systems are
regulated to varying degrees by the FCC. The construction and operation of
wireless systems also may be subject to state and local regulation.
The Company, through its wholly owned subsidiary McLeodUSA Telecommunications,
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 McLeodUSA Network Services,
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 and conditions. The Company believes that McLeodUSA
Network Services' 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 McLeodUSA
Network Services' 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, including, in certain
states, bonding requirements, due to its direct marketing, telemarketing and
fund-raising activities.
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
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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 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. On November 12, 1996,
the U.S Supreme Court refused to vacate the decision of 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
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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, incumbent
local exchange carriers, including the Regional Bell Operating Companies, are,
as of the date hereof, considered dominant carriers for the provision of
interstate access and interexchange 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 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. McLeodUSA
Telecommunications has obtained FCC authority to provide international
services. Services of non-dominant carriers are subject to relatively limited
regulation by the FCC. As of the date hereof, non-dominant carriers are
required to file tariffs listing the rates, terms and conditions of interstate
access 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, McLeodUSA
Telecommunications, 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.
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 interexchange 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. Long distance companies
are no longer required to file with the FCC tariffs for interstate
interexchange services and may immediately cease filing such tariffs. However,
several parties formally requested the FCC to reconsider its order, and MCI,
Sprint and The American Carriers Telephone Association have separately
appealed the FCC's order to the United States Court of Appeals for the
District of Columbia Circuit. On February 13, 1997, the United States Court of
Appeals for the District of Columbia Circuit stayed the FCC's order pending
judicial review of the appeals. If the appeals are unsuccessful and the FCC's
order becomes effective, the Company believes that the elimination of the
FCC's tariff requirement will permit the Company more rapidly to respond to
changes in the marketplace. In the absence of tariffs, however, the Company
will be required to obtain agreements with its customers regarding many of the
terms of its existing tariffs, and uncertainties regarding such new
contractual terms could increase the risk of claims against the Company from
its customers.
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On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the preservation and advancement of
universal telephone service (the "Universal Service Order"). The Universal
Service Order affirmed the policy principles for universal telephone service
set forth in the Telecommunications Act, including quality service, affordable
rates, access to advanced services, access in rural and high-cost areas,
equitable and non-discriminatory contributions, specific and predictable
support mechanisms, and access to advanced telecommunications services for
schools, health care providers and libraries. The Universal Service Order
added "competitive neutrality" to the FCC's universal service principles by
providing that universal service support mechanisms and rules should not
unfairly advantage or disadvantage one provider over another, nor unfairly
favor or disfavor one technology over another. The Universal Service Order
also requires all telecommunications carriers providing interstate
telecommunications services, including the Company, to contribute to universal
service support. Such contributions will be assessed based on interstate and
international end-user telecommunications revenues. The Company does not
expect the Universal Service Order to have a material adverse effect on the
Company.
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 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 were consolidated into proceedings 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
temporary 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, pending a decision on the merits. 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 do so. All other provisions of the
Interconnection Decision remain in effect pending resolution of the appeal on
the merits.
In connection with the Initial Interconnection Decisions, 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
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flexibility as the number of interconnection agreements and competitors
increases. In a related proceeding, the FCC has announced that it is adopting
new pricing rules that restructure local exchange carrier switched transport
rates in order to facilitate competition for switched access. In addition, on
May 7, 1997, the FCC adopted rules that will require independent local
exchange carriers and competitive local exchange carriers to substantially
decrease the prices they charge for switched and special access, and that will
change how access charges are calculated. These changes are intended to reduce
access charges paid by interexchange carriers, including the Company, to local
exchange companies and shift certain usage-based charges to flat-rate, monthly
per-line charges. The FCC has also requested comments on whether to impose
usage-sensitive charges on Internet service providers that are presently
exempt from access charges.
In January 1997, U S WEST proposed to implement certain interconnection
surcharges in each of the states in its service region. On February 20, 1997,
the Company and several other parties filed a petition with the FCC objecting
to U S WEST's proposal. The petition was based on Section 252(d) of the
Telecommunications Act, which governs the pricing of interconnection and
network elements. The Company believes that U S WEST's proposal is an unlawful
attempt to recover costs associated with the upgrading of U S WEST's network,
in violation of Section 252 of the Telecommunications Act. U S WEST filed an
opposition to the Company's petition with the FCC on March 3, 1997. The matter
remains pending before the FCC.
As of the date hereof, the Company does not offer PCS or cellular services.
On January 15, 1997, the FCC notified the Company that it was the successful
bidder for 26 "D" and "E" block frequency PCS licenses covering areas of Iowa,
Illinois, Minnesota, Nebraska and South Dakota. The Company filed an
application for such PCS licenses on January 30, 1997. On April 28, 1997, the
FCC awarded 25 of these PCS licenses to the Company. The Company's application
for the remaining license, an "E" block frequency PCS license covering
Rochester, Minnesota, has been challenged by a third party based on alleged
interference of the "E" block frequency with frequencies used by such third
party. Although the Company expects that the FCC will ultimately issue the
remaining PCS license to the Company, there can be no assurance that the
Company will succeed in obtaining such PCS license.
On April 28, 1997, the FCC informed the Company that it was also the
successful bidder for four WCS licenses in the Major Economic Areas of
Milwaukee, Wisconsin, Minneapolis-St. Paul, Minnesota, Des Moines-Quad Cities,
Iowa/Illinois and Omaha, Nebraska. The Company filed an application for such
licenses on May 12, 1997. If the Company receives such WCS licenses, the
Company intends to use the frequency blocks covered by such licenses to
provide certain fixed services such as wireless local loop, Internet access,
or meter reading. There can be no assurance that the Company will be
successful in acquiring any WCS licenses.
In general, applications for FCC radio licenses may be conditioned or
denied, and 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, and has complied with the
FCC's ownership, bidding and build-out rules.
All PCS licenses will be granted for a ten-year period, at the end of which,
absent prior revocation or a violation of the FCC's rules by the licensee,
they will be renewed. All PCS licensees must construct facilities that offer
coverage to one-third of the population of their service area within five
years of their initial license grants and to two-thirds of the population
within ten years. Licensees that fail to meet the coverage requirements may be
subject to forfeiture of the license.
The Communications Act requires the FCC's prior approval of the assignment
or transfer of control of a PCS license. In addition, the FCC has established
transfer disclosure requirements that require licensees who transfer control
of or assign a PCS license within the first three years to file associated
contracts for sale, option agreements, management agreements or other
documents disclosing the total consideration that the applicant would receive
in return for the transfer or assignment of its
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license. Non-controlling interests in an entity that holds a PCS license or
PCS system generally may be bought or sold by U.S. companies or individuals
without prior FCC approval.
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 company 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 succeeds in acquiring PCS licenses, 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. carrier
or subject the U.S. carrier to dominant carrier regulation on one or more
international routes. The Company's subsidiary, McLeodUSA Telecommunications,
holds FCC authority to provide international services, and therefore is also
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 Communications 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. As of the date hereof, the Company has no knowledge of
any alien ownership or affiliation with foreign telecommunications carriers in
violation of the Communications Act or the FCC's rules.
Following the grant of a PCS license, existing licensees that operate
certain fixed microwave systems within the PCS license area retain the right
to continue to operate their systems until 2005. To secure a sufficient amount
of unencumbered spectrum to operate a PCS system efficiently, the Company may
need to relocate many of these incumbent licensees. In an effort to balance
the competing interests of existing microwave users and newly authorized PCS
licensees, the FCC has adopted a transition plan to relocate such microwave
operators to other spectrum blocks. This transition plan allows most microwave
users to operate in the PCS spectrum for a one-year voluntary negotiation
period and an additional one-year mandatory negotiation period. For public
safety entities dedicating a majority of their system communications for
police, fire or emergency medical services operations, the voluntary
negotiation period is three years. Parties unable to reach agreement within
these time periods may refer the matter to the FCC for resolution, but the
incumbent microwave user is permitted to continue its operations until final
FCC resolution of the matter. In connection with its proposed PCS system, the
Company estimates that it may be required to relocate approximately 50
microwave links operated by approximately 19 different microwave licensees.
Wireless systems are also subject to certain Federal Aviation Administration
regulations respecting the location, lighting and construction of transmitter
towers and antennas and may be subject to regulation under the National
Environmental Policy Act and the environmental regulations of the FCC.
Wireless providers also must satisfy a variety of FCC requirements relating to
technical and reporting matters. One such requirement is the coordination of
proposed frequency usage between adjacent systems. In addition, the height and
power of base station transmitting facilities and the type of signals they
emit must fall within specified parameters.
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 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
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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. McLeodUSA Telecommunications, 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 McLeodUSA Telecommunications, 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 is authorized to provide
local exchange and long distance services through resale in Colorado,
Illinois, Iowa, Minnesota, Wisconsin, Wyoming, Montana, South Dakota, North
Dakota and Idaho. The Company also is authorized to offer long distance
service in 45 states in the continental United States. The Company has
obtained 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, some states where the legality of such competition
was previously uncertain have not yet completed regulatory or statutory
actions to comply 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, Wyoming 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.
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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 appealed two of these decisions by
the Iowa Utilities Board. On January 28, 1997, the Iowa District Court hearing
the appeals affirmed the decision of the Iowa Utilities Board in one of the
proceedings. U S WEST subsequently withdrew its appeal in the other matter.
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 Communications Act preempts state or local regulation of the entry of,
or the rates charged by, any commercial or private radio service provider.
Notwithstanding such preemption, a state may petition the FCC for authority to
begin regulating or to continue regulating commercial radio services rates.
Petitioners must demonstrate that existing market conditions cannot protect
consumers from unreasonable and unjust rates or that the service is a
replacement for traditional wireline telephone service for a substantial
portion of the wireline service within the state. As of the date hereof, the
states in which the Company plans to provide PCS service have not sought to
regulate such matters.
States are not, however, prohibited from regulating other terms and
conditions of commercial mobile radio service, such as quality, billing
procedures and consumer protection standards. In addition, the siting and
construction of radio transmitter towers, antennas and equipment shelters are
often subject to state or local zoning, land use and other regulations. Under
the Telecommunications Act, states may not restrict cell siting or
modification based on the environmental effects of radio frequency emissions
if the emissions meet FCC standards.
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 March 31, 1997, the Company employed a total of 2,104 full-time
employees and 371 part-time employees. The Company believes that its future
success will depend on its continued ability to
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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. In August 1996, the Company
purchased approximately 194 acres of farm land in southern Cedar Rapids, Iowa
on which the Company has constructed a one-story, 160,000 square foot building
that serves as the Company's new headquarters. The Company plans to construct
an additional office building as well as other buildings that will house the
Company's telephone switching, computer and maintenance equipment on this
property. The total cost of the construction of the Company's new corporate
headquarters and associated buildings is estimated to be approximately $37.1
million. The Company also maintains 55,000 square feet of office space at its
former headquarters in Cedar Rapids, Iowa, under a lease expiring in March
2001. 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 is dependent on the Regional Bell Operating Companies for
provision of its local and certain of its long distance services. As of the
date hereof, U S WEST and Ameritech are 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, as of the date hereof,
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
served by the Company.
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 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
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the Company's challenges include provisions of the laws of Iowa, Minnesota,
Nebraska, South Dakota, North Dakota, Idaho 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 entered into 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
and affirmed by the Iowa District Court for Polk County on February 21, 1997.
In Minnesota, U S WEST's initial filing was rejected on procedural grounds
by the Public Utilities Commission. 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. On December 23, 1996, an
administrative law judge ruled that U S WEST must continue to offer Centrex
service in Minnesota. U S WEST filed exceptions to this ruling. The Minnesota
Public Utilities Commission denied U S WEST's exceptions on February 20, 1997.
U S WEST has filed a petition for rehearing with the Minnesota Public
Utilities Commission. As of the date hereof, the Minnesota Public Utilities
Commission had not yet ruled on the petition for a rehearing.
In South Dakota, the Public Utilities Commission rejected the U S WEST
Centrex Action on August 22, 1996. U S WEST appealed the unfavorable decision
of the Public Utilities Commission in South Dakota state court. On December 2,
1996, the South Dakota state court hearing the appeal affirmed the decision of
the Public Utilities Commission.
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. U S WEST appealed the unfavorable
decision by the Public Service Commission in North Dakota state court. On
January 24, 1997, the North Dakota state court hearing the appeal affirmed the
decision of the Public Service Commission.
In Nebraska, on November 25, 1996, the Public Service Commission rejected
complaints objecting to the U S WEST Centrex Action. On February 3, 1997, the
Company and other parties appealed the order of the Public Service Commission
to the Nebraska Court of Appeals. The appeal remains pending.
In Idaho, on November 14, 1996, the Public Utilities Commission rejected
complaints by AT&T and MCI objecting to the U S WEST Centrex Action. On
January 31, 1997, the Company filed its own complaint with the Idaho Public
Utilities Commission. As of the date hereof, the Idaho Public Utilities
Commission has not yet ruled on the Company's complaint.
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In Utah, 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 on September 26, 1996. Upon rehearing, however, the Utah Public Service
Commission issued an order on April 29, 1997 including restrictions on Centrex
resale. The Company is preparing to appeal such order.
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
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 Colorado, on
September 3, 1996, an administrative law judge issued a recommendation that
the U S WEST Centrex Action be rejected. On December 20, 1996, the Colorado
Public Utilities Commission rejected U S WEST's exceptions to the
recommendation. In Wyoming, U S WEST's filing was rejected by the Public
Service Commission on September 6, 1996. On March 21, 1997, the Wyoming Public
Service Commission rejected U S WEST's petition for a rehearing of the matter.
U S WEST appealed the decision of the Public Service Commission to Wyoming
state court on April 2, 1997. The appeal remains pending. 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 Montana, on March 6, 1997, the Public Service Commission
approved the U S WEST Centrex Action. On April 4, 1997, AT&T filed an
application for a rehearing with the Montana Public Service Commission. As of
the date hereof, the Montana Public Service Commission had not yet ruled on
the application for rehearing.
The Company anticipates that U S WEST will continue to appeal unfavorable
decisions by public utilities commissions with respect to the U S WEST Centrex
Action.
In addition to the U S WEST Centrex Action, U S WEST has taken other
measures that may impede the Company's ability to use Centrex service to
provide its competitive local exchange services. In Colorado, U S WEST filed
new tariffs in July 1996 that, as interpreted by U S WEST, would prohibit the
Company from consolidating telephone lines of separate customers into leased
common blocks in U S WEST's central office switches, thereby significantly
increasing the cost of serving customers in Colorado through resale of Centrex
services. The Company filed a complaint with the Colorado Public Utilities
Commission on February 12, 1997 alleging that U S WEST's tariffs, as
interpreted by U S WEST, unlawfully create a barrier to the Company's ability
to compete in Colorado. The Company's complaint was suspended to allow the
Colorado Public Utilities Commission to rule on the same issues in a U S WEST
tariff proceeding, which ruling is expected in June 1997.
In January 1997, U S WEST proposed to implement certain interconnection
surcharges in each of the states in its service region. On February 20, 1997,
the Company and several other parties filed a petition with the FCC objecting
to U S WEST's proposal. The petition was based on Section 252(d) of the
Telecommunications Act, which governs the pricing of interconnection and
network elements. The Company believes that U S WEST's proposal is an unlawful
attempt to recover costs associated with the upgrading of U S WEST's network,
in violation of Section 252 of the Telecommunications Act. U S WEST filed an
opposition to the Company's petition with the FCC on March 3, 1997. The matter
remains pending before the FCC.
There can be no assurance that the Company will ultimately succeed in its
legal challenges to the U S WEST Centrex Action or other actions by U S WEST
that have the effect of preventing or deterring the Company from using Centrex
service, or that these actions by U S WEST, or similar actions by other
Regional Bell Operating Companies, will not have a material adverse effect on
the Company. In any jurisdiction where U S WEST prevails, the Company's
ability to offer integrated telecommunications services would be impaired,
which could have a material adverse effect on the Company. See "Risk Factors--
Dependence on Regional Bell Operating Companies; U S WEST Centrex Action" and
"--Competition."
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If the U S WEST Centrex Action or other actions by U S WEST have the effect
of preventing or deterring the Company from using Centrex service in any
jurisdiction and the Company is consequently not able to obtain Centrex access
on acceptable economic terms or at all in a state where the Company is doing
business or plans to do business, the Company intends to evaluate other U S
WEST services that could potentially be purchased and resold in such
jurisdiction to allow the Company to provide some form of integrated local and
long distance services until the Company can obtain access to unbundled
elements pursuant to interconnection agreements. There can be no assurance
that the Company would be able to identify, purchase and resell any such U S
WEST service or ultimately obtain access to such unbundled elements.
The Company also anticipates that U S WEST will seek various legislative
initiatives in states within the Company's target market area in an effort to
reduce state regulatory oversight over its rates and operations. There can be
no assurance that U S WEST will not succeed in such efforts or that any such
state legislative initiatives, if adopted, will not have a material adverse
effect on the Company.
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 had imposed a limit of processing one
new local service order of the Company per hour for each U S WEST central
office, creating a significant backlog of local service orders of the Company.
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.
On October 21, 1996, in accordance with the Iowa Utilities Board's order, the
Company and U S WEST jointly filed supplemental evidence regarding a potential
modification of order processing practices that would increase U S WEST's rate
of processing service orders. However, since implementing the new process, U S
WEST has not significantly increased its overall order processing rate. On
December 23, 1996, the Company filed a report with the Iowa Utilities Board
requesting further direction. On February 14, 1997, the Iowa Utilities Board
clarified that U S WEST must eliminate numerical limitations on the Company's
residential and business orders. On April 15, 1997, U S WEST agreed to
eliminate the backlog of the Company's local service orders by May 19, 1997
and to process the Company's service orders within a standard five-day period.
U S WEST also agreed to waive the installation fee for those service orders
not processed within five days until the backlog is eliminated. There can be
no assurance, however, that the decision of or any further action by 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. 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 and Stockholders'
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 March 31, 1997.
<TABLE>
<CAPTION>
TERM AS
NAME AGE POSITION(S) WITH COMPANY DIRECTOR EXPIRES
- ---- --- ------------------------ ----------------
<S> <C> <C> <C>
Clark E. McLeod......... 50 Chairman, Chief Executive Officer and 2000
Director
Stephen C. Gray......... 38 President, Chief Operating Officer 1999
and Director
Blake O. Fisher, Jr..... 53 Chief Financial Officer, Executive 2000
Vice President, Corporate
Administration, Treasurer and
Director
Kirk E. Kaalberg........ 37 Executive Vice President, Network
Services
Stephen K. Brandenburg.. 44 Executive Vice President and Chief
Information Officer
David M. Boatner........ 48 Executive Vice President, Business
Services
Albert P. Ruffalo....... 50 Executive Vice President, Consumer
Services
Arthur L.
Christoffersen......... 50 Executive Vice President, Publishing
Services
Casey D. Mahon.......... 45 Senior Vice President, General
Counsel and Secretary
Russell E. 1998
Christiansen(1)........ 61 Director
Thomas M. 1998
Collins(1)(2).......... 69 Director
Paul D. Rhines(2)....... 53 Director 1999
Lee Liu(2).............. 64 Director 2000
</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.
See "--Investor Agreement and Stockholders' Agreement."
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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. Mr. Gray is one of Mr. McLeod's nominees on the Board. 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.
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. See "--Investor Agreement and Stockholders' Agreement."
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
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
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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 McLeodUSA Publishing. Mr. Christoffersen has served
as Chairman, President and Chief Executive Officer of McLeodUSA Publishing
since November 1990, the date Mr. Christoffersen and other investors acquired
McLeodUSA 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 on the
Board. Since July 1996, Mr. Christiansen has served as Chairman of the Board
of MidAmerican. From June 1995 to July 1996, he was 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 1985 to
August 1990. He is also a director of APAC TeleServices, Inc., a telemarketing
company.
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 to the Board. He is
a founder and a general partner of R.W. Allsop & Associates, L.P. and R.W.
Allsop & Associates II Limited Partnership, two venture capital limited
partnerships established in Cedar Rapids, Iowa, in 1981 and 1983,
respectively. He is also a founder and general partner of MARK Venture
Partners L.P., a limited partnership which is the general partner of Allsop, a
venture capital limited partnership established in Cedar Rapids, Iowa in 1987.
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.
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<PAGE>
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 Chief Executive
Officer of IES since July 1991 and as President from July 1991 to November
1996. 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. See "--Investor
Agreement and Stockholders' Agreement."
INVESTOR AGREEMENT AND STOCKHOLDERS' 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, until June 1999, 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.
IES' nominee on the Board is Lee Liu, MidAmerican's nominee on the Board is
Russell E. Christiansen, and Mr. McLeod's nominees on the Board are himself,
Stephen C. Gray and Blake O. Fisher, Jr. The Investor Agreement also provides
that, until June 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 December 1996, the Board consented to (i) the transfer by
Clark and Mary McLeod of (A) an aggregate of 160,000 shares of Class A Common
Stock as a gift to the McLeod Charitable Foundation, Inc., an Iowa non-profit
corporation controlled by Mr. and Mrs. McLeod, and (B) an aggregate of 6,250
shares of Class A Common Stock as gifts to certain individuals, and (ii) any
future pledge of all or a portion of the Class A Common Stock held by Mr. and
Mrs. McLeod as collateral for one or more personal loan transactions. In March
1997, the Board consented to the transfers of 300,000 shares of Class B Common
Stock from IES Investments Inc. to the IES Industries Charitable Foundation,
an Iowa non-profit corporation, and 300,000 shares of Class B Common Stock
from MWR Investments Inc. to the MidAmerican Energy Foundation, an Iowa non-
profit corporation. The Company has been advised that these non-profit
corporations intend to convert the shares of Class B Common Stock into shares
of Class A Common Stock upon completion of the transfers. In May 1997, the
Board consented to the transfer by Mr. and Mrs. McLeod of up to an aggregate
of 500,000 shares of Class A Common Stock to two charitable unitrusts
controlled by Mr. and Mrs. McLeod.
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
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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.
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 MidAmerican (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.
In June 1997, the Company, the Investor Stockholders and certain
shareholders of CCI (collectively, the "CCI Shareholders") entered into a
Stockholders' Agreement (the "Stockholders' Agreement") that will become
effective upon consummation of the acquisition of CCI. Pursuant to the
Stockholders' Agreement, which will amend and restate the Investor Agreement
among the parties thereto, each Investor Stockholder and the CCI Shareholders,
for so long as each such party owns at least 10% of the outstanding Class A
Common Stock, shall, for a period of three years after the effective date of
the Stockholders' Agreement, vote such party's shares and take all action
within its power to (i) establish the size of the Board at up to eleven
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 Class A Common
Stock); (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
Class A Common Stock); (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 and Mary McLeod collectively own at least 10% of the Class A
Common Stock); (v) cause Richard A. Lumpkin to be elected to the Board (for so
long as the CCI Shareholders collectively own at least 10% of the Class A
Common Stock); and (vi) cause to be elected to the Board four non-employee
directors nominated by the Board. The Stockholders' Agreement also provides
that, until the earlier of the first anniversary of the effective date of the
Stockholders' Agreement or March 31, 1999, and subject to certain exceptions,
no Investor Stockholder or CCI Shareholder will sell or otherwise dispose of
any equity securities of the Company without the consent of the Board. In
addition, the Stockholders' Agreement provides that if the Company grants any
Investor Stockholder or CCI Shareholder the opportunity to register equity
securities of the Company under the Securities Act, the Company will grant all
other Investor Stockholders and CCI Shareholders the same opportunity to
register their pro rata portion of the Company equity securities owned by
them. The other operative provisions of the Investor Agreement remain
unchanged in the Stockholders' Agreement.
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
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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 the
Company's management 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.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to March 1996, there was no Compensation Committee and the entire
Board of Directors participated in deliberations regarding executive officer
compensation. During such period, Messrs. McLeod, Gray and Cram were directors
and executive officers of the Company. During the fiscal year ended December
31, 1996, no member of the Board of Directors 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.
In November 1996, in connection with the Company's public offering of shares
of Class A Common Stock, Clark E. McLeod, Mary E. McLeod, MidAmerican and IES
purchased 53,572, 53,571, 357,143 and 357,143 shares of Class A Common Stock,
respectively, directly from the Company at the public offering price of $28.00
per share for $1,500,016, $1,499,988, $10,000,004 and $10,000,004,
respectively. The Company was advised that such shares were purchased for
investment purposes. MidAmerican and IES are significant stockholders of the
Company. Lee Liu, a director of the Company, is Chairman 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. Russell E. Christiansen, a director of the Company, is Chairman of the
Board of MidAmerican.
On September 20, 1996, the Company acquired McLeodUSA 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
McLeodUSA Publishing as part of an incentive plan. At the time of the
acquisition, McLeodUSA Publishing 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 corporation 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, Casey D. Mahon, an
executive officer of the Company, and IES, a significant stockholder of the
Company, were shareholders of McLeodUSA Publishing. The Company paid
$18,571,982, $1,195,313, $105,187, $1,459,563, $250,219 and $1,000,875 to Mr.
and Mrs. McLeod, the McLeod Charitable Foundation, Inc., Aaron, Holly, Frank
and Jane McLeod, Mr. Rhines, Ms. Mahon and IES, respectively, in exchange for
the shares of McLeodUSA Publishing common stock held by them. Messrs. McLeod
and Rhines served as directors of McLeodUSA Publishing. A Special Committee of
the Board, consisting of disinterested directors, approved the acquisition of
McLeodUSA Publishing as fair to, and in the best interests of, the
stockholders of the Company.
Prior to September 20, 1996, the Company purchased advertising space in
telephone directories published by McLeodUSA Publishing. McLeodUSA Publishing
also purchased telecommunications service from the Company. The Company paid
McLeodUSA Publishing $11,000, $54,500 and $45,925
91
<PAGE>
in 1994, 1995 and 1996, respectively, for advertising fees and charged
McLeodUSA Publishing $103,112 and $155,025 for telecommunications services in
1995 and 1996, respectively.
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 associated buildings. 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.
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 56,177 shares of Class A
Common Stock were 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. Clark E. McLeod, a
director and executive officer of the Company, and Mary E. McLeod, a
significant stockholder of the Company, owned 110,454 shares of Ruffalo, Cody
common stock, which were exchanged for 72,873 shares of Class A Common Stock.
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 194,476 shares of Class A Common Stock.
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.
The Company and McLeodUSA Network Services (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. 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 (the "Guarantee") certain portions of the Credit
Facility, for which IES received (i) fees from the Company equal to $37,500,
$60,000 and $28,000, respectively, for the years ended December 31, 1994, 1995
and 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 Guarantee vested quarterly so long as IES remained exposed
under the Guarantee. At the time the Credit Facility and Guarantee were
terminated in June 1996, options to purchase an aggregate of 1,300,688 shares
of Class B Common Stock had vested.
In 1995 and 1996, the Company paid 2060 Partnership, L.P. $377,640 and
$565,261, respectively, for the rental of the Company's headquarters office
and parking spaces in Cedar Rapids, Iowa. 2001 Development Company ("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.
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<PAGE>
During 1994, 1995 and 1996, the Company paid $79,114, $147,313 and $179,996,
respectively, to Shuttleworth & Ingersoll, P.C., a law firm in Cedar Rapids,
Iowa, for legal services rendered. The Company has retained the firm in 1997.
Thomas M. Collins is Chairman and a stockholder of Shuttleworth & Ingersoll,
P.C.
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.
Except for the stock issued in connection with the Company's July 1996
acquisition of Ruffalo, Cody, all of the stock issuances described above were
for cash consideration.
For a description of certain other transactions, see "Certain Transactions."
EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the cash and
non-cash compensation paid or accrued during the periods indicated to the
Chief Executive Officer and the four other most highly compensated officers of
the Company whose combined salary and bonus exceeded $100,000 during the
fiscal year ended December 31, 1996 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
ANNUAL ------------
COMPENSATION SECURITIES
---------------- UNDERLYING ALL OTHER
YEAR(1) SALARY BONUS OPTIONS COMPENSATION(2)
------- -------- ------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Clark E. McLeod........... 1996 $156,269 $72,422 135,500 $48,200
Chairman and Chief 1995 142,803 74,902 75,000 1,500
Executive Officer
Stephen C. Gray........... 1996 156,269 72,422 105,500 3,200
President and Chief 1995 142,807 74,902 131,250 1,500
Operating Officer
Kirk E. Kaalberg.......... 1996 107,567 55,923 79,250 3,200
Executive Vice President, 1995 101,528 56,177 75,000 1,463
Network Services
James L. Cram............. 1996 112,807 53,299 79,250 3,200
Chief Accounting 1995 102,884 56,177 84,375 1,500
Officer(3)
David M. Boatner.......... 1996 84,807 94,907 248,000 --
Executive Vice President,
Business Services
</TABLE>
- --------
(1) Under rules promulgated by the Commission, since the Company was not a
reporting company during the three immediately preceding fiscal years,
information with respect to the most recent completed fiscal year is noted
in the Summary Compensation Table as well as information that was
previously required to be reported to the Commission.
(2) All other compensation represents matching contributions made by the
Company to the McLeod, Inc. 401(k) plan on behalf of the Named Executive
Officers, and, in the case of Clark E. McLeod, payment by the Company of
the $45,000 filing fee to the FTC for a notification filed by Mr. and Mrs.
McLeod pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended, in connection with their November 1996 purchase of Class
A Common Stock. See "Certain Transactions."
(3) Mr. Cram retired from the Company on January 31, 1997.
93
<PAGE>
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, 1996.
OPTION GRANTS DURING 1996
<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......... 112,500(3) 3.2% $ 2.93 January 25, 1996 January 25, 2001 $ 91,173 $ 201,468
13,636(4) 0.4 22.00 June 10, 1996 June 10, 2001 82,882 183,148
9,364(4) 0.3 20.00 June 10, 1996 June 10, 2006 117,779 298,476
Stephen C. Gray......... 82,500(3) 2.4 2.67 January 25, 1996 January 25, 2003 89,562 208,718
23,000(4) 0.7 20.00 June 10, 1996 June 10, 2006 289,292 733,122
Kirk E. Kaalberg........ 56,250(3) 1.6 2.67 January 25, 1996 January 25, 2003 61,065 142,308
23,000(4) 0.7 20.00 June 10, 1996 June 10, 2006 289,292 733,122
James L. Cram........... 56,250(3) 1.6 2.67 January 25, 1996 January 25, 2003 61,065 142,308
23,000(4) 0.7 20.00 June 10, 1996 June 10, 2006 289,292 733,122
David M. Boatner........ 225,000(3) 6.4 2.67 February 22, 1996 February 22, 2003 244,260 569,230
23,000(4) 0.7 20.00 June 10, 1996 June 10, 2006 289,292 733,122
</TABLE>
- --------
(1) All options are exercisable for shares of Class A Common Stock. Options
granted pursuant to the Company's 1993 Incentive Stock Option Plan (the
"1993 Plan") 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 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.
The options granted pursuant to the Company's 1996 Employee Stock Option
Plan (the "1996 Plan") to the Named Executive Officers will become
exercisable 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,
with an additional one-third becoming exercisable in each of the two
subsequent seven-month periods, except for the options granted to Clark E.
McLeod, the Company's Chairman and Chief Executive Officer. The options
granted to Mr. McLeod pursuant to the 1996 Plan will become exercisable as
follows: (i) with respect to options to purchase 13,636 shares, 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 and (ii) with
respect to options to purchase 9,364 shares, 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 Agreements."
(2) Based on exercise price.
(3) Granted pursuant to the 1993 Plan.
(4) Granted pursuant to the 1996 Plan.
94
<PAGE>
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 1996,
the number of securities underlying unexercised options at the 1996 year-end
and the year-end value of all unexercised in-the-money options held by such
individuals.
OPTION EXERCISES DURING 1996
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL YEAR- IN-THE-MONEY OPTIONS
SHARES END AT FISCAL YEAR-END(2)
ACQUIRED ON VALUE ------------------------- -------------------------
EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Clark E. McLeod......... -- $ -- 323,237 239,561 $ 8,036,810 $5,113,401
Stephen C. Gray......... 33,101 919,151 523,775 272,374 13,101,011 5,996,763
Kirk E. Kaalberg........ 36,316 1,101,243 179,310 201,124 4,442,475 4,312,648
James L. Cram........... 18,000 503,700 299,144 187,529 7,437,460 4,003,547
David M. Boatner........ -- -- -- 248,000 -- 5,263,250
</TABLE>
- --------
(1) Represents the difference between the exercise price and the closing price
of the Class A Common Stock on The Nasdaq National Market upon the date of
exercise.
(2) Represents the difference between the exercise price and the closing price
of the Class A Common Stock on The Nasdaq National Market at December 31,
1996.
MANAGEMENT AGREEMENTS
Employment, Confidentiality and Non-Competition Agreements. The Company has
employment, confidentiality and non-competition agreements with 64 members of
senior management, including the Named Executive Officers, pursuant to which
the senior management employees 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 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 874,000 shares of Class A Common Stock at
exercise prices ranging from $20.00 to $28.50 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 Stock granted to Clark E. McLeod as
partial consideration for the execution of an employment, confidentiality and
non-competition agreement vest (i) with respect to options to purchase 13,636
shares of Class A Common Stock (which are intended to qualify as incentive
stock options under the Code), 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, 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.
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<PAGE>
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 change-of-control agreements),
(i) the executive will be entitled to a lump sum payment equal to 24 times the
executive's "average monthly compensation" (as defined in the change-of-
control agreements) 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.
INCENTIVE COMPENSATION PLAN
On September 20, 1996, in connection with the Company's acquisition of
McLeodUSA Publishing, the Company adopted the McLeod, Inc. Incentive Plan (the
"Incentive Plan"). The 155 employees of McLeodUSA Publishing who held non-
vested options (the "Non-Vested Options") to purchase shares of McLeodUSA
Publishing common stock under its incentive stock option plan on September 20,
1996 (the "Participants") are eligible to participate in the Incentive Plan.
Under the Incentive Plan, each Participant received a unit of participation (a
"Unit") for each Non-Vested Option held by such Participant. On September 20,
1996, an aggregate of 210,825 Units were granted to the Participants under the
Incentive Plan and each Unit had a value of $12.75 less the option exercise
price of the corresponding 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 McLeodUSA Publishing's operating
income. Units vest on January 1 of the year following the year in which the
corresponding 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.
96
<PAGE>
CERTAIN TRANSACTIONS
In April 1997, the Company (through its wholly owned subsidiary Digital
Communications), Clark E. McLeod, Stephen C. Gray and Blake O. Fisher, Jr.
jointly purchased a jet aircraft for an aggregate of approximately $2.25
million, of which Digital Communications paid approximately $900,000, Mr.
McLeod paid approximately $900,000, Mr. Gray paid approximately $225,000 and
Mr. Fisher paid approximately $225,000. Digital Communications and Messrs.
McLeod, Gray and Fisher have entered into a Joint Ownership Agreement pursuant
to which the parties have agreed to share the operational expenses of the
aircraft in proportion to their respective ownership interest in the aircraft
(40% by Digital Communications, 40% by Mr. McLeod, 10% by Mr. Gray and 10% by
Mr. Fisher). Mr. McLeod is a director, executive officer and significant
stockholder of the Company. Messrs. Gray and Fisher are directors and
executive officers of the Company.
On January 30, 1997, the Company acquired Digital Communications in a stock
transaction valued at approximately $2.3 million, based on the average price
of the Class A Common Stock on The Nasdaq National Market at the time of the
transaction. Clark E. McLeod and Mary E. McLeod, a significant stockholder of
the Company, owned 280,000 shares (representing approximately 58%) of Digital
Communications' common stock, which were exchanged for 49,250 shares of Class
A Common Stock. Mr. McLeod served as a director of Digital Communications. A
Special Committee of the Board, consisting of disinterested directors,
approved the acquisition of Digital Communications as fair to, and in the best
interests of, the stockholders of the Company.
Prior to January 30, 1997, the Company rented facilities and equipment and
purchased maintenance and installation services from Digital Communications
and paid Digital Communications commission on local and long distance sales to
customers of Digital Communications. The Company paid Digital Communications
$83,591, $94,871 and $95,615 in 1994, 1995 and 1996, respectively.
In connection with their November 1996 purchase of Class A Common Stock,
Clark E. and Mary E. McLeod filed a notification with the FTC 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.
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 provides certain 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 $51,664, $38,411 and
$0 for these services in 1994, 1995 and 1996, respectively. Since June 1996,
the Company has rented office space from McLeod Educational Group. The Company
paid McLeod Educational Group an aggregate of approximately $47,283 from June
1996 through December 1996 for this space. Clark E. McLeod and Mary E. McLeod
own over 99% of the stock of McLeod Educational Group.
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. MidAmerican purchased 3,529,414 shares of Class B Common Stock of the
Company in June 1995 at an aggregate price of $8 million.
97
<PAGE>
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 (a rate of 6.65% per
annum as of the date hereof). 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.
In February 1994 and June 1995, the Company sold 511,365 and 64,163 shares,
respectively, of Class A Common Stock to Clark E. McLeod for $750,002 and
$145,435, respectively. In February 1994 and June 1995, the Company sold
511,362 and 64,159 shares, respectively, of Class A Common Stock to Mary E.
McLeod for $749,997 and $145,427, respectively.
In February 1994, the Company sold 15,000 shares of Class A Common Stock to
Stephen C. Gray and Sally W. Gray as tenants in common, for $22,000. 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. Sally W. Gray, Stephen Samuel Gray and Mr. Wham are Mr.
Gray's wife, son and father-in-law, respectively.
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. Ms. Mahon
is an executive officer of the Company. 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.
Except for the stock issued in connection with the Company's April 1995
acquisition of MWR and the January 1997 acquisition of Digital Communications,
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.
For a description of certain other transactions, see "Management--
Compensation Committee Interlocks and Insider Participation."
98
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Class A Common Stock as of June 26,
1997 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 and (iv) all directors and
executive officers of the Company as a group.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP(1)(2)
-----------------------------
NUMBER
NAME OF BENEFICIAL OWNER OF SHARES PERCENT
- ------------------------ ---------------- ------------
<S> <C> <C>
IES Investments Inc.(3)......................... 10,278,288 19.0%
Clark E. McLeod(4).............................. 9,249,126 17.5
MWR Investments Inc.(5)......................... 8,262,615 15.7
Mary E. McLeod(6)............................... 4,571,530 8.7
Putnam Investments, Inc.(7)..................... 3,938,544 7.5
Allsop Venture Partners III, L.P.(8)............ 3,888,393 7.4
Blake O. Fisher, Jr.(9)......................... 110,471 *
Russell E. Christiansen(10)..................... 23,438 *
Thomas M. Collins(11)........................... 248,526 *
Paul D. Rhines(12).............................. 3,944,645 7.5
Lee Liu(13)..................................... 56,252 *
James L. Cram(14)............................... 377,753 *
Stephen C. Gray(15)............................. 646,696 1.2
Kirk E. Kaalberg(16)............................ 236,811 *
David M. Boatner(17)............................ 61,250 *
Directors and executive officers as a group (14
persons)(18)................................... 15,326,747 28.3%
</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 also is 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 June 26, 1997 and those
shares of Class A Common Stock that may be acquired by such stockholder
within 60 days from June 26, 1997. 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 and principal stockholders. Unless otherwise indicated 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) IES Investments Inc. is a wholly owned indirect subsidiary of IES. The
address of IES is 200 First 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 and
Light Company, and with Interstate Power Company, which merger is subject
to certain regulatory and other approvals.
(4) Includes 4,321,530 shares of Class A Common Stock held of record by Mary
E. McLeod, Mr. McLeod's wife, over which Mr. McLeod has shared voting
power. Also includes 125,000 shares of Class A Common Stock held by the
Clark E. McLeod Unitary Trust and 125,000 shares of Class A Common Stock
held by the Mary E. McLeod Unitary Trust for which Mr. McLeod is a
99
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trustee. Mr. McLeod's address is c/o McLeodUSA Incorporated, McLeodUSA
Technology Park, 6400 C Street, SW, P.O. Box 3177, Cedar Rapids, IA 54206-
3177. Includes 183,752 shares of Class A Common Stock that Mr. McLeod has
the right to purchase within 60 days from June 26, 1997 pursuant to
options.
(5) MWR Investments Inc. is a wholly owned indirect subsidiary of
MidAmerican. The address of MWR Investments, Inc. is c/o MidAmerican
Energy Holdings Company, 500 E. Court Ave., Des Moines, IA 50309.
(6) Includes 125,000 shares of Class A Common Stock held by the Mary E.
McLeod Unitary Trust and 125,000 shares of Class A Common Stock held by
the Clark E. McLeod Unitary Trust for which Mrs. McLeod is a trustee.
Mrs. McLeod's address is c/o McLeodUSA Incorporated, McLeodUSA Technology
Park, 6400 C Street, SW, P.O. Box 3177, Cedar Rapids, IA 54206-3177.
(7) Includes 3,846,744 and 91,800 shares of Class A Common Stock held by
Putnam Investment Management, Inc. and The Putnam Advisory Company, Inc.,
respectively, as disclosed on a Schedule 13G filed by Putnam Investments,
Inc. with the Commission on January 27, 1997. The address of Putnam
Management, Inc. and The Putnam Advisory Company, Inc. is c/o Putnam
Investments, Inc., One Post Office Square, Boston, MA 02109.
(8) The address of Allsop is 2750 First Ave., NE, Cedar Rapids, IA 52402.
(9) Includes 82,033 shares of Class A Common Stock that Mr. Fisher has the
right to purchase within 60 days from June 26, 1997 pursuant to options.
(10) Includes 23,438 shares of Class A Common Stock that Mr. Christiansen has
the right to purchase within 60 days from June 26, 1997 pursuant to
options.
(11) Includes 56,252 shares of Class A Common Stock that Mr. Collins has the
right to purchase within 60 days from June 26, 1997 pursuant to options.
(12) 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, over which Mr. Rhines has shared
voting and dispositive power. Includes 56,252 shares of Class A Common
Stock that Mr. Rhines has the right to purchase within 60 days from June
26, 1997 pursuant to options.
(13) Includes 56,252 shares of Class A Common Stock that Mr. Liu has the right
to purchase within 60 days from June 26, 1997 pursuant to options.
(14) Includes 78,133 shares of Class A Common Stock held of record by members
of James L. Cram's family.
(15) Includes 24,194 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
Morgan Stanley Trust Company for the benefit of Mr. Gray. Includes
563,150 shares of Class A Common Stock that Mr. Gray has the right to
purchase within 60 days from June 26, 1997 pursuant to options.
(16) Includes 216,811 shares of Class A Common Stock that Mr. Kaalberg has the
right to purchase within 60 days from June 26, 1997 pursuant to options.
(17) Includes 56,250 shares of Class A Common Stock that Mr. Boatner has the
right to purchase within 60 days from June 26, 1997 pursuant to options.
(18) Includes 1,547,603 shares of Class A Common Stock that such persons have
the right to purchase within 60 days from June 26, 1997 pursuant to
options.
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DESCRIPTION OF THE EXCHANGE NOTES
GENERAL
The Senior Notes were, and the Exchange Notes will be, issued under the
Indenture between the Company and United States Trust Company of New York, as
trustee under the Indenture (the "Trustee"). For purposes of this Description
of the Exchange Notes, the term "Company" refers to McLeodUSA Incorporated and
does not include its subsidiaries except for purposes of financial data
determined on a consolidated basis.
The terms of the Exchange Notes are identical in all material respects to
the Senior Notes, except that (i) the Exchange Notes will have been registered
under the Securities Act and therefore will not be subject to certain
restrictions on transfer applicable to the Senior Notes and (ii) Holders of
the Exchange Notes will not be entitled to certain rights of Holders of Senior
Notes under the Registration Agreement. The terms of the Exchange Notes
include those stated in the Indenture and those made a part of the Indenture
by reference to the Trust Indenture Act of 1939 as in effect on the date of
the Indenture (the "Trust Indenture Act"). The Exchange Notes are subject to
all such terms, and Holders of the Exchange Notes are referred to the
Indenture and the Trust Indenture Act for a complete statement of such terms.
A copy of the Indenture is available from the Company on request. The
statements and definitions of terms under this caption relating to the
Exchange Notes and the Indenture are summaries and do not purport to be
complete. Such summaries make use of certain terms defined in the Indenture
and are qualified in their entirety by express reference to the Indenture.
Certain terms used herein are defined below under "--Certain Definitions."
The Exchange Notes rank pari passu in right of payment with the Senior Notes
and all other existing and future senior unsecured indebtedness of the Company
and rank senior in right of payment to all existing and future subordinated
indebtedness of the Company. As of March 31, 1997, the Company had no
outstanding subordinated indebtedness and, other than the Senior Notes, had no
outstanding indebtedness that would rank pari passu with the Exchange Notes.
The Exchange Notes are not secured by any assets and are effectively
subordinated to any existing and future secured indebtedness of the Company
and its subsidiaries, including any Senior Credit Facility or Qualified
Receivable Facility, to the extent of the value of the assets securing such
indebtedness. As of March 31, 1997, the Company and its subsidiaries had
approximately $2.9 million outstanding of secured indebtedness.
The operations of the Company are conducted through its subsidiaries and,
therefore, the Company is dependent upon cash flow from those entities to meet
its obligations. The Company's subsidiaries will have no direct obligation to
pay amounts due on the Exchange Notes and will not guarantee the Exchange
Notes. As a result, the Exchange Notes are effectively subordinated to all
existing and future third-party indebtedness (including any Senior Credit
Facility or any applicable Qualified Receivable Facility) and other
liabilities of the Company's subsidiaries (including trade payables). As of
March 31, 1997, the total liabilities of the Company's subsidiaries (after the
elimination of loans and advances by the Company to its subsidiaries) were
approximately $54.2 million. Of that amount, approximately $202,000 in
indebtedness was secured by first priority liens on certain assets of the
borrowing subsidiaries. Any rights of the Company and its creditors, including
the Holders of Exchange Notes, to participate in the assets of any of the
Company's subsidiaries upon any liquidation or reorganization of any such
subsidiary will be subject to the prior claims of that subsidiary's creditors
(including trade creditors).
PRINCIPAL, MATURITY AND INTEREST
The Exchange Notes will be limited in aggregate principal amount at maturity
to $500 million and will mature on March 1, 2007. The Senior Notes were issued
at a discount to their aggregate principal amount generating gross proceeds to
the Company of approximately $300 million. The Exchange
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Notes will accrete at a rate of 10 1/2% per annum, compounded semi-annually,
to an aggregate principal amount of $500 million by March 1, 2002 (assuming
all of the Senior Notes are exchanged for Exchange Notes in the Exchange
Offer). Interest will not accrue on the Exchange Notes prior to March 1, 2002.
Thereafter, interest on the Exchange Notes will accrue at the rate of 10 1/2%
per annum and will be payable in cash semi-annually on March 1 and September
1, commencing September 1, 2002. Interest will be computed on the basis of a
360-day year comprised of twelve 30-day months.
Principal and interest will be payable at the office of the Paying Agent
but, at the option of the Company, interest may be paid by check mailed to the
registered Holders at their registered addresses. The Exchange Notes will be
issued without coupons and in fully registered form only, in minimum
denominations of $1,000 at maturity and any integral multiples of $1,000 in
excess thereof. Unless otherwise designated by the Company, the Company's
office or agency in New York will be the office of the Trustee maintained for
such purpose.
The interest rate on the Exchange Notes will be subject to increase in
certain circumstances if the Registration Statement is not declared effective
on a timely basis or if certain other conditions are not satisfied, all as
further described under "--Exchange Offer; Registration Rights." All
references herein to interest shall include such Special Interest, if
appropriate.
BOOK-ENTRY SYSTEM
The Exchange Notes will initially be issued in the form of one or more
Global Securities (as defined in the Indenture) held in book-entry form. The
Exchange Notes will be deposited with the Trustee as custodian for DTC, and
DTC or its nominee will initially be the sole registered Holder of the
Exchange Notes for all purposes under the Indenture. Except as set forth
below, a Global Security may not be transferred except as a whole by DTC to a
nominee of DTC or by a nominee of DTC to DTC.
The Exchange Notes that are issued as described below under "--Certificated
Notes" will be issued in definitive form.
Upon the transfer of an Exchange Note in definitive form, such Exchange Note
will, unless the Global Security has previously been exchanged for Exchange
Notes in definitive form, be exchanged for an interest in the Global Security
representing the principal amount of the Exchange Notes being transferred.
Upon the issuance of a Global Security, DTC or its nominee will credit, on
its internal system, the accounts of persons holding through it with the
respective principal amount of Exchange Notes of the individual beneficial
interests represented by such Global Security. Ownership of beneficial
interests in a Global Security will be limited to persons that have accounts
with DTC ("participants") or persons that may hold interests through
participants. Ownership of beneficial interests by participants in a Global
Security will be shown on, and the transfer of that ownership interest will be
effected only through, records maintained by DTC or its nominee for such
Global Security. Ownership of beneficial interests in such Global Security by
persons that hold through participants will be shown on, and the transfer of
that ownership interest within such participant will be effected only through,
records maintained by such participant. The laws of some jurisdictions require
that certain purchasers of securities take physical delivery of such
securities in definitive form. Such limits and such laws may impair the
ability to transfer beneficial interests in a Global Security.
Payment of principal of, premium, if any, on and interest on Exchange Notes
represented by any such Global Security will be made to DTC or its nominee, as
the case may be, as the sole registered owner and the sole Holder of the
Exchange Notes represented thereby for all purposes under the Indenture. None
of the Company, the Trustee, any agent of the Company or the Initial
Purchasers will have any responsibility or liability for (i) any aspect of
DTC's reports relating to or payments made on account of beneficial ownership
interests in a Global Security representing any Exchange Notes or for
maintaining, supervising or reviewing any of DTC's records relating to such
beneficial ownership interests or (ii) any other matter relating to the
actions and practices of DTC or any of its participants.
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The Company has been advised by DTC that upon receipt of any payment of
principal of, premium, if any, on or interest on any Global Security, DTC will
immediately credit, on its book-entry registration and transfer system, the
accounts of participants with payments in amounts proportionate to their
respective beneficial interests in the principal or face amount of such Global
Security, as shown on the records of DTC. The Company expects that payments by
participants to owners of beneficial interests in a Global Security held
through such participants will be governed by standing instructions and
customary practices as is now the case with securities held for customer
accounts registered in "street name" and will be the sole responsibility of
such participants.
So long as DTC or its nominee is the registered owner or Holder of such
Global Security, DTC or such nominee, as the case may be, will be considered
the sole owner or Holder of the Exchange Notes represented by such Global
Security for the purposes of receiving payment on the Exchange Notes,
receiving notices and for all other purposes under the Indenture and the
Exchange Notes. Beneficial interests in Exchange Notes will be evidenced only
by, and transfers thereof will be effected only through, records maintained by
DTC and its participants. Except as provided above, owners of beneficial
interests in a Global Security will not be entitled to and will not be
considered the Holders of such Global Security for any purposes under the
Indenture. Accordingly, each person owning a beneficial interest in a Global
Security must rely on the procedures of DTC and, if such person is not a
participant, on the procedures of the participant through which such person
owns its interest, to exercise any rights of a Holder under the Indenture. The
Company understands that, under existing industry practices, in the event that
the Company requests any action of Holders or that an owner of a beneficial
interest in a Global Security desires to give or take any action that a Holder
is entitled to give or take under the Indenture, DTC would authorize the
participants holding the relevant beneficial interest to give or take such
action, and such participants would authorize beneficial owners owning through
such participants to give or take such action or would otherwise act upon the
instructions of beneficial owners owning through them.
DTC has advised the Company that it will take any action permitted to be
taken by a Holder of Exchange Notes (including the presentation of Exchange
Notes for exchange as described below) only at the direction of one or more
participants to whose account with DTC interests in the Global Security are
credited and only in respect of such portion of the aggregate principal amount
of the Exchange Notes as to which such participant or participants has or have
given such direction.
DTC has advised the Company that DTC is a limited-purpose trust company
organized under the Banking Law of the State of New York, a "banking
organization" within the meaning of New York Banking Law, a member of the
Federal Reserve System, a "clearing corporation" within the meaning of the New
York Uniform Commercial Code and a "clearing agency" registered under the
Exchange Act. DTC was created to hold the securities of its participants and
to facilitate the clearance and settlement of securities transactions among
its participants in such securities through electronic book-entry changes in
accounts of the participants, thereby eliminating the need for physical
movement of securities certificates. DTC's participants include securities
brokers and dealers (including the Initial Purchasers), banks, trust
companies, clearing corporations and certain other organizations some of whom
(and/or their representatives) own DTC. Access to DTC's book-entry system is
also available to others, such as banks, brokers, dealers and trust companies
that clear through or maintain a custodial relationship with a participant,
either directly or indirectly.
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Company believes to be reliable, but
the Company takes no responsibility for the accuracy thereof.
CERTIFICATED NOTES
The Exchange Notes represented by a Global Security are exchangeable for
certificated Exchange Notes only if (i) DTC notifies the Company that it is
unwilling or unable to continue as a
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depository for such Global Security or if at any time DTC ceases to be a
clearing agency registered under the Exchange Act, and a successor depository
is not appointed by the Company within 90 days, (ii) the Company executes and
delivers to the Trustee a notice that such Global Security shall be so
transferable, registrable and exchangeable, and such transfer shall be
registrable or (iii) there shall have occurred and be continuing an Event of
Default with respect to the Notes represented by such Global Security. Any
Global Security that is exchangeable for certificated Exchange Notes pursuant
to the preceding sentence will be transferred to, and registered and exchanged
for, certificated Exchange Notes in authorized denominations and registered in
such names as DTC or its nominee holding such Global Security may direct.
Subject to the foregoing, a Global Security is not exchangeable, except for a
Global Security of like denomination to be registered in the name of DTC or
its nominee. In the event that a Global Security becomes exchangeable for
certificated Exchange Notes, (i) certificated Exchange Notes will be issued
only in fully registered form in denominations of $1,000 or integral multiples
thereof, (ii) payment of principal, any repurchase price, and interest on the
certificated Exchange Notes will be payable, and the transfer of the
certificated Exchange Notes will be registrable, at the office or agency of
the Company maintained for such purposes and (iii) no service charge will be
made for any issuance of the certificated Exchange Notes, although the Company
may require payment of a sum sufficient to cover any tax or governmental
charge imposed in connection therewith.
OPTIONAL REDEMPTION
The Exchange Notes are subject to redemption at the option of the Company,
in whole or in part, at any time on or after March 1, 2002 and prior to
maturity, upon not less than 30 nor more than 60 days' notice, in amounts of
$1,000 or an integral multiple of $1,000, at the redemption prices (expressed
as percentages of principal amount) set forth below, plus accrued and unpaid
interest thereon (if any), if redeemed during the twelve months beginning
March 1 of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2002.......................................................... 105.250%
2003.......................................................... 103.500%
2004.......................................................... 101.750%
2005 and thereafter........................................... 100.000%
</TABLE>
The Exchange Notes are redeemable prior to March 1, 2000 only in the event
that the Company receives net proceeds from the sale of its Common Stock in a
Strategic Equity Investment before March 1, 2000, in which case the Company
may, at its option, use all or a portion of any such net proceeds to redeem
Notes in a principal amount of up to an aggregate amount equal to 33 1/3% of
the original principal amount of the Notes; provided, that Notes in an amount
equal to 66 2/3% of the original principal amount of the Notes remain
outstanding after such redemption. Such redemption must occur on a Redemption
Date within 90 days of such sale and upon not less than 30 nor more than 60
days' notice mailed to each Holder of Notes to be redeemed at such Holder's
address appearing in the Note Register, in amounts of $1,000 or an integral
multiple of $1,000 at a redemption price of 110.5% of the Accreted Value of
the Notes to but excluding the Redemption Date.
If less than all of the Notes are to be redeemed, the Trustee shall select,
in such manner as it shall deem fair and appropriate, the particular Notes to
be redeemed or any portion thereof that is an integral multiple of $1,000.
MANDATORY REDEMPTION
Except as set forth under "--Repurchase at the Option of Holders upon a
Change of Control" and "--Asset Sales," the Company is not required to make
mandatory redemption payments or sinking fund payments with respect to the
Exchange Notes.
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REPURCHASE AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each Holder shall have the right
to require the Company to repurchase all or any part (equal to $1,000
principal amount at maturity or an integral multiple thereof) of such Holder's
Exchange Notes pursuant to the offer described below (the "Change of Control
Offer") at a purchase price (the "Change of Control Purchase Price") equal to
101% of the Accreted Value thereof on any Change of Control Payment Date prior
to March 1, 2002, or 101% of the principal amount thereof plus accrued and
unpaid interest, if any, to any Change of Control Payment Date on or after
March 1, 2002.
Within 30 days following any Change of Control, the Company or the Trustee
(at the expense of the Company) shall mail a notice to each Holder stating:
(1) that a Change of Control Offer is being made pursuant to the covenant
described under "--Repurchase at the Option of Holders upon a Change of
Control" and that all Exchange Notes timely tendered will be accepted for
payment; (2) the Change of Control Purchase Price and the purchase date (the
"Change of Control Payment Date"), which shall be no earlier than 30 days nor
later than 60 days from the date such notice is mailed; (3) that any Exchange
Notes or portions thereof not tendered or accepted for payment will continue
to accrete in value or accrue interest, as the case may be; (4) that, unless
the Company defaults in the payment of the Change of Control Purchase Price,
all Exchange Notes or portions thereof accepted for payment pursuant to the
Change of Control Offer shall cease to accrete in value or accrue interest, as
the case may be, from and after the Change of Control Payment Date; (5) that
Holders electing to have any Exchange Notes or portions thereof purchased
pursuant to a Change of Control Offer will be required to surrender their
Exchange Notes prior to the close of business on the third Business Day
preceding the Change of Control Payment Date; (6) that Holders will be
entitled to withdraw their election if the Paying Agent receives, not later
than the close of business on the second Business Day preceding the Change of
Control Payment Date, a telegram, telex, facsimile transmission or letter
setting forth the name of the Holder, the principal amount of Exchange Notes
delivered for purchase, and a statement that such Holder is withdrawing his
election to have such Exchange Notes or portions thereof purchased; and (7)
that Holders whose Exchange Notes are being purchased only in part will be
issued new Notes equal in principal amount to the unpurchased portion of the
Exchange Note or Exchange Notes surrendered, which unpurchased portion must be
equal to $1,000 in principal amount at maturity or an integral multiple
thereof.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws and regulations, to the extent such
laws and regulations are applicable, in connection with the repurchase of
Exchange Notes pursuant to a Change of Control Offer.
On the Change of Control Payment Date, the Company will (1) accept for
payment Exchange Notes or portions thereof properly tendered pursuant to the
Change of Control Offer; (2) irrevocably deposit with the Paying Agent in
immediately available funds an amount equal to the Change of Control Purchase
Price in respect of all Exchange Notes or portions thereof so tendered; and
(3) deliver, or cause to be delivered, to the Trustee the Exchange Notes so
accepted together with an Officers' Certificate listing the Exchange Notes or
portions thereof tendered to the Company and accepted for payment. The Paying
Agent shall promptly mail to each Holder of Exchange Notes so accepted payment
in an amount equal to the Change of Control Purchase Price for such Exchange
Notes, and the Trustee shall promptly authenticate and mail to each Holder a
new Exchange Note equal in principal amount to any unpurchased portion of the
Exchange Notes surrendered, if any; provided that each such new Exchange Note
shall be in a principal amount at maturity of $1,000 or any integral multiple
thereof.
The existence of the Holders' right to require, subject to certain
conditions, the Company to repurchase Exchange Notes upon a Change of Control
may deter a third party from acquiring the Company in a transaction that
constitutes a Change of Control. If a Change of Control Offer is made,
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there can be no assurance that the Company will have sufficient funds to pay
the Change of Control Purchase Price for all Exchange Notes tendered by
Holders seeking to accept the Change of Control Offer. In addition,
instruments governing other indebtedness of the Company may prohibit the
Company from purchasing any Exchange Notes prior to their stated maturity,
including pursuant to a Change of Control Offer. In the event that a Change of
Control Offer occurs at a time when the Company does not have sufficient
available funds to pay the Change of Control Purchase Price for all Exchange
Notes tendered pursuant to such offer or a time when the Company is prohibited
from purchasing the Exchange Notes (and the Company is unable either to obtain
the consent of the holders of the relevant indebtedness or to repay such
indebtedness), an Event of Default would occur under the Indenture. In
addition, one of the events that constitutes a Change of Control under the
Indenture is a sale, conveyance, transfer or lease of all or substantially all
of the property of the Company. The Indenture will be governed by New York
law, and there is no established definition under New York law of
"substantially all" of the assets of a corporation. Accordingly, if the
Company were to engage in a transaction in which it disposed of less than all
of its assets, a question of interpretation could arise as to whether such
disposition was of "substantially all" of its assets and whether the Company
was required to make a Change of Control Offer.
Except as described herein with respect to a Change of Control, the
Indenture does not contain any other provisions that permit Holders of
Exchange Notes to require that the Company repurchase or redeem Exchange Notes
in the event of a takeover, recapitalization or similar restructuring.
ASSET SALES
The Company will not, and will not permit any Restricted Subsidiary to,
consummate an Asset Sale unless (i) the Company or such Restricted Subsidiary,
as the case may be, receives consideration for such Asset Sale at least equal
to the Fair Market Value (as evidenced by a Board Resolution delivered to the
Trustee) of the Property or assets sold or otherwise disposed of; (ii) at
least 75% of the consideration received by the Company or such Restricted
Subsidiary for such Property or assets consists of (a) cash, readily-
marketable cash equivalents, or Telecommunications Assets; (b) shares of
publicly-traded Voting Stock of any Person engaged in the Telecommunications
Business in the United States; or (c) the assumption of Indebtedness of the
Company or such Restricted Subsidiary (other than Indebtedness that is
subordinated to the Notes) and the release of the Company or the Restricted
Subsidiary, as the case may be, from all liability on the Indebtedness
assumed; and (iii) the Company or such Restricted Subsidiary, as the case may
be, uses the Net Cash Proceeds from such Asset Sale in the manner set forth in
the next paragraph.
Within 360 days after any Asset Sale, the Company or such Restricted
Subsidiary, as the case may be, may at its option (i) reinvest an amount equal
to the Net Cash Proceeds (or any portion thereof) from such Asset Sale in
Telecommunications Assets or in Capital Stock of any Person engaged in the
Telecommunications Business and/or (ii) apply an amount equal to such Net Cash
Proceeds (or remaining Net Cash Proceeds) to the permanent reduction of
Indebtedness of the Company (other than Indebtedness to a Restricted
Subsidiary) that is senior to or pari passu with the Notes or to the permanent
reduction of Indebtedness or preferred stock of any Restricted Subsidiary
(other than Indebtedness to, or preferred stock owned by, the Company or
another Restricted Subsidiary). Any Net Cash Proceeds from any Asset Sale that
are not used to reinvest in Telecommunications Assets or in Capital Stock of
any Person engaged in the Telecommunications Business and/or to reduce senior
or pari passu Indebtedness of the Company or Indebtedness or preferred stock
of its Restricted Subsidiaries shall constitute Excess Proceeds.
If at any time the aggregate amount of Excess Proceeds calculated as of such
date exceeds $5 million, the Company shall, within 30 days, use such Excess
Proceeds to make an offer to purchase (an "Asset Sale Offer") on a pro rata
basis, from all Holders, Notes in an aggregate principal amount equal to the
maximum principal amount that may be purchased out of Excess Proceeds, at a
purchase
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price (the "Offer Purchase Price") in cash equal to 100% of the Accreted Value
thereof on any purchase date occurring prior to March 1, 2002, or 100% of the
principal amount thereof on any purchase date occurring on or after March 1,
2002, plus accrued and unpaid interest, if any, to the purchase date, in
accordance with the procedures set forth in the Indenture. Upon completion of
an Asset Sale Offer (including payment of the Offer Purchase Price), any
surplus Excess Proceeds that were the subject of such offer shall cease to be
Excess Proceeds, and the Company may then use such amounts for general
corporate purposes.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws and regulations, to the extent such
laws and regulations are applicable, in connection with the repurchase of
Notes pursuant to an Asset Sale Offer.
CERTAIN COVENANTS
Set forth below are certain covenants that are contained in the Indenture:
Limitation on Consolidated Indebtedness
The Company will not, and will not permit any Restricted Subsidiary to,
Incur any Indebtedness after the Issue Date unless either (a) the ratio of (i)
the aggregate consolidated principal amount of Indebtedness of the Company
outstanding as of the most recent available quarterly or annual balance sheet,
after giving pro forma effect to the Incurrence of such Indebtedness and any
other Indebtedness Incurred since such balance sheet date and the receipt and
application of the proceeds thereof, to (ii) Consolidated Cash Flow Available
for Fixed Charges for the four full fiscal quarters immediately preceding the
Incurrence of such Indebtedness for which consolidated financial statements of
the Company have been filed with the Commission or have otherwise become
publicly available, determined on a pro forma basis as if any such
Indebtedness had been Incurred and the proceeds thereof had been applied at
the beginning of such four fiscal quarters, would be less than 5.5 to 1.0 for
such four-quarter periods ending prior to December 31, 2000 and 5.0 to 1.0 for
such periods ending thereafter, or (b) the Company's Consolidated Capital
Ratio as of the most recent quarterly or annual balance sheet of the Company
that has been filed with the Commission or has otherwise become publicly
available, after giving pro forma effect to (x) the Incurrence of such
Indebtedness and any other Indebtedness Incurred since such balance sheet date
and (y) paid-in capital received since such balance sheet date or concurrently
with the Incurrence of such Indebtedness, and in each case the receipt and
application of the proceeds thereof, is less than 2.0 to 1.0.
Notwithstanding the foregoing limitation, the Company and any Restricted
Subsidiary may Incur each and all of the following:
(i) Indebtedness under Senior Credit Facilities in an aggregate principal
amount outstanding or available at any one time not to exceed $100 million,
and any renewal, extension, refinancing or refunding thereof in an amount
which, together with any principal amount remaining outstanding or
available under all Senior Credit Facilities, does not exceed the aggregate
principal amount outstanding or available under all Senior Credit
Facilities immediately prior to such renewal, extension, refinancing or
refunding;
(ii) Indebtedness under Qualified Receivable Facilities in an aggregate
principal amount outstanding or available at any one time not to exceed the
greater of (x) $150 million or (y) an amount equal to 85% of net
Receivables determined in accordance with GAAP, and any renewal, extension,
refinancing or refunding thereof in an amount which, together with any
principal amount remaining outstanding or available under all Qualified
Receivable Facilities, does not exceed the aggregate principal amount
outstanding or available under all Qualified Receivable Facilities
immediately prior to such renewal, extension, refinancing or refunding;
(iii) Purchase Money Indebtedness, provided that the amount of such
Purchase Money Indebtedness does not exceed 90% of the cost of the
construction, acquisition or improvement of the applicable
Telecommunications Assets;
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(iv) Indebtedness owed by the Company to any Wholly-Owned Restricted
Subsidiary of the Company or Indebtedness owed by a Restricted Subsidiary
of the Company to the Company or a Wholly-Owned Restricted Subsidiary of
the Company; provided that upon either (x) the transfer or other
disposition by such Wholly-Owned Restricted Subsidiary or the Company of
any Indebtedness so permitted to a Person other than the Company or another
Wholly-Owned Restricted Subsidiary of the Company or (y) the issuance
(other than directors' qualifying shares), sale, lease, transfer or other
disposition of shares of Capital Stock (including by consolidation or
merger) of such Wholly-Owned Restricted Subsidiary to a Person other than
the Company or another such Wholly-Owned Restricted Subsidiary, the
provisions of this clause (iv) shall no longer be applicable to such
Indebtedness and such Indebtedness shall be deemed to have been Incurred at
the time of such transfer or other disposition;
(v) Indebtedness Incurred to renew, extend, refinance or refund (each, a
"refinancing") the Notes or Indebtedness outstanding at the date of the
Indenture or Purchase Money Indebtedness Incurred pursuant to clause (iii)
of this paragraph in an aggregate principal amount not to exceed the
aggregate principal amount of and accrued interest on the Indebtedness so
refinanced plus the amount of any premium required to be paid in connection
with such refinancing pursuant to the terms of the Indebtedness so
refinanced or the amount of any premium reasonably determined by the
Company as necessary to accomplish such refinancing by means of a tender
offer or privately negotiated repurchase, plus the expenses of the Company
incurred in connection with such refinancing; provided that Indebtedness
the proceeds of which are used to refinance the Notes or Indebtedness which
is pari passu to the Notes or Indebtedness which is subordinate in right of
payment to the Notes shall only be permitted under this clause (v) if (A)
in the case of any refinancing of the Notes or Indebtedness which is pari
passu to the Notes, the refinancing Indebtedness is made pari passu to the
Notes or constitutes Subordinated Indebtedness, and, in the case of any
refinancing of Subordinated Indebtedness, the refinancing Indebtedness
constitutes Subordinated Indebtedness and (B) in any case, the refinancing
Indebtedness by its terms, or by the terms of any agreement or instrument
pursuant to which such Indebtedness is issued, (x) does not provide for
payments of principal of such Indebtedness at stated maturity or by way of
a sinking fund applicable thereto or by way of any mandatory redemption,
defeasance, retirement or repurchase thereof by the Company (including any
redemption, retirement or repurchase which is contingent upon events or
circumstances, but excluding any retirement required by virtue of the
acceleration of any payment with respect to such Indebtedness upon any
event of default thereunder), in each case prior to the time the same are
required by the terms of the Indebtedness being refinanced and (y) does not
permit redemption or other retirement (including pursuant to an offer to
purchase made by the Company) of such Indebtedness at the option of the
holder thereof prior to the time the same are required by the terms of the
Indebtedness being refinanced, other than a redemption or other retirement
at the option of the holder of such Indebtedness (including pursuant to an
offer to purchase made by the Company) which is conditioned upon a change
of control pursuant to provisions substantially similar to those described
under "--Repurchase at the Option of Holders upon a Change of Control;"
(vi) Indebtedness consisting of Permitted Interest Rate and Currency
Protection Agreements;
(vii) Indebtedness (A) in respect of performance, surety or appeal bonds
provided in the ordinary course of business or (B) arising from customary
agreements providing for indemnification, adjustment of purchase price for
closing balance sheet changes within 90 days after closing, or similar
obligations, or from Guarantees or letters of credit, surety bonds or
performance bonds securing any obligations of the Company or any of its
Restricted Subsidiaries pursuant to such agreements, in each case Incurred
in connection with the disposition of any business, assets or Restricted
Subsidiary of the Company (other than Guarantees of Indebtedness Incurred
by any Person acquiring all or any portion of such business, assets or
Restricted Subsidiary of the Company for the purpose of financing such
acquisition) and in an
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aggregate principal amount not to exceed the gross proceeds actually
received by the Company or any Restricted Subsidiary in connection with
such disposition; and
(viii) Indebtedness not otherwise permitted to be Incurred pursuant to
clauses (i) through (vii) above, which, together with any other outstanding
Indebtedness Incurred pursuant to this clause (viii), has an aggregate
principal amount not in excess of $10 million at any time outstanding.
Notwithstanding any other provision of this "--Certain Covenants--Limitation
on Consolidated Indebtedness" covenant, the maximum amount of Indebtedness
that the Company or a Restricted Subsidiary may Incur pursuant to this "--
Certain Covenants--Limitation on Consolidated Indebtedness" covenant shall not
be deemed to be exceeded due solely as the result of fluctuations in the
exchange rates of currencies.
For purposes of determining any particular amount of Indebtedness under this
"--Certain Covenants--Limitation on Consolidated Indebtedness" covenant, (1)
Guarantees, Liens or obligations with respect to letters of credit supporting
Indebtedness otherwise included in the determination of such particular amount
shall not be included and (2) any Liens granted pursuant to the equal and
ratable provisions referred to in the "--Certain Covenants--Limitation on
Liens" covenant described below shall not be treated as Indebtedness. For
purposes of determining compliance with this "--Certain Covenants--Limitation
on Consolidated Indebtedness" covenant, in the event that an item of
Indebtedness meets the criteria of more than one of the types of Indebtedness
described in the above clauses, the Company, in its sole discretion, shall
classify such item of Indebtedness and only be required to include the amount
and type of such Indebtedness in one of such clauses.
Limitation on Indebtedness and Preferred Stock of Restricted Subsidiaries
The Company will not permit any Restricted Subsidiary of the Company to
Incur any Indebtedness or issue any Preferred Stock except:
(i) Indebtedness or Preferred Stock outstanding on the date of the
Indenture after giving effect to the application of the proceeds of the
Notes;
(ii) Indebtedness Incurred or Preferred Stock issued to and held by the
Company or a Wholly-Owned Restricted Subsidiary of the Company (provided
that such Indebtedness or Preferred Stock is at all times held by the
Company or a Wholly-Owned Restricted Subsidiary of the Company);
(iii) Indebtedness Incurred or Preferred Stock issued by a Person prior
to the time (A) such Person became a Restricted Subsidiary of the Company,
(B) such Person merges into or consolidates with a Restricted Subsidiary of
the Company or (C) another Restricted Subsidiary of the Company merges into
or consolidates with such Person (in a transaction in which such Person
becomes a Restricted Subsidiary of the Company), which Indebtedness or
Preferred Stock was not Incurred or issued in anticipation of such
transaction and was outstanding prior to such transaction;
(iv) Indebtedness under a Senior Credit Facility which is permitted to be
outstanding under clause (i) of the second paragraph of "--Certain
Covenants--Limitation on Consolidated Indebtedness;"
(v) in the case of a Restricted Subsidiary that is a Qualified Receivable
Subsidiary, Indebtedness under a Qualified Receivable Facility which is
permitted to be outstanding under clause (ii) of the second paragraph of
"--Certain Covenants--Limitation on Consolidated Indebtedness;"
(vi) Indebtedness consisting of Permitted Interest Rate and Currency
Protection Agreements;
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(vii) Indebtedness (A) in respect of performance, surety and appeal bonds
provided in the ordinary course of business or (B) arising from customary
agreements providing for indemnification, adjustment of purchase price for
closing balance sheet changes within 90 days after closing, or similar
obligations, or from Guarantees or letters of credit, surety bonds or
performance bonds securing any obligation of such Restricted Subsidiary
pursuant to such agreements, in each case Incurred in connection with the
disposition of any business, assets or Restricted Subsidiary of such
Restricted Subsidiary (other than Guarantees of Indebtedness Incurred by
any Person acquiring all or any portion of such business, assets or
Restricted Subsidiary for the purpose of financing such acquisition) and in
an aggregate principal amount not to exceed the gross proceeds actually
received by such Restricted Subsidiary in connection with such disposition;
and
(viii) Indebtedness or Preferred Stock which is exchanged for, or the
proceeds of which are used to refinance, refund or redeem, any Indebtedness
or Preferred Stock permitted to be outstanding pursuant to clauses (i) and
(iii) hereof or any extension or renewal thereof (for purposes hereof, a
"refinancing"), in an aggregate principal amount, in the case of
Indebtedness, or with an aggregate liquidation preference in the case of
Preferred Stock, not to exceed the aggregate principal amount of the
Indebtedness so refinanced or the aggregate liquidation preference of the
Preferred Stock so refinanced, plus the amount of any premium required to
be paid in connection with such refinancing pursuant to the terms of the
Indebtedness or Preferred Stock so refinanced or the amount of any premium
reasonably determined by the Company as necessary to accomplish such
refinancing by means of a tender offer or privately negotiated repurchase,
plus the amount of expenses of the Company and the applicable Restricted
Subsidiary Incurred in connection therewith and provided the Indebtedness
or Preferred Stock Incurred or issued upon such refinancing by its terms,
or by the terms of any agreement or instrument pursuant to which such
Indebtedness or Preferred Stock is Incurred or issued, (x) does not provide
for payments of principal or liquidation value at the stated maturity of
such Indebtedness or Preferred Stock or by way of a sinking fund applicable
to such Indebtedness or Preferred Stock or by way of any mandatory
redemption, defeasance, retirement or repurchase of such Indebtedness or
Preferred Stock by the Company or any Restricted Subsidiary of the Company
(including any redemption, retirement or repurchase which is contingent
upon events or circumstances, but excluding any retirement required by
virtue of acceleration of such Indebtedness upon an event of default
thereunder), in each case prior to the time the same are required by the
terms of the Indebtedness or Preferred Stock being refinanced and (y) does
not permit redemption or other retirement (including pursuant to an offer
to purchase made by the Company or a Restricted Subsidiary of the Company)
of such Indebtedness or Preferred Stock at the option of the Holder thereof
prior to the stated maturity of the Indebtedness or Preferred Stock being
refinanced, other than a redemption or other retirement at the option of
the Holder of such Indebtedness or Preferred Stock (including pursuant to
an offer to purchase made by the Company or a Restricted Subsidiary of the
Company) which is conditioned upon the change of control of the Company
pursuant to provisions substantially similar to those described under
"Repurchase at the Option of Holders upon a Change of Control" and
provided, further, that in the case of any exchange or redemption of
Preferred Stock of a Restricted Subsidiary of the Company, such Preferred
Stock may only be exchanged for or redeemed with Preferred Stock of such
Restricted Subsidiary.
Limitation on Restricted Payments
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, make any Restricted Payment unless, at the time of
and after giving effect to such proposed Restricted Payment (i) no Default or
Event of Default shall have occurred and be continuing or shall occur as a
consequence thereof; (ii) after giving effect, on a pro forma basis, to such
Restricted Payment and the incurrence of any Indebtedness the net proceeds of
which are used to finance such Restricted
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Payment, the Company could incur at least $1.00 of additional Indebtedness
pursuant to the first paragraph of "--Certain Covenants--Limitation on
Consolidated Indebtedness"; and (iii) after giving effect to such Restricted
Payment on a pro forma basis, the aggregate amount expended (the amount so
expended, if other than cash, to be determined in good faith by a majority of
the disinterested members of the Board of Directors, whose determination shall
be conclusive and evidenced by a resolution thereof) or declared for all
Restricted Payments after the Issue Date does not exceed the sum of (A) 50% of
the Consolidated Net Income of the Company (or, if Consolidated Net Income
shall be a deficit, minus 100% of such deficit) for the period (taken as one
accounting period) beginning on the last day of the fiscal quarter immediately
preceding the Issue Date and ending on the last day of the fiscal quarter for
which the Company's financial statements have been filed with the Commission
or otherwise become publicly available immediately preceding the date of such
Restricted Payment, plus (B) 100% of the net reduction in Investments,
subsequent to the Issue Date, in any Person, resulting from payments of
interest on Indebtedness, dividends, repayments of loans or advances, or other
transfers of Property (but only to the extent such interest, dividends,
repayments or other transfers of Property are not included in the calculation
of Consolidated Net Income), in each case to the Company or any Restricted
Subsidiary from any Person (including, without limitation, from Unrestricted
Subsidiaries) or from redesignations of Unrestricted Subsidiaries as
Restricted Subsidiaries (valued in each case as provided in the definition of
"Investments"), not to exceed in the case of any Person the amount of
Investments previously made subsequent to the Issue Date by the Company or any
Restricted Subsidiary in such Person and which was treated as a Restricted
Payment; provided that the Company or a Restricted Subsidiary of the Company
may make any Restricted Payment with the aggregate net proceeds received after
the date of the Indenture, including the fair value of property other than
cash (determined in good faith by the Board of Directors as evidenced by a
resolution of the Board of Directors filed with the Trustee), (x) as capital
contributions to the Company, (y) from the issuance (other than to a
Restricted Subsidiary) of Capital Stock (other than Disqualified Stock) of the
Company and warrants, rights or options on Capital Stock (other than
Disqualified Stock) of the Company, or (z) from the conversion of Indebtedness
of the Company into Capital Stock (other than Disqualified Stock and other
than by a Restricted Subsidiary) of the Company after the date of the
Indenture.
The foregoing limitations shall not prevent the Company from (i) paying a
dividend on its Capital Stock at any time within 60 days after the declaration
thereof if, on the declaration date, the Company could have paid such dividend
in compliance with the preceding paragraph; (ii) retiring (A) any Capital
Stock of the Company or any Restricted Subsidiary of the Company, (B)
Indebtedness of the Company that is subordinate to the Notes, or (C)
Indebtedness of a Restricted Subsidiary of the Company, in exchange for, or
out of the proceeds of the substantially concurrent sale of Qualified Stock of
the Company; (iii) retiring any Indebtedness of the Company subordinated in
right of payment to the Notes in exchange for, or out of the proceeds of, the
substantially concurrent incurrence of Indebtedness of the Company (other than
Indebtedness to a Subsidiary of the Company), provided that such new
Indebtedness (A) is subordinated in right of payment to the Notes at least to
the same extent as, (B) has an Average Life at least as long as, and (C) has
no scheduled principal payments due in any amount earlier than, any equivalent
amount of principal under the Indebtedness so retired; (iv) retiring any
Indebtedness of a Restricted Subsidiary of the Company in exchange for, or out
of the proceeds of, the substantially concurrent incurrence of Indebtedness of
the Company or any Restricted Subsidiary that is permitted under the covenant
described under "--Certain Covenants--Limitation on Consolidated Indebtedness"
(in the case of Indebtedness of the Company) and "--Certain Covenants--
Limitation on Indebtedness and Preferred Stock of Restricted Subsidiaries" (in
the case of Indebtedness of Restricted Subsidiaries) and that (A) is not
secured by any assets of the Company or any Restricted Subsidiary to a greater
extent than the retired Indebtedness was so secured, (B) has an Average Life
at least as long as the retired Indebtedness, and (C) is subordinated in right
of payment to the Notes at least to the same extent as the retired
Indebtedness; (v) retiring any Capital Stock or options to acquire Capital
Stock of the Company or any Restricted Subsidiary of the Company
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held by any directors, officers or employees of the Company or any Restricted
Subsidiary, provided that the aggregate price paid for all such retired
Capital Stock shall not exceed, in the aggregate, the sum of $2 million plus
the aggregate cash proceeds received by the Company subsequent to the Issue
Date from issuances of Capital Stock or options to acquire Capital Stock by
the Company to directors, officers or employees of the Company and its
Subsidiaries; (vi) making payments or distributions to dissenting stockholders
pursuant to applicable law in connection with a consolidation, merger or
transfer of assets permitted under "--Consolidation, Merger, Conveyance, Lease
or Transfer"; (vii) retiring any Capital Stock of the Company to the extent
necessary (as determined in good faith by a majority of the disinterested
members of the Board of Directors, whose determination shall be conclusive and
evidenced by a resolution thereof) to prevent the loss, or to secure the
renewal or reinstatement, of any license or franchise held by the Company or
any Restricted Subsidiary from any governmental agency; and (viii) making
Investments not otherwise permitted in an aggregate amount not to exceed $15
million at any time outstanding.
In determining the amount of Restricted Payments permissible under this
covenant, amounts expended pursuant to clauses (ii), (iii) and (iv) of the
foregoing paragraph shall not be included as Restricted Payments.
Not later than the date of making any Restricted Payment (including any
Restricted Payment permitted to be made pursuant to the two previous
paragraphs), the Company shall deliver to the Trustee an Officers' Certificate
stating that such Restricted Payment is permitted and setting forth the basis
upon which the required calculations were computed, which calculations may be
based upon the Company's latest available financial statements.
Limitation on Liens
The Company may not, and may not permit any Restricted Subsidiary of the
Company to, Incur or suffer to exist any Lien on or with respect to any
property or assets now owned or hereafter acquired to secure any Indebtedness
without making, or causing such Restricted Subsidiary to make, effective
provision for securing the Notes (x) equally and ratably with such
Indebtedness as to such property for so long as such Indebtedness will be so
secured or (y) in the event such Indebtedness is Indebtedness of the Company
which is subordinate in right of payment to the Notes, prior to such
Indebtedness as to such property for so long as such Indebtedness will be so
secured.
The foregoing restrictions shall not apply to: (i) Liens existing on the
date of the Indenture and securing Indebtedness outstanding on the date of the
Indenture or Incurred on or after the Issue Date pursuant to any Senior Credit
Facility or Qualified Receivable Facility; (ii) Liens securing Indebtedness in
an amount which, together with the aggregate amount of Indebtedness then
outstanding or available under all Senior Credit Facilities (or under
refinancings or amendments of such Senior Credit Facilities), does not exceed
1.5 times the Company's Consolidated Cash Flow Available for Fixed Charges for
the four full fiscal quarters preceding the Incurrence of such Lien for which
the Company's consolidated financial statements have been filed with the
Commission or become publicly available, determined on a pro forma basis as if
such Indebtedness had been Incurred and the proceeds thereof had been applied
at the beginning of such four fiscal quarters; (iii) Liens in favor of the
Company or any Wholly-Owned Restricted Subsidiary of the Company; (iv) Liens
on Property of the Company or a Restricted Subsidiary acquired, constructed or
constituting improvements made after the Issue Date of the Notes to secure
Purchase Money Indebtedness which is otherwise permitted under the Indenture,
provided that (a) the principal amount of any Indebtedness secured by any such
Lien does not exceed 100% of such purchase price or cost of construction or
improvement of the Property subject to such Lien, (b) such Lien attaches to
such property prior to, at the time of or within 180 days after the
acquisition, completion of construction or commencement of operation of such
Property and (c) such Lien does not extend to or cover any Property other than
the specific item of Property (or portion thereof) acquired, constructed or
constituting the improvements made with the proceeds of such
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Purchase Money Indebtedness; (v) Liens to secure Acquired Indebtedness,
provided that (a) such Lien attaches to the acquired asset prior to the time
of the acquisition of such asset and (b) such Lien does not extend to or cover
any other Property; (vi) Liens to secure Indebtedness Incurred to extend,
renew, refinance or refund (or successive extensions, renewals, refinancings
or refundings), in whole or in part, Indebtedness secured by any Lien referred
to in the foregoing clauses (i), (ii), (iv) and (v) so long as such Lien does
not extend to any other Property and the principal amount of Indebtedness so
secured is not increased except as otherwise permitted under clause (v) of the
second paragraph of""--Certain Covenants--Limitation on Consolidated
Indebtedness" (in the case of Indebtedness of the Company) or clause (viii) of
"--Certain Covenants--Limitation on Indebtedness and Preferred Stock of
Restricted Subsidiaries" (in the case of Indebtedness of Restricted
Subsidiaries); (vii) Liens not otherwise permitted by the foregoing clauses
(i) through (vi) in an aggregate amount not to exceed 5% of the Company's
Consolidated Tangible Assets; (viii) Liens granted after the Issue Date
pursuant to the immediately preceding paragraph to secure the Notes; and (ix)
Permitted Liens.
Limitation on Sale and Leaseback Transactions
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, enter into, assume, Guarantee or otherwise become
liable with respect to any Sale and Leaseback Transaction (other than a Sale
and Leaseback Transaction between the Company or a Restricted Subsidiary on
the one hand and a Restricted Subsidiary or the Company on the other hand),
unless (i) the Company or such Restricted Subsidiary, as the case may be,
receives consideration at the time of such Sale and Leaseback Transaction at
least equal to the Fair Market Value (as evidenced by a Board Resolution
delivered to the Trustee) of the Property subject to such transaction; (ii)
the Attributable Indebtedness of the Company or such Restricted Subsidiary
with respect thereto is included as Indebtedness and would be permitted by the
covenant described under "--Certain Covenants--Limitation on Consolidated
Indebtedness" or "--Certain Covenants--Limitation on Indebtedness and
Preferred Stock of Restricted Subsidiaries", as the case may be; (iii) the
Company or such Restricted Subsidiary would be permitted to create a Lien on
such Property without securing the Notes by the covenant described under "--
Certain Covenants--Limitation on Liens"; and (iv) the Net Cash Proceeds from
such transaction are applied in accordance with the covenant described under
"--Asset Sales"; provided that the Company shall be permitted to enter into
Sale and Leaseback Transactions for up to $25 million with respect to phase I
of the Company's headquarters buildings located in Cedar Rapids, Iowa,
provided that such transaction is entered into on or before December 31, 1997
and up to $30 million with respect to other phases of such headquarters
building, provided that any such transaction is entered into within 180 days
of the earlier of (x) substantial completion or (y) occupation of the
applicable phase of such headquarters building.
Limitation on Dividends and Other Payment Restrictions Affecting Restricted
Subsidiaries
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, cause or suffer to exist or become effective, or enter
into, any encumbrance or restriction (other than pursuant to law or
regulation) on the ability of any Restricted Subsidiary (i) to pay dividends
or make any other distributions in respect of its Capital Stock or pay any
Indebtedness or other obligation owed to the Company or any Restricted
Subsidiary; (ii) to make loans or advances to the Company or any Restricted
Subsidiary; or (iii) to transfer any of its Property to the Company or any
other Restricted Subsidiary, except: (a) any encumbrance or restriction
existing as of the Issue Date pursuant to the Indenture or any other agreement
relating to any Existing Indebtedness or any Indebtedness under a Qualified
Receivable Facility otherwise permitted under the Indenture; (b) any
encumbrance or restriction pursuant to an agreement relating to an acquisition
of Property, so long as the encumbrances or restrictions in any such agreement
relate solely to the Property so acquired; (c) any encumbrance or restriction
relating to any Indebtedness of any Restricted Subsidiary existing on the date
on which such Restricted Subsidiary is acquired by the Company or another
Restricted Subsidiary
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(other than any such Indebtedness Incurred by such Restricted Subsidiary in
connection with or in anticipation of such acquisition); (d) any encumbrance
or restriction pursuant to an agreement effecting a permitted refinancing of
Indebtedness issued pursuant to an agreement referred to in the foregoing
clauses (a) through (c), so long as the encumbrances and restrictions
contained in any such refinancing agreement are not materially more
restrictive than the encumbrances and restrictions contained in such
agreements; (e) customary provisions (A) that restrict the subletting,
assignment or transfer of any property or asset that is a lease, license,
conveyance or contract or similar property or asset; (B) existing by virtue of
any transfer of, agreement to transfer, option or right with respect to, or
Lien on, any property or assets of the Company or any Restricted Subsidiary
not otherwise prohibited by the Indenture or (C) arising or agreed to in the
ordinary course of business, not relating to any Indebtedness, and that do
not, individually or in the aggregate, detract from the value of property or
assets of the Company or any Restricted Subsidiary in any manner material to
the Company or any Restricted Subsidiary; (f) in the case of clause (iii)
above, restrictions contained in any security agreement (including a Capital
Lease Obligation) securing Indebtedness of the Company or a Restricted
Subsidiary otherwise permitted under the Indenture, but only to the extent
such restrictions restrict the transfer of the property subject to such
security agreement; and (g) any restriction with respect to a Restricted
Subsidiary of the Company imposed pursuant to an agreement which has been
entered into for the sale or disposition of all or substantially all of the
Capital Stock or assets of such Restricted Subsidiary, provided that the
consummation of such transaction would not result in an Event of Default or an
event that, with the passing of time or the giving of notice or both, would
constitute an Event of Default, that such restriction terminates if such
transaction is not consummated and that the consummation or abandonment of
such transaction occurs within one year of the date such agreement was entered
into.
Nothing contained in this "--Certain Covenants--Limitation on Dividend and
Other Payment Restrictions Affecting Restricted Subsidiaries" covenant shall
prevent the Company or any other Restricted Subsidiary from (1) creating,
incurring, assuming or suffering to exist any Liens otherwise permitted under
the "--Certain Covenants--Limitation on Liens" covenant or (2) restricting the
sale or other disposition of property or assets of the Company or any of its
Restricted Subsidiaries that secure Indebtedness of the Company or any of its
Restricted Subsidiaries otherwise permitted under "--Certain Covenants--
Limitation on Consolidated Indebtedness" or "--Certain Covenants--Limitations
on Indebtedness and Preferred Stock of Restricted Subsidiaries", as the case
may be.
Limitation on Issuance and Sale of Capital Stock of Restricted Subsidiaries
The Company (i) shall not permit any Restricted Subsidiary to issue any
Capital Stock other than to the Company or a Wholly-Owned Restricted
Subsidiary unless immediately after giving effect thereto such Restricted
Subsidiary would no longer constitute a Restricted Subsidiary and any
Investment of the Company or any other Restricted Subsidiary in such
Restricted Subsidiary would have been permitted under "--Certain Covenants--
Limitation on Restricted Payments" if made on the date of such issuance and
(ii) shall not permit any Person other than the Company or a Wholly-Owned
Restricted Subsidiary to own any Capital Stock of any Restricted Subsidiary,
other than directors' qualifying shares and except for (a) a sale of 100% of
the Capital Stock of a Restricted Subsidiary sold in a transaction not
prohibited by the covenant described under "--Asset Sales"; (b) Capital Stock
of a Restricted Subsidiary issued and outstanding on the Issue Date and held
by Persons other than the Company or any Restricted Subsidiary; (c) Capital
Stock of a Restricted Subsidiary issued and outstanding prior to the time that
such Person becomes a Restricted Subsidiary so long as such Capital Stock was
not issued in anticipation or contemplation of such Person's becoming a
Restricted Subsidiary or otherwise being acquired by the Company; and (d) any
Preferred Stock permitted to be issued under "--Certain Covenants--Limitation
on Indebtedness and Preferred Stock of Restricted Subsidiaries."
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Transactions with Affiliates
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, sell, lease, transfer, or otherwise dispose of,
any of its Properties or assets to, or purchase any Property or assets from,
or enter into any contract, agreement, understanding, loan, advance or
Guarantee with or for the benefit of, any Affiliate (each of the foregoing, an
"Affiliate Transaction"), unless (a) such Affiliate Transaction or series of
Affiliate Transactions is on terms that are no less favorable to the Company
or such Restricted Subsidiary than those that would have been obtained in a
comparable arm's-length transaction by the Company or such Restricted
Subsidiary with a Person that is not an Affiliate (or, in the event that there
are no comparable transactions involving Persons who are not Affiliates of the
Company or the relevant Restricted Subsidiary to apply for comparative
purposes, is otherwise on terms that, taken as a whole, the Company has
determined to be fair to the Company or the relevant Restricted Subsidiary)
and (b) the Company delivers to the Trustee (i) with respect to any Affiliate
Transaction involving aggregate payments in excess of $1 million, a
certificate of the chief executive, operating or financial officer of the
Company evidencing such officer's determination that such Affiliate
Transaction or series of Affiliate Transactions complies with clause (a) above
and is in the best interests of the Company or such Restricted Subsidiary and
(ii) with respect to any Affiliate Transaction or series of Affiliate
Transactions involving aggregate payments in excess of $5 million, a Board
Resolution certifying that such Affiliate Transaction or series of Affiliate
Transactions complies with clause (a) above and that such Affiliate
Transaction or series of Affiliate Transactions has been approved by a
majority of the disinterested members of the Board of Directors who have
determined that such Affiliate Transaction or series of Affiliate Transactions
is in the best interest of the Company or such Restricted Subsidiary; provided
that the following shall not be deemed Affiliate Transactions: (i) any
employment agreement entered into by the Company or any of its Restricted
Subsidiaries in the ordinary course of business and consistent with industry
practice; (ii) any agreement or arrangement with respect to the compensation
of a director or officer of the Company or any Restricted Subsidiary approved
by a majority of the disinterested members of the Board of Directors and
consistent with industry practice; (iii) transactions between or among the
Company and its Restricted Subsidiaries; (iv) transactions permitted by the
covenant described under "--Certain Covenants--Limitation on Restricted
Payments"; (v) transactions pursuant to any agreement or arrangement existing
on the Issue Date; and (vi) transactions with respect to wireline or wireless
transmission capacity, the lease or sharing or other use of cable or
fiberoptic lines, equipment, rights-of-way or other access rights, between the
Company or any Restricted Subsidiary and any other Person; provided, in any
case, that such transaction is on terms that are no less favorable, taken as a
whole, to the Company or the relevant Restricted Subsidiary than those that
could have been obtained in a comparable transaction by the Company or such
Restricted Subsidiary with Persons who are not Affiliates of the Company or
the relevant Restricted Subsidiary (or, in the event that there are no
comparable transactions involving Persons who are not Affiliates of the
Company or the relevant Restricted Subsidiary to apply for comparative
purposes, is otherwise on terms that, taken as a whole, the Company has
determined to be fair to the Company or the relevant Restricted Subsidiary).
Restricted and Unrestricted Subsidiaries
(a) The Company may designate a Subsidiary (including a newly formed or
newly acquired Subsidiary) of the Company or any of its Restricted
Subsidiaries as an Unrestricted Subsidiary if such Subsidiary does not have
any obligations which, if in Default, would result in a cross default on
Indebtedness of the Company or a Restricted Subsidiary (other than
Indebtedness to the Company or a Wholly-Owned Restricted Subsidiary), and (i)
such Subsidiary has total assets of $1,000 or less, (ii) such Subsidiary has
assets of more than $1,000 and an Investment in such Subsidiary in an amount
equal to the Fair Market Value of such Subsidiary would then be permitted
under the first paragraph of "--Certain Covenants--Limitation on Restricted
Payments" or (iii) such designation is effective immediately upon such Person
becoming a Subsidiary. Unless so designated as an Unrestricted Subsidiary, any
Person that becomes a Subsidiary of the Company or any of its Restricted
Subsidiaries shall be classified as a Restricted Subsidiary thereof.
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(b) The Company will not, and will not permit any of its Restricted
Subsidiaries to, take any action or enter into any transaction or series of
transactions that would result in a Person (other than a newly formed
Subsidiary having no outstanding Indebtedness (other than Indebtedness to the
Company or a Restricted Subsidiary) at the date of determination) becoming a
Restricted Subsidiary (whether through an acquisition, the redesignation of an
Unrestricted Subsidiary or otherwise) unless, after giving effect to such
action, transaction or series of transactions, on a pro forma basis, (i) the
Company could incur at least $1.00 of additional Indebtedness pursuant to the
first paragraph of "--Certain Covenants--Limitation on Consolidated
Indebtedness" and (ii) no Default or Event of Default would occur.
(c) Subject to clause (b), an Unrestricted Subsidiary may be redesignated as
a Restricted Subsidiary. The designation of a Subsidiary as an Unrestricted
Subsidiary or the designation of an Unrestricted Subsidiary as a Restricted
Subsidiary in compliance with clause (b) shall be made by the Board of
Directors pursuant to a Board Resolution delivered to the Trustee and shall be
effective as of the date specified in such Board Resolution, which shall not
be prior to the date such Board Resolution is delivered to the Trustee.
Reports
The Company has agreed that, for so long as any Notes remain outstanding, it
will furnish to the Holders of the Notes and to securities analysts and
prospective investors, upon their request, the information required to be
delivered pursuant to Rule 144A(d)(4) under the Securities Act. The Company
will file with the Trustee within 15 days after it files them with the
Commission copies of the annual and quarterly reports and the information,
documents, and other reports that the Company is required to file with the
Commission pursuant to Section 13(a) or 15(d) of the Exchange Act ("SEC
Reports"). In the event the Company shall cease to be required to file SEC
Reports pursuant to the Exchange Act, the Company will nevertheless continue
to file such reports with the Commission (unless the Commission will not
accept such a filing) and the Trustee. The Company will furnish copies of the
SEC Reports to the Holders of Notes at the time the Company is required to
file the same with the Trustee and will make such information available to
investors who request it in writing.
CONSOLIDATION, MERGER, CONVEYANCE, LEASE OR TRANSFER
The Company will not, in any transaction or series of transactions,
consolidate with, or merge with or into, any other Person (other than a merger
of a Restricted Subsidiary into the Company in which the Company is the
continuing corporation), or sell, convey, assign, transfer, lease or otherwise
dispose of all or substantially all of the Property and assets of the Company
and the Restricted Subsidiaries taken as a whole to any other Person, unless:
(i) either (a) the Company shall be the continuing corporation or (b) the
corporation (if other than the Company) formed by such consolidation or
into which the Company is merged, or the Person which acquires, by sale,
assignment, conveyance, transfer, lease or disposition, all or
substantially all of the Property and assets of the Company and the
Restricted Subsidiaries taken as a whole (such corporation or Person, the
"Surviving Entity"), shall be a corporation organized and validly existing
under the laws of the United States of America, any political subdivision
thereof, any state thereof or the District of Columbia, and shall expressly
assume, by a supplemental indenture, the due and punctual payment of the
principal of (and premium, if any) and interest on all the Notes and the
performance of the Company's covenants and obligations under the Indenture;
(ii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or
in respect of such transaction or series of transactions), no Event of
Default or Default shall have occurred and be continuing;
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(iii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or
in respect of such transaction or series of transactions), the Company (or
the Surviving Entity, if the Company is not continuing) would (A) be
permitted to Incur at least $1.00 of additional Indebtedness pursuant to
the first paragraph of "--Certain Covenants--Limitation on Consolidated
Indebtedness" and (B) have a Consolidated Net Worth that is not less than
the Consolidated Net Worth of the Company immediately before such
transaction or series of transactions; and
(iv) if, as a result of any such transaction, Property of the Company
would become subject to a Lien prohibited by the provisions of the
Indenture described under "--Certain Covenants--Limitation on Liens" above,
the Company or the successor entity to the Company shall have secured the
Notes as required thereby.
EVENTS OF DEFAULT
Each of the following is an "Event of Default" under the Indenture:
(a) default in the payment of interest on any Note when the same becomes
due and payable, and the continuance of such default for a period of 30
days;
(b) default in the payment of the principal of (or premium, if any, on)
any Note at its maturity, upon optional redemption, required repurchase
(including pursuant to a Change of Control Offer or an Asset Sale Offer) or
otherwise or the failure to make an offer to purchase any Note as required;
(c) the Company fails to comply with any of its covenants or agreements
described under""--Repurchase at the Option of the Holders upon a Change of
Control," "--Asset Sales" or""--Consolidation, Merger, Conveyance, Lease or
Transfer";
(d) default in the performance, or breach, of any covenant or warranty of
the Company in the Indenture (other than a covenant or warranty addressed
in (a), (b) or (c) above) and continuance of such Default or breach for a
period of 60 days after written notice thereof has been given to the
Company by the Trustee or to the Company and the Trustee by Holders of at
least 25% of the aggregate principal amount of the outstanding Notes;
(e) Indebtedness of the Company or any Restricted Subsidiary is not paid
when due within the applicable grace period, if any, or is accelerated by
the Holders thereof and, in either case, the principal amount of such
unpaid or accelerated Indebtedness exceeds $10 million;
(f) the entry by a court of competent jurisdiction of one or more final
judgments against the Company or any Restricted Subsidiary in an uninsured
or unindemnified aggregate amount in excess of $10 million which is not
discharged, waived, appealed, stayed, bonded or satisfied for a period of
45 consecutive days;
(g) the entry by a court having jurisdiction in the premises of (i) a
decree or order for relief in respect of the Company or any Restricted
Subsidiary in an involuntary case or proceeding under U.S. bankruptcy laws,
as now or hereafter constituted, or any other applicable Federal, state, or
foreign bankruptcy, insolvency, or other similar law or (ii) a decree or
order adjudging the Company or any Restricted Subsidiary a bankrupt or
insolvent, or approving as properly filed a petition seeking
reorganization, arrangement, adjustment or composition of or in respect of
the Company or any Restricted Subsidiary under U.S. bankruptcy laws, as now
or hereafter constituted, or any other applicable Federal, state or foreign
bankruptcy, insolvency or similar law, or appointing a custodian, receiver,
liquidator, assignee, trustee, sequestrator or other similar official of
the Company or any Restricted Subsidiary or of any substantial part of the
Property or assets of the Company or any Restricted Subsidiary, or ordering
the winding up or liquidation of the affairs of the Company or any
Restricted Subsidiary, and the continuance of any such decree or order for
relief or any such other decree or order unstayed and in effect for a
period of 60 consecutive days; or
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(h) (i) the commencement by the Company or any Restricted Subsidiary of a
voluntary case or proceeding under U.S. bankruptcy laws, as now or
hereafter constituted, or any other applicable Federal, state or foreign
bankruptcy, insolvency or other similar law or of any other case or
proceeding to be adjudicated a bankrupt or insolvent; or (ii) the consent
by the Company or any Restricted Subsidiary to the entry of a decree or
order for relief in respect of the Company or any Restricted Subsidiary in
an involuntary case or proceeding under U.S. bankruptcy laws, as now or
hereafter constituted, or any other applicable Federal, state or foreign
bankruptcy, insolvency or other similar law or to the commencement of any
bankruptcy or insolvency case or proceeding against the Company or any
Restricted Subsidiary; or (iii) the filing by the Company or any Restricted
Subsidiary of a petition or answer or consent seeking reorganization or
relief under U.S. bankruptcy laws, as now or hereafter constituted, or any
other applicable Federal, state or foreign bankruptcy, insolvency or other
similar law; or (iv) the consent by the Company or any Restricted
Subsidiary to the filing of such petition or to the appointment of or
taking possession by a custodian, receiver, liquidator, assignee, trustee,
sequestrator or similar official of the Company or any Restricted
Subsidiary or of any substantial part of the Property or assets of the
Company or any Restricted Subsidiary, or the making by the Company or any
Restricted Subsidiary of an assignment for the benefit of creditors; or (v)
the admission by the Company or any Restricted Subsidiary in writing of its
inability to pay its debts generally as they become due; or (vi) the taking
of corporate action by the Company or any Restricted Subsidiary in
furtherance of any such action.
If any Event of Default (other than an Event of Default specified in clause
(g) or (h) above) occurs and is continuing, then and in every such case the
Trustee or the Holders of not less than 25% of the outstanding aggregate
principal amount of Notes may declare the Default Amount and any accrued and
unpaid interest on all Notes then outstanding to be immediately due and
payable by a notice in writing to the Company (and to the Trustee if given by
Holders of the Notes), and upon any such declaration, such Default Amount and
any accrued interest will become and be immediately due and payable. If any
Event of Default specified in clause (g) or (h) above occurs, the Default
Amount and any accrued and unpaid interest on the Notes then outstanding shall
become immediately due and payable without any declaration or other act on the
part of the Trustee or any Holder of Notes. In the event of a declaration of
acceleration because an Event of Default set forth in clause (e) above has
occurred and is continuing, such declaration of acceleration shall be
automatically rescinded and annulled if the event of default triggering such
Event of Default pursuant to clause (e) shall be remedied, or cured or waived
by the Holders of the relevant Indebtedness, within 60 days after such event
of default. Until March 1, 2002, the Default Amount shall equal the Accreted
Value of the Notes as of such date. On or after March 1, 2002, the Default
Amount shall equal 100% of the principal amount thereof. Under certain
circumstances, the Holders of a majority in principal amount of the
outstanding Notes by notice to the Company and the Trustee may rescind an
acceleration and its consequences.
The Company will be required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required within 30
days after becoming aware of any Default or Event of Default, to deliver to
the Trustee a statement describing such Default or Event of Default, its
status and what action the Company is taking or proposes to take with respect
thereto. The Trustee may withhold from Holders of the Notes notice of any
continuing Default or Event of Default (other than relating to the payment of
principal or interest) if the Trustee determines that withholding such notice
is in the Holders' interest.
AMENDMENT, SUPPLEMENT AND WAIVER
The Company and the Trustee may, at any time and from time to time, without
notice to or consent of any Holder of Notes, enter into one or more indentures
supplemental to the Indenture (1) to evidence the succession of another Person
to the Company and the assumption by such successor of
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the covenants of the Company in the Indenture and the Notes; (2) to add to the
covenants of the Company, for the benefit of the Holders, or to surrender any
right or power conferred upon the Company by the Indenture; (3) to add any
additional Events of Default; (4) to provide for uncertificated Notes in
addition to or in place of certificated Notes; (5) to evidence and provide for
the acceptance of appointment under the Indenture of a successor Trustee; (6)
to secure the Notes; (7) to cure any ambiguity in the Indenture, to correct or
supplement any provision in the Indenture which may be inconsistent with any
other provision therein or to add any other provisions with respect to matters
or questions arising under the Indenture; provided such actions shall not
adversely affect the interests of the Holders in any material respect; or (8)
to comply with the requirements of the Commission in order to effect or
maintain the qualification of the Indenture under the Trust Indenture Act.
With the consent of the Holders of not less than a majority in principal
amount of the outstanding Notes, the Company and the Trustee may enter into
one or more indentures supplemental to the Indenture for the purpose of adding
any provisions to or changing in any manner or eliminating any of the
provisions of the Indenture or modifying in any manner the rights of the
Holders; provided that no such supplemental indenture shall, without the
consent of the Holder of each outstanding Note: (1) change the Stated Maturity
of the principal of, or any installment of interest on, any Note, or alter the
redemption provisions thereof, or reduce the principal amount thereof (or
premium, if any), or the interest thereon that would be due and payable upon
Maturity thereof, or change the place of payment where, or the coin or
currency in which, any Note or any premium or interest thereon is payable, or
impair the right to institute suit for the enforcement of any such payment on
or after the maturity thereof; (2) reduce the percentage in principal amount
of the outstanding Notes, the consent of whose Holders is necessary for any
such supplemental indenture or required for any waiver of compliance with
certain provisions of the Indenture or certain Defaults thereunder; (3)
subordinate in right of payment, or otherwise subordinate, the Notes to any
other Indebtedness; (4) modify any provision of the Indenture relating to the
calculation of Accreted Value; or (5) modify any provision of this paragraph
(except to increase any percentage set forth herein).
The Holders of not less than a majority in principal amount of the
outstanding Notes may, on behalf of the Holders of all the Notes, waive any
past Default under the Indenture and its consequences, except a Default (1) in
the payment of the principal of (or premium, if any) or interest on any Note,
or (2) in respect of a covenant or provision hereof which under the proviso to
the prior paragraph cannot be modified or amended without the consent of the
Holder of each outstanding Note affected.
SATISFACTION AND DISCHARGE OF THE INDENTURE, DEFEASANCE
The Company may terminate its obligations under the Indenture when (i)
either (A) all outstanding Notes have been delivered to the Trustee for
cancellation or (B) all such Notes not theretofore delivered to the Trustee
for cancellation have become due and payable, will become due and payable
within one year or are to be called for redemption within one year under
irrevocable arrangements satisfactory to the Trustee for the giving of notice
of redemption by the Trustee in the name and at the expense of the Company,
and the Company has irrevocably deposited or caused to be deposited with the
Trustee funds in an amount sufficient to pay and discharge the entire
indebtedness on the Notes not theretofore delivered to the Trustee for
cancellation, for principal of (or premium, if any, on) and interest to the
date of deposit or maturity or date of redemption; (ii) the Company has paid
or caused to be paid all sums payable by the Company under the Indenture; and
(iii) the Company has delivered an Officers' Certificate and an Opinion of
Counsel relating to compliance with the conditions set forth in the Indenture.
The Company, at its election, shall (a) be deemed to have paid and
discharged its debt on the Notes and the Indenture shall cease to be of
further effect as to all outstanding Notes (except as to (i) rights of
registration of transfer, substitution and exchange of Notes and the Company's
right of
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optional redemption, (ii) rights of Holders to receive payments of principal
of, premium, if any, and interest on the Notes (but not the Change of Control
Purchase Price or the Offer Purchase Price) and any rights of the Holders with
respect to such amounts, (iii) the rights, obligations and immunities of the
Trustee under the Indenture and (iv) certain other specified provisions in the
Indenture) or (b) cease to be under any obligation to comply with certain
restrictive covenants including those described under "--Certain Covenants,"
after the irrevocable deposit by the Company with the Trustee, in trust for
the benefit of the Holders, at any time prior to the maturity of the Notes, of
(A) money in an amount, (B) U.S. Government Obligations which through the
payment of interest and principal will provide, not later than one day before
the due date of payment in respect of the Notes, money in an amount, or (C) a
combination thereof, sufficient to pay and discharge the principal of, and
interest on, the Notes then outstanding on the dates on which any such
payments are due in accordance with the terms of the Indenture and of the
Notes. Such defeasance or covenant defeasance shall be deemed to occur only if
certain conditions are satisfied, including, among other things, delivery by
the Company to the Trustee of an opinion of counsel reasonably acceptable to
the Trustee to the effect that (i) such deposit, defeasance and discharge will
not be deemed, or result in, a taxable event for federal income tax purposes
with respect to the Holders; and (ii) the Company's deposit will not result in
the Trust or the Trustee being subject to regulation under the Investment
Company Act of 1940.
THE TRUSTEE
United States Trust Company of New York is the Trustee under the Indenture
and its current address is 114 West 47th Street, New York, New York 10036.
The Holders of not less than a majority in principal amount of the
outstanding Notes will have the right to direct the time, method and place of
conducting any proceeding for exercising any remedy available to the Trustee,
subject to certain exceptions. Except during the continuance of an Event of
Default, the Trustee will perform only such duties as are specifically set
forth in the Indenture. The Indenture provides that in case an Event of
Default shall occur (which shall not be cured or waived), the Trustee will be
required, in the exercise of its rights and powers under the Indenture, to use
the degree of care of a prudent person in the conduct of such person's own
affairs. Subject to such provisions, the Trustee will be under no obligation
to exercise any of its rights or powers under the Indenture at the request of
any of the Holders of the Notes, unless such Holders shall have offered to the
Trustee indemnity satisfactory to it against any loss, liability or expense.
NO PERSONAL LIABILITY OF CONTROLLING PERSONS, DIRECTORS, OFFICERS, EMPLOYEES
AND STOCKHOLDERS
No controlling Person, director, officer, employee, incorporator or
stockholder of the Company, as such, shall have any liability for any
covenant, agreement or other obligations of the Company under the Notes or the
Indenture or for any claim based on, in respect of, or by reason of, such
obligations or their creation, solely by reason of its past, present or future
status as a controlling Person, director, officer, employee, incorporator or
stockholder of the Company. By accepting a Note each Holder waives and
releases all such liability (but only such liability). The waiver and release
are part of the consideration for issuance of the Notes. Nonetheless, such
waiver may not be effective to waive liabilities under the federal securities
laws and it has been the view of the Commission that such a waiver is against
public policy.
TRANSFER AND EXCHANGE
The Senior Notes are subject to certain restrictions on transfer. A Holder
may transfer or exchange Notes in accordance with the Indenture. The Company,
the Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a Holder to pay any taxes and fees required by law or permitted by the
Indenture.
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EXCHANGE OFFER; REGISTRATION RIGHTS
The Company entered into the Registration Agreement with the Initial
Purchasers, for the benefit of the holders of Senior Notes, pursuant to which
the Company agreed to file the Registration Statement (of which this
Prospectus constitutes a part) with the Commission. The Registration Agreement
provides that the Company will, at its cost, use its best efforts to cause the
Registration Statement to be declared effective under the Securities Act not
later than 150 days after the Closing Date (as defined in the Purchase
Agreement among the Company and the Initial Purchasers attached as an exhibit
to the Registration Statement of which this Prospectus is a part). Upon the
effectiveness of the Registration Statement, the Company will offer the
Exchange Notes in exchange for surrender of the Senior Notes. The Company has
agreed to keep the Exchange Offer open for not less than 30 days and not more
than 45 days (or longer if required by applicable law) after the date notice
of the Exchange Offer is mailed to the holders of Senior Notes. For each
Senior Note surrendered to the Company pursuant to the Exchange Offer, the
holder of such Senior Note will receive an Exchange Note having a principal
amount equal to that of the surrendered Senior Note. Under existing Commission
interpretations, the Exchange Notes would be freely transferable by holders
other than affiliates of the Company after the Exchange Offer without further
registration under the Securities Act if the holder of the Exchange Notes
represents that it is acquiring the Exchange Notes in the ordinary course of
its business, that it has no arrangement or understanding with any person to
participate in the distribution of the Exchange Notes and that it is not an
affiliate of the Company, as such terms are interpreted by the Commission;
provided that broker-dealers ("Participating Broker-Dealers") receiving
Exchange Notes in the Exchange Offer will have a prospectus delivery
requirement with respect to resales of such Exchange Notes. The Commission has
taken the position that Participating Broker-Dealers may fulfill their
prospectus delivery requirements with respect to Exchange Notes with the
prospectus contained in the Registration Statement under certain
circumstances. Under the Registration Agreement, the Company is required to
allow Participating Broker-Dealers and other persons, if any, with similar
prospectus delivery requirements to use this Prospectus in connection with the
resale of such Exchange Notes.
A holder of Senior Notes (other than certain specified holders) who wishes
to exchange such Senior Notes for Exchange Notes in the Exchange Offer will be
required to represent that, among other things, any Exchange Notes to be
received by it will be acquired in the ordinary course of its business and
that at the time of the commencement of the Exchange Offer it has no
arrangement or understanding with any person to participate in the
distribution (within the meaning of the Securities Act) of the Exchange Notes
and that it is not an "affiliate" of the Company, as defined in Rule 405 of
the Securities Act, or if it is an affiliate, that it will comply with the
registration and prospectus delivery requirements of the Securities Act to the
extent applicable.
The Company has filed the Registration Statement and will commence the
Exchange Offer pursuant to the Registration Agreement. In the event that
applicable interpretations of the staff of the Commission do not permit the
Company to effect the Exchange Offer, or if for any other reason the Exchange
Offer is not consummated within 180 days after the Closing Date, or if the
Initial Purchasers so request with respect to Senior Notes not eligible to be
exchanged for Exchange Notes in the Exchange Offer, or if any holder of Senior
Notes does not receive freely tradeable Exchange Notes in the Exchange Offer,
the Company has agreed, at its cost, (a) as promptly as practicable, to file a
Shelf Registration Statement covering resales of the Senior Notes or the
Exchange Notes, as the case may be, (b) to use its best efforts to cause the
Shelf Registration Statement to be declared effective under the Securities Act
and (c) to keep the Shelf Registration Statement effective until three years
(or any shorter period under Rule 144(k) under the Securities Act) after its
effective date or such shorter period ending when all resales of Senior Notes
or Exchange Notes covered by such Shelf Registration Statement have been made.
The Company has agreed, in the event a Shelf Registration Statement is filed,
among other things, to provide to each holder for whom such Shelf Registration
Statement was filed copies of the prospectus which is a part
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of the Shelf Registration Statement, to notify each such holder when the Shelf
Registration Statement has become effective and to take certain other actions
as are required to permit unrestricted resales of the Senior Notes or the
Exchange Notes, as the case may be. A holder selling such Senior Notes or
Exchange Notes pursuant to the Shelf Registration Statement generally would be
required to be named as a selling security holder in the related prospectus
and to deliver a prospectus to purchasers, will be subject to certain of the
civil liability provisions under the Securities Act in connection with such
sales and will be bound by the provisions of the Registration Agreement which
are applicable to such holder (including certain indemnification obligations).
If (i) within 90 days after the Closing Date, neither the Registration
Statement nor the Shelf Registration Statement has been filed with the
Commission; (ii) within 150 days after the Closing Date the Registration
Statement has not been declared effective; (iii) within 180 days after the
Closing Date, neither the Exchange Offer has been consummated nor the Shelf
Registration Statement has been declared effective; or (iv) after either the
Registration Statement or the Shelf Registration Statement has been declared
effective, such Registration Statement thereafter ceases to be effective or
usable (subject to certain exceptions) in connection with resales of Senior
Notes or Exchange Notes in accordance with and during the periods specified in
the Registration Agreement, Special Interest will accrue on the Senior Notes
and the Exchange Notes (in addition to the stated interest on the Senior Notes
and the Exchange Notes) from and including the date on which any such
Registration Default shall occur to but excluding the date on which all
Registration Defaults have been cured. Special Interest will accrue at a rate
of 0.50% per annum during the 90-day period immediately following the
occurrence of any Registration Default and shall increase by 0.25% per annum
at the end of each subsequent 90-day period, but in no event shall such rate
exceed 2.00% per annum in the aggregate regardless of the number of
Registration Defaults.
The summary herein of certain provisions of the Registration Agreement does
not purport to be complete and is subject to, and is qualified in its entirety
by reference to, all the provisions of the Registration Agreement, a copy of
which has been filed as an exhibit to the Registration Statement of which this
Prospectus is a part.
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any capitalized terms used herein for which no
definition is provided.
"Accreted Value" means, as of any date prior to March 1, 2002, an amount per
$1,000 principal amount at maturity of Notes that is equal to the sum of (a)
the offering price ($600 per $1,000 principal amount at maturity of Notes) of
such Notes and (b) the portion of the excess of the principal amount of such
Notes over such offering price which shall have been amortized through such
date, such amount to be so amortized on a daily basis and compounded semi-
annually on each March 1 and September 1 at the rate of 10 1/2% per annum from
the date of original issue of the Notes through the date of determination
computed on the basis of a 360-day year of twelve 30-day months, and as of any
date on or after March 1, 2002, the principal amount of each Note.
"Acquired Indebtedness" means, with respect to any specified Person,
Indebtedness of any other Person existing at the time such other Person merged
with or into or became a Subsidiary of such specified Person; provided that
such Indebtedness was not incurred in connection with, or in anticipation or
contemplation of, such other Person merging with or into or becoming a
Subsidiary of such specified Person, but excluding Indebtedness which is
extinguished, retired or repaid in connection with such other Person merging
with or into or becoming a Subsidiary of such specified Person.
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"Affiliate" means, as to any Person, any other Person which directly or
indirectly controls, or is under common control with, or is controlled by,
such Person; provided that each Unrestricted Subsidiary shall be deemed to be
an Affiliate of the Company and of each other Subsidiary of the Company;
provided, further, that neither the Company nor any of its Restricted
Subsidiaries shall be deemed to be Affiliates of each other. For purposes of
this definition, "control" (including, with correlative meanings, the terms
"controlling," "under common control with" and "controlled by"), as used with
respect to any Person, shall mean the possession, directly or indirectly, of
the power to direct or cause the direction of the management or policies of
such Person, whether through the ownership of Voting Stock, by agreement or
otherwise.
"Asset Sale" by any Person means any transfer, conveyance, sale, lease or
other disposition by such Person or any of its Restricted Subsidiaries
(including a consolidation or merger or other sale of any such Restricted
Subsidiary with, into or to another Person in a transaction in which such
Restricted Subsidiary ceases to be a Restricted Subsidiary of the specified
Person, but excluding a disposition by a Restricted Subsidiary of such Person
to such Person or a Wholly-Owned Restricted Subsidiary of such Person or by
such Person to a Wholly-Owned Restricted Subsidiary of such Person) of (i)
shares of Capital Stock or other ownership interests of a Restricted
Subsidiary of such Person (other than as permitted by the provisions of the
Indenture described above under "--Certain Covenants--Limitation on
Indebtedness and Preferred Stock of Restricted Subsidiaries"), (ii)
substantially all of the assets of such Person or any of its Restricted
Subsidiaries representing a division or line of business (other than as part
of a Permitted Investment) or (iii) other assets or rights of such Person or
any of its Restricted Subsidiaries outside of the ordinary course of business
and, in each case, that is not governed by the provisions of the Indenture
applicable to consolidations, mergers, and transfers of all or substantially
all of the assets of the Company; provided that "Asset Sale" shall not include
(i) sales or other dispositions of inventory, receivables and other current
assets in the ordinary course of business, (ii) simultaneous exchanges by the
Company or any Restricted Subsidiary of Telecommunications Assets for other
Telecommunications Assets in the ordinary course of business; provided that
the applicable Telecommunications Assets received by the Company or such
Restricted Subsidiary have at least substantially equal Fair Market Value to
the Company or such Restricted Subsidiary (as determined by the Board of
Directors whose good faith determination shall be conclusive and evidenced by
a Board Resolution), and (iii) sales or other dispositions of assets with a
Fair Market Value (as certified in an Officers' Certificate) not in excess of
$1 million.
"Attributable Indebtedness" means, with respect to any Sale and Leaseback
Transaction of any Person, as at the time of determination, the greater of (i)
the capitalized amount in respect of such transaction that would appear on the
balance sheet of such Person in accordance with GAAP and (ii) the present
value (discounted at a rate consistent with accounting guidelines, as
determined in good faith by the responsible accounting officer of such Person)
of the payments during the remaining term of the lease (including any period
for which such lease has been extended or may, at the option of the lessor, be
extended) or until the earliest date on which the lessee may terminate such
lease without penalty or upon payment of a penalty (in which case the rental
payments shall include such penalty).
"Average Life" means, as of any date, with respect to any debt security or
Disqualified Stock, the quotient obtained by dividing (i) the sum of the
products of (x) the number of years from such date to the dates of each
scheduled principal payment or redemption payment (including any sinking fund
or mandatory redemption payment requirements) of such debt security or
Disqualified Stock multiplied in each case by (y) the amount of such principal
or redemption payment, by (ii) the sum of all such principal or redemption
payments.
"Board of Directors" means the Board of Directors of the Company or any
committee thereof duly authorized to act on behalf of the Board of Directors.
"Board Resolution" means a duly adopted resolution of the Board of Directors
in full force and effect at the time of determination.
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"Capital Lease Obligation" of any Person means the obligation to pay rent or
other payment amounts under a lease of (or other Indebtedness arrangement
conveying the right to use) real or personal property of such Person which is
required to be classified and accounted for as a capital lease or a liability
on the face of a balance sheet of such Person prepared in accordance with
GAAP, and the stated maturity thereof shall be the date of the last payment of
rent or any amount due under such lease prior to the first date upon which
such lease may be terminated by the lessee without payment of a penalty.
"Capital Stock" in any Person means any and all shares, interests,
participations or other equivalents in the equity interest (however
designated) in such Person and any rights (other than Indebtedness convertible
into an equity interest), warrants or options to subscribe for or acquire an
equity interest in such Person.
"Change of Control" shall be deemed to occur if (i) the sale, conveyance,
transfer or lease of all or substantially all of the assets of the Company to
any "Person" or "group" (within the meaning of Sections 13(d)(3) and 14(d)(2)
of the Exchange Act or any successor provision to either of the foregoing,
including any group acting for the purpose of acquiring, holding or disposing
of securities within the meaning of Rule 13d-5(b)(i) under the Exchange Act),
other than any Permitted Holder (as defined below) or any Restricted
Subsidiary of the Company, shall have occurred; (ii) any "Person" or "group"
(within the meaning of Sections 13(d)(3) and 14(d)(2) of the Exchange Act or
any successor provision to either of the foregoing, including any group acting
for the purpose of acquiring, holding or disposing of securities within the
meaning of Rule 13d-5(b)(i) under the Exchange Act), other than any Permitted
Holder, becomes the "beneficial owner" (as defined in Rule 13d-3 under the
Exchange Act) of more than 35% of the total voting power of all classes of the
Voting Stock of the Company (including any warrants, options or rights to
acquire such Voting Stock), calculated on a fully diluted basis, and such
voting power percentage is greater than or equal to the total voting power
percentage then beneficially owned by the Permitted Holders in the aggregate;
or (iii) during any period of two consecutive years, individuals who at the
beginning of such period constituted the Board of Directors (together with any
directors whose election or appointment by the Board of Directors or whose
nomination for election by the stockholders of the Company was approved by a
vote of a majority of the directors then still in office who were either
directors at the beginning of such period or whose election or nomination for
election was previously so approved) cease for any reason to constitute a
majority of the Board of Directors then in office.
"Common Stock" means Capital Stock other than Preferred Stock.
"Consolidated Capital Ratio" of any Person as of any date means the ratio of
(i) the aggregate consolidated principal amount of Indebtedness of such Person
then outstanding to (ii) the aggregate consolidated paid-in capital of such
Person as of such date.
"Consolidated Cash Flow Available for Fixed Charges" for any period means
the Consolidated Net Income of the Company and its Restricted Subsidiaries for
such period increased by the sum of (i) Consolidated Interest Expense of the
Company and its Restricted Subsidiaries for such period, plus (ii)
Consolidated Income Tax Expense of the Company and its Restricted Subsidiaries
for such period, plus (iii) the consolidated depreciation and amortization
expense included in the income statement of the Company and its Restricted
Subsidiaries for such period, plus (iv) any non-cash expense related to the
issuance to employees of the Company or any Restricted Subsidiary of the
Company of options to purchase Capital Stock of the Company or such Restricted
Subsidiary, plus (v) any charge related to any premium or penalty paid in
connection with redeeming or retiring any Indebtedness prior to its stated
maturity; and plus (vi) any non-cash expense related to a purchase accounting
adjustment not requiring an accrual or reserve and separately disclosed in the
Company's Consolidated Income Statement, and decreased by the amount of any
non-cash item that increases such Consolidated Net Income, all as determined
on a consolidated basis in accordance with GAAP; provided that there shall
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be excluded therefrom the Consolidated Cash Flow Available for Fixed Charges
(if positive) of any Restricted Subsidiary of the Company (calculated
separately for such Restricted Subsidiary in the same manner as provided above
for the Company) that is subject to a restriction which prevents the payment
of dividends or the making of distributions to the Company or another
Restricted Subsidiary of the Company to the extent of such restriction.
"Consolidated Income Tax Expense" for any period means the aggregate amounts
of the provisions for income taxes of the Company and its Restricted
Subsidiaries for such period calculated on a consolidated basis in accordance
with GAAP.
"Consolidated Interest Expense" means for any period the interest expense
included in a consolidated income statement (excluding interest income) of the
Company and its Restricted Subsidiaries for such period in accordance with
GAAP, including without limitation or duplication (or, to the extent not so
included, with the addition of), (i) the amortization of Indebtedness
discount; (ii) any payments or fees with respect to letters of credit,
bankers' acceptances or similar facilities; (iii) fees with respect to
interest rate swap or similar agreements or foreign currency hedge, exchange
or similar agreements; (iv) Preferred Stock dividends of the Company and its
Restricted Subsidiaries (other than dividends paid in shares of Preferred
Stock that is not Disqualified Stock) declared and paid or payable; (v)
accrued Disqualified Stock dividends of the Company and its Restricted
Subsidiaries, whether or not declared or paid; (vi) interest on Indebtedness
guaranteed by the Company and its Restricted Subsidiaries; and (vii) the
portion of any Capital Lease Obligation paid during such period that is
allocable to interest expense in accordance with GAAP.
"Consolidated Net Income" of any Person means, for any period, the aggregate
net income (or net loss) of such Person and its Restricted Subsidiaries for
such period on a consolidated basis determined in accordance with GAAP;
provided that there shall be excluded therefrom, without duplication (i) all
items classified as extraordinary, (ii) any net income (or net loss) of any
Person other than such Person and its Restricted Subsidiaries, except to the
extent of the amount of dividends or other distributions actually paid to such
Person or its Restricted Subsidiaries by such other Person during such period,
(iii) the net income of any Person acquired by such Person or any of its
Restricted Subsidiaries in a pooling-of-interests transaction for any period
prior to the date of the related acquisition, (iv) any gain or loss, net of
taxes, realized on the termination of any employee pension benefit plan, (v)
net gains (or net losses) in respect of Asset Sales by such Person or its
Restricted Subsidiaries, (vi) the net income (or net loss) of any Restricted
Subsidiary of such Person to the extent that the payment of dividends or other
distributions to such Person is restricted by the terms of its charter or any
agreement, instrument, contract, judgment, order, decree, statute, rule,
governmental regulation or otherwise, except for any dividends or
distributions actually paid by such Restricted Subsidiary to such Person,
(vii) with regard to a non-wholly owned Restricted Subsidiary, any aggregate
net income (or loss) in excess of such Person's or such Restricted
Subsidiary's pro rata share of such non-wholly owned Restricted Subsidiary's
net income (or loss) and (viii) the cumulative effect of changes in accounting
principles.
"Consolidated Net Worth" of any Person means, at any date of determination,
the consolidated stockholders' equity or partners' capital (excluding
Disqualified Stock) of such Person and its subsidiaries, as determined in
accordance with GAAP.
"Consolidated Tangible Assets" of any Person means the total amount of
assets (less applicable reserves and other properly deductible items) which
under GAAP would be included on a consolidated balance sheet of such Person
and its Subsidiaries after deducting therefrom all goodwill, trade names,
trademarks, patents, unamortized debt discount and expense and other like
intangibles, which in each case under GAAP would be included on such
consolidated balance sheet.
"Default" means any event, act or condition, the occurrence of which is, or
after notice or the passage of time or both would be, an Event of Default.
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"Disqualified Stock" means any Capital Stock which, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, or otherwise, matures or is
mandatorily redeemable, pursuant to a sinking fund obligation or otherwise, or
is redeemable at the option of the holder thereof, or is exchangeable for
Indebtedness at any time, in whole or in part, prior to the Stated Maturity of
the Notes.
"Eligible Cash Equivalents" means (i) securities issued or directly and
fully guaranteed or insured by the United States of America or any agency or
instrumentality thereof, provided that the full faith and credit of the United
States of America is pledged in support thereof; (ii) time deposits and
certificates of deposit of any commercial bank organized in the United States
having capital and surplus in excess of $500 million with a maturity date not
more than one year from the date of acquisition, (iii) repurchase obligations
with a term of not more than seven days for underlying securities of the types
described in clause (i) above entered into with any bank meeting the
qualifications specified in clause (ii) above; (iv) direct obligations issued
by any state of the United States of America or any political subdivision of
any such state or any public instrumentality thereof maturing, or subject to
tender at the option of the holder thereof within 270 calendar days after the
date of acquisition thereof and, at the time of acquisition, having a rating
of A or better from Standard & Poor's Corporation or A-2 or better from
Moody's Investors Service, Inc., (v) commercial paper issued by the parent
corporation of any commercial bank organized in the United States having
capital and surplus in excess of $500 million and commercial paper issued by
others having one of the two highest ratings obtainable from either Standard &
Poor's Corporation or Moody's Investors Service, Inc. and in each case
maturing within 270 calendar days after the date of acquisition, (vi)
overnight bank deposits and bankers' acceptances at any commercial bank
organized in the United States having capital and surplus in excess of $500
million; (vii) deposits available for withdrawal on demand with a commercial
bank organized in the United States having capital and surplus in excess of
$500 million; and (viii) investments in money market funds substantially all
of whose assets comprise securities of the types described in clauses (i)
through (vi).
"Existing Indebtedness" means Indebtedness outstanding on the date of the
Indenture (other than under the Senior Credit Facility).
"Fair Market Value" means, with respect to any asset or Property, the sale
value that would be obtained in an arm's-length transaction between an
informed and willing seller under no compulsion to sell and an informed and
willing buyer under no compulsion to buy, as determined in good faith by the
Board of Directors.
"GAAP" means United States generally accepted accounting principles,
consistently applied, as set forth in the opinions and pronouncements of the
Accounting Principles Board of the American Institute of Certified Public
Accountants and statements and pronouncements of the Financial Accounting
Standards Board, or in such other statements by such other entity as may be
approved by a significant segment of the accounting profession of the United
States, that are applicable to the circumstances as of the date of
determination; provided that, except as otherwise specifically provided, all
calculations made for purposes of determining compliance with the terms of the
provisions of the Indenture shall utilize GAAP as in effect on the Issue Date.
"Guarantee" means any direct or indirect obligation, contingent or
otherwise, of a Person guaranteeing or having the economic effect of
guaranteeing any Indebtedness of any other Person in any manner (and
"Guaranteed," "Guaranteeing" and "Guarantor" shall have meanings correlative
to the foregoing).
"Holder" means (i) in the case of any certificated Note, the Person in whose
name such certificated Note is registered in the Note Register and (ii) in the
case of any Global Note, the Depositary.
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"Incur" means, with respect to any Indebtedness or other obligation of any
Person, to create, issue, incur (by conversion, exchange or otherwise),
assume, Guarantee or otherwise become liable in respect of such Indebtedness
or other obligation including by acquisition of Subsidiaries or the recording,
as required pursuant to GAAP or otherwise, of any such Indebtedness or other
obligation on the balance sheet of such Person (and "Incurrence," "Incurred,"
"Incurrable" and "Incurring" shall have meanings correlative to the
foregoing); provided that a change in GAAP that results in an obligation of
such Person that exists at such time becoming Indebtedness shall not be deemed
an Incurrence of such Indebtedness and that neither the accrual of interest
nor the accretion of original issue discount shall be deemed an Incurrence of
Indebtedness. Indebtedness otherwise incurred by a Person before it becomes a
Subsidiary of the Company (whether by merger, consolidation, acquisition or
otherwise) shall be deemed to have been incurred at the time at which such
Person becomes a Subsidiary of the Company.
"Indebtedness" means, at any time (without duplication), with respect to any
Person, whether recourse is to all or a portion of the assets of such Person,
and whether or not contingent, (i) any obligation of such Person for money
borrowed, (ii) any obligation of such Person evidenced by bonds, debentures,
notes, Guarantees or other similar instruments, including, without limitation,
any such obligations incurred in connection with the acquisition of Property,
assets or businesses, excluding trade accounts payable made in the ordinary
course of business, (iii) any reimbursement obligation of such Person with
respect to letters of credit, bankers' acceptances or similar facilities
issued for the account of such Person, (iv) any obligation of such Person
issued or assumed as the deferred purchase price of Property or services (but
excluding trade accounts payable or accrued liabilities arising in the
ordinary course of business, which in either case are not more than 60 days
overdue or which are being contested in good faith), (v) any Capital Lease
Obligation of such Person, (vi) the maximum fixed redemption or repurchase
price of Disqualified Stock of such Person and, to the extent held by Persons
other than such Person or its Restricted Subsidiaries, the maximum fixed
redemption or repurchase price of Disqualified Stock of such Person's
Restricted Subsidiaries, at the time of determination, (vii) every obligation
under Interest Rate and Currency Protection Agreements of such Person, (viii)
any Attributable Indebtedness with respect to any Sale and Leaseback
Transaction to which such Person is a party and (ix) any obligation of the
type referred to in clauses (i) through (viii) of this definition of another
Person and all dividends and distributions of another Person the payment of
which, in either case, such Person has Guaranteed or is responsible or liable,
directly or indirectly, as obligor, Guarantor or otherwise. For purposes of
the preceding sentence, the maximum fixed repurchase price of any Disqualified
Stock that does not have a fixed repurchase price shall be calculated in
accordance with the terms of such Disqualified Stock as if such Disqualified
Stock were repurchased on any date on which Indebtedness shall be required to
be determined pursuant to the Indenture; provided that, if such Disqualified
Stock is not then permitted to be repurchased, the repurchase price shall be
the book value of such Disqualified Stock. The amount of Indebtedness of any
Person at any date shall be the outstanding balance at such date of all
unconditional obligations as described above and, with respect to contingent
obligations, the maximum liability upon the occurrence of the contingency
giving rise to the obligation; provided that the amount outstanding at any
time of any Indebtedness issued with original issue discount (including,
without limitation, the Notes) is the face amount of such Indebtedness less
the remaining unamortized portion of the original issue discount of such
Indebtedness at such time as determined in conformity with GAAP.
"Interest Rate or Currency Protection Agreement" of any Person means any
forward contract, futures contract, swap, option, future option or other
financial agreement or arrangement (including, without limitation, caps,
floors, collars and similar agreements) relating to, or the value of which is
dependent upon, interest rates or currency exchange rates or indices.
"Investment" in any Person means any direct, indirect or contingent (i)
advance or loan to, Guarantee of any Indebtedness of, extension of credit or
capital contribution to such Person, (ii) the
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acquisition of any shares of Capital Stock, bonds, notes, debentures or other
securities of such Person, or (iii) the acquisition, by purchase or otherwise,
of all or substantially all of the business, assets or stock or other evidence
of beneficial ownership of such Person; provided that Investments shall
exclude commercially reasonable extensions of trade credit. The amount of any
Investment shall be the original cost of such Investment, plus the cost of all
additions thereto and minus the amount of any portion of such Investment
repaid to such Person in cash as a repayment of principal or a return of
capital, as the case may be, but without any other adjustments for increases
or decreases in value, or write-ups, write-downs or write-offs with respect to
such Investment. In determining the amount of any Investment involving a
transfer of any Property other than cash, such Property shall be valued at its
Fair Market Value at the time of such transfer.
"Issue Date" means the date on which the Senior Notes are first
authenticated and delivered under the Indenture.
"Lien" means, with respect to any Property or other asset, any mortgage or
deed of trust, pledge, hypothecation, assignment, deposit arrangement,
security interest, lien (statutory or other), charge, easement, encumbrance,
preference, priority or other security or similar agreement or preferential
arrangement of any kind or nature whatsoever on or with respect to such
Property or other asset (including, without limitation, any conditional sale
or title retention agreement having substantially the same economic effect as
any of the foregoing).
"Maturity" means, when used with respect to a Note, the date on which the
principal of such Note becomes due and payable as provided therein or in the
Indenture, whether on the date specified in such Note as the fixed date on
which the principal of such Note is due and payable, on the Change of Control
Payment Date or purchase date established pursuant to the terms of the
Indenture with regard to a Change of Control Offer or an Asset Sale Offer, as
applicable, or by declaration of acceleration, call for redemption or
otherwise.
"Net Cash Proceeds" means, with respect to the sale of any Property or
assets by any Person or any of its Restricted Subsidiaries, cash or readily
marketable cash equivalents received net of (i) all reasonable out-of-pocket
expenses of such Person or such Restricted Subsidiary incurred in connection
with such sale, including, without limitation, all legal, title and recording
tax expenses, commissions and other fees and expenses incurred (but excluding
any finder's fee or broker's fee payable to any Affiliate of such Person) and
all federal, state, foreign and local taxes arising in connection with such
sale that are paid or required to be accrued as a liability under GAAP by such
Person or its Restricted Subsidiaries, (ii) all payments made or required to
be made by such Person or its Restricted Subsidiaries on any Indebtedness
which is secured by such Properties or other assets in accordance with the
terms of any Lien upon or with respect to such Properties or other assets or
which must, by the terms of such Lien, or in order to obtain a necessary
consent to such transaction or by applicable law, be repaid in connection with
such sale, (iii) all contractually required distributions and other payments
made to minority interest holders (but excluding distributions and payments to
Affiliates of such Person) in Restricted Subsidiaries of such Person as a
result of such transaction and (iv) appropriate amounts to be provided by such
Person or any Restricted Subsidiary thereof, as the case may be, as a reserve
in accordance with GAAP against any liabilities associated with such assets
and retained by such Person or any Restricted Subsidiary thereof, as the case
may be, after such transaction, including, without limitation, liabilities
under any indemnification obligations and severance and other employee
termination costs associated with such transaction, in each case as determined
by the Board of Directors of such Person, in its reasonable good faith
judgment evidenced by a resolution of the Board of Directors filed with the
Trustee; provided that, in the event that any consideration for a transaction
(which would otherwise constitute Net Cash Proceeds) is required to be held in
escrow pending determination of whether a purchase price adjustment will be
made, such consideration (or any portion thereof) shall become Net Cash
Proceeds only at such time as it is
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released to such Person or its Restricted Subsidiaries from escrow; and
provided, further, that any non-cash consideration received in connection with
any transaction, which is subsequently converted to cash, shall be deemed to
be Net Cash Proceeds at such time, and shall thereafter be applied in
accordance with the Indenture.
"Officers' Certificate" means a certificate signed by (i) the Chairman of
the Board, a Vice Chairman of the Board, the President, the Chief Executive
Officer or a Vice President, and (ii) the Chief Financial Officer, the Chief
Accounting Officer, the Treasurer, an Assistant Treasurer, the Secretary or an
Assistant Secretary of the Company and delivered to the Trustee, which shall
comply with the Indenture.
"Permitted Holders" means IES Industries Inc. and MidAmerican Energy
Holdings Company and their respective successors and assigns, and Clark E. and
Mary E. McLeod and foundations and trusts controlled by them or either of
them, and Affiliates (other than the Company and the Restricted Subsidiaries)
of each of the foregoing.
"Permitted Interest Rate or Currency Protection Agreement" of any Person
means any Interest Rate or Currency Protection Agreement entered into with one
or more financial institutions in the ordinary course of business that is
designed to protect such Person against fluctuations in interest rates or
currency exchange rates with respect to Indebtedness Incurred and which shall
have a notional amount no greater than the payments due with respect to the
Indebtedness being hedged thereby and not for purposes of speculation.
"Permitted Investments" means (i) Eligible Cash Equivalents; (ii)
Investments in Property used in the ordinary course of business; (iii)
Investments in any Person as a result of which such Person becomes a
Restricted Subsidiary in compliance with the Indenture; (iv) Investments
pursuant to agreements or obligations of the Company or a Restricted
Subsidiary, in effect on the Issue Date, to make such Investments; (v)
Investments in prepaid expenses, negotiable instruments held for collection
and lease, utility and workers' compensation, performance and other similar
deposits; (vi) Permitted Interest Rate or Currency Protection Agreements with
respect to any floating rate Indebtedness that is permitted by the terms of
the Indenture to be outstanding; (vii) bonds, notes, debentures or other debt
securities received as a result of Asset Sales permitted under the covenant
described under "--Asset Sales"; (viii) Investments in existence at the Issue
Date; (ix) commission, payroll, travel and similar advances to employees in
the ordinary course of business to cover matters that are expected at the time
of such advances ultimately to be treated as expenses in accordance with GAAP;
and (x) stock, obligations or securities received in satisfaction of
judgments.
"Permitted Joint Ventures" means Investments in an aggregate amount not to
exceed $25 million at any time outstanding in Persons who are not Subsidiaries
and who are engaged in the Telecommunications Business.
"Permitted Liens" means (i) Liens for taxes, assessments, governmental
charges or claims which are not yet delinquent or which are being contested in
good faith by appropriate proceedings, if a reserve or other appropriate
provision, if any, as shall be required in conformity with GAAP shall have
been made therefor; (ii) other Liens incidental to the conduct of the
Company's and its Restricted Subsidiaries' business or the ownership of its
property and assets not securing any Indebtedness, and which do not in the
aggregate materially detract from the value of the Company's and its
Restricted Subsidiaries' property or assets when taken as a whole, or
materially impair the use thereof in the operation of its business; (iii)
Liens with respect to assets of a Restricted Subsidiary granted by such
Restricted Subsidiary to the Company to secure Indebtedness owing to the
Company; (iv) pledges and deposits made in the ordinary course of business in
connection with workers' compensation and unemployment insurance, statutory
Liens of landlords, carriers, warehousemen, mechanics, materialmen, repairmen
and other types of statutory obligations; (v) deposits made to secure the
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performance of tenders, bids, leases, and other obligations of like nature
incurred in the ordinary course of business (exclusive of obligations for the
payment of borrowed money); (vi) zoning restrictions, servitudes, easements,
rights-of-way, restrictions and other similar charges or encumbrances incurred
in the ordinary course of business which, in the aggregate, do not materially
detract from the value of the property subject thereto or interfere with the
ordinary conduct of the business of the Company or its Restricted
Subsidiaries; (vii) Liens arising out of judgments or awards against the
Company or any Restricted Subsidiary with respect to which the Company or such
Restricted Subsidiary is prosecuting an appeal or proceeding for review and
the Company or such Restricted Subsidiary is maintaining adequate reserves in
accordance with GAAP; (viii) any interest or title of a lessor in the property
subject to any lease other than a Capital Lease; (ix) Liens (including
extensions and renewals thereof) upon real or personal property acquired after
the Issue Date; provided that (a) such Lien is created solely for the purpose
of securing Indebtedness Incurred, in accordance with "--Certain Covenants--
Limitation on Consolidated Indebtedness," (1) to finance the cost (including
the cost of improvement or construction) of the item of property or assets
subject thereto and such Lien is created prior to, at the time of or within
six months after the later of the acquisition, the completion of construction
or the commencement of full operation of such property or (2) to refinance any
Indebtedness previously so secured, (b) the principal amount of the
Indebtedness secured by such Lien does not exceed 100% of such cost and (c)
any such Lien shall not extend to or cover any property or assets other than
such item of property or assets and any improvements on such item; (x) leases
or subleases granted to others that do not materially interfere with the
ordinary course of business of the Company and its Restricted Subsidiaries;
(xi) Liens encumbering property or assets under construction arising from
progress or partial payments by a customer of the Company or its Restricted
Subsidiaries relating to such property or assets; (xii) Liens arising from
filing precautionary Uniform Commercial Code financing statements regarding
leases; (xiii) Liens on property of, or on shares of stock or Indebtedness of,
any corporation existing at the time such corporation becomes, or becomes a
part of, any Restricted Subsidiary; provided that such Liens do not extend to
or cover any property or assets of the Company or any Restricted Subsidiary
other than the property or assets acquired; (xiv) Liens in favor of the
Company or any Restricted Subsidiary; (xv) Liens securing reimbursement
obligations with respect to letters of credit that encumber documents and
other property relating to such letters of credit and the products and
proceeds thereof; (xvi) Liens in favor of customs and revenue authorities
arising as a matter of law to secure payment of customs duties in connection
with the importation of goods; (xvii) Liens encumbering customary initial
deposits and margin deposits, and other Liens that are either within the
general parameters customary in the industry and incurred in the ordinary
course of business, in each case, securing Indebtedness under Permitted
Interest Rate Agreements and Currency Agreements; and (xviii) Liens arising
out of conditional sale, title retention, consignment or similar arrangements
for the sale of goods entered into by the Company or any of its Restricted
Subsidiaries in the ordinary course of business in accordance with the past
practices of the Company and its Restricted Subsidiaries prior to the Issue
Date.
"Person" means any individual, corporation, limited liability company,
partnership, limited liability partnership, joint venture, trust,
unincorporated organization or government or any agency or political
subdivision thereof.
"Preferred Stock" of any Person means Capital Stock of such Person of any
class or classes (however designated) that ranks prior, as to the payment of
dividends or as to the distribution of assets upon any voluntary or
involuntary liquidation, dissolution or winding up of such Person, to shares
of Capital Stock of any other class of such Person.
"Property" means, with respect to any Person, any interest of such Person in
any kind of property or asset, whether real, personal or mixed, or tangible or
intangible, excluding Capital Stock in any other Person.
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"Purchase Money Indebtedness" means Indebtedness of the Company (including
Acquired Indebtedness and Capital Lease Obligations, mortgage financings and
purchase money obligations) incurred for the purpose of financing all or any
part of the cost of construction, acquisition, development or improvement by
the Company or any Restricted Subsidiary of any Telecommunications Assets of
the Company or any Restricted Subsidiary and including any related notes,
Guarantees, collateral documents, instruments and agreements executed in
connection therewith, as the same may be amended, supplemented, modified or
restated from time to time.
"Qualified Receivable Facility" means Indebtedness of the Company or any
Subsidiary Incurred from time to time pursuant to either (x) credit facilities
secured by Receivables or (y) receivable purchase facilities, and including
any related notes, Guarantees, collateral documents, instruments and
agreements executed in connection therewith, as the same may be amended,
supplemented, modified or restated from time to time.
"Qualified Receivable Subsidiary" means a Restricted Subsidiary formed
solely for the purpose of obtaining a Qualified Receivable Facility and
substantially all of the Property of which is Receivables.
"Qualified Stock" of any Person means a class of Capital Stock other than
Disqualified Stock.
"Receivables" means receivables, chattel paper, instruments, documents or
intangibles evidencing or relating to the right to payment of money and
proceeds and products thereof in each case generated in the ordinary course of
business.
"Restricted Payment" means (i) a dividend or other distribution declared or
paid on the Capital Stock of the Company or to the Company's stockholders (in
their capacity as such), or declared or paid to any Person other than the
Company or a Restricted Subsidiary of the Company on the Capital Stock of any
Restricted Subsidiary of the Company, in each case, other than dividends,
distributions or payments made solely in Qualified Stock of the Company or
such Restricted Subsidiary, (ii) a payment made by the Company or any of its
Restricted Subsidiaries (other than to the Company or any Restricted
Subsidiary) to purchase, redeem, acquire or retire any Capital Stock of the
Company or of a Restricted Subsidiary, (iii) a payment made by the Company or
any of its Restricted Subsidiaries (other than a payment made solely in
Qualified Stock of the Company) to redeem, repurchase, defease (including an
in-substance or legal defeasance) or otherwise acquire or retire for value
(including pursuant to mandatory repurchase covenants), prior to any scheduled
maturity, scheduled sinking fund or mandatory redemption payment, Indebtedness
of the Company or such Restricted Subsidiary which is subordinate (whether
pursuant to its terms or by operation of law) in right of payment to the Notes
and which was scheduled to mature on or after the maturity of the Notes or
(iv) an Investment in any Person, including an Unrestricted Subsidiary or the
designation of a Subsidiary as an Unrestricted Subsidiary, other than (a) a
Permitted Investment or a Permitted Joint Venture, (b) an Investment by the
Company in a Wholly-Owned Restricted Subsidiary or (c) an Investment by a
Restricted Subsidiary in the Company or a Wholly-Owned Restricted Subsidiary
of the Company.
"Restricted Subsidiary" means any Subsidiary of the Company that has not
been designated as an "Unrestricted Subsidiary."
"Sale and Leaseback Transaction" means, with respect to any Person, any
direct or indirect arrangement pursuant to which Property is sold or
transferred by such Person or a Restricted Subsidiary of such Person and is
thereafter leased back from the purchaser or transferee thereof by such Person
or one of its Restricted Subsidiaries.
"Senior Credit Facility" means Indebtedness of the Company and its
Subsidiaries Incurred from time to time pursuant to one or more credit
agreements or similar facilities made available from time to time to the
Company and its Subsidiaries, whether or not secured, and including any
related notes, Guarantees, collateral documents, instruments and agreements
executed in connection therewith, as the same may be amended, supplemented,
modified or restated from time to time.
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"Strategic Equity Investment" means an equity investment made by a Strategic
Investor in the Company in an aggregate amount of not less than $25 million.
"Strategic Investor" means a Person (other than the Permitted Holders)
engaged in one or more Telecommunications Businesses that has, or 80% or more
of the Voting Stock of which is owned by a Person that has, an equity market
capitalization at the time of its initial Investment in the Company in excess
of $2 billion.
"Subordinated Indebtedness" means Indebtedness of the Company as to which
the payment of principal of (and premium, if any) and interest and other
payment obligations in respect of such Indebtedness shall be subordinate to
the prior payment in full of the Notes to at least the following extent: (i)
no payments of principal of (or premium, if any) or interest on or otherwise
due in respect of such Indebtedness may be permitted for so long as any
default in the payment of principal (or premium, if any) or interest on the
Notes exists; (ii) in the event that any other default that with the passing
of time or the giving of notice, or both, would constitute an event of default
exists with respect to the Notes, upon notice by 25% or more in principal
amount of the Notes to the Trustee, the Trustee shall have the right to give
notice to the Company and the holders of such Indebtedness (or trustees or
agents therefor) of a payment blockage, and thereafter no payments of
principal of (or premium, if any) or interest on or otherwise due in respect
of such Indebtedness may be made for a period of 179 days from the date of
such notice; and (iii) such Indebtedness may not (x) provide for payments of
principal of such Indebtedness at the stated maturity thereof or by way of a
sinking fund applicable thereto or by way of any mandatory redemption,
defeasance, retirement or repurchase thereof by the Company (including any
redemption, retirement or repurchase which is contingent upon events or
circumstances, but excluding any retirement required by virtue of acceleration
of such Indebtedness upon an event of default thereunder), in each case prior
to the final Stated Maturity of the Notes or (y) permit redemption or other
retirement (including pursuant to an offer to purchase made by the Company) of
such other Indebtedness at the option of the holder thereof prior to the final
Stated Maturity of the Notes, other than a redemption or other retirement at
the option of the holder of such Indebtedness (including pursuant to an offer
to purchase made by the Company) which is conditioned upon a change of control
of the Company pursuant to provisions substantially similar to those described
under "--Repurchase at the Option of Holders upon a Change of Control" (and
which shall provide that such Indebtedness will not be repurchased pursuant to
such provisions prior to the Company's repurchase of the Notes required to be
repurchased by the Company pursuant to the provisions described under "--
Repurchase at the Option of Holders upon a Change of Control").
"Subsidiary" means, with respect to any Person, (i) any corporation more
than 50% of the outstanding shares of Voting Stock of which is owned, directly
or indirectly, by such Person, or by one or more other Subsidiaries of such
Person, or by such Person and one or more other Subsidiaries of such Person,
(ii) any general partnership, joint venture or similar entity, more than 50%
of the outstanding partnership or similar interests of which are owned,
directly or indirectly, by such Person, or by one or more other Subsidiaries
of such Person, or by such Person and one or more other Subsidiaries of such
Person and (iii) any limited partnership of which such Person or any
Subsidiary of such Person is a general partner.
"Telecommunications Assets" means all assets, rights (contractual or
otherwise) and properties, whether tangible or intangible, used or intended
for use in connection with a Telecommunications Business.
"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, voice, video or data
through owned or leased wireline or wireless transmission facilities, (ii)
creating, developing, constructing, installing, repairing, maintaining or
marketing communications-related systems, network equipment and facilities,
software and other products, (iii) creating, developing, producing or
marketing audiotext or videotext, (iv) publishing or
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distributing telephone (including Internet) directories, whether in paper,
electronic, audio or video format, (v) marketing (including direct marketing
and telemarketing), or (vi) evaluating, participating in or pursuing any other
business that is primarily related to those identified in the foregoing
clauses (i), (ii), (iii), (iv) or (v) above (in the case of clauses (iii),
(iv) and (v), however, in a manner consistent with the Company's manner of
business on the Issue Date), and shall, in any event, include all businesses
in which the Company or any of its Subsidiaries are engaged on the Issue Date;
provided that the determination of what constitutes a Telecommunications
Business shall be made in good faith by the Board of Directors.
"Trading Day" means, with respect to a security traded on a securities
exchange, automated quotation system or market, a day on which such exchange,
system or market is open for a full day of trading.
"Unrestricted Subsidiary" means any Subsidiary of the Company that the
Company has classified as an "Unrestricted Subsidiary" and that has not been
reclassified as a Restricted Subsidiary, pursuant to the terms of the
Indenture.
"U.S. Government Obligations" means (x) securities that are (i) direct
obligations of the United States of America for the payment of which the full
faith and credit of the United States of America is pledged or (ii)
obligations of a Person controlled or supervised by and acting as an agency or
instrumentality of the United States of America the payment of which is
unconditionally guaranteed as a full faith and credit obligation by the United
States of America, which, in either case, are not callable or redeemable at
the option of the issuer thereof, and (y) depository receipts issued by a bank
(as defined in Section 3(a)(2) of the Securities Act) as custodian with
respect to any U.S. Government Obligation which is specified in clause (x)
above and held by such Bank for the account of the holder of such depository
receipt, or with respect to any specific payment of principal or interest on
any U.S. Government Obligation which is so specified and held, provided that
(except as required by law) such custodian is not authorized to make any
deduction from the amount payable to the holder of such depository receipt
from any amount received by the custodian in respect of the U.S. Government
Obligation or the specific payment of principal or interest of the U.S.
Government Obligation evidenced by such depository receipt.
"Voting Stock" means, with respect to any Person, securities of any class or
classes of Capital Stock in such Person entitling the holders thereof (whether
at all times or at the times that such class of Capital Stock has voting power
by reason of the happening of any contingency) to vote in the election of
members of the board of directors or comparable body of such Person.
"Wholly-Owned Restricted Subsidiary" of any Person means a Subsidiary of
such Person all of the outstanding Capital Stock or other ownership interests
(other than any director's qualifying shares) of which shall at the time be
owned by such Person or by one or more other Wholly-Owned Restricted
Subsidiaries of such Person or by such Person and one or more other Wholly-
Owned Restricted Subsidiaries of such Person.
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PLAN OF DISTRIBUTION
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. This Prospectus, as it may
be amended or supplemented from time to time, may be used by a broker-dealer
in connection with resales of Exchange Notes received in exchange for Senior
Notes where such Senior Notes were acquired as a result of market-making
activities or other trading activities. The Company has agreed that, starting
on the Expiration Date and ending on the close of business on the first
anniversary of the Expiration Date, it will make this Prospectus, as amended
or supplemented, available to any broker-dealer for use in connection with any
such resale.
The Company will not receive any proceeds from any sale of Exchange Notes by
broker-dealers. Exchange Notes received by broker-dealers for their own
account pursuant to the Exchange Offer may be sold from time to time in one or
more transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the Exchange Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at
prices related to such prevailing market prices or negotiated prices. Any such
resale may be made directly to purchasers or to or through brokers or dealers
who may receive compensation in the form of commissions or concessions from
any such broker-dealer and/or the purchasers of any such Exchange Notes. Any
broker-dealer that resells Exchange Notes that were received by it for its own
account pursuant to the Exchange Offer and any broker or dealer that
participates in a distribution of such Exchange Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit of any
such resale of Exchange Notes and any commissions or concessions received by
any such persons may be deemed to be underwriting compensation under the
Securities Act. The Letter of Transmittal states that by acknowledging that it
will deliver and by delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the
Securities Act.
For a period of one year after the Expiration Date, the Company will
promptly send additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requests such
documents in the Letter of Transmittal. The Company has agreed to pay all
expenses incident to the Exchange Offer (including the expenses of one counsel
for the holders of the Senior Notes), other than commissions or concessions of
any brokers or dealers, and will indemnify the holders of the Senior Notes
(including any broker-dealers) against certain liabilities, including
liabilities under the Securities Act.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes, subject to the limitations set forth
below, the material U.S. federal income tax consequences associated with the
exchange of the Senior Notes for the Exchange Notes and with the ownership and
disposition of the Notes. The discussion is based upon provisions of the Code,
its legislative history, judicial authority, current administrative rulings
and practice, and existing and proposed Treasury Regulations, including
regulations concerning the treatment of debt instruments issued with original
issue discount (the "OID Regulations"), all as in effect and existing on the
date hereof. Legislative, judicial or administrative changes or
interpretations may be forthcoming that could alter or modify the validity of
the statements and conclusions set forth below. Any such changes or
interpretations may be retroactive and could adversely affect a holder of the
Notes. This discussion assumes that the Notes are or will be held as capital
assets (as defined in Section 1221 of the Code) by the holders thereof. Except
as otherwise described herein, this discussion applies only to a person who is
a holder who purchased Senior Notes pursuant to the Offering at the "issue
price" (as defined below) and who is (i) a citizen or resident of the United
States for United States federal income tax purposes, (ii) a corporation,
partnership or other entity created or organized in or under the laws of the
United States or of any political subdivision thereof, or (iii) an estate or
trust the income of which is subject to United States federal income taxation
regardless of its source (a "U.S. Holder"). This discussion does not purport
to deal with all aspects of U.S. federal income taxation that might be
relevant to particular holders in light of their personal investment
circumstances or status, nor does it discuss the U.S. federal income tax
consequences to certain types of holders subject to special treatment under
the U.S. federal income tax laws, such as certain financial institutions,
insurance companies, dealers in securities or foreign currency, tax-exempt
organizations, or persons that hold Notes that are a hedge against, or that
are hedged against, currency risk or that are part of a straddle or conversion
transaction, or persons whose functional currency is not the U.S. dollar.
Moreover, the effect of any applicable state, local or foreign tax laws is not
discussed.
Hogan & Hartson L.L.P., tax counsel to the Company, has reviewed the
following discussion and is of the opinion that, to the extent that it
constitutes matters of law or legal conclusions or purports to describe
certain provisions of the federal tax laws, the following discussion is a
correct summary in all material respects of the matters discussed therein.
THE FOLLOWING DISCUSSION IS FOR GENERAL INFORMATION ONLY. EACH PURCHASER IS
STRONGLY URGED TO CONSULT WITH ITS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF
SUCH PURCHASER'S PERSONAL TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES,
INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN OR OTHER TAX LAWS,
OF THE EXCHANGE OF THE SENIOR NOTES FOR THE EXCHANGE NOTES AND THE OWNERSHIP
AND DISPOSITION OF THE NOTES.
THE EXCHANGE
The exchange of Senior Notes for Exchange Notes will not be treated as an
exchange for federal income tax purposes because the Exchange Notes will not
differ materially in kind or extent from the Senior Notes. As a result, U.S.
Holders who exchange their Senior Notes for Exchange Notes will not recognize
any income, gain or loss for federal income tax purposes. A U.S. Holder will
have the same adjusted issue price, adjusted basis and holding period in the
Exchange Notes immediately after the exchange as it had in the Senior Notes
immediately before the exchange.
ORIGINAL ISSUE DISCOUNT
General
The Notes bear original issue discount ("OID"), and each U.S. Holder is
required to include in income (regardless of whether such U.S. Holder is a
cash or accrual basis taxpayer) in each year, in
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advance of the receipt of cash payments on such Notes, that portion of the
OID, computed on a constant yield basis, attributable to each day during such
year on which the U.S. Holder held the Notes. See "--Taxation of Original
Issue Discount" below.
The Amount of Original Issue Discount
The amount of OID with respect to each Note is equal to the excess of (i)
its "stated redemption price at maturity" over (ii) its "issue price." Under
the OID Regulations, the "issue price" of the Notes is the initial offering
price to the public (not including any bond house, broker or similar person or
organization acting in the capacity of an underwriter, placement agent or
wholesaler) at which a substantial amount of the Notes are sold. Under the OID
Regulations, the "stated redemption price at maturity" of each Note includes
all payments to be made in respect thereof, including any stated interest
payments. Accordingly, payments on the Notes (including principal and stated
interest payments) are not separately included in a U.S. Holder's income as
interest, but rather are treated first as payments of previously accrued OID
and then as payments of principal.
Taxation of Original Issue Discount
A U.S. Holder of a debt instrument issued with OID is required to include in
gross income for U.S. federal income tax purposes an amount equal to the sum
of the "daily portions" of such OID for all days during the taxable year on
which the holder holds the debt instrument. The daily portions of OID required
to be included in a holder's gross income in a taxable year is determined upon
a constant yield basis by allocating to each day during the taxable year on
which the holder holds the debt instrument a pro rata portion of the OID on
such debt instrument which is attributable to the "accrual period" in which
such day is included. Accrual periods with respect to a Note may be of any
length selected by the U.S. Holder and may vary in length over the term of the
Note as long as (i) no accrual period is longer than one year and (ii) each
scheduled payment of interest or principal on the Note occurs on either the
final or first day of an accrual period. The amount of the OID attributable to
each "accrual period" is the product of (i) the "adjusted issue price" at the
beginning of such accrual period and (ii) the "yield to maturity" of the debt
instrument (stated in a manner appropriately taking into account the length of
the accrual period). The "yield to maturity" is the discount rate that, when
used in computing the present value of all payments to be made under the Note,
produces an amount equal to the issue price of the Note. The "adjusted issue
price" of a Note at the beginning of an accrual period is generally defined as
the issue price of the Note plus the aggregate amount of OID that accrued in
all prior accrual periods, less any cash payments on the Note. Accordingly, a
U.S. Holder of a Note is required to include OID thereon in gross income for
U.S. federal tax purposes in advance of the receipt of cash in respect of such
income. The amount of OID allocable to an initial short accrual period may be
computed using any reasonable method if all other accrual periods, other than
a final short accrual period, are of equal length. The amount of OID allocable
to the final accrual period at maturity of a Note is the difference between
(x) the amount payable at the maturity of the Note and (y) the Note's adjusted
issue price as of the beginning of the final accrual period.
Effect of Mandatory and Optional Redemptions on OID
In the event of a Change of Control, the Company will be required to offer
to redeem all of the Notes, at redemption prices specified elsewhere herein.
In the event that the Company receives net proceeds from a Strategic Equity
Investment, the Company may, at its option, use all or a portion of such net
proceeds to redeem Notes having an aggregate principal amount of up to one-
third of the original principal amount of the Notes at redemption prices
specified elsewhere herein; provided that Notes having an aggregate principal
amount equal to at least two-thirds of the original principal amount of the
Notes remain outstanding after such redemption. Under the OID Regulations,
computation of the yield and maturity of the Notes is not affected by such
redemption rights and obligations if, based on all the facts and circumstances
as of the issue date, the stated payment schedule of the Notes (that
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does not reflect a Change of Control or a Strategic Equity Investment) is
significantly more likely than not to occur. The Company has determined that,
based on all of the facts and circumstances as of the issue date, it is
significantly more likely than not that the Notes will be paid according to
their stated schedule.
The Company may redeem the Notes, in whole or in part, at any time on or
after March 1, 2002, at redemption prices specified elsewhere herein plus
accrued and unpaid interest to the date of redemption. The OID Regulations
contain rules for determining the "maturity date" and the stated redemption
price at maturity of an instrument that may be redeemed prior to its stated
maturity date at the option of the issuer. Under the OID Regulations, solely
for purposes of the accrual of OID, it is assumed that the issuer will
exercise any option to redeem a debt instrument if such exercise will lower
the yield-to-maturity of the debt instrument. The Company believes that it
will not be presumed to redeem the Notes prior to their stated maturity under
these rules because the exercise of such option would not lower the yield-to-
maturity of the Notes.
Tax Basis
A U.S. Holder's initial tax basis in a Note generally is equal to the
purchase price paid by such U.S. Holder for such Note. A U.S. Holder's tax
basis in a Note is increased by the amount of OID that is included in such
U.S. Holder's income pursuant to the foregoing rules and is decreased by the
amount of any cash payments received.
MARKET DISCOUNT, ACQUISITION PREMIUM
If a U.S. Holder acquires a Note for an amount that is less than its revised
issue price (generally, adjusted issued price) at the time of acquisition, the
amount of such difference will be treated as "market discount" for U.S.
federal income tax purposes, unless such difference is less than a specified
de minimis amount. Under the market discount rules, a U.S. Holder is required
to treat any principal payment on, or any gain on the sale, exchange,
retirement or other disposition of, a Note as ordinary income to the extent of
the market discount which has not previously been included in income and is
treated as having accrued on such Note at the time of such payment or
disposition. If a U.S. Holder makes a gift of a Note, accrued market discount,
if any, is recognized as if such U.S. Holder had sold such Note for a price
equal to its fair market value. In addition, the U.S. Holder may be required
to defer, until the maturity of the Note or the earlier disposition of the
Note in a taxable transaction, the deduction of a portion of the interest
expense on any indebtedness incurred or continued to purchase or carry such
Note.
Any market discount is considered to accrue on a straight-line basis during
the period from the date of acquisition to the maturity date of the Note,
unless the U.S. Holder elects to accrue market discount on a constant interest
method. A U.S. Holder of a Note may elect to include market discount in income
currently as it accrues (on either a straight-line basis or constant interest
method), in which case the rules described above regarding the deferral of
interest deductions will not apply. This election to include market discount
in income currently, once made, applies to all market discount obligations
acquired on or after the first day of the first taxable year to which the
election applies and may not be revoked without the consent of the Internal
Revenue Service.
A U.S. Holder who acquires a Note for an amount that is greater than the
adjusted issue price of such Note but equal to or less than the sum of all
amounts payable on such Note after the purchase date is considered to have
purchased such Note at an "acquisition premium." Under the acquisition premium
rules of the Code and the OID Regulations, the amount of OID which such holder
must include in its gross income with respect to such Note for any taxable
year is reduced by the portion of such acquisition premium properly allocable
to such year.
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SALE OR REDEMPTION
Unless a nonrecognition provision applies, the sale, exchange, redemption
(including pursuant to an offer by the Company) or other disposition of a Note
is a taxable event for U.S. federal income tax purposes. In such event, a U.S.
Holder will recognize gain or loss equal to the difference between (i) the
amount of cash plus the fair market value of any property received upon such
sale, exchange, redemption or other taxable disposition and (ii) the U.S.
Holder's adjusted tax basis therein. Except with respect to accrued market
discount, such gain or loss should be capital gain or loss and will be long-
term capital gain or loss if the Note will have been held by the U.S. Holder
for more than one year at the time of such sale, exchange, redemption or other
disposition. The excess of net long-term capital gains over net short-term
capital losses is taxed at a lower rate than ordinary income for certain non-
corporate taxpayers. The distinction between capital gain or loss and ordinary
income or loss is also relevant for purposes of, among other things,
limitations on the deductibility of capital losses.
NON-U.S. HOLDERS
Subject to the discussion of "backup" withholding below, payments of
principal, if any, and interest (including OID) by the Company or its agent
(in its capacity as such) to any holder who is a beneficial owner of a Note
but is not a U.S. Holder is not subject to U.S. federal withholding tax
provided, in the case of interest (including OID) that (i) such holder does
not actually or constructively own 10% or more of the total combined voting
power of all classes of stock of the Company entitled to vote, (ii) such
holder is not a controlled foreign corporation for U.S. tax purposes that is
related to the Company through stock ownership, and (iii) either (A) the
beneficial owner of the Note certified to the Company or its agent, under
penalties of perjury, that it is not a U.S. Holder and provides its name and
address or (B) a securities clearing organization, bank or other financial
institution that holds customers' securities in the ordinary course of its
trade or business (a "financial institution") certified to the Company or its
agent, under penalties of perjury, that the certification described in clause
(A) hereof has been received from the beneficial owner by it or by another
financial institution acting for the beneficial owner. A holder of a Note who
is not a U.S. Holder, and who does not meet the requirements of the preceding
sentence, would generally be subject to U.S. federal withholding tax at a flat
rate of 30% (or a lower applicable treaty rate) on payments of interest
(including OID) on the Notes.
If a holder of a Note who is not a U.S. Holder is engaged in a trade or
business in the United States and interest (including OID) on the Note is
effectively connected with the conduct of such trade or business, such holder,
although exempt from U.S. federal withholding tax as discussed in the
preceding paragraph (or by reason of the delivery of properly completed Form
4224), is subject to U.S. federal income tax on such interest (including OID)
and on any gain realized on the sale, exchange or other dispositions of a Note
in the same manner as if it were a U.S. Holder. In addition, if such Non-U.S.
Holder is a foreign corporation, it may be subject to a branch profits tax
equal to 30% of its effectively connected earnings and profits for that
taxable year, unless it qualifies for a lower rate under an applicable income
tax treaty.
Subject to the discussion of "backup" withholding below, any capital gain
realized upon the sale, exchange or retirement of a Note by a holder who is
not a U.S. Holder is not subject to U.S. federal income or withholding taxes
unless (i) such gain is effectively connected with a U.S. trade or business of
the holder, or (ii) in the case of an individual, such holder is present in
the United States for 183 days or more in the taxable year of the retirement
or disposition and certain other conditions are met.
Notes held by an individual who is neither a citizen nor a resident of the
United States for U.S. federal income tax purposes at the time of such
individual's death is not subject to U.S. federal estate tax, provided that
the income from the Notes was not or would not have been effectively connected
with a U.S. trade or business of such individual and that such individual
qualified for the exemption from U.S. federal withholding tax (without regard
to the certification requirements) that is described above.
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BACKUP WITHHOLDING AND INFORMATION REPORTING
The "backup" withholding and information reporting requirements may apply to
certain payments of principal and interest (including OID) on a Note and to
certain payments of proceeds of the sale or retirement of a Note. The Company,
its agent, a broker, the Trustee or any paying agent, as the case may be, is
required to withhold tax from any payment that is subject to backup
withholding at a rate of 31% of such payment if the holder fails to furnish
his taxpayer identification number (social security number or employer
identification number), to certify that such holder is not subject to backup
withholding, or to otherwise comply with the applicable requirements of the
backup withholding rules. Certain holders (including, among others, all
corporations) are not subject to the backup withholding and reporting
requirements.
Under current Treasury Regulations, backup withholding and information
reporting do not apply to payments made by the Company or any agent thereof
(in its capacity as such) to a holder of a Note who has provided the required
certification under penalties of perjury that it is not a U.S. Holder as set
forth in clause (iii) in the first paragraph under "--Non-U.S. Holders" or has
otherwise established an exemption (provided that neither the Company nor such
agent has actual knowledge that the holder is a U.S. Holder or that the
conditions of any other exemption are not in fact satisfied).
Payments of the proceeds from the sale by a holder who is not a U.S. Holder
of a Note made to or through a foreign office of a broker will not be subject
to U.S. information reporting or backup withholding, except that if the broker
is a U.S. person, a controlled foreign corporation for U.S. tax purposes or a
foreign person 50% or more of whose gross income is effectively connected with
a United States trade or business for a specified three-year period, U.S.
information reporting may apply to such payments. Payments of the proceeds
from the sale of a Note to or through the United States office of a broker is
subject to U.S. information reporting and backup withholding unless the holder
or beneficial owner certifies as to its non-U.S. status or otherwise
establishes an exemption from U.S. information reporting and backup
withholding.
Any amounts withheld under the backup withholding rules from a payment to a
holder may be claimed as a credit against such holder's United States federal
income tax liability.
The Company is required to furnish certain information to the Internal
Revenue Service, and will furnish annually to record holders of Notes,
information with respect to interest and OID accruing during the calendar
year. The OID information will be based upon the adjusted issue price of the
debt instrument as if the holder were the original holder of the debt
instrument. No assurance can be given that the Internal Revenue Service will
not challenge the accuracy of the reported information. Subsequent holders who
purchase Notes for an amount other than the adjusted issue price and/or on a
date other than the last day of an accrual period will be required to
determine for themselves the amount of OID, if any, they are required to
include in gross income for U.S. federal income tax purposes.
LEGAL MATTERS
The legality of the Exchange Notes offered hereby are being passed upon for
the Company by Hogan & Hartson L.L.P., Washington, D.C., special counsel for
the Company. Certain legal matters relating to the Offering were passed upon
for the Initial Purchasers by Mayer, Brown & Platt, Chicago, Illinois.
EXPERTS
The consolidated balance sheets of the Company as of December 31, 1996 and
1995, and the consolidated statements of operations, stockholders' equity and
cash flows for each of the years in the
139
<PAGE>
three-year period ended December 31, 1996 and financial statement schedule
included in this Registration Statement have been audited by McGladrey &
Pullen, LLP, independent auditors, 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 statements of income, redeemable common stock and warrants
and common stockholders' equity (deficit) and cash flows of Ruffalo, Cody &
Associates, Inc. for the years ended December 31, 1995 and 1994 and financial
statement schedule included in this Registration Statement have been audited
by McGladrey & Pullen, LLP, independent auditors, 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 statements of income, stockholders' equity and cash flows
of Telecom*USA Publishing Group, Inc. for each of the years in the three-year
period ended August 31, 1996 and financial statement schedule included in this
Registration Statement have been audited by McGladrey & Pullen, LLP,
independent auditors, 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.
CHANGES IN ACCOUNTANTS
On March 27, 1997, the Company engaged the accounting firm of Arthur
Andersen LLP as the Company's principal independent accountants to replace
McGladrey & Pullen, LLP, the Company's former independent accountants,
effective with such engagement. The decision to change independent accountants
was made following a review of competitive proposals submitted by Arthur
Andersen LLP and two other major public accounting firms, and was recommended
by the Audit Committee of the Board of Directors and approved by the Board.
McGladrey & Pullen, LLP did not resign and did not decline to stand for re-
election. During the Company's two most recent fiscal years and during the
interim period prior to the engagement, there have been no consultations with
the newly engaged accountants with regard to either the application of
accounting principles as to any specific transaction, either completed or
proposed; the type of audit opinion that would be rendered on the Company's
financial statements; or any matter of disagreement with the former
accountants.
During the two most recent fiscal years ended December 31, 1996 and 1995,
and the interim period subsequent to December 31, 1996, there have been no
disagreements with McGladrey & Pullen, LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure which would have caused McGladrey & Pullen, LLP to make reference in
their report to such disagreements if not resolved to their satisfaction.
McGladrey & Pullen, LLP's reports on the financial statements of the Company
for the fiscal years ended December 31, 1996 and 1995 have contained no
adverse opinion or disclaimer of opinion and were not qualified or modified as
to uncertainty, audit scope or accounting principles.
The Company has provided McGladrey & Pullen, LLP with a copy of this
disclosure and requested that McGladrey & Pullen, LLP furnish it with a letter
addressed to the Commission stating whether it agrees with the above
statements. (A copy of the McGladrey & Pullen, LLP letter addressed to the
Commission is filed as Exhibit 16.1 to the Registration Statement).
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act, and, in accordance therewith, files 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,
140
<PAGE>
Illinois 60661 and 7 World Trade Center, Suite 1300, New York, New York 10048.
Copies of such reports, proxy statements and other information can also be
obtained from the Public Reference Section of the Commission at 450 Fifth
Street, N.W., 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 Company's Class A Common Stock 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 Exchange Offer. 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 Exchange Offer, 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.
The Company is required by the terms of the Indenture to furnish the Trustee
with annual reports containing consolidated financial statements audited by
their independent public accountants and with quarterly reports containing
audited condensed consolidated financial statements for each of the first
three quarters of each fiscal year.
141
<PAGE>
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 though 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 temporarily 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.
G-1
<PAGE>
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.
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.
G-2
<PAGE>
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.
G-3
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
Independent Auditor's Report.............................................. F-2
Consolidated Balance Sheets as of March 31, 1997 (unaudited) and as of
December 31, 1996 and 1995............................................... F-3
Consolidated Statements of Operations for the three months ended March 31,
1997 and 1996 (unaudited) and for the years ended December 31, 1996, 1995
and 1994................................................................. F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1996, 1995 and 1994 and for the three months ended March 31,
1997 (unaudited)......................................................... F-5
Consolidated Statements of Cash Flows for the three months ended March 31,
1997 and 1996 (unaudited) and for the years ended December 31, 1996, 1995
and 1994................................................................. F-6
Notes to Consolidated Financial Statements................................ F-7
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
Independent Auditor's Report.............................................. F-22
Consolidated Statements of Income for the years ended December 31, 1995
and 1994................................................................. F-23
Consolidated Statements of Redeemable Common Stock and Warrants and Common
Stockholders' Equity (Deficit) for the years ended December 31, 1995 and
1994..................................................................... F-24
Consolidated Statements of Cash Flows for the years ended December 31,
1995 and 1994............................................................ F-25
Notes to Consolidated Financial Statements................................ F-26
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
Independent Auditor's Report.............................................. F-31
Consolidated Statements of Income for the years ended August 31, 1996,
1995 and 1994............................................................ F-32
Consolidated Statements of Stockholders' Equity for the years ended August
31, 1996, 1995 and 1994.................................................. F-33
Consolidated Statements of Cash Flows for the years ended August 31, 1996,
1995 and 1994............................................................ F-34
Notes to Consolidated Financial Statements................................ F-35
</TABLE>
F-1
<PAGE>
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, 1996 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, 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 McLeod,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1996 in conformity with generally accepted
accounting principles.
McGladrey & Pullen, LLP
Cedar Rapids, Iowa
January 31, 1997, except for the first paragraph of
Note 4 as to which the date is March 4, 1997
F-2
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, -----------------
1997 1996 1995
----------- -------- -------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS (NOTE 4)
Current Assets
Cash and cash equivalents (Note 3)............. $366,999 $ 96,480 $ --
Investment in available-for-sale securities
(Note 3)...................................... 67,842 80,518 --
Trade receivables, net (Note 2)................ 26,200 27,560 6,689
Inventory...................................... 2,409 1,600 1,598
Deferred expenses.............................. 11,073 12,156 --
Prepaid expenses and other..................... 7,417 6,087 220
-------- -------- -------
TOTAL CURRENT ASSETS......................... 481,940 224,401 8,507
-------- -------- -------
Property and Equipment
Land........................................... 2,246 2,246 311
Telecommunication networks..................... 42,511 32,041 8,056
Furniture, fixtures and equipment.............. 24,610 22,302 5,742
Networks in progress (Note 5).................. 43,957 35,481 4,155
Building in progress (Note 5).................. 10,293 6,103 --
-------- -------- -------
123,617 98,173 18,264
Less accumulated depreciation.................. 8,105 6,050 2,145
-------- -------- -------
115,512 92,123 16,119
-------- -------- -------
Investments, Intangibles and Other Assets
Investment in available-for-sale securities
(Note 3)...................................... 39,348 47,474 --
Goodwill, net.................................. 58,567 57,012 2,525
Customer lists, net............................ 23,261 17,095 --
Noncompete agreements, net..................... 14,156 6,737 --
Deferred line installation costs, net.......... 3,914 2,083 1,424
PCS licenses (Note 5).......................... 31,968 4,800
Other.......................................... 10,988 1,269 411
-------- -------- -------
182,202 136,470 4,360
-------- -------- -------
$779,654 $452,994 $28,986
======== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt (Note
4)............................................ $ 1,190 $ 793 $ --
Contracts payable (Notes 4 and 11)............. 6,360 -- --
Accounts payable............................... 18,994 15,807 5,832
Checks issued not yet presented for payment.... -- -- 919
Accrued payroll and payroll related expenses... 6,154 7,259 1,955
Other accrued liabilities...................... 2,275 3,095 857
Due on PCS licenses (Note 5)................... 25,413 -- --
Deferred revenue, current portion.............. 1,960 1,793 134
Customer deposits.............................. 9,720 9,686 18
-------- -------- -------
TOTAL CURRENT LIABILITIES.................... 72,066 38,433 9,715
-------- -------- -------
Long-Term Debt, less current maturities (Note
4)............................................. 304,304 2,573 3,600
-------- -------- -------
Deferred Revenue, less current portion.......... 9,057 8,559 713
-------- -------- -------
Commitments (Note 5)
Stockholders' Equity (Notes 4, 7, 8 and 9)
Capital stock:
Preferred, Class A, $5.50 par value; autho-
rized 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 and outstanding
1997 36,919,930; 1996 36,172,817 shares;
1995 16,387,081 shares...................... 369 362 164
Common, Class B, convertible, $.01 par value;
authorized 22,000,000 shares; issued and
outstanding 1997, 1996 and 1995 15,625,929
shares...................................... 156 156 156
Additional paid-in capital..................... 454,882 450,736 40,117
Accumulated deficit............................ (61,180) (47,825) (25,479)
-------- -------- -------
394,227 403,429 14,958
-------- -------- -------
$779,654 $452,994 $28,986
======== ======== =======
</TABLE>
See Notes to Consolidated Financial Statements.
F-3
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
----------------- ----------------------------
1997 1996 1996 1995 1994
-------- ------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue (Note 2).............. $ 35,747 $12,488 $ 81,323 $ 28,998 $ 8,014
-------- ------- -------- -------- --------
Operating expenses:
Cost of service............. 21,200 9,250 52,624 19,667 6,212
Selling, general and
administrative............. 23,985 6,345 46,044 18,054 12,373
Depreciation and
amortization............... 4,122 969 8,485 1,835 772
Other....................... 1,608 -- 2,380 -- --
-------- ------- -------- -------- --------
TOTAL OPERATING EXPENSES.. 50,915 16,564 109,533 39,556 19,357
-------- ------- -------- -------- --------
OPERATING LOSS............ (15,168) (4,076) (28,210) (10,558) (11,343)
-------- ------- -------- -------- --------
Nonoperating income (expense):
Interest income............. 4,253 1 6,034 139 145
Interest (expense).......... (2,447) (265) (665) (910) (218)
Other income................ 7 -- 495 -- --
-------- ------- -------- -------- --------
TOTAL NONOPERATING INCOME
(EXPENSE)................ 1,813 (264) 5,864 (771) (73)
-------- ------- -------- -------- --------
LOSS BEFORE INCOME TAXES.. (13,355) (4,340) (22,346) (11,329) (11,416)
Income taxes (Note 6)......... -- -- -- -- --
-------- ------- -------- -------- --------
NET LOSS.................. $(13,355) $(4,340) $(22,346) $(11,329) $(11,416)
======== ======= ======== ======== ========
Loss per common and common
equivalent share (Note 8).... $ (0.26) $ (0.12) $ (0.52) $ (0.31) $ (0.31)
======== ======= ======== ======== ========
Weighted average common and
common equivalent shares
outstanding (Note 8)......... 52,327 37,055 43,019 37,055 36,370
======== ======= ======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NOTES 8, 9 AND 13)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 AND
THREE MONTHS ENDED MARCH 31, 1997 (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARES)
<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,
1993................... $ -- $120 $ 56 $ 10,494 $ (2,734) $ -- $ 7,936
Net loss............... -- -- -- -- (11,416) -- (11,416)
Issuance of 2,484,720
shares of Class A
common stock.......... -- 25 -- 3,604 -- -- 3,629
Issuance of 2,045,457
shares of Class B
common stock.......... -- -- 20 2,980 -- -- 3,000
Purchase of 22,500
shares of common stock
for the treasury...... -- -- -- -- -- (33) (33)
Amortization of fair
value of stock options
issued to nonemployees
(Note 4).............. -- -- -- 175 -- -- 175
----- ---- ---- -------- -------- ----- --------
Balance, December 31,
1994................... -- 145 76 17,253 (14,150) (33) 3,291
Net loss............... -- -- -- -- (11,329) -- (11,329)
Issuance of 1,908,600
shares of Class A
common stock.......... -- 19 -- 4,278 -- -- 4,297
Issuance of 4,279,414
shares of Class B
common stock.......... -- -- 43 9,652 -- -- 9,695
Issuance of 3,676,058
shares of Class B
common stock in
connection with the
acquisition of MWR
Telecom Inc. (Note
11)................... -- -- 37 8,296 -- -- 8,333
Reissuance of 22,500
shares of treasury
stock................. -- -- -- 6 -- 33 39
Amortization of fair
value of stock options
issued to nonemployees
(Note 4).............. -- -- -- 632 -- -- 632
----- ---- ---- -------- -------- ----- --------
Balance, December 31,
1995................... -- 164 156 40,117 (25,479) -- 14,958
Net loss............... -- -- -- -- (22,346) -- (22,346)
Issuance of 19,424,316
shares of Class A
common stock.......... -- 194 -- 396,020 -- -- 396,214
Issuance of 361,420
shares of Class A
common stock in
connection with the
acquisition of
Ruffalo, Cody &
Associates, Inc. (Note
11)................... -- 4 -- 8,941 -- -- 8,945
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
options (Note 11)..... -- -- -- 3,301 -- -- 3,301
Amortization of fair
value of stock options
issued to nonemployees
(Note 4).............. -- -- -- 341 -- -- 341
Amortization of
compensation expense
related to stock
options (Note 7)...... -- -- -- 2,016 -- -- 2,016
----- ---- ---- -------- -------- ----- --------
Balance, December 31,
1996................... -- 362 156 450,736 (47,825) -- 403,429
Net loss (unaudited)... -- -- -- -- (13,355) -- (13,355)
Issuance of 625,576
shares of Class A
common stock
(unaudited)........... -- 6 -- 310 -- -- 316
Release of 37,107
shares of Class A
common stock from
escrow (unaudited)
(Note 11) ............ -- -- -- 1,020 -- -- 1,020
Issuance of 84,430
shares of Class A
common stock in
connection with the
acquisition of Digital
Communications of
Iowa, Inc. (unaudited)
(Note 11) ............ -- 1 -- 2,249 -- -- 2,250
Amortization of
compensation expense
related to stock
options (unaudited)
(Note 7) ............. -- -- -- 567 -- -- 567
----- ---- ---- -------- -------- ----- --------
Balance, March 31, 1997
(unaudited)............ $ -- $369 $156 $454,882 $(61,180) $ -- $394,227
===== ==== ==== ======== ======== ===== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------ -----------------------------
1997 1996 1996 1995 1994
-------- -------- --------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash Flows from Operating
Activities
Net loss.................... $(13,355) $ (4,340) $ (22,346) $(11,329) $(11,416)
Adjustments to reconcile
net loss to net cash (used
in) operating activities:
Depreciation............... 1,930 512 3,944 1,299 633
Amortization............... 2,192 644 4,882 1,168 314
Accretion of interest on
senior discount notes..... 2,621 -- -- -- --
Changes in assets and
liabilities, net of
effects of acquisitions
(Note 11):
(Increase) decrease in
trade receivables........ 1,739 (4,932) (9,317) (3,575) (2,272)
(Increase) in inventory.. (26) (204) (2) (269) (185)
Decrease in deferred
expenses................. 1,083 -- 1,966 -- --
(Increase) in deferred
line installation
costs.................... (2,120) (230) (1,289) (806) (1,136)
Increase in accounts
payable and accrued
expenses................. 950 2,715 3,192 4,084 1,994
Increase in deferred
revenue.................. 291 2,118 9,505 9 716
Increase in customer
deposits................. 34 -- 1,366 11 6
Other, net............... (1,263) (187) (3,703) (70) (16)
-------- -------- --------- -------- --------
NET CASH (USED IN)
OPERATING ACTIVITIES..... (5,924) (3,904) (11,802) (9,478) (11,362)
-------- -------- --------- -------- --------
Cash Flows from Investing
Activities
Purchase of property and
equipment.................. (24,511) (3,942) (70,290) (5,272) (3,363)
Available-for-sale
securities:
Purchases.................. (32,721) -- (207,681) -- --
Sales...................... 30,730 -- 17,577 -- --
Maturities................. 22,793 -- 62,389 -- --
Business acquisitions (Note
11)........................ (7,529) -- (80,081) -- --
Deposits on PCS licenses
(Note 5)................... (1,755) -- (4,800) -- --
Other....................... (143) -- (222) (266) (79)
-------- -------- --------- -------- --------
NET CASH (USED IN)
INVESTING ACTIVITIES..... (13,136) (3,942) (283,108) (5,538) (3,442)
-------- -------- --------- -------- --------
Cash Flows from Financing
Activities
Increase (decrease) in
checks issued not yet
presented for payment...... -- 123 (919) 885 34
Proceeds from line of
credit agreements.......... -- 25,100 55,925 42,200 8,400
Payments on line of credit
agreements................. -- (17,400) (59,825) (42,100) (4,900)
Proceeds from long-term
debt....................... 289,796 -- 2,060 -- --
Payments on long-term
debt....................... (533) -- (2,065) -- --
Net proceeds from issuance
of common stock............ 316 23 396,214 13,992 6,629
Reissuance (purchase) of
treasury stock............. -- -- -- 39 (33)
-------- -------- --------- -------- --------
NET CASH PROVIDED BY
FINANCING ACTIVITIES..... 289,579 7,846 391,390 15,016 10,130
-------- -------- --------- -------- --------
NET INCREASE (DECREASE)
IN CASH AND CASH
EQUIVALENTS.............. 270,519 -- 96,480 -- (4,674)
Cash and cash equivalents:
Beginning................... 96,480 -- -- -- 4,674
-------- -------- --------- -------- --------
Ending...................... $366,999 $ -- $ 96,480 $ -- $ --
======== ======== ========= ======== ========
Supplemental Disclosure of
Cash Flow Information
Cash payment for interest,
net of interest
capitalized 1997 $290;
1996 $204; 1995 $62; and
1994 none.................. $ -- $ 99 $ 300 $ 261 $ 35
======== ======== ========= ======== ========
Supplemental Schedule of
Noncash Investing and
Financing Activities
Release of 37,107 shares of
Class A common stock from
escrow
(Note 11).................. $ 1,020
========
Liability recorded for
payment on PCS licenses
(Note 5)................... $ 25,413
========
Accounts payable incurred
for property and equipment
........................... $ 5,541 $ 1,681 $ 5,989 $ 1,234 $ 141
======== ======== ========= ======== ========
Acquisitions (Note 11)
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 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 the Midwest, primarily in
Iowa and Illinois. The Company's services primarily include local and long-
distance telecommunications services, competitive access services, including
special access and private line services, and maintenance and installation
services on fiber optic telecommunications networks. The Company also provides
telemarketing services to businesses and nonprofit 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 December 31, 1996 and March 31,
1997 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 fiber
optic networks. As of March 31, 1997, inventories of approximately $1.5
million used to support a maintenance agreement are being amortized on a
straight-line basis over the 10-year life of the agreement (see Note 2).
F-7
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Property and equipment: Property and equipment is stated at cost.
Construction costs, including interest, are capitalized during the
installation of fiber optic telecommunications networks. Depreciation is
computed by the straight-line method over the following estimated useful
lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Telecommunications networks.......................................... 5-15
Furniture, fixtures and equipment.................................... 2-10
</TABLE>
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.
Goodwill and customer lists: Goodwill and customer lists resulting from the
Company's acquisitions are being amortized over a range of 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. Accumulated amortization on goodwill totaled $1,618,000, $1,049,000
and $117,000, and accumulated amortization on customer lists totaled $813,000,
$432,000 and none at March 31, 1997, December 31, 1996 and 1995, respectively.
Noncompete agreements: Noncompete agreements primarily relate to directories
previously acquired by Telecom*USA Publishing Group, Inc. (now known as
McLeodUSA Publishing Company (McLeodUSA Publishing)) and are being amortized
by the straight-line method over various periods. Accumulated amortization on
noncompete agreements totaled $493,000, $250,000 and none at March 31, 1997,
December 31, 1996 and 1995, respectively.
Deferred line installation costs: Deferred line installation costs include
costs incurred in the establishment of local access lines for customers and
are being amortized on the straight-line method over the life of the average
customer contract. The contracts' terms do not exceed 60 months. Accumulated
amortization on deferred line installation costs totaled $1,437,000,
$1,148,000 and $518,000 at March 31, 1997, December 31, 1996 and 1995,
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 telecommunications 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 telecommunications services. The revenue from
long-term leases of fiber optic telecommunications networks is recognized over
the term of the lease. Base annual revenue for telecommunications 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.
F-8
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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 telecommunications networks. The 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: In fiscal year 1996, the Company adopted
the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, which
establishes a fair value based method for the financial reporting of its
stock-based employee compensation plans. However, as allowed by the new
standard, the Company has elected to continue to measure compensation using
the intrinsic value based method as prescribed by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. Under this method,
compensation is measured as the difference between the market value of the
stock on the grant date, 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 8). 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 nonemployees: The Company uses the Black-Scholes
model to determine the fair value of the stock options issued to nonemployees
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: Loss per common and common
equivalent share has been computed using the number of shares of common stock
and common stock equivalents outstanding after giving effect to the
recapitalization (see Note 8). Pursuant to Securities and Exchange Commission
Staff Accounting Bulletin No. 83, stock issued and stock options granted with
exercise prices below the initial public offering price during the twelve-
month period preceding the date of the initial filing of the Registration
Statement filed in connection with the Company's initial public offering have
been included in the calculation as if they were outstanding for all periods
through June 30, 1996, the end of the quarter in which the initial public
offering was declared effective.
F-9
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Fair value of financial instruments: The fair value of the Company's
investment in available-for-sale securities is disclosed in Note 3. The
carrying amount of long-term debt approximates fair value because these
obligations bear interest at current rates.
Reclassifications: Certain items in the 1995 consolidated financial
statements have been reclassified, with no effect on net loss or accumulated
deficit, to be consistent with the classification in the 1996 consolidated
financial statements.
Interim Financial Information (unaudited): The financial statements and
notes related thereto as of March 31, 1997, and for the three-month periods
ended March 31, 1997 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 Company's 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 AND MAJOR CUSTOMER
The composition of trade receivables, net is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1996 1995
------- ------
(IN THOUSANDS)
<S> <C> <C>
Trade receivables:
Billed................................................ $22,846 $6,908
Unbilled.............................................. 8,613 --
------- ------
31,459 6,908
Less allowance for doubtful accounts and discounts...... (3,899) (219)
------- ------
$27,560 $6,689
======= ======
</TABLE>
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 $5,936,000, $4,937,000 and $3,407,000 for
1996, 1995 and 1994, respectively. The Company also had additional revenues
from the State of Iowa for various fiber optic network construction projects,
which totaled $3,788,000 and $403,000 in 1996 and 1995, respectively. Trade
receivables include approximately $4,860,000 and $2,143,000 from this customer
at December 31, 1996 and 1995, respectively.
NOTE 3. INVESTMENTS
At March 31, 1997, the Company held $290,250,000, $100,362,000, $45,113,000
and $6,750,000 in repurchase agreements, corporate debt securities, United
States Government and governmental agency securities and mortgage-backed
securities, respectively. At December 31, 1996, the Company held none,
$147,439,000, $54,759,000 and $7,850,000 in these securities, respectively.
The Company has classified these securities as available-for-sale, and at
March 31, 1997 and December 31, 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 $335,285,000,
$67,842,000 and $39,348,000, respectively, being recorded in each
classification at March 31, 1997. At December 31, 1996, $82,056,000,
$80,518,000 and $47,474,000, respectively, were recorded in each
classification.
F-10
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 3. INVESTMENTS--(CONTINUED)
The contractual maturities of the available-for-sale securities are as
follows (In thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
--------- ------------
<S> <C> <C>
Due within one year................................... $401,829 $161,205
Due after one year through three years................ 33,896 40,731
Due after three years................................. -- 262
Mortgage-backed securities............................ 6,750 7,850
-------- --------
$442,475 $210,048
======== ========
</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.
NOTE 4. PLEDGED ASSETS AND DEBT
Debt offering: On March 4, 1997, the Company completed a private offering of
10 1/2% Senior Discount Notes (the "Notes") due March 1, 2007 at an original
issue discount in which the Company received approximately $289.8 million in
net proceeds. The Notes will accrete interest at a rate of 10 1/2% per year,
compounded semi-annually, to an aggregate principal amount of $500 million by
March 1, 2002. Interest will not accrue on the Notes for five years, after
which time the Notes will accrue interest at 10 1/2%, payable semi-annually.
The Notes contain certain covenants which, among other things, restrict the
ability of the Company to incur additional indebtedness, pay dividends or make
distributions of the Company's or its subsidiaries' stock, enter into sale and
leaseback transactions, create liens, enter into transactions with affiliates
or related persons, or consolidate, merge or sell all of its assets. The Notes
have not been registered under the Securities Act of 1933, and therefore are
not tradeable securities, however, the Company has agreed to file a
registration statement with the Securities and Exchange Commission with
respect to a registered offer to exchange the Notes for new notes that will be
tradeable.
F-11
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 4. PLEDGED ASSETS AND DEBT--(CONTINUED)
The Company's debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, -------------
1997 1996 1995
--------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Contracts payable, unsecured, non-interest bearing,
due in various installments through September 1997
(See Note 11)..................................... $ 6,360 $ -- $ --
======== ====== ======
Borrowings on line of credit agreements (A) and
(B)............................................... $ -- $ -- $3,600
10 1/2% Senior Discount Notes...................... 302,621 -- --
Note payable, due January 1, 1997, including
interest at 6.625%. Collateralized by a second
lien on publishing rights to purchased
directories....................................... -- 500 --
Note payable, due in various annual installments,
including interest at 8.25%, through 2006.
Collateralized by publishing rights to purchased
directories....................................... 1,022 1,008 --
Contracts payable, to finance company, due in
various monthly payments, including interest at
8.50% to 8.625%, through November 1998,
collateralized by equipment with a depreciated
cost of approximately $290,000 at March 31, 1997.. 202 248 --
Incentive compensation agreements, due in various
estimated amounts plus interest at 6% through
January 2001 (See Note 11)........................ 1,610 1,610 --
Other.............................................. 39 -- --
-------- ------ ------
305,494 3,366 3,600
Less current maturities............................ 1,190 793 --
-------- ------ ------
$304,304 $2,573 $3,600
======== ====== ======
</TABLE>
- --------
(A) At December 31, 1995, the Company had a line of credit agreement with The
First National Bank of Chicago under which it could borrow up to
$20,000,000 from any of three facilities as specified in the agreement. In
March 1996, the agreement was amended to increase the allowable maximum
borrowings to $32,000,000. The agreement required interest payments and
facility fees to be paid at various rates. Class B common stock options
were granted to a stockholder which guaranteed any borrowings under two of
the facilities. The Company used the Black-Scholes model to determine the
value of the options, which was approximately $3,400,000, at the date of
issuance. This value was being amortized over the vesting period of the
options. A portion of the proceeds from the Company's initial public
offering on June 10, 1996 (see Note 8) was used to pay off all existing
indebtedness under these credit facilities, which were subsequently
cancelled. Upon cancellation, the vesting on Class B common stock options
was terminated which also terminated the amortization of the fair value of
the options. At December 31, 1996, a total of 1,300,688 Class B common
stock options are vested.
Due to the inclusion of the amortization of the fair value of these options
in interest expense, the effective average interest rate on the borrowings
under these credit facilities was approximately 15%, 27% and 47% for the
years ended December 31, 1996, 1995 and 1994, respectively.
(B) At December 31, 1996, a subsidiary of the Company has a line of credit
agreement with a bank, which expires May 2, 1997. The subsidiary 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 the subsidiary's assets and bear interest at the
bank's prime rate (the current effective rate is 8.25%).
F-12
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 4. PLEDGED ASSETS AND DEBT--(CONTINUED)
Principal payments required on the debt at December 31, 1996 are as follows
(in thousands):
<TABLE>
<S> <C>
1997............................................................... $ 793
1998............................................................... 1,090
1999............................................................... 515
2000............................................................... 378
2001............................................................... 114
Later years........................................................ 476
------
$3,366
======
</TABLE>
NOTE 5. LEASES AND COMMITMENTS
Leases: The Company leases its facilities under noncancelable 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, 1996 under the leases
mentioned above is as follows (In thousands):
<TABLE>
<S> <C>
1997.............................................................. $ 4,935
1998.............................................................. 4,133
1999.............................................................. 3,386
2000.............................................................. 2,702
2001.............................................................. 1,619
Thereafter........................................................ 6,510
-------
$23,285
=======
</TABLE>
The total rental expense included in the consolidated statements of
operations for 1996, 1995 and 1994 is approximately $3,640,000, $1,558,000 and
$622,000, respectively, which also includes short-term rentals for office
facilities.
Network construction: During 1995, the Company was awarded contracts from
the State of Iowa to build 265 fiber optic telecommunications 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. For the years ended December 31, 1996 and 1995, revenue of $445,000 and
none, respectively, 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 $24,986,000. The Company, 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
F-13
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 5. LEASES AND COMMITMENTS--(CONTINUED)
with respect to such construction, in order to optimize the design of its
network. The Company anticipates that the costs to complete this project will
be incurred as follows (In thousands):
<TABLE>
<S> <C>
1997.............................................................. $13,413
1998.............................................................. 9,701
1999.............................................................. 1,872
-------
$24,986
=======
</TABLE>
Buildings: In August 1996, the Company purchased approximately 194 acres of
land on which the Company is constructing its headquarters and associated
buildings. Of the land purchased, approximately 75 acres was purchased from a
subsidiary of a stockholder for approximately $692,000. At December 31, 1996,
the total remaining commitments on the building in progress, including
fixtures, is approximately $14.7 million.
Personal Communications Services (PCS) licenses: In April 1997, the Federal
Communications Commission (FCC) awarded the Company 25 "D" and "E" block
frequency PCS licenses in 23 market areas in Iowa, Illinois, Minnesota,
Nebraska and South Dakota. The PCS licenses will allow the Company to provide
wireless telecommunications services to its customers in the markets covered
by the licenses. The Company paid the FCC an aggregate of approximately $32
million for the licenses. The Company made a $4.8 million deposit with the FCC
at the beginning of the bidding process in 1996, made an additional deposit of
$1.8 million in January 1997 and paid the balance of $25.4 million for these
PCS licenses on May 12, 1997.
NOTE 6. INCOME TAX MATTERS
Net deferred taxes consist of the following components as of December 31,
1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
------- -------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $19,419 $ 9,681
Accruals and reserves not currently deductible............ 4,033 529
Deferred revenues......................................... 285 301
Other..................................................... 571 17
------- -------
24,308 10,528
Less valuation allowance.................................. 16,211 8,418
------- -------
8,097 2,110
------- -------
Deferred tax liabilities:
Deferred line installation cost........................... 833 570
Property and equipment.................................... 2,202 1,540
Customer list............................................. 3,698 --
Deferred expenses......................................... 1,035 --
Other..................................................... 329 --
------- -------
8,097 2,110
------- -------
$ -- $ --
======= =======
</TABLE>
F-14
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 6. INCOME TAX MATTERS--(CONTINUED)
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 $48.5 million which expire in various amounts in the
years 2008 to 2011.
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 1996, 1995 and
1994 due to the following:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Computed "expected" tax (benefit)............... $(7,821) $(3,965) $(3,996)
Increase (decrease) in income taxes resulting
from:
Change in valuation allowance................. 7,793 3,007 4,622
Deferred tax rate differential on temporary
differences.................................. 1,661 919 (594)
Tax deductions due to exercises of incentive
stock options................................ (2,028) -- --
Other......................................... 395 39 (32)
------- ------- -------
$ -- $ -- $ --
======= ======= =======
</TABLE>
NOTE 7. STOCK-BASED COMPENSATION PLANS
At December 31, 1996, the Company has various stock-based compensation plans
which are described below. Grants under the Company's stock option plans are
accounted for in accordance with Accounting Principles Board (APB) Opinion No.
25 and related Interpretations. 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 is
amortizing approximately $9,190,000 over the vesting period of these options.
Compensation cost of $2,016,000 has been charged to income for the year ended
December 31, 1996 using the intrinsic value based method as prescribed by APB
No. 25. Had compensation cost for all of the stock-based compensation plans
been determined based on the grant date fair values of awards granted during
1996 and 1995, as prescribed by SFAS No. 123, reported net loss and loss per
common and common equivalent share would have been as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
-------- --------
<S> <C> <C>
Pro forma net loss...................................... $(24,776) $(11,646)
Pro forma loss per common and common equivalent share... (0.58) (0.31)
</TABLE>
1992, 1993 and 1995 Incentive Stock Option Plans: The Company has reserved
5,410,588 shares of Class A common stock for issuance to employees under the
1992, 1993 and 1995 Incentive Stock Option Plans. Options outstanding under
these plans were granted at prices equal to the estimated fair market value on
the dates of grant as determined by the Company's Board of Directors. Under
the 1992 and 1993 plans, all options granted become exercisable at a rate of
25% per year, on a cumulative basis, and expire seven years after the date of
grant. Under the 1995 plan, all options, except for options granted 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 granted to the Company's chairman and chief executive
officer vest at a rate of 20% per year
F-15
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 7. STOCK-BASED COMPENSATION PLANS--(CONTINUED)
on a cumulative basis. All options granted under the 1995 plan expire ten
years after the date of grant. These plans have been superseded by the 1996
Employee Stock Option Plan, and no future grants of options will be made under
these plans.
1996 Employee Stock Option Plan: The Company has reserved 4,458,236 shares
of Class A common stock for issuance to employees under the 1996 Employee
Stock Option Plan, which supersedes the 1992, 1993 and 1995 Incentive Stock
Option Plans. The exercise price for options granted under this plan is the
fair market value of the Company's Class A common stock on the day before the
grant date (or 110% of the fair market value if the grantee beneficially owns
more than 10% of the outstanding Class A common stock). The options granted
expire ten 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), and 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 by an individual employee. The 1996
Plan will terminate in March 2006, unless terminated earlier by the Board of
Directors.
Directors' Stock Option Plan: The Company has reserved 550,000 shares of
Class A common stock for issuance under the Directors' Plan to directors who
are not officers or employees of the Company. The Director's Plan was adopted
and approved by the stockholders in 1993 and amended and restated on March 28,
1996 to be a "formula" plan providing for an automatic grant of options to
eligible directors. Each eligible director who commences service on the Board
of Directors after the amendment and restatement of the plan 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 after each of the next two annual meetings to each eligible director
who remains for the two-year period. Options granted under the Directors' Plan
vest at a rate of 25% per year, on a cumulative basis, and expire seven years
after the date of grant (ten years after the date of grant for options granted
under the amended and restated plan). However, upon a change in control of the
Company as defined in the Directors' Plan, all options will become fully
exercisable. The Company has the right to repurchase any Class A common stock
issued pursuant to the exercise of an option granted under this plan that is
offered for sale to an individual who is not an employee or director of the
Company. The Directors' Plan will terminate in March 2006, unless terminated
earlier by the Board of Directors.
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, 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 90% of the closing price
of the 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 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. The
Company has implemented this plan effective February 1, 1997.
F-16
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 7. STOCK-BASED COMPENSATION PLANS--(CONTINUED)
The fair value of each grant under the Company's stock option plans is
estimated at the grant date using the Black-Scholes option-pricing model with
the following weighted-average assumptions for grants in 1996 and 1995,
respectively: risk-free interest rates of 6.08% and 6.30%; price volatility of
40% and expected lives of 4 years for both years and no expected dividends.
A summary of the status of the Company's stock option plans as of and for
the years ended December 31, 1996, 1995 and 1994 is as follows (In thousands,
except price data):
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE
SHARES PRICE
------ ---------
<S> <C> <C>
Outstanding at January 1, 1994............................. 2,569 $ 0.60
Granted.................................................. 786 1.55
Forfeited................................................ (233) 0.95
-----
Outstanding at December 31, 1994........................... 3,122 0.82
Granted.................................................. 2,006 2.18
Exercised................................................ (11) 0.29
Forfeited................................................ (248) 1.75
-----
Outstanding at December 31, 1995........................... 4,869 1.33
Granted.................................................. 3,502 13.14
Exercised................................................ (491) 1.30
Forfeited................................................ (336) 7.64
-----
Outstanding at December 31, 1996........................... 7,544 6.54
=====
</TABLE>
<TABLE>
<CAPTION>
NUMBER OF OPTIONS
-----------------
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Exercisable, end of year................................. 2,324 1,581 1,035
===== ===== =====
Weighted-average fair value per option of options granted
during the year......................................... 5.74 0.86
===== =====
</TABLE>
Other pertinent information related to the options outstanding at December
31, 1996 is as follows (In thousands except life and price data):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------- ---------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
--------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$0.27 to $1.47.......... 2,517 3.42 $ .71 1,969 $0.61
$1.73 to $2.93.......... 3,351 6.05 2.39 333 2.10
$4.29 to $9.30.......... 56 7.19 6.49 22 4.37
$20.00 to $28.50........ 1,620 9.57 24.21 -- --
----- -----
7,544 5.94 6.54 2,324 0.85
===== =====
</TABLE>
In addition, the Company has reserved 1,300,688 shares of Class B common
stock for issuance to a stockholder which had guaranteed certain debt
agreements which were repaid with proceeds from the Company's initial public
offering and cancelled. All of these options have vested at December 31, 1996.
F-17
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 8. CAPITAL STOCK INFORMATION AND INVESTOR AGREEMENT
Public offerings: On June 10, 1996, the Company undertook an initial public
offering of Class A common stock which yielded net proceeds of approximately
$258 million. On November 20, 1996, the Company completed an additional public
offering of Class A common stock which yielded net proceeds of approximately
$138 million in additional capital.
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. 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 restated
Articles of Incorporation also authorizes the Board of 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.
Additionally, 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.
Investor Agreement: On April 1, 1996, certain 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, and which was amended on October 23, 1996. 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.
NOTE 9. EMPLOYMENT AGREEMENTS
Employment, Confidentiality and Noncompetition Agreements: As of March 31,
1997, the Company has employment, confidentiality and noncompetition
agreements with 64 members of senior management, which provide that during
their term of employment and for a two-year period following termination of
employment, 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. As partial consideration for signing these
agreements, the senior management employees have been granted options to
purchase an aggregate of 874,000 shares of Class A common stock, at exercise
prices ranging from $20.00 to $28.50 per share. These options vest with
respect to one-third of the shares underlying the options 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. The agreements also provide that the senior
management employees may not disclose any confidential information during or
after employment.
F-18
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 9. EMPLOYMENT AGREEMENTS--(CONTINUED)
Change-of-Control Agreements: On May 29, 1996, the Company also entered into
change-of-control agreements with the 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 10. RETIREMENT PLANS
The Company has various 401(k) profit-sharing plans available to eligible
employees. The Company's contributions to the plans are discretionary. The
Company contributed approximately $242,000, $44,000 and $12,000 for the years
ended December 31, 1996, 1995 and 1994, respectively.
NOTE 11. ACQUISITIONS
MWR Telecom, Inc. (MWR): 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. MWR provides fiber
optics telecommunication services between interexchange carriers and their
customers in the Des Moines, Iowa area. 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.
Ruffalo, Cody & Associates, Inc. (Ruffalo, Cody): On July 15, 1996, the
Company acquired Ruffalo, Cody for a total purchase price of approximately
$17.3 million, which consisted of approximately $5.1 million in cash
(including approximately $243,000 in direct acquisition costs), 361,420 shares
of Class A common stock and 158,009 options to purchase shares of Class A
common stock granted to the holders of Ruffalo, Cody options. An additional
$50,782 in cash and 113,387 shares of Class A common stock were placed into
escrow for delivery to certain stockholders of Ruffalo, Cody contingent upon
certain conditions relating to ongoing revenues from an agreement with a major
long distance carrier to provide telemarketing services. The long distance
carrier terminated this contract effective December 31, 1996. In January 1997,
a total of $50,782 in cash and 37,107 shares were distributed pursuant to the
escrow agreement. In April 1997, an additional 19,070 shares were distributed
pursuant to the escrow agreement.
McLeodUSA Publishing: On September 20, 1996, the Company acquired McLeodUSA
Publishing for a total purchase price of approximately $76.1 million, which
consisted of approximately $74.5 million in cash (including approximately
$436,000 in direct acquisition costs) and $1.6 million resulting from the
Company entering into an incentive compensation program with all holders of
nonvested McLeodUSA Publishing options, which provides for payments to be made
to these individuals on January 1 of the year following the year in which the
corresponding options would have vested.
Total Communications Systems, Inc. (TCSI): On December 9, 1996, the Company
purchased the customer base and certain other assets of TCSI for a cash
purchase price of approximately $534,000.
F-19
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 11. ACQUISITIONS--(CONTINUED)
Digital Communications of Iowa, Inc. (DCI): In January 1997, the Company
issued 84,430 shares of Class A common stock in exchange for all the
outstanding shares of DCI, in a transaction accounted for as a purchase. The
total purchase price was approximately $2.3 million based on the average
closing market price of the Company's Class A common stock at the time of the
acquisition.
Fronteer Financial Holdings, Ltd. (Fronteer): In January 1997, McLeodUSA
Publishing exercised its option to acquire six directories from Fronteer for a
total purchase price of approximately $3.7 million.
Indiana Directories, Inc. (Indiana Directories): On March 31, 1997,
McLeodUSA Publishing acquired 26 telephone directories published by Indiana
Directories at a price to be determined based on the sum of the revenues
derived from the last Indiana Directories editions of the directories. The
purchase price is estimated to be approximately $10.7 million.
The following table summarizes the purchase price allocations for the
Company's business acquisitions:
<TABLE>
<CAPTION>
RUFFALO, MCLEODUSA INDIANA
MWR CODY PUBLISHING TCSI DCI FRONTEER DIRECTORIES
------ -------- ---------- ---- ------ -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash purchase price..... $ -- $ 4,808 $74,060 $534 $ -- $ 1,500 $ 6,000
Acquisition costs....... -- 243 436 -- 29 -- --
Incentive agreements.... -- -- 1,610 -- -- -- --
Stock issued............ 8,333 8,945 -- -- 2,250 -- --
Options to purchase
Class A common stock... -- 3,911 -- -- -- -- --
Less cash to be received
upon exercise of
options................ -- (610) -- -- -- -- --
------ ------- ------- ---- ------ ------- -------
$8,333 $17,297 $76,106 $534 $2,279 $ 1,500 $ 6,000
====== ======= ======= ==== ====== ======= =======
Working capital
acquired, net.......... $ 393 $ 758 $ 8,367 $ 13 $ 543 $ -- $ --
Fair value of other
assets acquired,
primarily
telecommunications
networks and
equipment.............. 5,298 1,379 4,408 30 658 -- 150
Intangibles, primarily
goodwill, customer
lists, and noncompete
agreements............. 2,642 15,160 64,315 491 1,118 3,700 10,510
Liabilities assumed..... -- -- (984) -- (40) (1,700) (4,660)
Option agreement........ -- -- -- -- -- (500) --
------ ------- ------- ---- ------ ------- -------
$8,333 $17,297 $76,106 $534 $2,279 $ 1,500 $ 6,000
====== ======= ======= ==== ====== ======= =======
</TABLE>
These acquisitions have been accounted for as purchases and the results of
operations are included in the consolidated financial statements since the
dates of acquisition.
The unaudited consolidated results of operations for the years ended
December 31, 1996 and 1995 on a pro forma basis as though MWR, Ruffalo, Cody,
McLeodUSA Publishing and TCSI had been acquired as of the beginning of the
respective periods are as follows:
<TABLE>
<CAPTION>
1996 1995
--------- --------
(IN THOUSANDS)
<S> <C> <C>
Revenue................................................. $ 128,624 $ 86,476
Net loss................................................ (22,889) (17,249)
Loss per common and common equivalent share............. (0.53) (0.46)
</TABLE>
F-20
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 IS
UNAUDITED)
NOTE 11. ACQUISITIONS--(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.
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 McLeodUSA Incorporated or
are affiliates. Revenues provided totaled $254,000, $103,000 and none and
services purchased, primarily rent and legal services, totaled $934,000,
$675,000 and $173,000, for the years ended December 31, 1996, 1995 and 1994,
respectively.
In addition, at December 31, 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.
F-21
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Ruffalo, Cody & Associates, Inc.
Cedar Rapids, Iowa
We have audited the accompanying consolidated statements of income,
redeemable common stock and warrants and common stockholders' equity
(deficit), and cash flows of Ruffalo, Cody & Associates, Inc. and subsidiary
for the years ended December 31, 1995 and 1994. 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 results of operations and cash
flows of Ruffalo, Cody & Associates, Inc. and subsidiary for the years ended
December 31, 1995 and 1994 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-22
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1994
------------ ------------
<S> <C> <C>
Telemarketing and other revenue (Note 7)........... $ 13,286,146 $ 9,756,894
------------ -----------
Operating expenses:
Cost of service................................... 6,618,481 4,752,031
Selling, general and administrative............... 5,376,135 4,022,104
Depreciation and amortization..................... 475,296 313,499
------------ -----------
TOTAL OPERATING EXPENSES........................ 12,469,912 9,087,634
OPERATING INCOME................................ 816,234 669,260
Financial income (expense):
Interest income................................... 41,780 1,034
Interest (expense)................................ (119,305) (45,280)
------------ -----------
INCOME BEFORE INCOME TAXES...................... 738,709 625,014
Income taxes (Note 3).............................. 273,735 223,380
------------ -----------
NET INCOME...................................... $ 464,974 $ 401,634
============ ===========
Net income (loss) attributable to common
stockholders...................................... $ (148,663) $ (416,548)
============ ===========
Income (loss) per common and common equivalent
share............................................. $ (0.29) $ (0.83)
============ ===========
Weighted average common and common equivalent
shares outstanding................................ 508,546 500,000
============ ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-23
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF REDEEMABLE COMMON STOCK
AND WARRANTS AND COMMON STOCKHOLDER'S EQUITY (DEFICIT) (NOTE 6)
YEARS ENDED DECEMBER 31, 1995 AND 1994
<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, 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 op-
tions (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
========= ====== ======= =========
</TABLE>
<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, 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 release to 401(k) profit-
sharing plan shares................. -- -- (69,453) (69,453)
------- ---------- ------- --------
Balance, December 31, 1995............ 558,925 (1,153,381) (69,453) (663,909)
======= ========== ======= ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-24
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1994
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities
Net income........................................ $ 464,974 $ 401,634
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation..................................... 304,255 213,725
Amortization..................................... 171,041 99,774
Provision for doubtful accounts.................. -- 38,072
(Gain) loss on sale of equipment................. (3,942) 10,761
Deferred income taxes............................ 52,000 --
Changes in assets and liabilities:
(Increase) in other receivables................. (47,451) (869,041)
(Increase) in income taxes receivable........... (1,737) (4,121)
(Increase) decrease in prepaid expenses......... 20,434 (42,726)
Increase (decrease) in accounts payable and
accrued expenses............................... (43,337) 411,916
Increase in customer deposits................... 631,543 16,086
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES...... 1,547,780 276,080
------------ ------------
Cash Flows from Investing Activities
Proceeds from sale of equipment................... 52,000 5,000
Purchase of equipment and leasehold improvements.. (568,660) (784,985)
Purchase of intangibles........................... (49,378) (483,596)
------------ ------------
NET CASH (USED IN) INVESTING ACTIVITIES........ (566,038) (1,263,581)
------------ ------------
Cash Flows from Financing Activities
Proceeds from notes payable....................... 6,120,000 3,510,000
Principal payments on notes payable............... (6,570,000) (2,960,000)
Proceeds from long-term borrowings................ -- 600,000
Principal payments on long-term borrowings........ (345,845) (254,155)
Proceeds from issuance of common stock upon the
exercise of options.............................. 5,500 --
Cash dividends paid............................... -- (245,455)
Increase (decrease) in checks issued not yet
presented for payment............................ (191,397) 207,773
------------ ------------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES.................................... (981,742) 858,163
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS................................... -- (129,338)
Cash and cash equivalents:
Beginning......................................... -- 129,338
------------ ------------
Ending............................................ $ -- $ --
============ ============
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest......................................... $ 125,530 $ 39,183
Income taxes..................................... 223,472 235,517
Supplemental Schedule of Noncash Investing and Fi-
nancing Activities
Common stock contributed to 401(k) profit-sharing
plan (Note 4).................................... $ 53,425
============
Increase in estimated redemption price of
redeemable common stock and warrants............. $ 613,637 $ 818,182
============ ============
</TABLE>
See Notes to Consolidated Financial Statements
F-25
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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
F-26
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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.
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-27
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2. PLEDGED ASSETS, CURRENT NOTES PAYABLE AND LONG-TERM DEBT
The Company has a line of credit with a bank under which they may borrow up
to 80% of eligible trade receivables up to a maximum of $1,500,000. The
Company has $100,000 outstanding under this agreement at December 31, 1995.
Borrowings under this agreement are collateralized by substantially all of the
Company's assets and bear interest at the bank's prime rate plus 1/2% (the
effective rate is 9% at December 31, 1995). The agreement contains various
covenants including, among others, a restriction on the payment of any
dividends and a requirement to maintain a certain amount of tangible net
worth, all of which were complied with or waived as of December 31, 1995.
Additional available borrowings under the agreement totaled approximately
$1,350,000 at December 31, 1995. The agreement expires May 2, 1997.
NOTE 3. INCOME TAX MATTERS
Income tax expense is composed of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1994
----------- -----------
<S> <C> <C>
Current tax expense.................................. $ 221,735 $ 223,380
Deferred tax expense................................. 52,000 --
----------- -----------
$ 273,735 $ 223,380
=========== ===========
</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 1995 and 1994
due to the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1994
----------- -----------
<S> <C> <C>
Computed "expected" tax............................ $ 251,161 $ 212,505
Increase (decrease) in income taxes resulting from:
Nondeductible expenses........................... 9,774 6,072
State income taxes, net of federal income tax
benefit......................................... 4,691 1,864
Other............................................ 8,109 2,939
----------- -----------
$ 273,735 $ 223,380
=========== ===========
</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, 1995 and 1994 is $59,494 and $52,473 respectively.
The contributions for 1995 and 1994 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 December 31, 1995, 10,685 shares held by the
401(k) profit-sharing plan, at a fair value of 6.50 per share, have been
reclassified from stockholders' equity to liabilities.
F-28
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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, 1995 and 1994 is $186,466 and $179,165 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 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
=======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1994
-------- --------
NUMBER OF SHARES
<S> <C> <C>
Available for grant, end of year............................ 56,500 56,500
======== =======
Options exercisable, end of year............................ 135,500 72,500
======== =======
</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.
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, 1995 and 1994 is
approximately $353,800 and $293,200, respectively.
F-29
<PAGE>
RUFFALO, CODY & ASSOCIATES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 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.
NOTE 7. MAJOR CUSTOMER
Telemarketing revenue for the years ended December 31, 1995 and 1994
includes approximately $5,600,000 and $3,465,000, respectively, from a major
customer.
The major customer has terminated 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 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-30
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Telecom*USA Publishing Group, Inc.
Cedar Rapids, Iowa
We have audited the accompanying consolidated statements of income,
stockholders' equity, and cash flows of Telecom*USA Publishing Group, Inc. and
subsidiaries 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 results of operations and cash
flows of Telecom*USA Publishing Group, Inc. 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-31
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Revenue................................. $52,117,929 $38,620,274 $31,438,605
----------- ----------- -----------
Operating expenses:
Production and distribution........... 22,340,587 15,022,983 12,568,411
Market sales.......................... 13,798,321 10,940,711 9,244,961
Sales and marketing administrative.... 2,294,370 2,279,484 1,761,103
General and administrative............ 7,249,349 5,020,000 4,322,338
Depreciation and amortization......... 2,348,490 1,891,198 1,167,458
Restructuring loss (Note 11).......... -- -- 524,670
----------- ----------- -----------
TOTAL OPERATING EXPENSES............ 48,031,117 35,154,376 29,588,941
----------- ----------- -----------
OPERATING INCOME.................... 4,086,812 3,465,898 1,849,664
----------- ----------- -----------
Nonoperating (income) expense:
Interest income....................... (251,000) (93,997) (1,707)
Interest expense...................... 1,767,309 1,497,699 843,961
Loan inducement fee payoff (Note 7)... -- 1,330,000 --
Loss on disposal of investment (Note
3)................................... 500,000 -- --
----------- ----------- -----------
2,016,309 2,733,702 842,254
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND
MINORITY INTEREST IN CONSOLIDATED
SUBSIDIARY......................... 2,070,503 732,196 1,007,410
Federal and state income taxes
(Note 6)............................... 975,610 302,586 137,190
----------- ----------- -----------
INCOME BEFORE MINORITY INTEREST IN
NET (LOSS) IN CONSOLIDATED SUBSIDI-
ARY................................ 1,094,893 429,610 870,220
Minority interest in net (loss) of con-
solidated subsidiary................... (327,227) (15,959) --
----------- ----------- -----------
NET INCOME.......................... $ 1,422,120 $ 445,569 $ 870,220
=========== =========== ===========
Earnings per common and common equiva-
lent shares outstanding:
Primary............................... $ 0.43 $ 0.14 $ 0.27
=========== =========== ===========
Fully diluted......................... $ 0.36 $ 0.14 $ 0.26
=========== =========== ===========
Weighted average common and common
equivalent shares outstanding:
Primary............................... 3,332,659 3,271,497 3,198,776
=========== =========== ===========
Fully diluted......................... 4,678,549 3,289,720 4,510,864
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-32
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
LESS
MAXIMUM
CASH
OBLIGATION
RELATED TO
401(K)
LESS PROFIT-
COMMON RETAINED TREASURY 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 contrib-
uted 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 contrib-
uted 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 contrib-
uted 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-33
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED AUGUST 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------ ----------- ------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income........................... $ 1,422,120 $ 445,569 $ 870,220
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation......................... 1,116,508 802,428 551,531
Amortization......................... 1,231,982 1,088,770 615,927
Deferred income taxes................ 90,000 (813,000) (171,512)
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............. (327,227) (15,959) --
Provision for doubtful accounts and
adjustments......................... 2,636,421 1,669,478 1,340,069
Change in assets and liabilities:
(Increase) in accounts receivable... (5,729,376) (2,539,025) (2,235,749)
(Increase) in income taxes receiv-
able............................... (54,710) -- --
(Increase) in deferred expenses..... (1,181,630) (1,769,831) (1,454,860)
Increase (decrease) in accounts
payable and accrued expenses....... (163,439) 887,580 345,414
Increase in customer deposits....... 772,817 1,469,140 1,609,118
Increase (decrease) in income taxes
payable............................ (172,524) 115,524 209,224
Other............................... 67,230 (94,998) (67,702)
------------ ----------- ------------
NET CASH PROVIDED BY OPERATING AC-
TIVITIES.......................... 208,172 2,575,676 2,136,350
------------ ----------- ------------
Cash Flows from Investing Activities
Purchase of equipment and furniture.. (1,598,290) (1,483,881) (809,908)
Purchase of customer lists........... (457,276) (3,121,804) (583,522)
Purchase of noncompete agreements.... (204,692) (3,681,801) (684,828)
Investment in Colorado Directory Com-
pany, L.L.C. (Note 3)............... -- (1,000,000) --
Proceeds received on disposal of in-
vestment............................ 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 ACTIV-
ITIES............................. (1,860,258) (9,945,818) (2,078,258)
------------ ----------- ------------
Cash Flows from Financing Activities
Increase (decrease) in checks issued
not yet presented for payment....... $ 197,961 $ (83,223) $ (3,493)
Borrowings on revolving credit agree-
ments............................... 21,211,000 10,109,500 12,906,000
Payments on revolving credit agree-
ments............................... (17,733,200) (9,103,500) (12,853,000)
Proceeds from long-term debt......... -- 9,330,500 --
Principal payments on long-term
debt................................ (2,187,923) (3,374,447) (105,811)
Proceeds from issuance of common
stock upon the exercise of options.. 208,850 19,775 925
Purchase of common stock for retire-
ment................................ (40,602) (28,463) (2,713)
Payment on redemption of preferred
stock............................... (200,000) -- --
Capital contribution received from
minority owner-unconsolidated
subsidiary.......................... 196,000 500,000 --
------------ ----------- ------------
NET CASH PROVIDED BY (USED IN) FI-
NANCING ACTIVITIES................ 1,652,086 7,370,142 (58,092)
------------ ----------- ------------
NET INCREASE IN CASH AND CASH
EQUIVALENTS....................... -- -- --
Cash and cash equivalents:
Beginning............................ -- -- --
------------ ----------- ------------
Ending............................... $ -- $ -- $ --
============ =========== ============
Supplemental Disclosures of Cash Flow
Information
Cash payments for:
Interest............................. $ 1,767,309 $ 1,247,048 $ 793,609
Income taxes, net of refunds......... 1,115,250 1,000,062 99,478
Supplemental Schedules of Noncash In-
vesting and Financing Activities
Customer list acquired by issuance
payables............................ $ 829,022 $ 464,923 $ 669,000
Noncompete agreement acquired by is-
suance payables..................... 578,506 974,923 669,000
Common stock contributed to 401(k)
profit-sharing plan (Note 9)........ 57,470 57,307 53,126
Reclassification of intangibles to
deferred income taxes (Note 6)...... 1,188,488
Equipment acquired by contracts pay-
able................................ 28,753 552,612
Current note payable converted to
long-term debt (Note 4)............. 2,236,000
</TABLE>
See Notes to Consolidated Financial Statements.
F-34
<PAGE>
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 $950,000, $600,000, and $548,000 for the years ended August 31,
1996, 1995, and 1994, respectively.
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.
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 realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
F-35
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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 eight and forty directories during the years ended August 31, 1996 and
1995, 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
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.
F-36
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
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>
1996 1995
---- ----------
<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, 1996 and 1995, the Company had
$2,773,800 and $1,532,000, 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.
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.
F-37
<PAGE>
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)
Long-term debt consists of:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<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........................................ 465,377 905,377
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........................................ 321,398 444,988
Loan inducement fee payable (See Note 8)............ -- 1,330,000
----------- -----------
17,453,175 16,386,345
Less current maturities............................. 1,224,286 875,050
----------- -----------
$16,228,889 $15,511,295
=========== ===========
</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-38
<PAGE>
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 1996, 1995, and 1994 was approximately
$1,528,000, $1,312,000, and $1,225,000, respectively.
NOTE 6. INCOME TAXES
The provision for income taxes charged to operations for 1996, 1995, and
1994 consists of the following:
<TABLE>
<CAPTION>
1996 1995 1994
-------- ---------- ---------
<S> <C> <C> <C>
Current tax expense.......................... $885,610 $1,115,586 $ 308,702
Deferred tax expense......................... 90,000 (813,000) (171,512)
-------- ---------- ---------
$975,610 $ 302,586 $ 137,190
======== ========== =========
</TABLE>
F-39
<PAGE>
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 1996, 1995, and
1994 due to the following:
<TABLE>
<CAPTION>
1996 1995 1994
---------------- ----------------- -----------------
% 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.................. $724,676 35% $ 256,269 35% $ 352,593 35%
Increase (decrease) in
income taxes resulting
from:
State income taxes, net
of federal tax
benefit................ 71,656 3 96,866 13 60,445 6
Meals and
entertainment.......... 74,724 4 59,767 8 20,920 2
Minority interest in net
loss of consolidated
limited liability
subsidiary............. 114,529 6 5,586 1 -- --
Additional deferred
income taxes after
reclassification of
intangibles to deferred
income taxes........... -- -- -- -- (396,907) (39)
Other................... (9,975) (1) (115,902) (16) 100,139 10
-------- --- --------- --- --------- ---
$975,610 47% $ 302,586 41% $ 137,190 14%
======== === ========= === ========= ===
</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 1996, 1995, and 1994, the
loan inducement fee expense was approximately none, $190,000, and $153,000,
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.
--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.
F-40
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 1996, 1995, and 1994
was approximately $117,500, $80,000, and $56,000, respectively. The
contributions for 1995 and 1994 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 $720,000, $471,000, and $362,000 for 1996, 1995, and 1994,
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 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>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Options exercisable, end of year........................ 251,900 384,300 245,325
======= ======= =======
Available for grant, end of year........................ 48,750 55,400 625
======= ======= =======
</TABLE>
F-41
<PAGE>
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10. STOCK OPTION PLAN AND STOCK PURCHASE WARRANTS--(CONTINUED)
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.
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-42
<PAGE>
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS PRO-
SPECTUS IN CONNECTION WITH THE OFFER MADE HEREBY, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHO-
RIZED BY THE COMPANY. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE INFORMATION SET FORTH HEREIN OR IN THE AFFAIRS
OF THE COMPANY SINCE THE DATE AS OF WHICH INFORMATION IS GIVEN IN THIS PRO-
SPECTUS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANY-
ONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED
OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO
DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITA-
TION.
-----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary.................................................................. 1
Risk Factors............................................................. 13
The Exchange Offer....................................................... 29
Use of Proceeds.......................................................... 37
Capitalization........................................................... 38
Selected Consolidated Financial Data..................................... 39
Pro Forma Financial Data................................................. 41
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 43
Business................................................................. 53
Management............................................................... 86
Certain Transactions..................................................... 97
Principal Stockholders................................................... 99
Description of the Exchange Notes........................................ 101
Plan of Distribution..................................................... 134
Certain United States Federal Income Tax Consequences.................... 135
Legal Matters............................................................ 139
Experts.................................................................. 139
Changes in Accountants................................................... 140
Available Information.................................................... 140
Glossary................................................................. G-1
Index to Consolidated Financial Statements............................... F-1
</TABLE>
$500,000,000
MCLEODUSA
INCORPORATED
10 1/2% SENIOR DISCOUNT NOTES DUE 2007
[LOGO OF MCLEOD USA APPEARS HERE]
PROSPECTUS
DATED , 1997
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. 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.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
*1.1 Purchase Agreement, dated as of February 26, 1997 among Salomon
Brothers Inc, Morgan Stanley & Co. Incorporated and McLeod, Inc.
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 as of 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, filed with the
Commission on July 29, 1996 and incorporated herein by reference).
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
2.3 Agreement and Plan of Reorganization dated as of 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, filed with the
Commission on August 26, 1996 and incorporated herein by reference).
2.4 Agreement and Plan of Reorganization dated as of January 27, 1997
among McLeod, Inc., Digital Communications of Iowa, Inc., Clark E.
McLeod and Mary E. McLeod. (Filed as Exhibit 2 to Current Report on
Form 8-K, File No. 0-20763, filed with the Commission on February 24,
1997 and incorporated herein by reference).
2.5 Asset Purchase Agreement dated as of May 30, 1997 by and among
McLeodUSA Incorporated, ESI/McLeodUSA, Inc., and ESI Communications,
Inc., ESI Communications/SW, Inc., ESI Communications/West, Inc., ESI
Communications Downtown, Inc., ESI Communications North, Inc., and
Michael Reichert, Peter Jones, John Pupkes and Jeff Meehan. (Filed as
Exhibit 2.1 to Current Report on Form 8-K, File No. 0-20763, filed with
the Commission on June 26, 1997 and incorporated herein by reference).
2.6 Agreement and Plan of Reorganization dated as of June 14, 1997 among
McLeodUSA Incorporated, Eastside Acquisition Co. and Consolidated
Communications Inc. (Filed as Exhibit 2.2 to Current Report on Form 8-
K, File No. 0-20763, filed with the Commission on June 26, 1997 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. (Filed as Exhibit 3.2 to
Registration Statement on Form S-1, File No. 333-13885 ("November Form
S-1"), and incorporated herein by reference).
3.3 Certificate of Amendment of Amended and Restated Certificate of
Incorporation 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 Indenture dated March 4, 1997 between McLeod, Inc. and United States
Trust Company of New York, as Trustee, relating to the 10 1/2% Senior
Discount Notes Due 2007 of McLeod, Inc. (Filed as Exhibit 4.2 to
Annual Report on Form 10-K, File No. 0-20763, filed with the
Commission on March 31, 1997 and incorporated herein by reference).
4.3 Initial Global 10 1/2% Senior Discount Note Due March 1, 2007 of
McLeod, Inc., dated March 4, 1997. (Filed as Exhibit 4.3 to Annual
Report on Form 10-K, File No. 0-20763, filed with the Commission on
March 31, 1997 and incorporated herein by reference).
4.4 Form of Certificated 10 1/2% Senior Discount Note Due March 1, 2007 of
McLeod, Inc. (Filed as Exhibit 4.4 to Annual Report on Form 10-K, File
No. 0-20763, filed with the Commission on March 31, 1997 and
incorporated herein by reference).
4.5 Registration Agreement dated March 4, 1997 among McLeod, Inc., Salomon
Brothers Inc and Morgan Stanley & Co. Incorporated. (Filed as Exhibit
4.5 to Annual Report on Form 10-K, File No. 0-20763, filed with the
Commission on March 31, 1997 and incorporated herein by reference).
4.6 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).
</TABLE>
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4.7 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. (Filed
as Exhibit 4.3 to November Form S-1 and incorporated herein by
reference).
4.8 Form of Exchange Note (contained in Indenture filed as Exhibit 4.2).
5.1 Opinion of Hogan & Hartson L.L.P.
8.1 Tax 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).
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 Form S-1 and
incorporated herein by reference).
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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).
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).
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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).
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).
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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
WiITeI, 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. (Filed as
Exhibit 10.55 to November Form S-1 and incorporated herein by
reference).
10.56 McLeod, Inc. Employee Stock Purchase Plan, as amended. (Filed as
Exhibit 10.56 to Annual Report on Form 10-K, File No. 0-20763, filed
with the Commission on March 31, 1997 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).
</TABLE>
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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 between Ryan
Properties, Inc. and McLeod, Inc. (Filed as Exhibit 10.59 to November
Form S-1 and incorporated herein by reference).
10.60 Assignment of Purchase Agreement dated August 14, 1996 between Ryan
Properties, Inc. and McLeod, Inc. (Filed as Exhibit 10.60 to November
Form S-1 and incorporated herein by reference).
10.61 Asset Purchase Agreement dated September 4, 1996 between Total
Communication Services, Inc. and McLeod Telemanagement, Inc. (Filed as
Exhibit 10.61 to November Form S-1 and incorporated herein by
reference).
10.62 First Amendment to Asset Purchase Agreement dated September 30, 1996
between Total Communication Services, Inc. and McLeod Telemanagement,
Inc. (Filed as Exhibit 10.62 to November Form S-1 and incorporated
herein by reference).
10.63 McLeod, Inc. Incentive Plan. (Filed as Exhibit 10.63 to November Form
S-1 and incorporated herein by reference).
10.64 Amended and Restated Credit Agreement dated as of May 5, 1996 among
Telecom*USA Publishing Group, Inc., Telecom*USA Publishing Company and
Telecom*USA Neighborhood Directories, Inc. and Norwest Bank Iowa,
National Association. (Filed as Exhibit 10.64 to November Form S-1 and
incorporated herein by reference).
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. (Filed
as Exhibit 10.65 to November Form S-1 and incorporated herein by
reference).
10.66 Lease Agreement dated as of September 26, 1994 between Ryan
Properties, Inc. and Ruffalo, Cody & Associates, Inc. (Filed as
Exhibit 10.66 to November Form S-1 and incorporated herein by
reference).
10.67 First Lease Amendment dated as of April 12, 1995 between Ryan
Properties, Inc. and Ruffalo, Cody & Associates, Inc. (Filed as
Exhibit 10.67 to November Form S-1 and incorporated herein by
reference).
10.68 Lease Agreement dated as of July 18, 1995 between 2060 Partnership,
L.P. and Telecom*USA Publishing Company. (Filed as Exhibit 10.68 to
November Form S-1 and incorporated herein by reference).
10.69 Lease Agreement dated April 26, 1995 by and between A.M. Henderson and
Telecom*USA Publishing Company. (Filed as Exhibit 10.69 to November
Form S-1 and incorporated herein by reference).
10.70 License Agreement dated as of April 19, 1994, between Ameritech
Information Industry Services and Telecom*USA Publishing Company.
(Filed as Exhibit 10.70 to November Form S-1 and incorporated herein
by reference).
10.71 License Agreement dated September 13, 1993 between U S WEST
Communications, Inc. and Telecom*USA Publishing Company. (Filed as
Exhibit 10.71 to November Form S-1 and incorporated herein by
reference).
10.72 Form of McLeod, Inc. Directors Stock Option Plan Option Agreement.
(Filed as Exhibit 10.72 to November Form S-1 and incorporated herein
by reference).
</TABLE>
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NUMBER EXHIBIT DESCRIPTION
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10.73 Forms of McLeod, Inc. 1996 Employee Stock Option Plan Incentive Stock
Option Agreement. (Filed as Exhibit 10.73 to November Form S-1 and
incorporated herein by reference).
10.74 Forms of McLeod, Inc. 1996 Employee Stock Option Plan Non-Incentive
Stock Option Agreement. (Filed as Exhibit 10.74 to November Form S-1
and incorporated herein by reference).
10.75 Option Agreement dated April 27, 1995 between Fronteer Directory
Company, Inc. and Telecom*USA Publishing Company. (Filed as Exhibit
10.75 to November Form S-1 and incorporated herein by reference).
10.76 Promissory Note dated May 5, 1995 between Telecom*USA Publishing
Company and Fronteer Directory Company, Inc. (Filed as Exhibit 10.76
to November Form S-1 and incorporated herein by reference).
10.77 Security Agreement dated May 5, 1995 between Telecom*USA Publishing
Company and Fronteer Directory Company, Inc. (Filed as Exhibit 10.77
to November Form S-1 and incorporated herein by reference).
10.78 Design/Build Construction Contract dated September 17, 1996 between
Ryan Construction Company of Minnesota, Inc. and McLeod, Inc. (Filed
as Exhibit 10.78 to November Form S-1 and incorporated herein by
reference).
10.79 Guaranty Agreement dated as of October 17, 1996 by McLeod, Inc. in
favor of Kirkwood Community College. (Filed as Exhibit 10.79 to
November Form S-1 and incorporated herein by reference).
10.80 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod Telemanagement, Inc.
(Filed as Exhibit 10.80 to November Form S-1 and incorporated herein
by reference).
10.81 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod Telecommunications, Inc.
(Filed as Exhibit 10.81 to November Form S-1 and incorporated herein
by reference).
10.82 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod Network Services, Inc.
(Filed as Exhibit 10.82 to November Form S-1 and incorporated herein
by reference).
10.83 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod, Inc. (Filed as Exhibit
10.83 to November Form S-1 and incorporated herein by reference).
10.84 Change Order No. 1 to the Construction Services Agreement dated
November 22, 1995 by and between MWR TeIecom, Inc. and MFS Network
Technologies, Inc. (Filed as Exhibit 10.84 to November Form S-1 and
incorporated herein by reference).
10.85 Change Order No. 2 to the Construction Services Agreement dated August
14, 1996 between MWR Telecom, Inc. and MFS Network Technologies, Inc.
(Filed as Exhibit 10.85 to November Form S-1 and incorporated herein
by reference).
10.86 Change Order No. 3 to the Construction Services Agreement dated
October 31, 1996 between MWR Telecom, Inc. and MFS Network
Technologies, Inc. (Filed as Exhibit 10.86 to November Form S-1 and
incorporated herein by reference).
10.87 Independent Contractor Sales Agreement dated May, 1995 between Sprint
Communications Company L.P. and Ruffalo, Cody & Associates, Inc.
(Filed as Exhibit 10.87 to November Form S-1 and incorporated herein
by reference).
</TABLE>
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NUMBER EXHIBIT DESCRIPTION
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10.88 Second Amendment to Asset Purchase Agreement dated October 31, 1996
between Total Communication Services, Inc. and McLeod Telemanagement,
Inc. (Filed as Exhibit 10.88 to November Form S-1 and incorporated
herein by reference)
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. (Filed as Exhibit 10.89 to November Form S-1 and
incorporated herein by reference).
10.90 Sale and Purchase Agreement dated January 27, 1997 among McLeodUSA
Publishing Company, Fronteer Financial Holdings, Ltd., Classified
Directories, Inc., Larry A. Scott, James Greff, Randall L. Gowin and
Edwin Dressler and certain directors, officers and shareholders of
Fronteer Financial Holdings, Ltd. (Filed as Exhibit 10.90 to Annual
Report on Form 10-K, File No. 0-20763, filed with the Commission on
March 31, 1997 and incorporated herein by reference).
10.91 Sale and Purchase Agreement dated February 27, 1997 among McLeodUSA
Publishing Company, Indiana Directories, Inc., John Morgan, Hank
Meijer, Jack Hendricks, Brad Nelson and Talking Directories, Inc.
(Filed as Exhibit 10.91 to Annual Report on Form 10-K, File No. 0-
20763, filed with the Commission on March 31, 1997 and incorporated
herein by reference).
10.92 Amendment to Sale and Purchase Agreement dated February 28, 1997
between McLeodUSA Publishing Company and Indiana Directories, Inc.
(Filed as Exhibit 10.92 to Annual Report on Form 10-K, File No. 0-
20763, filed with the Commission on March 31, 1997 and incorporated
herein by reference).
10.93 Ameritech Centrex Service Confirmation of Service Orders dated August
21, 1996 between McLeod Telemanagement, Inc. and Ameritech Information
Industry Services. (Filed as Exhibit 10.93 to Annual Report on Form
10-K, File No. 0-20763, filed with the Commission on March 31, 1997
and incorporated herein by reference).
+10.94 Amended and Restated Program Enrollment Terms dated November 1, 1996
between WorldCom Network Services, Inc. d/b/a WilTel and McLeod
Telemanagement, Inc. (Filed as Exhibit 10.94 to Annual Report on Form
10-K/A, File No. 0-20763, filed with the Commission on April 8, 1997
and incorporated herein by reference).
10.95 Letter Agreement dated April 15, 1997 between U S WEST Communications
and McLeodUSA Network Services, Inc. (Filed as Exhibit 10.1 to
Quarterly Report on
Form 10-Q, File No. 0-20763, filed with the Commission on May 14, 1997
and incorporated herein by reference).
*10.96 Network Agreement dated April 7, 1997, between Wisconsin Power and
Light Company and McLeodUSA Telecommunications Services, Inc.
*11.1 Statement regarding Computation of Per Share Earnings.
*16.1 Letter regarding Change in Certifying Accountant.
21.1 Subsidiaries of McLeod, Inc. (Filed as Exhibit 21.1 to Annual Report
on Form 10-K,
File No. 0-20763, filed with the Commission on March 31, 1997 and
incorporated herein by reference).
23.1 Consents of McGladrey & Pullen, LLP.
23.2 Consent of Hogan & Hartson L.L.P. (included in Exhibit 5.1).
24.1 Power of attorney (included on signature page).
*24.2 Statement on Form T-1 of Eligibility of Trustee.
</TABLE>
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NUMBER EXHIBIT DESCRIPTION
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27.1 Financial Data Schedule. (Filed as Exhibit 27.1 to Quarterly Report on
Form 10-Q, File No. 0-20763, filed with the Commission on May 14, 1997
and incorporated herein by reference).
99.1 Purchase Agreement dated as of August 15, 1996 between Iowa Land and
Building Company and Ryan Properties, Inc. (Filed as Exhibit 99.1 to
November Form S-1 and incorporated herein by reference).
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. (Filed
as Exhibit 99.2 to November Form S-1 and incorporated herein by
reference).
*99.3 Form of Letter of Transmittal.
*99.4 Form of Notice of Guaranteed Delivery.
99.5 Form of Letter to Brokers, Dealers, Commercial Banks, Trust Companies
and other Nominees.
99.6 Form of Letter to Clients.
</TABLE>
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*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
Consolidated Financial Statements of the Company or notes thereto.
ITEM 22. 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.
The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11 or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of this Registration Statement through
the date of responding to the request.
II-10
<PAGE>
The undersigned registrant hereby undertakes to supply by means of a post-
effective amendment all information concerning a transaction, and the company
being acquired involved therein, that was not the subject of and included in
this Registration Statement when it became effective.
The undersigned registrant hereby undertakes that 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.
The undersigned registrant hereby undertakes that 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.
The undersigned registrant hereby undertakes to file, during any period in
which offers or sales are being made, a post-effective amendment to this
Registration Statement;
(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933 (the "Securities Act");
(ii) to reflect in the prospectus any facts or events arising after the
effective date of this Registration Statement (or the most recent post-
effective amendment hereof) which, individually or in the aggregate,
represents a fundamental change in the information set forth in this
Registration Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Securities and
Exchange Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in this Registration Statement when it becomes
effective; and
(iii) to include any material information with respect to the plan of
distribution not previously disclosed in this Registration Statement or any
material change to such information in this Registration Statement.
The undersigned registrant hereby undertakes to remove from registration by
means of a post-effective amendment any of the securities being registered
which remain unsold at the termination of the offering.
II-11
<PAGE>
SIGNATURES
Pursuant to the requirements of Securities Act, the Company has duly caused
this Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Cedar Rapids, Iowa, on this 3rd day
of July, 1997.
McLeodUSA Incorporated
/s/ Clark E. McLeod
By: _________________________________
CLARK E. MCLEOD CHAIRMAN AND CHIEF
EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed below by the following persons, in the capacities
indicated below, on this 3rd day of July, 1997.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Clark E. McLeod Chairman, Chief Executive
- ------------------------------------- Officer and Director (Principal
CLARK E. MCLEOD Executive Officer)
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)
Vice President, Finance,
* Corporate Controller and
- ------------------------------------- Principal Accounting Officer
JOSEPH H. CERYANEC (Principal Accounting Officer)
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-12
<PAGE>
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
January 31, 1997
<PAGE>
MCLEODUSA INCORPORATED
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,
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
========== =========== ==== ==== ===========
Year Ended December 31,
1996:
Allowance for doubtful
accounts and
discounts............ $ 219,000 $ 3,680,000* $-- $-- $ 3,899,000
Valuation reserve on
deferred tax assets.. 8,418,000 7,793,000 -- -- 16,211,000
---------- ----------- ---- ---- -----------
$8,637,000 $11,473,000 $-- $-- $20,110,000
========== =========== ==== ==== ===========
</TABLE>
- --------
* Includes $2,768,000 of allowance for doubtful accounts and discounts related
to acquisitions during the year.
<PAGE>
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>
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>
4
<PAGE>
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>
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>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<S> <C>
*1.1 Purchase Agreement, dated as of February 26, 1997 among Salomon
Brothers Inc, Morgan Stanley & Co. Incorporated and McLeod, Inc.
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 as of 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, filed with the
Commission on July 29, 1996 and incorporated herein by reference).
2.3 Agreement and Plan of Reorganization dated as of August 15, 1996 among
TelecomwUSA Publishing Group, Inc. and McLeod, Inc. (Filed as Exhibit
2 to Current Report on Form 8-K, File No. 0-20763, filed with the
Commission on August 26, 1996 and incorporated herein by reference).
2.4 Agreement and Plan of Reorganization dated as of January 27, 1997
among McLeod, Inc., Digital Communications of Iowa, Inc., Clark E.
McLeod and Mary E. McLeod. (Filed as Exhibit 2 to Current Report on
Form 8-K, File No. 0-20763, filed with the Commission on February 24,
1997 and incorporated herein by reference).
2.5 Asset Purchase Agreement dated as of May 30, 1997 by and among
McLeodUSA Incorporated, ESI/McLeodUSA, Inc., and ESI Communications,
Inc., ESI Communications/SW, Inc., ESI Communications/West, Inc., ESI
Communications Downtown, Inc., ESI Communications North, Inc., and
Michael Reichert, Peter Jones, John Pupkes and Jeff Meehan. (Filed as
Exhibit 2.1 to Current Report on Form 8-K, File No. 0-20763, filed with
the Commission on June 26, 1997 and incorporated herein by reference).
2.6 Agreement and Plan of Reorganization dated as of June 14, 1997 among
McLeodUSA Incorporated, Eastside Acquisition Co. and Consolidated
Communications Inc. (Filed as Exhibit 2.2 to Current Report on Form 8-
K, File No. 0-20763, filed with the Commission on June 26, 1997 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. (Filed as Exhibit 3.2 to
Registration Statement on Form S-1, File No. 333-13885 ("November Form
S-1"), and incorporated herein by reference).
3.3 Certificate of Amendment of Amended and Restated Certificate of
Incorporation 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 Indenture dated March 4, 1997 between McLeod, Inc. and United States
Trust Company of New York, as Trustee, relating to the 10 1/2% Senior
Discount Notes Due 2007 of McLeod, Inc. (Filed as Exhibit 4.2 to
Annual Report on Form 10-K, File No. 0-20763, filed with the
Commission on March 31, 1997 and incorporated herein by reference).
4.3 Initial Global 10 1/2% Senior Discount Note Due March 1, 2007 of
McLeod, Inc., dated March 4, 1997. (Filed as Exhibit 4.3 to Annual
Report on Form 10-K, File No. 0-20763, filed with the Commission on
March 31, 1997 and incorporated herein by reference).
</TABLE>
1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
4.4 Form of Certificated 10 1/2% Senior Discount Note Due March 1, 2007 of
McLeod, Inc. (Filed as Exhibit 4.4 to Annual Report on Form 10-K, File
No. 0-20763, filed with the Commission on March 31, 1997 and
incorporated herein by reference).
4.5 Registration Agreement dated March 4, 1997 among McLeod, Inc., Salomon
Brothers Inc and Morgan Stanley & Co. Incorporated. (Filed as Exhibit
4.5 to Annual Report on Form 10-K, File No. 0-20763, filed with the
Commission on March 31, 1997 and incorporated herein by reference).
4.6 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
4.7 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. (Filed
as Exhibit 4.3 to November Form S-1 and incorporated herein by
reference).
4.8 Form of Exchange Note (contained in Indenture filed as Exhibit 4.2).
5.1 Opinion of Hogan & Hartson L.L.P.
8.1 Tax 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).
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).
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
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).
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).
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
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).
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).
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
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
WiITeI, 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).
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<S> <C>
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. (Filed as
Exhibit 10.55 to November Form S-1 and incorporated herein by
reference).
10.56 McLeod, Inc. Employee Stock Purchase Plan, as amended. (Filed as
Exhibit 10.56 to Annual Report on Form 10 K, File No. 0-20763, filed
with the Commission on March 31, 1997 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 between Ryan
Properties, Inc. and McLeod, Inc. (Filed as Exhibit 10.59 to November
Form S-1 and incorporated herein by reference).
10.60 Assignment of Purchase Agreement dated August 14, 1996 between Ryan
Properties, Inc. and McLeod, Inc. (Filed as Exhibit 10.60 to November
Form S-1 and incorporated herein by reference).
10.61 Asset Purchase Agreement dated September 4, 1996 between Total
Communication Services, Inc. and McLeod Telemanagement, Inc. (Filed as
Exhibit 10.61 to November Form S-1 and incorporated herein by
reference).
10.62 First Amendment to Asset Purchase Agreement dated September 30, 1996
between Total Communication Services, Inc. and McLeod Telemanagement,
Inc. (Filed as Exhibit 10.62 to November Form S-1 and incorporated
herein by reference).
10.63 McLeod, Inc. Incentive Plan. (Filed as Exhibit 10.63 to November Form
S-1 and incorporated herein by reference).
10.64 Amended and Restated Credit Agreement dated as of May 5, 1996 among
TelecomwUSA Publishing Group, Inc., TelecomwUSA Publishing Company and
TelecomwUSA Neighborhood Directories, Inc. and Norwest Bank Iowa,
National Association. (Filed as Exhibit 10.64 to November Form S-1 and
incorporated herein by reference).
10.65 First Amendment to Amended and Restated Credit Agreement dated as of
January 31, 1996 by and between TelecomwUSA Publishing Group, Inc.,
TelecomwUSA Publishing Company and TelecomwUSA Neighborhood
Directories, Inc. and Norwest Bank Iowa, National Association. (Filed
as Exhibit 10.65 to November Form S-1 and incorporated herein by
reference).
10.66 Lease Agreement dated as of September 26, 1994 between Ryan
Properties, Inc. and Ruffalo, Cody & Associates, Inc. (Filed as
Exhibit 10.66 to November Form S-1 and incorporated herein by
reference).
10.67 First Lease Amendment dated as of April 12, 1995 between Ryan
Properties, Inc. and Ruffalo, Cody & Associates, Inc. (Filed as
Exhibit 10.67 to November Form S-1 and incorporated herein by
reference).
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<S> <C>
10.68 Lease Agreement dated as of July 18, 1995 between 2060 Partnership,
L.P. and TelecomwUSA Publishing Company. (Filed as Exhibit 10.68 to
November Form S-1 and incorporated herein by reference).
10.69 Lease Agreement dated April 26, 1995 by and between A.M. Henderson and
TelecomwUSA Publishing Company. (Filed as Exhibit 10.69 to November
Form S-1 and incorporated herein by reference).
10.70 License Agreement dated as of April 19, 1994, between Ameritech
Information Industry Services and TelecomwUSA Publishing Company.
(Filed as Exhibit 10.70 to November Form S-1 and incorporated herein
by reference).
10.71 License Agreement dated September 13, 1993 between U S WEST
Communications, Inc. and TelecomwUSA Publishing Company. (Filed as
Exhibit 10.71 to November Form S-1 and incorporated herein by
reference).
10.72 Form of McLeod, Inc. Directors Stock Option Plan Option Agreement.
(Filed as Exhibit 10.72 to November Form S-1 and incorporated herein
by reference).
10.73 Forms of McLeod, Inc. 1996 Employee Stock Option Plan Incentive Stock
Option Agreement. (Filed as Exhibit 10.73 to November Form S-1 and
incorporated herein by reference).
10.74 Forms of McLeod, Inc. 1996 Employee Stock Option Plan Non-Incentive
Stock Option Agreement. (Filed as Exhibit 10.74 to November Form S-1
and incorporated herein by reference).
10.75 Option Agreement dated April 27, 1995 between Fronteer Directory
Company, Inc. and TelecomwUSA Publishing Company. (Filed as Exhibit
10.75 to November Form S-1 and incorporated herein by reference).
10.76 Promissory Note dated May 5, 1995 between TelecomwUSA Publishing
Company and Fronteer Directory Company, Inc. (Filed as Exhibit 10.76
to November Form S-1 and incorporated herein by reference).
10.77 Security Agreement dated May 5, 1995 between TelecomwUSA Publishing
Company and Fronteer Directory Company, Inc. (Filed as Exhibit 10.77
to November Form S-1 and incorporated herein by reference).
10.78 Design/Build Construction Contract dated September 17, 1996 between
Ryan Construction Company of Minnesota, Inc. and McLeod, Inc. (Filed
as Exhibit 10.78 to November Form S-1 and incorporated herein by
reference).
10.79 Guaranty Agreement dated as of October 17, 1996 by McLeod, Inc. in
favor of Kirkwood Community College. (Filed as Exhibit 10.79 to
November Form S-1 and incorporated herein by reference).
10.80 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod Telemanagement, Inc.
(Filed as Exhibit 10.80 to November Form S-1 and incorporated herein
by reference).
10.81 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod Telecommunications, Inc.
(Filed as Exhibit 10.81 to November Form S-1 and incorporated herein
by reference).
10.82 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod Network Services, Inc.
(Filed as Exhibit 10.82 to November Form S-1 and incorporated herein
by reference).
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
10.83 Industrial New Jobs Training Agreement dated as of October 31, 1996
between Kirkwood Community College and McLeod, Inc. (Filed as Exhibit
10.83 to November Form S-1 and incorporated herein by reference).
10.84 Change Order No. 1 to the Construction Services Agreement dated
November 22, 1995 by and between MWR TeIecom, Inc. and MFS Network
Technologies, Inc. (Filed as Exhibit 10.84 to November Form S-1 and
incorporated herein by reference).
10.85 Change Order No. 2 to the Construction Services Agreement dated August
14, 1996 between MWR Telecom, Inc. and MFS Network Technologies, Inc.
(Filed as Exhibit 10.85 to November Form S-1 and incorporated herein
by reference).
10.86 Change Order No. 3 to the Construction Services Agreement dated
October 31, 1996 between MWR Telecom, Inc. and MFS Network
Technologies, Inc. (Filed as Exhibit 10.86 to November Form S-1 and
incorporated herein by reference).
10.87 Independent Contractor Sales Agreement dated May, 1995 between Sprint
Communications Company L.P. and Ruffalo, Cody & Associates, Inc.
(Filed as Exhibit 10.87 to November Form S-1 and incorporated herein
by reference).
10.88 Second Amendment to Asset Purchase Agreement dated October 31, 1996
between Total Communication Services, Inc. and McLeod Telemanagement,
Inc. (Filed as Exhibit 10.88 to November Form S-1 and incorporated
herein by reference).
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. (Filed as Exhibit 10.89 to November Form S-1 and
incorporated herein by reference).
10.90 Sale and Purchase Agreement dated January 27, 1997 among McLeodUSA
Publishing Company, Fronteer Financial Holdings, Ltd., Classified
Directories, Inc., Larry A. Scott, James Greff, Randall L. Gowin and
Edwin Dressler and certain directors, officers and shareholders of
Fronteer Financial Holdings, Ltd. (Filed as Exhibit 10.90 to Annual
Report on Form 10-K, File No. 0-20763, filed with the Commission on
March 31, 1997 and incorporated herein by reference).
10.91 Sale and Purchase Agreement dated February 27, 1997 among McLeodUSA
Publishing Company, Indiana Directories, Inc., John Morgan, Hank
Meijer, Jack Hendricks, Brad Nelson and Talking Directories, Inc.
(Filed as Exhibit 10.91 to Annual Report on Form 10-K, File No. 0-
20763, filed with the Commission on March 31, 1997 and incorporated
herein by reference).
10.92 Amendment to Sale and Purchase Agreement dated February 28, 1997
between McLeodUSA Publishing Company and Indiana Directories, Inc.
(Filed as Exhibit 10.92 to Annual Report on Form 10-K, File No. 0-
20763, filed with the Commission on March 31, 1997 and incorporated
herein by reference).
10.93 Ameritech Centrex Service Confirmation of Service Orders dated August
21, 1996 between McLeod Telemanagement, Inc. and Ameritech Information
Industry Services. (Filed as Exhibit 10.93 to Annual Report on Form
10-K, File No. 0-20763, filed with the Commission on March 31, 1997
and incorporated herein by reference).
+10.94 Amended and Restated Program Enrollment Terms dated November 1, 1996
between WorldCom Network Services, Inc. d/b/a WilTel and McLeod
Telemanagement, Inc. (Filed as Exhibit 10.94 to Annual Report on Form
10-K/A, File No. 0-20763, filed with the Commission on April 8, 1997
and incorporated herein by reference).
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<C> <S>
10.95 Letter Agreement dated April 15, 1997 between U S WEST Communications
and McLeodUSA Network Services, Inc. (Filed as Exhibit 10.1 to
Quarterly Report on
Form 10-Q, File No. 0-20763, filed with the Commission on May 14, 1997
and incorporated herein by reference).
*10.96 Network Agreement dated April 7, 1997, between Wisconsin Power and
Light Company and McLeodUSA Telecommunications Services, Inc.
*11.1 Statement regarding Computation of Per Share Earnings.
*16.1 Letter regarding Change in Certifying Accountant.
21.1 Subsidiaries of McLeod, Inc. (Filed as Exhibit 21.1 to Annual Report
on Form 10-K, File No. 0-20763, filed with the Commission on March 31,
1997 and incorporated herein by reference).
23.1 Consents of McGladrey & Pullen, LLP.
23.2 Consent of Hogan & Hartson L.L.P. (included in Exhibit 5.1).
24.1 Power of attorney (included on signature page).
*24.2 Statement on Form T-1 of Eligibility of Trustee.
27.1 Financial Data Schedule. (Filed as Exhibit 27.1 to Quarterly Report on
Form 10-Q, File No. 0-20763, filed with the Commission on May 14, 1997
and incorporated herein by reference).
99.1 Purchase Agreement dated as of August 15, 1996 between Iowa Land and
Building Company and Ryan Properties, Inc. (Filed as Exhibit 99.1 to
November Form S-1 and incorporated herein by reference).
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. (Filed
as Exhibit 99.2 to November Form S-1 and incorporated herein by
reference).
*99.3 Form of Letter of Transmittal.
*99.4 Form of Notice of Guaranteed Delivery.
99.5 Form of Letter to Brokers, Dealers, Commercial Banks, Trust Companies
and other Nominees.
99.6 Form of Letter to Clients.
</TABLE>
- --------
* Previously filed.
+ Confidential treatment has been granted. The copy filed as an exhibit omits
the information subject to the confidential treatment request.
9
<PAGE>
EXHIBIT 3.3
CERTIFICATE OF AMENDMENT
OF
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
McLEOD, INC.
McLEOD, INC., a corporation organized and existing under the laws of
the State of Delaware (the "Corporation"), hereby certifies as follows:
FIRST: The name of the Corporation is McLeod, Inc. The original
Certificate of Incorporation of the Corporation was filed with the Secretary of
State of the State of Delaware on July 29, 1993. An amended and Restated
Certificate of Incorporation (the "Certificate of Incorporation") was filed with
the Secretary of State of the State of Delaware on May 2, 1996.
SECOND: Pursuant to Sections 141 and 242 of the Delaware General
Corporation Law, as amended (the "DGCL") and in accordance with the By-laws of
the Corporation, the Board of Directors of the Corporation, at a meeting duly
called and held on March 27, 1997, adopted resolutions proposing and declaring
advisable and in the best interests of the Corporation the following two
amendments to the Certificate of Incorporation:
1. ARTICLE "1" of the Certificate of Incorporation is hereby amended
and restated as follows:
"ARTICLE 1. NAME
The name of this corporation is "McLeodUSA Incorporated."
2. ARTICLE "4" of the Certificate of Incorporation is hereby amended
and restated as follows:
"ARTICLE 4. CAPITAL STOCK
4.1. Authorized Shares
The total number of shares of stock that the Corporation shall be
authorized to issue is 274,000,000 shares, divided into three classes as
follows: (i) 250,000,000 shares of Class A common stock having a par value
of $.01 per share ("Class A Common Stock"); (ii) 22,000,000 shares of Class
B common stock having a par value of $.01 per share ("Class B Common
Stock"); and (iii) 2,000,000 shares of serial
<PAGE>
preferred stock, having a par value of $.01 per share ("Preferred Stock").
4.2. Class A Common Stock
4.2.1. Relative Rights
The Class A Common Stock shall be subject to all of the rights,
privileges, preferences and priorities of the Preferred Stock, as set forth
herein and in the certificate or certificates of designations filed to
establish the respective series of Preferred Stock. Each share of Class A
Common Stock shall have the same relative rights as and be identical in all
respects to all the other shares of Class A Common Stock.
4.2.2. Dividends
Whenever there shall have been paid, or declared and set aside
for payment, to the holders of shares of any class of stock having
preference over the Class A Common Stock and the Class B Common Stock as to
the payment of dividends, the full amount of dividends and of sinking fund
or retirement payments, if any, to which such holders are respectively
entitled in preference to the Class A Common Stock and the Class B Common
Stock, then dividends may be paid equally on each share of the Class A
Common Stock, the Class B Common Stock and any class or series of stock
entitled to participate therewith as to dividends, out of any assets
legally available for the payment of dividends thereon, but only when and
as declared by the Board of Directors of the Corporation.
4.2.3. Dissolution, Liquidation, Winding Up
In the event of any dissolution, liquidation, or winding up of
the Corporation, 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, in whole or in
part, as to the distribution of assets in such event, shall become entitled
to participate in the distribution of any assets of the Corporation
remaining after the Corporation shall have paid, or provided for payment
of, all debts and liabilities of the Corporation and after the Corporation
shall have paid, or set aside for payment, to the holders of any class of
stock having preference over the Class A Common Stock and the Class B
Common Stock in the event of dissolution, liquidation or winding up the
full preferential amounts (if any) to which they are entitled.
2
<PAGE>
4.2.4. Voting Rights
Each holder of shares of Class A Common Stock shall be entitled
to attend all special and annual meetings of the stockholders of the
Corporation 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
to 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. Each holder of shares of
Class A Common Stock shall be entitled to cast one vote for each
outstanding share of Class A Common Stock so held.
4.3. Class B Common Stock
4.3.1. Relative Rights
The Class B Common Stock shall be subject to all of the rights,
privileges, preferences and priorities of the Preferred Stock, as set forth
herein and in the certificate or certificates of designations filed to
establish the respective series of Preferred Stock. Each share of Class B
Common Stock shall have the same relative rights as and be identical in all
respects to all the other shares of Class B Common Stock.
4.3.2. Dividends
Whenever there shall have been paid, or declared and set aside
for payment, to the holders of shares of any class of stock having
preference over the Class B Common Stock and the Class A Common Stock as to
the payment of dividends, the full amount of dividends and of sinking fund
or retirement payments, if any, to which such holders are respectively
entitled in preference to the Class B Common Stock and the Class A Common
Stock, then dividends may be paid equally on each share of the Class B
Common Stock, the Class A Common Stock and any class or series of stock
entitled to participate therewith as to dividends, out of any assets
legally available for the payment of dividends thereon, but only when and
as declared by the Board of Directors of the Corporation.
4.3.3. Dissolution, Liquidation, Winding Up
In the event of any dissolution, liquidation, or winding up of
the Corporation, whether voluntary or involuntary, the holders of the Class
B Common Stock, the holders of the Class A Common Stock and holders of any
class or series of stock entitled to participate
3
<PAGE>
therewith, in whole or in part, as to the distribution of assets in such
event, shall become entitled to participate in the distribution of any
assets of the Corporation remaining after the Corporation shall have paid,
or provided for payment of, all debts and liabilities of the Corporation
and after the Corporation shall have paid, or set aside for payment, to the
holders of any class of stock having preference over the Class B Common
Stock and the Class A Common Stock in the event of dissolution, liquidation
or winding up the full preferential amounts (if any) to which they are
entitled.
4.3.4. Voting Rights
Each holder of shares of Class B Common Stock shall be entitled
to attend all special and annual meetings of the stockholders of the
Corporation 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
to 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. Each holder of shares of
Class B Common Stock shall be entitled to cast .40 vote for each
outstanding share of Class B Common Stock so held.
4.3.5. Conversion Rights
The shares of Class B Common Stock may be converted into fully
paid and nonassessable shares of Class A Common Stock at any time at the
option of the holder thereof at the rate of one share of Class A Common
Stock for each share of Class B Common Stock, subject to adjustment as
provided below. If, at any time shares of Class B Common Stock are
outstanding, the Corporation shall issue Class A Common Stock in a Class A
Common Stock split without a corresponding Class B Common Stock split, the
conversion rate shall be adjusted so that each share of Class B Common
Stock shall be convertible into the number of shares of Class A Common
Stock representing the same proportion of the total number of shares of
Class A Common Stock outstanding after such stock split as the number of
shares of Class A Common Stock into which such share of Class B Common
Stock would have been convertible in the absence of such stock split bears
to the total number of shares of Class A Common Stock outstanding
immediately prior to such stock split.
Any holder of shares of Class B Common Stock desiring to convert
all or any part of such holder's shares of Class B Common Stock into shares
of Class A Common Stock shall give written notice thereof to the
Corporation, specifying the number of shares of Class B
4
<PAGE>
Common Stock such holder desires to convert and the desired conversion date
(the "Conversion Date"), which shall be on a business day not less than
five days after the date of such notice. On and after the Conversion Date,
such holder shall be entitled to receive, upon surrender of a certificate
or certificates representing the shares of Class B Common Stock so
converted, a certificate for the corresponding number of shares of Class A
Common Stock, determined in accordance with the provisions hereof. All
shares of Class B Common Stock to be converted on the Conversion Date
shall, whether or not the certificates for such shares shall have been
surrendered for cancellation, be deemed to be no longer outstanding for any
purpose and all rights with respect to such shares (except the right of the
holder of the certificates for such shares to receive certificates for
shares of Class A Common Stock) shall thereupon cease and terminate. Shares
of Class B Common Stock converted pursuant to this paragraph shall be
canceled and retired and shall not be reissued. Upon conversion, no
fractional shares shall be issued and any fractions of a share shall be
rounded up to the next highest number.
4.4. Preferred Stock
The Board of Directors is authorized, subject to limitations
prescribed by the Delaware General Corporation Law and the provisions of
this Amended and Restated Certificate of Incorporation, to provide, by
resolution or resolutions from time to time and filing a certificate
pursuant to the applicable provision of the Delaware General Corporation
Law, for the issuance of the shares of Preferred Stock in series, to
establish from time to time the number of shares to be included in each
such series, to fix the powers, designation, preferences, relative,
participating, optional or other special rights of the shares of each such
series and the qualifications, limitations and restrictions thereof.
4.5. Redemption
Notwithstanding any other provision of this Amended and Restated
Certificate of Incorporation to the contrary, outstanding shares of stock
of the Corporation shall always be subject to redemption by the
Corporation, by action of the Board of Directors, if in the judgment of the
Board of Directors such action should be taken, pursuant to Section 151(b)
of the Delaware General Corporation Law or any other applicable provision
of law, to the extent necessary to prevent the loss or secure the
reinstatement of any license or franchise from any governmental agency held
by the Corporation or any of its
5
<PAGE>
subsidiaries to conduct any portion of the business of the Corporation or
any of its subsidiaries, which license or franchise is conditioned upon
some or all of the holders of the Corporation's stock possessing prescribed
qualifications. The terms and conditions of such redemption shall be as
follows:
(A) The redemption price of the shares to be redeemed pursuant to this
Section 4.5 shall be determined by the Board of Directors and shall be
equal to the Fair Market Value (as defined herein) of such shares or, if
such shares were purchased by a Disqualified Holder (as defined herein)
within one year of the Redemption Date (as defined herein), the lesser of
(i) the Fair Market Value of such shares and (ii) the purchase price paid
by such Disqualified Holder for such shares;
(B) At the election of the Corporation, the redemption price of such
shares may be paid in cash, Redemption Securities (as defined herein) or
any combination thereof;
(C) If fewer than all shares held by Disqualified Holders are to be
redeemed, the shares to be redeemed shall be selected in such manner as
shall be determined by the Board of Directors, which may include selection
first of the most recently purchased shares thereof, selection by lot or
selection in any other manner determined by the Board of Directors;
(D) At least 30 days' prior written notice of the Redemption Date
shall be given to any Disqualified Holder of shares selected to be redeemed
(unless waived in writing by any such holder), provided that the Redemption
Date may be the date on which written notice shall be given to such holder
if the cash or Redemption Securities necessary to effect the redemption
shall have been deposited in trust for the benefit of such holder and
subject to immediate withdrawal by it upon surrender of the stock
certificates for the shares to be redeemed;
(E) From and after the Redemption Date, any and all rights of whatever
nature that any Disqualified Holder may have with respect to any shares
selected for redemption (including without limitation any rights to vote or
participate in dividends declared on stock of the same class or series as
such shares) shall cease and terminate, and such Disqualified Holder shall
thenceforth be entitled only to receive, with respect to such shares, the
cash or Redemption Securities payable upon redemption; and
(F) Such additional terms and conditions as the Board of Directors
shall determine.
6
<PAGE>
For purposes of this Section 4.5:
(i) "Disqualified Holder" shall mean any holder of shares of stock of
the Corporation whose holding of such stock, either individually or when
taken together with the holding of shares of stock of the Corporation by
any other holders, may result, in the judgment of the Board of Directors,
in the loss of, or the failure to secure the reinstatement of, any license
or franchise from any governmental agency held by the Corporation or any of
its subsidiaries to conduct any portion of the business of the Corporation
or any of its subsidiaries.
(ii) "Fair Market Value" of a share of the Corporation's stock of any
class or series shall mean the average Closing Price (as defined herein)
for such a share for each of the 45 most recent days on which shares of
stock of such class or series shall have been traded preceding the day on
which notice of redemption shall be given pursuant to paragraph (D) of this
Section 4.5; provided, however, that if shares of stock of such class or
-------- -------
series are not traded on any securities exchange or in the over-the-counter
market, "Fair Market Value" shall be determined by the Board of Directors
in good faith. "Closing Price" on any day means the reported closing sales
price or, in case no such sale takes place, the average of the reported
closing bid and asked prices on the principal United States securities
exchange registered under the Securities Exchange Act of 1934 on which such
stock is listed, or, if such stock is not listed on any such exchange, the
highest closing sales price or bid quotation for such stock on the National
Association of Securities Dealers, Inc. Automated Quotations System or any
system then in use, or if no such prices or quotations are available, the
fair market value on the day in question as determined by the Board of
Directors in good faith.
(iii) "Redemption Date" shall mean the date fixed by the Board of
Directors for the redemption of any shares of stock of the Corporation
pursuant to this Section 4.5.
(iv) "Redemption Securities" shall mean any debt or equity securities
of the Corporation, any of its subsidiaries or any other corporations, or
any combination thereof, having such terms and conditions as shall be
approved by the Board of Directors and which, together with any cash to be
paid as part of the redemption price, in the opinion of any investment
banking firm selected by the Board of Directors (which may be a firm which
provides other investment banking, brokerage or other services to the
Corporation), has a value, at the time notice of redemption is given
pursuant to paragraph (D)
7
<PAGE>
of this Section 4.5, at least equal to the price required to be paid
pursuant to paragraph (A) of this Section 4.5 (assuming for purposes of
such valuation, in the case of Redemption Securities to be publicly traded,
such Redemption Securities were fully distributed and trading under normal
conditions)."
THIRD: The foregoing amendments to the Certificate of Incorporation were
approved at the Corporation's annual meeting of stockholders held on May 29,
1997, by the holders of at least a majority of the outstanding shares of common
stock of the Corporation.
FOURTH: The foregoing amendments to the Certificate of Incorporation were
duly adopted and approved in accordance with the requirements of Sections 141
and 242 of the DGCL.
[Rest of page intentionally left blank]
8
<PAGE>
IN WITNESS WHEREOF, the Corporation has caused this Certificate of
Incorporation to be executed by its duly authorized officer, as of the 29th day
of May, 1997.
McLEOD, INC.
By: /s/ Clark E. McLeod
------------------------------
Clark E. McLeod
Chairman and Chief Executive
Officer
9
<PAGE>
Exhibit 5.1
[HOGAN & HARTSON L.L.P. LETTERHEAD]
July 3, 1997
McLeodUSA Incorporated
McLeodUSA Technology Park
6400 C Street, SW
P.O. Box 3177
Cedar Rapids, IA 52406
Ladies and Gentlemen:
This firm has acted as special counsel to McLeodUSA Incorporated, a
Delaware corporation (the "Company"), in connection with its Registration
Statement on Form S-4, as amended (File No. 333-27647) (the "Registration
Statement"), filed with the Securities and Exchange Commission relating to the
proposed offering of up to $500,000,000 in aggregate principal amount of 10 1/2%
Senior Discount Notes Due March 1, 2007 (the "Exchange Notes") in exchange for
up to $500,000,000 in aggregate principal amount of the Company's outstanding 10
1/2% Senior Discount Notes Due March 1, 2007 (the "Senior Notes"). This opinion
letter is furnished to you at your request to enable you to fulfill the
requirements of Item 601(b)(5) of Regulation S-K, 17 C.F.R. (S)229.601(b)(5), in
connection with the Registration Statement.
For purposes of this opinion letter, we have examined copies of the
following documents:
1. An executed copy of the Registration Statement.
2. An executed copy of the Indenture dated March 4, 1997 (the
"Indenture"), by and between the Company and United States Trust
Company of New York, including the form of Exchange Note to be
issued pursuant thereto, as filed as Exhibit 4.2 to the
Registration Statement.
3. The Amended and Restated Certificate of Incorporation of the
Company, as certified by the Secretary of State of the State of
Delaware on June 9, 1997 (the "Amended and Restated Certificate"),
the Certificate of Amendment of Amended and
<PAGE>
July 3, 1997
Page 2
Restated Certificate of Incorporation of the Company, as certified
by the Secretary of State of the State of Delaware on June 17,
1997 (together with the Amended and Restated Certificate, the
"Certificate of Incorporation"), and the Certificate of
Incorporation as certified by the Secretary of the Company on the
date hereof as being complete, accurate and in effect.
4. The Amended and Restated By-laws of the Company, as certified by
the Secretary of the Company on the date hereof as being complete,
accurate and in effect.
5. Resolutions of the Board of Directors of the Company adopted on
February 24, 1997, as certified by the Secretary of the Company on
the date hereof as being complete, accurate and in effect,
relating to the issuance and sale of the Exchange Notes and
arrangements in connection therewith.
In our examination of the aforesaid documents, we have assumed the
genuineness of all signatures, the legal capacity of all natural persons, the
accuracy and completeness of all documents submitted to us, the authenticity of
all original documents, and the conformity to authentic original documents of
all documents submitted to us as copies (including telecopies). This opinion
letter is given, and all statements herein are made, in the context of the
foregoing.
This opinion letter is based as to matters of law solely on applicable
provisions of the General Corporation Law of the State of Delaware, as amended,
and the contract law of the State of New York (but not including any statutes,
ordinances, administrative decisions, rules or regulations of any political
subdivision of the State of New York). We express no opinion herein as to any
other laws, statutes, ordinances, rules or regulations not specifically referred
to above.
Based upon, subject to and limited by the foregoing, we are of the
opinion that the Exchange Notes have been duly authorized on behalf of the
Company and that, (i) following the effectiveness of the Registration Statement
and receipt by the Company of the Senior Notes in exchange for the Exchange
Notes as specified in the resolutions of the Board of Directors referred to
above, and (ii) assuming due execution, authentication, issuance and delivery of
the Exchange Notes as provided in the Indenture, the Exchange Notes will
constitute valid and binding obligations of the Company entitled to the benefits
of the Indenture and
<PAGE>
July 3, 1997
Page 3
enforceable in accordance with their terms, except as may be limited by
bankruptcy, insolvency, reorganization, moratorium or other laws affecting
creditors' rights (including, without limitation, the effect of statutory and
other law regarding fraudulent conveyances, fraudulent transfers and
preferential transfers) and as may be limited by the exercise of judicial
discretion and the application of principles of equity including without
limitation, requirements of good faith, fair dealing, conscionability and
materiality (regardless of whether the Exchange Notes are considered in a
proceeding in equity or at law).
We assume no obligation to advise you of any changes in the foregoing
subsequent to the delivery of this opinion letter. This opinion letter has been
prepared solely for your use in connection with the filing of the Registration
Statement on the date of this opinion letter and should not be quoted in whole
or in part or otherwise referred to, nor filed with or furnished to any
governmental agency or other person or entity, without the prior written consent
of this firm.
We hereby consent to the filing of this opinion letter as Exhibit 5.1
to the Registration Statement and to the reference to this firm under the
caption "Legal Matters" in the prospectus constituting a part of the
Registration Statement. In giving this consent, we do not thereby admit that we
are an "expert" within the meaning of the Securities Act of 1933, as amended.
Very truly yours,
HOGAN & HARTSON L.L.P.
<PAGE>
Exhibit 8.1
[HOGAN & HARTSON L.L.P. LETTERHEAD]
July 3, 1997
McLeodUSA Incorporated
McLeodUSA Technology Park
6400 C Street SW, P.O. Box 3177
Cedar Rapids, IA 52406-0000
Ladies and Gentlemen:
This firm has acted as special counsel to McLeodUSA Incorporated, a
Delaware corporation (the "Company"), in connection with the proposed exchange
(the "Exchange") by the Company of an aggregate of $500,000,000 principal amount
of its 10 1/2% Senior Discount Notes due 2007 which have been registered under
the Securities Act of 1933, as amended (the "Act") for an equal principal amount
of its outstanding unregistered 10 1/2% Senior Discount Notes due 2007.
For purposes of this opinion letter, we have examined the Registration
Statement on Form S-4 (Registration No. 333-27647), as amended (the
"Registration Statement"), that the Company filed with the Securities and
Exchange Commission on the date hereof with respect to the registration of the
Exchange Notes under the Act. We also have examined such other materials and
have obtained such additional information as we have deemed relevant and
necessary. In such examination, we have assumed the authenticity, accuracy and
completeness of all documents submitted to us, and the conformity with the
original documents of all documents submitted to us as certified, telecopied,
photostatic, or reproduced copies. This opinion letter is given, and all
statements herein are made, in the context of the foregoing.
This opinion letter is based as to matters of law solely on the
Internal Revenue Code of 1986, as amended, its legislative history, judicial
authority, current administrative rulings and practice, and existing and
proposed Treasury Regulations, including regulations concerning the treatment of
debt instruments issued with original issue discount, all as in effect and
existing on the date hereof (collectively, "federal tax laws"). We express no
opinion herein as to any other laws, statutes, regulations, or ordinances.
Based upon, subject to and limited by the foregoing and subject to the
qualifications, limitations and exceptions contained in the Prospectus forming a
<PAGE>
McLeodUSA Incorporated
July 3, 1997
Page 2
part of the Registration Statement (the "Prospectus"), we are of the opinion
that the information in the Prospectus under the caption "Certain United States
Federal Income Tax Consequences" and in the first paragraph under the caption
"Risk Factors -- Original Issue Discount; Possible Unfavorable Tax and Other
Legal Consequences for Holders of Notes and the Company," to the extent that
such information constitutes matters of law or legal conclusions or purports to
describe certain provisions of the federal tax laws, has been reviewed by us and
is a correct summary in all material respects of the matters discussed therein.
We assume no obligation to advise you of any changes in the foregoing
subsequent to the delivery of this opinion letter. This opinion letter has been
prepared solely for your use in connection with Registration Statement.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to us under the captions "Legal
Matters" and "Certain United States Federal Income Tax Consequences" in the
Prospectus which is a part thereof. In giving such consent, we do not admit
that we are in the category of person whose consent is required under Section 7
of the Act.
Very truly yours,
HOGAN & HARTSON L.L.P.
<PAGE>
Exhibit 23.1
[McGLADREY & PULLEN, LLP LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
McLeodUSA Incorporated
(formerly McLeod, Inc.)
Cedar Rapids, Iowa
We hereby consent to the use in this Registration Statement of our report, dated
January 31, 1997, except for the first paragraph of Note 4, as to which the
date is March 4, 1997, 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
July 1, 1997
<PAGE>
Exhibit 23.1
[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
July 1, 1997
<PAGE>
Exhibit 23.1
[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
July 1, 1997
<PAGE>
Exhibit 99.5
MCLEODUSA INCORPORATED
OFFER TO EXCHANGE ITS
10 1/2% SENIOR DISCOUNT NOTES DUE MARCH 1, 2007
WHICH HAVE BEEN REGISTERED UNDER
THE SECURITIES ACT OF 1933
FOR ANY AND ALL OF ITS OUTSTANDING
10 1/2% SENIOR DISCOUNT NOTES DUE MARCH 1, 2007
PURSUANT TO THE PROSPECTUS DATED JULY , 1996
TO: BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES AND OTHER NOMINEES:
McLeodUSA Incorporated (the "Company") is offering to exchange (the
"Exchange Offer"), upon and subject to the terms and conditions set forth in
the enclosed Prospectus, dated July , 1997 (the "Prospectus"), and the
enclosed Letter of Transmittal (the "Letter of Transmittal"), its 10 1/2%
Senior Discount Notes Due March 1, 2007 which have been registered under the
Securities Act of 1933 (the "Exchange Notes") for any and all of its
outstanding 10 1/2% Senior Discount Notes Due March 1, 2007 (the "Senior
Notes"). The Exchange Offer is being made in order to satisfy certain
obligations of the Company contained in the Registration Agreement dated as of
March 4, 1997, among the Company, Salomon Brothers Inc and Morgan Stanley &
Co. Incorporated.
In connection with the Exchange Offer, we are requesting that you contact
your clients for whom you hold Senior Notes registered in your name or in the
name of your nominee, or who hold Senior Notes registered in their own names.
The Company will not pay any fees or commissions to any broker, dealer or
other person in connection with the solicitation of tenders pursuant to the
Exchange Offer. However, you will, upon request, be reimbursed for reasonable
out-of-pocket expenses incurred in connection with soliciting acceptances of
the Exchange Offer. The Company will pay or cause to be paid all transfer
taxes applicable to the exchange of Senior Notes pursuant to the Exchange
Offer, except as set forth in the Prospectus and the Letter of Transmittal.
For your information and for forwarding to your clients, we are enclosing
the following documents:
1. Prospectus dated July , 1997;
2. A Letter of Transmittal for your use and for the information of your
clients;
3. A form of Notice of Guaranteed Delivery; and
4. A form of letter which may be sent to your clients for whose account you
hold Senior Notes registered in your name or the name of your nominee,
with space provided for obtaining such clients' instructions with regard
to the Exchange Offer.
YOUR PROMPT ACTION IS REQUESTED. THE EXCHANGE OFFER WILL EXPIRE AT 5:00
P.M., NEW YORK CITY TIME, ON , 1997 (THE "EXPIRATION DATE"), UNLESS
EXTENDED BY THE COMPANY (IN WHICH CASE THE TERM "EXPIRATION DATE" SHALL MEAN
THE LATEST DATE AND TIME TO WHICH THE EXCHANGE OFFER IS EXTENDED). THE SENIOR
NOTES TENDERED PURSUANT TO THE EXCHANGE OFFER MAY BE WITHDRAWN, SUBJECT TO THE
PROCEDURES DESCRIBED IN THE PROSPECTUS AND THE LETTER OF TRANSMITTAL, AT ANY
TIME PRIOR TO THE EXPIRATION DATE.
To participate in the Exchange Offer, a duly executed and properly completed
Letter of Transmittal (or facsimile thereof), with any required signature
guarantees and any other required documents, should be sent to the Exchange
Agent and certificates representing the Senior Notes should be
<PAGE>
delivered to the Exchange Agent, all in accordance with the instructions set
forth in the Prospectus and the Letter of Transmittal.
If holders of Senior Notes wish to tender, but it is impracticable for them
to forward their certificates for Senior Notes prior to the expiration of the
Exchange Offer or to comply with the book-entry transfer procedures on a timely
basis, a tender may be effected by following the guaranteed delivery procedures
described in the Prospectus and the Letter of Transmittal.
Any inquiries you may have with respect to the Exchange Offer, or requests
for additional copies of the enclosed materials, should be directed to the
Exchange Agent for the Senior Notes, at its address and telephone number set
forth on the front of the Letter of Transmittal.
Very truly yours,
McLeodUSA Incorporated
NOTHING HEREIN OR IN THE ENCLOSED DOCUMENTS SHALL CONSTITUTE YOU OR ANY OTHER
PERSON AS AN AGENT OF THE COMPANY OR THE EXCHANGE AGENT, OR AUTHORIZE YOU OR
ANY OTHER PERSON TO USE ANY DOCUMENT OR MAKE ANY STATEMENTS ON BEHALF OF EITHER
OF THEM WITH RESPECT TO THE EXCHANGE OFFER, EXCEPT FOR STATEMENTS EXPRESSLY
MADE IN THE PROSPECTUS OR THE LETTER OF TRANSMITTAL.
2
<PAGE>
Exhibit 99.6
MCLEODUSA INCORPORATED
OFFER TO EXCHANGE ITS
10 1/2% SENIOR DISCOUNT NOTES DUE MARCH 1, 2007
WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933
FOR ANY AND ALL OF ITS OUTSTANDING
10 1/2% SENIOR DISCOUNT NOTES DUE MARCH 1, 2007
TO OUR CLIENTS:
Enclosed for your consideration is a Prospectus, dated July , 1997 (the
"Prospectus"), and a form of Letter of Transmittal (the "Letter of
Transmittal"), relating to the offer (the "Exchange Offer") of McLeodUSA
Incorporated (the "Company") to exchange its 10 1/2% Senior Discount Notes due
March 1, 2007 which have been registered under the Securities Act of 1933 (the
"Exchange Notes") for any and all of its outstanding 10 1/2% Senior Discount
Notes due March 1, 2007 (the "Senior Notes"), upon the terms and subject to
the conditions described in the Prospectus and the Letter of Transmittal. The
Exchange Offer is being made in order to satisfy certain obligations of the
Company contained in the Registration Agreement dated as of March 4, 1997,
among the Company, Salomon Brothers Inc and Morgan Stanley & Co. Incorporated.
This material is being forwarded to you as the beneficial owner of the
Senior Notes carried by us in your account but not registered in your name. A
TENDER OF SUCH SENIOR NOTES MAY ONLY BE MADE BY US AS THE HOLDER OF RECORD AND
PURSUANT TO YOUR INSTRUCTIONS.
Accordingly, we request instructions as to whether you wish us to tender on
your behalf the Senior Notes held by us for your account, pursuant to the
terms and conditions set forth in the enclosed Prospectus and Letter of
Transmittal.
Your instructions should be forwarded to us as promptly as possible in order
to permit us to tender the Senior Notes on your behalf in accordance with the
provisions of the Exchange Offer. The Exchange Offer will expire at 5:00 p.m.,
New York City time, on , 1997, unless extended by the Company (the
"Expiration Date"). Any Senior Notes tendered pursuant to the Exchange Offer
may be withdrawn, subject to the procedures described in the Prospectus and
the Letter of Transmittal, at any time prior to the Expiration Date.
If you wish to have us tender your Senior Notes, please so instruct us by
completing, executing and returning to us the instruction form included with
this letter. THE LETTER OF TRANSMITTAL IS FURNISHED TO YOU FOR INFORMATION
ONLY AND MAY NOT BE USED DIRECTLY BY YOU TO TENDER SENIOR NOTES.
<PAGE>
INSTRUCTIONS WITH RESPECT TO
THE EXCHANGE OFFER
The undersigned acknowledge(s) receipt of your letter and the enclosed
material referred to therein, including the Prospectus and the accompanying
form of Letter of Transmittal, relating to the Exchange Offer made by McLeodUSA
Incorporated with respect to its Senior Notes.
This will instruct you as to the action to be taken by you relating to the
Exchange Offer with respect to the Senior Notes held by you for the account of
the undersigned, upon and subject to the terms and conditions set forth in the
Prospectus and the Letter of Transmittal.
The aggregate principal amount at maturity of the Senior Notes held by you
for the account of the undersigned is (fill in amount):
$ ___________________________________
of the 10 1/2% Senior Discount
Notes due March 1, 2007
With respect to the Exchange Offer, the undersigned hereby instructs you
(check appropriate box):
[_]To TENDER the following Senior Notes held by you for the account of the
undersigned (insert aggregate principal amount at maturity of Senior
Notes to be tendered, in integral multiples of $1,000):
$ ___________________________________
of the 10 1/2% Senior Discount
Notes due March 1, 2007
[_]NOT to tender any Senior Notes held by you for the account of the
undersigned.
2
<PAGE>
If the undersigned instructs you to tender the Senior Notes held by you for
the account of the undersigned, it is understood that you are authorized to
make, on behalf of the undersigned (and the undersigned, by its signature
below, hereby makes to you), the representations, warranties and agreements
contained in the Letter of Transmittal that are to be made with respect to the
undersigned as beneficial owner.
SIGN HERE
Name of beneficial owner(s): ___________________________________________________
Signature(s): __________________________________________________________________
Name(s) (please print): ________________________________________________________
Address: _______________________________________________________________________
Telephone Number: ______________________________________________________________
Taxpayer Identification or Social Security Number(s): __________________________
Date: __________________________________________________________________________
None of the Senior Notes held by us for your account will be tendered unless
we receive written instructions from you to do so. Unless a specific contrary
instruction is given in the space provided, your signature(s) hereon shall
constitute an instruction to us to tender all the Senior Notes held by us for
your account.
3
