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Filed Pursuant to Rule 424(b)(1)
Registration No. 333-34227
PROSPECTUS
$225,000,000
[LOGO OF MCLEODUSA]
MCLEODUSA INCORPORATED
OFFER TO EXCHANGE ALL OUTSTANDING 9 1/4% SENIOR NOTES DUE JULY 15, 2007
FOR 9 1/4% SENIOR NOTES DUE JULY 15, 2007 OF MCLEODUSA INCORPORATED
INTEREST PAYABLE JULY 15 AND JANUARY 15, COMMENCING JANUARY 15, 1998
THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P.M., NEW YORK
CITY TIME, ON JANUARY 9, 1998, 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 of its 9 1/4% Senior
Notes due July 15, 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 of its outstanding unregistered 9 1/4% Senior Notes
due July 15, 2007, of which $225 million in aggregate principal amount 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 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 July 21, 1997 (the "Registration Agreement") among the Company and
Salomon Brothers Inc, Bear, Stearns & Co. Inc. and Morgan Stanley Dean Witter
(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 July 21, 1997 between
the Company and the United States Trust Company of New York, as trustee,
governing the Senior Notes and the Exchange Notes.
The Exchange Notes will mature on July 15, 2007. Interest on the Exchange
Notes will be payable semi-annually in arrears on July 15 and January 15 of
each year at a rate of 9 1/4% per annum, commencing January 15, 1998. 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 July
15, 2002, at the redemption prices set forth herein, plus accrued and unpaid
interest, if any, to but excluding the date of redemption. In the event of a
Strategic Equity Investment (as defined herein) on or before July 15, 2000,
the Company may, at its option, use all or a portion of the net proceeds
therefrom to redeem up to a
(Continued on next page.)
SEE "RISK FACTORS" COMMENCING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS
WHICH HOLDERS 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 December 1, 1997
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maximum of 33 1/3% of the original principal amount of the Exchange Notes at a
redemption price of 109.25% of the principal amount thereof, plus accrued and
unpaid interest, if any, to but excluding the date of redemption. In the event
of a Change of Control (as defined herein), holders of the Exchange Notes will
have the right to require the Company to repurchase all or any part of the
Exchange Notes at a repurchase price equal to 101% of the principal amount
thereof plus accrued and unpaid interest, if any, to the date of repurchase.
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 ranking
pari passu in right of payment with all existing and future senior unsecured
indebtedness of the Company and rank senior to all existing and future
subordinated indebtedness of the Company. The Exchange Notes are effectively
subordinated to all 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 are effectively subordinated to all existing
and future third-party indebtedness and other liabilities of the Company's
subsidiaries. As of September 30, 1997, the total liabilities of the Company's
subsidiaries were approximately $217.8 million, and the total secured
indebtedness of the Company and its subsidiaries was approximately $25.3
million.
The Senior Notes were originally issued and sold on July 21, 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
pursuant to the Exchange Offer, 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 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
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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 January 9, 1998 (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
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 December 1, 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."
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INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 and
15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
subsequent to the date of this Prospectus and prior to the termination of any
offering made by this Prospectus shall be deemed to be incorporated by
reference in this Prospectus and to be a part hereof from the date of filing
of such documents (each such document being hereinafter referred to as an
"Incorporated Document"). Any statement contained in this Prospectus shall be
deemed to be modified or superseded to the extent that a statement contained
in any subsequently filed Incorporated Document modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon the written or oral request of such person, a
copy of any or all of the Incorporated Documents (other than exhibits to such
documents, unless such exhibits are specifically incorporated by reference
into such documents). Such requests should be directed to McLeodUSA
Incorporated, McLeodUSA Technology Park, 6400 C Street, SW, P.O. Box 3177,
Cedar Rapids, IA 52406-3177, telephone number: (319) 364-0000, Attention:
General Counsel.
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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 in Iowa, Illinois, North Dakota, South Dakota,
Minnesota, Wisconsin, Indiana, Colorado and Wyoming and to residential
customers in Iowa, Illinois, North Dakota and South Dakota. 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 and telephone equipment
sales, service and installation, (iii) private line and data services, (iv) the
sale of advertising space in telephone directories, (v) local exchange services
through the operation of an independent local exchange company, Illinois
Consolidated Telephone Company ("ICTC"), acquired as part of the CCI
Acquisition (as defined herein), and (vi) telemarketing services. As of
September 30, 1997, the Company served over 200,800 telecommunications
customers in 214 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 offers a
variety of private line and data services to large businesses, institutional
customers and interexchange carriers. The Company also sells, installs and
services telephone equipment, primarily to business customers in Iowa and
Minnesota, and provides network maintenance services for the State of Iowa's
fiber optic network. In addition, the Company annually publishes over 12
million competitive "white page" and "yellow page" telephone directories in 19
states. 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." In areas
other than those served by ICTC (which operates its own lines and switches),
the Company provides local service using existing telephone lines and switches
or unbundled network elements (lines only) 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 long distance
carriers or, in central Illinois, by using its inter-city fiber optic network.
Using the Company's sophisticated proprietary software, known as Raterizer(R),
most business customers subscribing to the Company's integrated
telecommunications services receive the lowest
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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 business
customer and agreed to by the Company. The Company also provides voice mail,
paging and Internet access services. In ICTC's service area, which includes 37
central office exchanges in east central Illinois, local and long distance
service is offered using facilities owned by ICTC. The Company is currently
constructing fiber optic networks in both Iowa and Illinois to carry additional
telecommunications services traffic on its own network. See "Business--Current
Products and Services" and "Business--Network Facilities."
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. In addition, the Company completed a private offering of $500 million
aggregate principal amount at maturity of 10 1/2% senior discount notes due
March 1, 2007 (the "Senior Discount Notes") yielding net proceeds of
approximately $289.6 million in March 1997, and completed the Offering in July
1997 yielding net proceeds of approximately $218.5 million. The Senior Discount
Notes were subsequently exchanged for $500 million aggregate principal amount
at maturity of substantially identical 10 1/2% senior discount notes due March
1, 2007 that had been registered under the Securities Act (the "Senior Discount
Exchange Notes") in an exchange offer (the "Senior Discount Note Exchange
Offer") that expired on August 24, 1997. 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 Iowa, Illinois,
North Dakota and South Dakota 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) 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; (iii) in September 1996, the Company acquired
Telecom*USA Publishing Group, Inc. (now known as McLeodUSA Media Group, Inc.
("McLeodUSA Publishing")), which publishes and distributes competitive "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; (iv) the Company has constructed approximately 3,100 new route
miles of fiber optic network at a cost of approximately $66.9 million; (v) in
May, July and September 1997, the Company acquired a total of 27 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 (vi) in September 1997, the Company acquired
Consolidated Communications Inc. ("CCI"), which offers a variety of
communications products and services, including local exchange and long
distance services and "white page" and "yellow page" telephone directory
publishing (the "CCI Acquisition"). See "Business--Recent Transactions."
BUSINESS STRATEGY
The Company's objective is to become a leading provider of integrated
wireline and wireless telecommunications services in Iowa, Illinois, North
Dakota, South Dakota, Minnesota, Wisconsin, Indiana, Colorado, Missouri,
Montana, Idaho, Nebraska, Utah and Wyoming. 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:
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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. 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 17.3
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 and Illinois. As part of the CCI Acquisition, the Company acquired
approximately 900 route miles of fiber optic network in central Illinois. 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 continue to 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 or rights-of-way (e.g.,
utilities, railroad companies and cable operators). As of September 30, 1997,
the Company owned approximately 4,600 route miles of fiber optic network and,
subject to the foregoing factors, expects to construct approximately 5,800
additional route miles of fiber optic network during the next three years.
Through its strategic relationships with its electric utility stockholders and
other owners of infrastructure and rights-of-way, 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 has
achieved and will be able to continue 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 creates an attractive customer-focused platform for the provision of
local, long distance, wireless and enhanced services. See "Business--Network
Facilities."
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TRANSITION INTO LOCAL SWITCHED SERVICES BUSINESS. Through a subsidiary of
CCI, the Company has two interconnection agreements with Ameritech Corporation
("Ameritech") under which the Company provides facilities-based switched
services to over 8,000 local lines in central Illinois and in Indiana. When
certain judicial and regulatory proceedings are resolved, and assuming the
economics are favorable to the Company, the Company intends to begin offering
additional facilities-based switched services in other markets by using its six
existing high capacity digital switches 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 vacated by July and October 1997 court decisions, and may be subject
to further judicial and regulatory proceedings. Although these court decisions
do not prevent the Company from negotiating interconnection agreements, they do
create uncertainty about the rules governing pricing, terms and conditions of
interconnection agreements. If the Company can negotiate favorable
interconnection agreements, and subject to court and regulatory proceedings
necessary to implement such agreements, the Company believes that it could
begin offering additional local facilities-based switched services in other
markets over the next three years. The Company has received state regulatory
approval in Iowa, Illinois, Indiana and Wisconsin to offer local facilities-
based switched services in all areas serviced by U S WEST in Iowa and in
certain cities in Illinois, Indiana and Wisconsin. The Company intends to seek
regulatory approval to provide such services in other markets targeted by the
Company when the economic terms of interconnection with the incumbent local
exchange carrier make the provision of local facilities-based switched services
cost-effective. See "Business--Expansion of Certain Facilities-based Services"
and "Business--Regulation."
EXPLORE POTENTIAL ACQUISITIONS AND STRATEGIC ALLIANCES. The Company believes
that its strategic alliances with two utilities in its Iowa markets, one
utility in Wisconsin and one utility and one railroad in Illinois provide it
with access to rights-of-way and other resources on favorable terms. The
Company believes that its acquisitions of Ruffalo, Cody, McLeodUSA Publishing
and CCI will increase the Company's penetration of its current markets and
accelerate its entry into new markets. As part of its expansion strategy, the
Company contemplates additional acquisitions, joint ventures and strategic
alliances with businesses that are related or complementary to its current
operations. The Company believes that the addition of such related or
complementary businesses will help it to continue 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 eleven 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.
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RECENT DEVELOPMENTS
In April and June 1997, the FCC granted the Company a total of 26 "D" and "E"
block frequency PCS licenses and in September 1997 the Company acquired one
additional "E" block frequency PCS license as a result of the CCI Acquisition
(the "CCI PCS License"), giving the Company 27 PCS licenses in a total of 25
markets covering areas of Iowa, Illinois, Minnesota, Nebraska and South Dakota.
The Company paid the FCC approximately $32.8 million for the 26 PCS licenses
granted to the Company by the FCC in April and June 1997. CCI paid the FCC for
the CCI PCS License prior to the CCI Acquisition. The Company's PCS licenses
encompass approximately 110,000 square miles and a population of approximately
6.9 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 September 24, 1997, the Company acquired CCI pursuant to an Agreement and
Plan of Reorganization dated as of June 14, 1997 (the "Merger Agreement"). As
consideration for the acquisition, the Company issued an aggregate of 8,488,596
shares of Class A Common Stock and paid approximately $155 million in cash to
the shareholders of CCI. CCI is a diversified telecommunications holding
company that as of September 30, 1997 served telecommunications customers in 45
cities and towns primarily in Illinois. CCI's wholly owned subsidiary ICTC is
an independent local exchange carrier with 37 central office exchanges in east
central Illinois serving over 89,000 access lines as of the date of this
Prospectus. CCI's wholly owned subsidiary Consolidated Communications Telecom
Services Inc. ("CCTS") is a competitive local exchange carrier offering
integrated local, long distance and other telecommunications services to over
5,800 customers in central and southern Illinois and in Indiana. CCI's wholly
owned subsidiary Consolidated Communications Directories Inc. ("CCD") publishes
and distributes annual "white page" and "yellow page" telephone directories in
38 states and the United States Virgin Islands. CCI also operates an operator
service company, an inmate pay-phone company and a full service telemarketing
agency. In addition, CCI owns a majority interest in a cable television company
serving customers in Greene, Sangamon and Menard counties in Illionis and in
Benton Harbor, Michigan, and owns a minority interest in a cellular telephone
partnership serving parts of east central Illinois.
On September 25, 1997, and pursuant to the terms of the Merger Agreement,
Richard A. Lumpkin, the Chairman and Chief Executive Officer of CCI and Robert
J. Currey, the President and Chief Operating Officer of CCI, were elected
directors of the Company and joined the Company's executive management team.
Mr. Lumpkin, certain members of his family and trusts for the benefit thereof
own approximately 13.8% of the shares of Class A Common Stock outstanding as of
October 31, 1997.
The Company believes that the business strategy of CCI is closely aligned
with that of the Company. The Company believes it can successfully leverage the
integrated local, long distance and other telecommunications services offered
by CCI to enhance the Company's efforts to offer similar services in adjoining
target markets. The combined competitive local exchange sales force of CCI and
the Company is approximately 560 persons as of the date of this Prospectus. In
addition, CCI currently owns approximately 900 route miles of fiber optic
network and three local and two long distance switches in eastern and southern
Illinois, St. Louis, Missouri and Indianapolis, Indiana, reducing the Company's
need to construct network and install switches in those regions. Both CCI and
the Company have focused,
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and intend to continue to focus, on second and third tier cities in the
Midwest. The Company believes the CCI Acquisition creates the first super-
regional competitive local exchange carrier, with six switches, over 244,000
lines, 4,600 route miles of fiber optic network and 4,600 employees.
The Company also believes that CCI's competitive "white page" and "yellow
page" telephone directory publishing operations can be successfully integrated
into the Company's telephone directory advertising and distribution activities
in nineteen states in the midwestern and Rocky Mountain regions of the United
States. The Company currently publishes over 12 million competitive telephone
directories annually, including the over 3 million competitive telephone
directories published annually by CCI. The directory sales force of the Company
subsequent to the CCI Acquisition is approximately 610 persons as of the date
of this Prospectus. The Company intends to use CCI's competitive telephone
directories together with its own directories to help increase brand awareness
of its telecommunications products.
The Company believes that the extensive experience of CCI's management and
employees in offering local services, and in interconnecting CCI's network with
Ameritech in Champaign-Urbana, Decatur, Peoria, Bloomington, Fairview Heights,
and Springfield, Illinois, enhances the Company's ability to more expeditiously
enter the local service market through interconnection with the incumbent
Regional Bell Operating Companies. The Company believes that successful
interconnection arrangements will be accompanied by concomitant cost savings.
In addition, the Company believes that the CCI Acquisition enables the Company
to more easily access capital markets at lower rates, thereby strengthening the
Company's competitive position in its target markets.
The Company's beliefs as to the benefits to be derived from the CCI
Acquisition are "forward-looking statements" within the meaning of the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. The
benefits the Company will actually derive from the CCI Acquisition may differ
materially as a result of the difficulty of assimilating CCI's operations and
personnel, the possible inability of management to maximize the financial and
strategic position of the Company through the successful incorporation of CCI
into the Company's operations, particularly in view of the size and complexity
of CCI's operations, and the risks of entering markets in which the Company has
little or no direct prior experience. See "Risk Factors--Risks Associated with
Acquisitions" and "Business--Recent Transactions."
THE EXCHANGE OFFER
The Exchange Offer.......... Up to $225 million aggregate principal amount of
Exchange Notes are being offered in exchange for
a like aggregate principal amount of Senior
Notes. Senior Notes may be tendered for exchange
in whole or in part in integral multiples of
$1,000 principal amount. 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 January 9, 1998
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 of Senior Notes being tendered.
6
<PAGE>
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."
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
7
<PAGE>
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
pursuant to the Exchange Offer, 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 gain or loss or
any interest income as a result of such exchange.
See "The Exchange Offer--Certain United States
Federal Income Tax Consequences."
THE EXCHANGE NOTES
Securities Offered.......... $225 million aggregate principal amount of 9 1/4%
Senior Notes due July 15, 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 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
8
<PAGE>
evidence the same debt as the Senior Notes and
will be issued pursuant to and entitled to the
benefits of the Senior Note Indenture (as defined
herein).
Interest.................... Interest on the Exchange Notes will accrue at the
rate of 9 1/4% per annum and will be payable in
cash semi-annually in arrears on July 15 and
January 15, commencing January 15, 1998.
Ranking..................... The Exchange Notes rank pari passu in right of
payment with the Senior Discount Exchange Notes,
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 September 30, 1997, the
Company had no outstanding subordinated
indebtedness and, other than the Senior Discount
Exchange Notes and 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. 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 September 30,
1997, the total liabilities of the Company's
subsidiaries (after the elimination of loans and
advances by the Company to its subsidiaries) were
approximately $217.8 million, and the total
secured indebtedness of the Company and its
subsidiaries was approximately $25.3 million. 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 July 15, 2002 at the
redemption prices set forth herein, plus accrued
and unpaid interest thereon (if any) to but
excluding 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 July 15, 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 33 1/3% of the
original principal amount of the Notes at a
redemption price equal to 109.25% of the
principal amount of the Notes plus accrued and
unpaid interest thereon (if any) to but excluding
the redemption date;
9
<PAGE>
provided that at least 66 2/3% of the original
principal amount of the Notes would remain
outstanding immediately after giving effect to
such redemption. 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 principal amount of
the Exchange Notes tendered by such holder plus
accrued and unpaid interest, if any, to any
Change of Control Payment Date (as defined
herein). 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."
Certain Covenants........... The Senior Note 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
HOLDERS OF THE SENIOR NOTES SHOULD CONSIDER CAREFULLY CERTAIN FACTORS SET
FORTH UNDER THE CAPTION "RISK FACTORS" BEFORE TENDERING SENIOR NOTES FOR
EXCHANGE NOTES. 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, McLeodUSA Publishing and CCI on July 15, 1996,
September 20, 1996 and September 24, 1997, respectively, using the purchase
method of accounting, and also reflects the issuance of the Senior Discount
Notes on March 4, 1997 and the issuance of the Senior Notes on July 21, 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, McLeodUSA Publishing and CCI 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, McLeodUSA Publishing and CCI.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30,
----------------------------------------------------------- -------------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996(4)(5) 1996 (1)(6) 1997(1)(7)(8) 1997(4)(9)
---- ---- ---- ---------- ---------- ----------- ----------- ------------- -----------
(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 $379,598 $ 45,497 $131,595 $325,900
----- ------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Cost of service..... 262 1,528 6,212 19,667 52,624 195,586 31,693 80,680 181,044
Selling, general and
administrative..... 219 2,390 12,373 18,054 46,044 147,130 25,626 83,428 148,491
Depreciation and
amortization....... 6 235 772 1,835 8,485 49,878 4,734 15,708 44,575
Other............... -- -- -- -- 2,380 12,568 -- 2,689 8,307
----- ------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses........... 487 4,153 19,357 39,556 109,533 405,162 62,053 182,505 382,417
----- ------- -------- -------- -------- -------- -------- -------- --------
Operating loss....... (237) (2,603) (11,343) (10,558) (28,210) (25,564) (16,556) (50,910) (56,517)
Interest income
(expense), net...... -- 163 (73) (771) 5,369 (26,583) 2,860 (2,686) (13,612)
Other non-operating
income.............. -- -- -- -- 495 2,946 278 40 1,122
Income taxes......... -- -- -- -- -- -- -- -- --
----- ------- -------- -------- -------- -------- -------- -------- --------
Net loss............. $(237) $(2,440) $(11,416) $(11,329) $(22,346) $(49,201) $(13,418) $(53,556) $(69,007)
===== ======= ======== ======== ======== ======== ======== ======== ========
Loss per common and
common equivalent
share............... $(.02) $ (.08) $ (.31) $ (.31) $ (.52) $ (.95) $ (.33) $ (1.02) $ (1.13)
===== ======= ======== ======== ======== ======== ======== ======== ========
Ratio of earnings to
fixed charges(10)... -- -- -- -- -- -- -- -- --
===== ======= ======== ======== ======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30, 1997
--------------------------------------------- ------------------
1992 1993 1994 1995(1)(11) 1996(1)(12) ACTUAL(1)(8)(13)
----- ------ ------- ----------- ----------- ------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets......... $ 544 $7,077 $ 4,862 $ 8,507 $224,401 $ 574,069
Working capital (defi-
cit).................. $(440) $5,962 $ 1,659 $(1,208) $185,968 $ 432,860
Property and equipment,
net................... $ 135 $1,958 $ 4,716 $16,119 $ 92,123 $ 336,211
Total assets........... $ 694 $9,051 $10,687 $28,986 $452,994 $1,361,999
Long-term debt......... -- -- $ 3,500 $ 3,600 $ 2,573 $ 607,247
Stockholders' equity
(deficit)............. $(290) $7,936 $ 3,291 $14,958 $403,429 $ 579,456
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30,
----------------------------------------------------------- -------------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996(4)(5) 1996(1)(6) 1997(1)(7)(8) 1997(4)(9)
---- ---- ---- ---------- ---------- ----------- ----------- ------------- -----------
(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 $231,388 $136,404 $540,368 $556,694
EBITDA(14)........... $(231) $(2,368) $(10,571) $(8,723) $(17,345) $ 36,882 $(11,822) $(32,513) $ (3,635)
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- SEPTEMBER 30,
1994 1995 1996 1997
------ ------ ------ -------------
<S> <C> <C> <C> <C>
OTHER OPERATING DATA:
Local lines................................ 17,112 35,795 65,367 244,005
Number of telecommunications customers..... 5,137 8,776 17,872 200,812
Cities and towns served.................... 25 77 120 214
Route miles................................ 8 218 2,352 4,617
Employees.................................. 302 419 2,077 4,690
</TABLE>
- --------
(1) The acquisitions of MWR Telecom, Inc. ("MWR") (now part of McLeodUSA
Network Services, Inc. ("McLeodUSA Network Services")), Ruffalo, Cody,
McLeodUSA Publishing and CCI in April 1995, July 1996, September 1996 and
September 1997, 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, the issuance of the Senior Discount
Notes in March 1997, the issuance of the Senior Notes in July 1997, and
the CCI Acquisition in September 1997 affect the comparability of the pro
forma data presented to the data for prior periods shown.
(5) Includes operations of Ruffalo, Cody, McLeodUSA Publishing and CCI from
January 1, 1996 to December 31, 1996 and certain adjustments attributable
to the acquisitions of Ruffalo, Cody, McLeodUSA Publishing and CCI by the
Company. Also reflects certain adjustments attributable to the issuance of
the Senior Discount Notes and the Senior Notes computed as if the Senior
Discount Notes and the Senior Notes had been issued on January 1, 1996.
(6) Includes operations of Ruffalo, Cody from July 16, 1996 to September 30,
1996 and operations of McLeodUSA Publishing from September 21, 1996 to
September 30, 1996.
(7) Includes operations of CCI from September 25, 1997 to September 30, 1997.
(8) Reflects the issuance of the Senior Discount Notes on March 4, 1997 and
the Senior Notes on July 21, 1997.
(9) Reflects certain adjustments attributable to the issuance of the Senior
Discount Notes and the Senior Notes computed as if the Senior Discount
Notes and the Senior Notes had been issued on January 1, 1997. Also
reflects certain adjustments attributable to the CCI Acquisition as if it
had been consummated on January 1, 1997.
(10) 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 nine months ended
September 30, 1996 and 1997, earnings were insufficient to cover fixed
charges by $13.6 million and $56.4 million, respectively. On a pro forma
basis computed as if the acquisitions by the Company of Ruffalo, Cody,
McLeodUSA Publishing and CCI, the issuance of the Senior Discount Notes
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 $50.7 million and $85.4 million for the year ended
December 31, 1996 and the nine months ended September 30, 1997,
respectively.
(11) Includes MWR, which was acquired by the Company on April 28, 1995.
(12) Includes Ruffalo, Cody and McLeodUSA Publishing, which were acquired by
the Company on July 15, 1996 and September 20, 1996, respectively.
(13) Includes CCI, which was acquired by the Company on September 24, 1997.
(14) 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 nine months ended September 30, 1997 were approximately $11.4 million,
$11.3 million, $22.3 million and $53.6 million, respectively. At September 30,
1997, the Company had an accumulated deficit of $101.4 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 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 from operating activities in the future. If the Company cannot
achieve operating profitability 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
Continued expansion of the Company's operations, facilities, network and
services will require significant capital expenditures. As of September 30,
1997, the Company estimates that its aggregate capital requirements for the
remainder of 1997, 1998 and 1999 will be approximately $404 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) developing, constructing and operating a PCS system and (iv)
completing construction of its new corporate headquarters and associated
buildings. These capital requirements are expected to be funded, in large
part, out of the approximately $218.5 million in net proceeds from the
Offering, approximately $174 million remaining from the Company's private
offering of the Senior Discount Notes, 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.
The Company's estimate of its future capital requirements is a "forward-
looking statement" within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. The Company's actual capital
requirements may differ materially as a result of regulatory, technological
and competitive developments (including new opportunities) in the Company's
industry.
The Company expects to meet its additional capital needs with the proceeds
from credit facilities and other borrowings, and additional debt and equity
issuances. The Company currently plans to obtain one or more lines of credit,
although no such lines of credit have yet been negotiated. There can be no
assurance, however, that the Company will be successful in producing
sufficient cash flows or raising sufficient debt or equity capital to meet its
strategic objectives or that such funds, if available at all, will be
available on a timely basis or on terms that are acceptable to the Company.
Failure to generate or raise sufficient funds may require the Company to delay
or abandon some of its future
13
<PAGE>
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) and the General Telephone Operating Companies, which currently
dominate their respective local telecommunications 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. 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.
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. More recently, MCI and WorldCom have announced an
agreement to merge, subject to stockholder approval. 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, a number of companies, including MCI and AT&T, currently hold
certificates of public convenience and necessity to offer local and long
distance service in Iowa, Illinois and certain other states within the
Company's 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
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 additional 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 were appealed to the
U.S. Eighth Circuit Court of
14
<PAGE>
Appeals. In July and October 1997, the U.S. Eighth Circuit Court of Appeals
vacated portions of the Interconnection Decision, including provisions
establishing a pricing methodology and a procedure permitting new entrants to
"pick and choose" among various provisions of existing interconnection
agreements. Although the decisions vacating the Interconnection Decision do
not prevent the Company from negotiating interconnection agreements with local
exchange carriers, they do create uncertainty about the rules governing
pricing, terms and conditions of interconnection agreements, and could make
negotiating such agreements more difficult and protracted. In November 1997,
the FCC filed a petition for a writ of certiorari with the U.S. Supreme Court
challenging the decisions of the 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 "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 or, in the case of customers served in
central Illinois, to local lines. The Company uses such access to partition
the local switch or transmit traffic over unbundled local line segments
("loops") and thereby provide local service to its customers.
The Company purchases access to local switches 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 to most of its
customers, 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.
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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 the filing. 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 subsequently filed a petition for rehearing with the Minnesota Public
Utilities Commission. On July 29, 1997, the Minnesota Public Utilities
Commission denied 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 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, on September 26, 1996, the Public Service Commission rejected the U
S WEST Centrex Action and ordered U S WEST to continue the availability of
Centrex service for resale. Upon rehearing, however, the Utah Public Service
Commission issued an order on April 29, 1997 imposing temporary restrictions
on Centrex resale. The Company is currently evaluating its options regarding
these temporary restrictions.
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.
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On October 1, 1997, the FCC issued a decision addressing the preemption of
certain statutory and regulatory provisions of Texas law which had been
challenged as impermissible under the Telecommunications Act. As part of its
decision, the FCC ruled that certain restrictions on the resale of
Southwestern Bell Telephone Company's Centrex service were preempted by the
Telecommunications Act. Specifically, the FCC held that the resale of Centrex
service could not be limited to "continuous property," as Southwestern Bell
Telephone Company had requested and the Texas Public Utility Commission had
approved, because such a limitation constituted a barrier to entry in
violation of Section 253(a) of the Telecommunications Act; was not
competitively neutral, and was therefore impermissible under Section 253(b) of
the Telecommunications Act; and was an unreasonable and discriminatory
restriction on resale, in violation of Section 251(c)(4)(B) of the
Telecommunications Act. The FCC declined to preempt another limitation (which
contained a minimum station line requirement) on the grounds that an
arbitration decision in Texas made such a restriction "presumptively
unreasonable." While the Company believes that this decision supports its
position with respect to the resale of Centrex service, there can be no
guarantee that this decision will not be modified, if challenged on appeal, or
that it will be consistently applied without further litigation in the States
in which the Company offers telecommunications services or intends to offer
telecommunications services.
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. On July 28, 1997, the Colorado Public Utilities
Commission issued a written order which concluded that the restrictions in U S
WEST'S tariffs were inconsistent with both state and federal law, and required
that they be removed from the tariff. U S WEST's request for reconsideration
of the Colorado Public Utilities Commission decision to allow the resale of
Centrex service to residential customers was denied on September 9, 1997.
In January 1997, U S WEST proposed to implement certain interconnection
surcharges in several 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 any such
state legislative initiatives, if adopted, will not have a material adverse
effect on the Company.
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REFUSAL OF U S WEST TO IMPROVE ITS PROCESSING OF SERVICE ORDERS
As a result of its significant use of the Centrex product to serve its
customers inU S WEST's service territories, 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. Although U S WEST agreed to process
the Company's service orders within a standard five-day period, order backlogs
continue to occur. The Company has filed a request for additional action by
the Iowa Utilities Board. 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 local and
long distance services, in order to verify most of 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.
On July 7, 1997, U S WEST and the Company entered into an agreement which
requires U S WEST to set "flags" to capture call detail records on 95% of the
Company's converted lines within 36 hours of the time the line is converted to
the Company's service. In the event that U S WEST fails to
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meet that standard, U S WEST is required to provide certain credits to the
Company. 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 Senior Note 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. As of September 30, 1997, the total liabilities of the Company's
subsidiaries (after the elimination of loans and advances by the Company to
its subsidiaries) were approximately $217.8 million. In addition, the
indenture relating to the Senior Discount Exchange Notes (the "Senior Discount
Note Indenture") and the Senior Note Indenture 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. See "Description of the Exchange
Notes--Certain Covenants--Limitation on Consolidated Indebtedness" and
"Description of Other Indebtedness."
The Exchange Notes also are unsecured and will be effectively subordinated
to any secured indebtedness of the Company to the extent of the value of the
assets securing such indebtedness. As of September 30, 1997, the total secured
indebtedness of the Company and its subsidiaries was approximately $25.3
million. The Senior Discount Note Indenture and the Senior Note Indenture
permit 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 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" and "Description of Other Indebtedness."
WIRELESS COMPETITION
The Company does not currently offer PCS or cellular services. In April and
June 1997, the FCC granted the Company a total of 26 "D" and "E" block
frequency PCS licenses and in September 1997 the Company acquired the CCI PCS
License, giving the Company 27 PCS licenses in a total of 25 markets 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), wireline replacement products
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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.
There are over ten principal cellular providers and over 20 principal PCS
licensees in the Company's proposed PCS markets.
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 currently
offer wireless 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 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, state or local
regulatory scheme affecting the operation of PCS systems
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(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 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
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any term employment agreements with these employees. 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.
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. ("McLeodUSA
Telecommunications") and CCTS, wholly owned subsidiaries of the Company, are
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 and CCTS also are 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 and
CCTS also have 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.
ICTC is subject to rate of return regulation by the Illinois Commerce
Commission (the "ICC"). Under such regulation, ICTC is allowed to earn up to a
fixed rate of return on its equity. In the event that the ICC finds that ICTC
has exceeded its authorized rate of return on equity, ICTC could be required
to lower its customer rates or make refunds. While the Company believes ICTC
is earning less than its authorized rate of return, there can be no assurance
that the ICC will not, at some future date, find that ICTC has earned more
than its authorized rate of return or that such a finding would not have a
material adverse effect on the Company.
In addition, a substantial proportion of ICTC's revenues are derived from
access charges imposed on interexchange carriers. Currently, both the FCC and
the ICC are reviewing, on an industry wide basis, whether the access charge
rate structure should be revised. If the FCC decides to revise the access
charge rate structure, such a revision could result in a reduction of ICTC's
revenues and gross margins and could have a material adverse effect on the
Company.
ICTC, as well as other CCI subsidiaries, also holds state and federal
certificates and FCC licenses in connection with the operation of wireline
telecommunications services and paging services.
The licensing, construction, operation, sale and interconnection
arrangements of wireless telecommunications systems are regulated to varying
degrees by the FCC. In April and June 1997, the FCC granted the Company a
total of 26 "D" and "E" block frequency PCS licenses and in September 1997 the
Company acquired the CCI PCS License, giving the Company 27 PCS licenses in a
total of 25 markets covering areas of Iowa, Illinois, Minnesota, Nebraska and
South Dakota.
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FCC licenses to provide PCS and other services are subject to renewal and
revocation. The PCS licenses that the Company holds 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 two of its wholly owned subsidiaries, 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 these subsidiaries 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 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."
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 switches, interconnect with the local
exchange company's network, 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 continue 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."
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RISKS ASSOCIATED WITH ACQUISITIONS
As part of its business strategy, the Company has acquired Ruffalo, Cody,
McLeodUSA Publishing and 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. The Company also may encounter additional risks in connection with
the CCI Acquisition as a result of the size and complexity of CCI's
operations. There can be no assurance that the Company will be successful in
overcoming these risks or any other problems encountered in connection with
the CCI Acquisition or any 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 (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 similar
long-term agreements with Wisconsin Power and Light Company for access to
rights-of-way, poles and towers primarily located in Wisconsin and with
Illinois Power Company ("Illinois Power") and Illinois Central Railroad
Corporation ("Illinois Central Railroad") for access to rights-of-way, poles
and towers located in Illinois. 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, Illinois Power, Illinois
Central Railroad 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.
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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
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 October 31, 1997, IES, MidAmerican, Richard A. Lumpkin, certain
members of his family and various trusts for the benefit thereof, 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, Richard A.
Lumpkin, certain members of his family and various trusts for the benefit
thereof, and Mr. and Mrs. McLeod 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 Exchange 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 Exchange Notes. In addition, the Company's stockholders may
have an interest in pursuing acquisitions, divestitures, financings or other
transactions that, in their judgment, could enhance their equity investment,
even though such transactions might involve risk to the holders of the
Exchange 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 Exchange
Notes.
INCREASED LEVERAGE; RESTRICTIVE COVENANTS
As of September 30, 1997, the Company's total amount of indebtedness
outstanding was $631.5 million and the Company had stockholder's equity of
$579.5 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 Senior Discount Note Indenture and the Senior Note Indenture impose
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."
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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 following the Exchange Offer.
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 pursuant to the Exchange Offer, 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."
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 certain rights to have such
Senior Notes registered under the Securities Act. 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 of outstanding Senior Notes will decrease, which
will result in a decrease in the liquidity of the Senior Notes. Any trading
market for Senior Notes which remain outstanding after the Exchange Offer
could be adversely affected.
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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 the Depository Trust
Company ("DTC" or the "Depository"), (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 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 pursuant to the Exchange Offer, 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 of Exchange Notes for each $1,000 principal
amount 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.
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 have been registered
under the Securities Act and
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therefore are not 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 indebtedness as the Senior
Notes (which they replace) and will be issued pursuant to, and entitled to the
benefits of, the Senior Note 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, $225 million aggregate principal amount 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 January
9, 1998 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
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<PAGE>
withdraw their tendered Senior Notes as described under "--Withdrawal Rights,"
and (iv) to waive any 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,
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<PAGE>
nevertheless, on behalf of the Company and subject to Rule 14e-1(c) under the
Exchange Act, retain 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.
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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.
32
<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 pursuant to the
Exchange Offer, 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
33
<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
Interest on the Senior Notes and the Exchange Notes will be payable semi-
annually in arrears on July 15 and January 15 of each year at a rate of 9 1/4%
per annum, commencing January 15, 1998.
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 in exchange for
Senior Notes pursuant to the Exchange Offer 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 directly 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
34
<PAGE>
amend the terms of the Exchange Offer in any respect. If such waiver or
amendment constitutes a 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.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The exchange of the Senior Notes for the Exchange Notes will not be a
taxable exchange for federal income tax purposes, and holders of Senior Notes
should not recognize any taxable gain or loss or any interest income as a
result of such exchange.
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) 780-0592
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
35
<PAGE>
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 September 30, 1997, the capitalization
of the Company, including 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>
SEPTEMBER 30, 1997
------------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C>
Short-term debt............................................. $ 24,283
----------
Long-term debt.............................................. 607,247
----------
Stockholders' equity:
Preferred Stock, $.01 par value, 2,000,000 shares
authorized; none outstanding............................. --
Class A Common Stock, $.01 par value, 250,000,000 shares
authorized; 61,429,429 shares issued and outstanding..... 614
Class B Common Stock, convertible, $.01 par value,
22,000,000 shares authorized; none issued or
outstanding.............................................. --
Additional paid-in capital................................ 680,223
Accumulated deficit....................................... (101,381)
----------
Total stockholders' equity.............................. 579,456
----------
Total capitalization.................................... $1,210,986
==========
</TABLE>
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 nine-month periods
ended September 30, 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, McLeodUSA Publishing and CCI on July 15, 1996, September 20,
1996 and September 24, 1997, respectively, using the purchase method of
accounting, and also reflects the issuance of the Senior Discount Notes on
March 4, 1997 and the issuance of the Senior Notes on July 21, 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, McLeodUSA Publishing and CCI 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, McLeodUSA Publishing and CCI.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30,
------------------------------------------------------------ -------------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996 (4)(5) 1996(1)(6) 1997(1)(7)(8) 1997(4)(9)
---- ---- ---- ---------- ---------- ----------- ----------- ------------- -----------
(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 $379,598 $ 45,497 $131,595 $325,900
------ ------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Cost of service.... 262 1,528 6,212 19,667 52,624 195,586 31,693 80,680 181,044
Selling, general
and
administrative.... 219 2,390 12,373 18,054 46,044 147,130 25,626 83,428 148,491
Depreciation and
amortization...... 6 235 772 1,835 8,485 49,878 4,734 15,708 44,575
Other.............. -- -- -- -- 2,380 12,568 -- 2,689 8,307
------ ------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses.......... 487 4,153 19,357 39,556 109,533 405,162 62,053 182,505 382,417
------ ------- -------- -------- -------- -------- -------- -------- --------
Operating loss...... (237) (2,603) (11,343) (10,558) (28,210) (25,564) (16,556) (50,910) (56,517)
Interest income
(expense), net..... -- 163 (73) (771) 5,369 (26,583) 2,860 (2,686) (13,612)
Other non-operating
income............. -- -- -- -- 495 2,946 278 40 1,122
Income taxes........ -- -- -- -- -- -- -- -- --
------ ------- -------- -------- -------- -------- -------- -------- --------
Net loss............ $ (237) $(2,440) $(11,416) $(11,329) $(22,346) $(49,201) $(13,418) $(53,556) $(69,007)
====== ======= ======== ======== ======== ======== ======== ======== ========
Loss per common and
common equivalent
share.............. $ (.02) $ (.08) $ (.31) $ (.31) $ (.52) $ (.95) $ (.33) $ (1.02) $ (1.13)
====== ======= ======== ======== ======== ======== ======== ======== ========
Weighted average
common and common
equivalent shares
outstanding........ 14,925 29,665 36,370 37,055 43,019 51,703 41,188 52,752 61,054
====== ======= ======== ======== ======== ======== ======== ======== ========
Ratio of earnings to
fixed charges(10).. -- -- -- -- -- -- -- -- --
====== ======= ======== ======== ======== ======== ======== ======== ========
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
DECEMBER 31, 1997
--------------------------------------------- ----------------
1992 1993 1994 1995(1)(11) 1996(1)(12) ACTUAL(1)(8)(13)
----- ------ ------- ----------- ----------- ----------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets........ $ 544 $7,077 $ 4,862 $ 8,507 $224,401 $ 574,069
Working capital
(deficit)............ $(440) $5,962 $ 1,659 $(1,208) $185,968 $ 432,860
Property and
equipment, net....... $ 135 $1,958 $ 4,716 $16,119 $ 92,123 $ 336,211
Total assets.......... $ 694 $9,051 $10,687 $28,986 $452,994 $1,361,999
Long-term debt........ -- -- $ 3,500 $ 3,600 $ 2,573 $ 607,247
Stockholders' equity
(deficit)............ $(290) $7,936 $ 3,291 $14,958 $403,429 $ 579,456
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30,
----------------------------------------------------------- -------------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995(1)(2) 1996(1)(3) 1996(4)(5) 1996 (1)(6) 1997(1)(7)(8) 1997(4)(9)
---- ---- ---- ---------- ---------- ----------- ----------- ------------- -----------
(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 $231,388 $136,404 $540,368 $556,694
EBITDA(14)........... $(231) $(2,368) $(10,571) $(8,723) $(17,345) $ 36,882 $(11,822) $(32,513) $ (3,635)
</TABLE>
- -------
(1) The acquisitions of MWR, Ruffalo, Cody, McLeodUSA Publishing and CCI in
April 1995, July 1996, September 1996 and September 1997, 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, the issuance of the Senior Discount
Notes in March 1997, the issuance of the Senior Notes in July 1997, and
the CCI Acquisition in September 1997 affect the comparability of the pro
forma data presented to the data for prior periods shown.
(5) Includes operations of Ruffalo, Cody, McLeodUSA Publishing and CCI from
January 1, 1996 to December 31, 1996 and certain adjustments attributable
to the acquisitions of Ruffalo, Cody, McLeodUSA Publishing and CCI by the
Company. Also reflects certain adjustments attributable to the issuance
of the Senior Discount Notes and the Senior Notes computed as if the
Senior Discount Notes and the Senior Notes had been issued on January 1,
1996.
(6) Includes operations of Ruffalo, Cody from July 16, 1996 to September 30,
1996 and operations of McLeodUSA Publishing from September 21, 1996 to
September 30, 1996.
(7) Includes operations of CCI from September 25, 1997 to September 30, 1997.
(8) Reflects the issuance of the Senior Discount Notes on March 4, 1997 and
the Senior Notes on July 21, 1997.
(9) Reflects certain adjustments attributable to the issuance of the Senior
Discount Notes and the Senior Notes computed as if the Senior Discount
Notes and the Senior Notes had been issued on January 1, 1997. Also
reflects certain adjustments attributable to the CCI Acquisition as if it
had been consummated on January 1, 1997.
(10) 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 nine months ended
September 30, 1996 and 1997, earnings were insufficient to cover fixed
charges by $13.6 million and $56.4 million, respectively. On a pro forma
basis computed as if the acquisitions by the Company of Ruffalo, Cody,
McLeodUSA Publishing and CCI the issuance of the Senior Discount Notes
and the Offering were consummated at the beginning of the periods
presented, earnings would not have been sufficient to cover fixed charges
by $50.7 million and $85.4 million for the year ended December 31, 1996
and the nine months ended September 30, 1997, respectively.
(11) Includes MWR, which was acquired by the Company on April 28, 1995.
(12) Includes Ruffalo, Cody and McLeodUSA Publishing, which were acquired by
the Company on July 15, 1996 and September 20, 1996, respectively.
(13) Includes CCI, which was acquired by the Company on September 24, 1997.
(14) 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 (i) the acquisitions of Ruffalo, Cody and McLeodUSA Publishing
by the Company in July 1996 and September 1996, respectively (the
"Acquisitions"), (ii) the CCI Acquisition in September 1997, (iii) the
issuance of the Senior Discount Notes in March 1997 and (iv) the issuance of
the Senior Notes in July 1997. The Unaudited Pro Forma Condensed Consolidated
Statements of Operations reflect the Acquisitions and the CCI Acquisition
using the purchase method of accounting, and assume that the Acquisitions, the
CCI Acquisition, the issuance of the Senior Discount Notes 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, McLeodUSA Publishing and CCI 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 and the CCI Acquisition been
consummated at the beginning of the periods presented, nor is it necessarily
indicative of future operating results or financial position.
41
<PAGE>
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
-----------------------------------------------------------------------------------------------------------
ADJUSTMENTS PRO FORMA
RUFFALO, CODY MCLEODUSA ADJUSTMENTS PRO FORMA FOR FOR
MCLEODUSA & ASSOCIATES, MEDIA FOR FOR SENIOR DISCOUNT SENIOR DISCOUNT
INCORPORATED(1) INC.(2) GROUP, INC.(3) ACQUISITIONS ACQUISITIONS NOTES NOTES
--------------- ------------- -------------- ------------ ------------ --------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS
STATEMENT DATA:
Revenue.......... $ 81,323 $8,891(5) $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(6) 12,756 -- 12,756
Other............ 2,380 -- -- 2,588(8) 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(9) 5,255 (17,520)(10) (12,265)
Other non-
operating income
(expense)........ 495 -- (489) -- 6 -- 6
Income taxes..... -- (182) (1,120) 1,302(12) -- -- --
-------- ------ ------- ------- --------- -------- --------
Net income
(loss)........... $(22,346) 331 $ 1,654 $(2,528) $ (22,889) $(17,520) $(40,409)
======== ====== ======= ======= ========= ======== ========
Loss per common
and common
equivalent
share............ $(0.52) $ (0.53) $ (0.94)
======== ========= ========
Weighted average
common and common
equivalent shares
outstanding...... 43,019 43,214 43,214
======== ========= ========
OTHER FINANCIAL
DATA:
EBITDA(13)....... $(17,345) $ 812 $ 6,107 $ -- $ (10,426) $ -- $(10,426)
<CAPTION>
-----------------------------------------------------------------------
CONSOLIDATED ADJUSTMENTS PRO FORMA ADJUSTMENTS PRO FORMA
COMMUNICATIONS FOR CCI FOR CCI FOR FOR
INC.(4) ACQUISITION ACQUISITION SENIOR NOTES SENIOR NOTES
-------------- ----------- ----------- ------------ ------------
<C> <C> <C> <C> <C>
OPERATIONS
STATEMENT DATA:
Revenue.......... $250,974 $ -- $379,598 $ -- $379,598
-------- -------- -------- -------- --------
Operating
expenses:
Cost of service.. 123,952 -- 195,586 -- 195,586
Selling, general
and
administrative... 79,714 -- 147,130 -- 147,130
Depreciation and
amortization..... 22,517 14,605(7) 49,878 -- 49,878
Other............ -- 7,600(8) 12,568 -- 12,568
-------- -------- -------- -------- --------
Total operating
expenses........ 226,183 22,205 405,162 -- 405,162
-------- -------- -------- -------- --------
Operating income
(loss)........... 24,791 (22,205) (25,564) -- (25,564)
Interest income
(expense), net... (3,779) -- (16,044) (10,539)(11) (26,583)
Other non-
operating income
(expense)........ 2,940 -- 2,946 -- 2,946
Income taxes..... (8,862) 8,862(12) -- -- --
-------- -------- -------- -------- --------
Net income
(loss)........... $ 15,090 $(13,343) $(38,662) $(10,539) $(49,201)
======== ======== ======== ======== ========
Loss per common
and common
equivalent
share............ $ (0.75) $ (0.95)
======== ========
Weighted average
common and common
equivalent shares
outstanding...... 51,703 51,073
======== ========
OTHER FINANCIAL
DATA:
EBITDA(13)....... $ 47,308 $ -- $ 36,882 $ -- $ 36,882
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
-------------------------------------------------------------------------------------------------------------
ADJUSTMENTS PRO FORMA
FOR FOR ADJUSTMENTS PRO FORMA ADJUSTMENTS
SENIOR SENIOR CONSOLIDATED FOR FOR FOR PRO FORMA
MCLEODUSA DISCOUNT DISCOUNT COMMUNI- CCI CCI SENIOR FOR SENIOR
INCORPORATED NOTES NOTES CATIONS INC.(14) ACQUISITION ACQUISITION NOTES NOTES
------------ ----------- --------- ---------------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATIONS
STATEMENT DATA:
Revenue.......... $131,595 $ -- $131,595 $194,305 $ -- $325,900 $ -- $325,900
-------- ------- -------- -------- -------- ------- --------
Operating
expenses:
Cost of service.. 80,680 -- 80,680 100,364 -- 181,044 -- 181,044
Selling, general
and
administrative.. 83,428 -- 83,428 65,063 -- 148,491 -- 148,491
Depreciation and
amortization.... 15,708 -- 15,708 17,913 10,954 (7) 44,575 -- 44,575
Other............ 2,689 -- 2,689 -- 5,618 (8) 8,307 -- 8,307
-------- ------- -------- -------- -------- -------- ------- --------
Total operating
expenses....... 182,505 -- 182,505 183,340 16,572 382,417 -- 382,417
-------- ------- -------- -------- -------- -------- ------- --------
Operating income
(loss).......... (50,910) -- (50,910) 10,965 (16,572) (56,517) -- (56,517)
Interest income
(expense), net.. (2,686) (2,196)(10) (4,882) (2,972) -- (7,854) (5,758)(11) (13,612)
Other non-
operating
income.......... 40 -- 40 1,082 -- 1,122 -- 1,122
Income taxes..... -- -- -- (3,477) 3,477 (12) -- -- --
-------- ------- -------- -------- -------- -------- ------- --------
Net income
(loss).......... $(53,556) $(2,196) $(55,752) $ 5,598 $(13,095) $(63,249) $(5,758) $(69,007)
======== ======= ======== ======== ======== ======== ======= ========
Loss per common
and common
equivalent
share........... $ (1.02) $ (1.06) $ (1.04) $ (1.13)
======== ======== ======== ========
Weighted average
common and
common
equivalent
shares
outstanding..... 52,752 52,752 61,054 61,054
======== ======== ======== ========
OTHER FINANCIAL
DATA:
EBITDA(13)....... $(32,513) $ -- $(32,513) $ 28,878 $ -- $ (3,635) $ -- $ (3,635)
</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 operations of CCI from January 1, 1996 to December 31, 1996.
(5) 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.
(6) 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.
(7) To adjust depreciation and amortization to include amortization of
intangibles acquired in the CCI Acquisition. The intangibles acquired in
the CCI Acquisition will be amortized over periods ranging from 3 to 30
years.
(8) To recognize the costs associated with the directories in progress at the
time of the Company's acquisition of McLeodUSA Publishing and CCI.
(9) 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.
(10) To record the interest expense on the Senior Discount Notes at 10 1/2%
compounded semi-annually, reduced by an estimated annual yield of 5% on
the net proceeds from the issuance of the Senior Discount Notes and
estimated additional interest capitalization of $1,280,000 and $541,000
for the year ended December 31, 1996 and the nine months ended September
30, 1997, respectively.
(11) To record the interest expense on the Senior Notes at 9 1/4% reduced by
an estimated annual yield of approximately 5% on the proceeds for the
issuance of the Senior Notes.
(12) Net income (loss) includes pro forma adjustments for income taxes due to
the availability of net operating loss carryforwards and a valuation
allowance.
(13) 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.
(14) Includes operations of CCI from January 1, 1997 to September 24, 1997.
43
<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 derives its revenue from (i) the sale of "bundled" local and
long distance telecommunications services to end users, (ii)
telecommunications network maintenance services and telephone equipment sales,
service and installation, (iii) private line and data services, (iv) the sale
of advertising space in telephone directories, (v) local exchange services
through the operation of an independent local exchange company, ICTC, acquired
as part of the CCI Acquisition, and (vi) telemarketing services. The Company
began providing local exchange services as a result of the CCI Acquisition in
September 1997, telephone directory advertising as a result of its acquisition
of McLeodUSA Publishing in September 1996, and telemarketing services as a
result of its acquisition of Ruffalo, Cody in July 1996. The table set forth
below summarizes the Company's percentage of revenues from these sources:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
---------------- -------------
1994 1995 1996 1996 1997
---- ---- ---- ------ ------
<S> <C> <C> <C> <C> <C>
Local and long distance
telecommunications services............. 58% 74% 51% 63% 45%
Network maintenance and equipment
services................................ 42 17 7 10 9
Private line and data services........... -- 9 13 18 6
Telephone directory advertising.......... -- -- 19 -- 34
Local exchange services (ICTC)........... -- -- -- -- 1(1)
Telemarketing services................... -- -- 10 9 5
--- --- --- ------ ------
100% 100% 100% 100% 100%
=== === === ====== ======
</TABLE>
- --------
(1) Represents revenues from September 25, 1997 through September 30, 1997.
The Company began offering "bundled" local and long distance services to
business customers in January 1994. At the end of 1995, the Company began
offering, 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 expanded its PrimeLine(R) service to
certain additional cities in Iowa and Illinois and began offering the service
to customers in North Dakota and South Dakota during the first nine months of
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 have been enhanced by its July 1996
acquisition of Ruffalo, Cody, which specializes in direct marketing and
telemarketing services, including telecommunications sales, its September 1996
acquisition of McLeodUSA Publishing, which publishes and distributes
competitive "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, and its September 1997
acquisition of CCI, including its subsidiary CCD, which publishes and
distributes "white page" and "yellow page" telephone directories in 38 states
and the United States Virgin Islands.
In September 1997, the Company completed the CCI Acquisition. CCI's wholly
owned subsidiary ICTC is an independent local exchange carrier serving
approximately 71,400 customers in east central Illinois. CCI's wholly owned
subsidiary CCTS is a competitive local exchange carrier offering integrated
44
<PAGE>
local, long distance and other telecommunications services to over 5,800
customers in central and southern Illinois and in Indiana. CCI's wholly owned
subsidiary CCD publishes and distributes over 3 million competitive annual
"white page" and "yellow page" telephone directories. CCI also operates an
operator service company, an inmate pay-phone company and a full service
telemarketing agency. In addition, CCI owns a majority interest in a cable
television company serving customers in Greene, Sangamon and Menard counties
in Illinois and Benton Harbor, Michigan, and owns a minority interest in a
cellular telephone partnership serving parts of east central Illinois. The
Company believes the CCI Acquisition will allow it to enhance its efforts to
offer its telecommunications services in adjoining target markets including
expansion into Indiana and Missouri, states where CCI currently is providing
telecommunications services.
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. The Iowa
Communications Network is a fiber optic network that links certain of the
State of Iowa's schools, libraries and other public buildings. SG&A consists
of sales and marketing, customer service and 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 local
telecommunications service.
As the Company expands into new markets, both cost of service and SG&A will
increase. The Company expects to incur cost of service and SG&A expenses prior
to achieving significant revenues in new markets. Fixed costs related to
leasing of central office facilities needed to provide telephone services must
be incurred prior to generating revenue in new markets, while significant
levels of marketing activity may be necessary in the new markets in order for
the Company to build a customer base large enough to generate sufficient
revenue to offset such fixed costs and marketing expenses.
In January and February 1996, the Company granted options to purchase an
aggregate of 965,166 and 688,502 shares of its 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. Additionally, in
September 1997, the Company granted options to purchase an aggregate of
1,483,245 shares of its Class A Common Stock at an exercise price of $24.50 to
certain employees of CCI. The fair market value of these options, in the
aggregate, at the date of grant exceeded the aggregate exercise price by
approximately $15.9 million. These amounts are 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.
As a result of the CCI Acquisition, the Company anticipates a reduction in
operating losses and the generation of positive cash flows from operations in
the future. The anticipated financial benefits from the CCI Acquisition are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The financial benefits the Company will
actually derive from the CCI Acquisition may differ materially as a result of
a variety of factors,
45
<PAGE>
including technological, regulatory or other developments in the Company's
business, the difficulty of assimilating CCI's operations and personnel, the
possible inability of management to maximize the financial and strategic
position of the Company through successful incorporation of CCI into the
Company's operations, and the risks of entering markets in which the Company
has little or no direct prior experience. In addition, the projected increases
in capital expenditures will continue to generate negative cash flows from
construction activities during the next several years while the Company
installs and expands its fiber optic network and develops and constructs its
proposed PCS system. The Company may also 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.
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.
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1996
Revenue increased from $45.5 million for the nine months ended September
30, 1996 to $131.6 million for the nine months ended September 30, 1997,
representing an increase of $86.1 million or 189%. Revenue from the sale of
local and long distance telecommunications services accounted for $31.2
million of this increase, including $2.8 million contributed by CCI from
September 25, 1997 to September 30, 1997. In addition, revenues from McLeodUSA
Publishing contributed $45.6 million to the increase. The remaining increase
was primarily due to the acquisitions of Ruffalo, Cody, Digital Communications
(as defined herein) and ESI Communications in July 1996, January 1997 and June
1997, respectively. Excluding the acquisitions of Digital Communications, ESI
Communications and CCI, revenue would have been $121.6 million.
Cost of service increased from $31.7 million for the nine months ended
September 30, 1996 to $80.7 million for the nine months ended September 30,
1997, representing an increase of $49 million or 155%. 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,
McLeodUSA Publishing, Digital Communications, ESI Communications and CCI,
which contributed an aggregate of $23.5 million to the increase. Cost of
service as a percentage of revenue decreased from 70% for the nine months
ended September 30, 1996 to 61% for the nine months ended September 30, 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 72% for the nine months ended
September 30, 1996 to 77% for the nine months ended September 30, 1997,
primarily as a result of increased line costs associated with the Company's
accelerated expansion into new markets.
SG&A increased from $25.6 million for the nine months ended September 30,
1996 to $83.4 million for the nine months ended September 30, 1997, an
increase of $57.8 million or 226%. The acquisitions of Ruffalo, Cody,
McLeodUSA Publishing, Digital Communications, ESI Communications and CCI
contributed an aggregate of $27.6 million to the increase. Also contributing
to this increase were increased costs of $30.2 million primarily related to
expansion of selling, customer support and administration activities to
support the Company's growth.
Depreciation and amortization expenses increased from $4.7 million for the
nine months ended September 30, 1996 to $15.7 million for the nine months
ended September 30, 1997, representing an increase of $11 million or 231%. The
increase consisted of $4.7 million related to the acquisitions of Ruffalo,
Cody, McLeodUSA Publishing, Digital Communications, ESI Communications and
CCI, and $6.3 million due primarily to the growth of the Company's network.
46
<PAGE>
Other operating expenses represented the realization of a purchase
accounting adjustment related to the capitalization of costs associated with
CCD directories in progress at the time the Company acquired CCI.
Interest income increased from $3.4 million for the nine-month period ended
September 30, 1996 to $18.1 million for the same period in 1997. This increase
resulted from increased earnings on investments made with a portion of the
proceeds from the Company's offerings of Class A Common Stock in June and
November 1996 and from the private offerings of the Senior Discount Notes and
the Senior Notes in March 1997 and July 1997, respectively.
Gross interest expense increased from $748,000 for the first nine months of
1996 to $23.6 million for the first nine months of 1997. This increase was
primarily a result of accretion of interest on the Senior Discount Exchange
Notes of $18.3 million and accrual of interest on the Senior Notes of $4.3
million. Interest expense of approximately $2.9 million and $204,000 was
capitalized as part of the Company's construction of fiber optic network
during the first nine months of 1997 and 1996, respectively.
Net loss increased from $13.4 million for the nine months ended September
30, 1996 to $53.6 million for the nine months ended September 30, 1997, an
increase of $40.2 million. This increase resulted primarily from the expansion
of the Company's local and long distance telecommunications services and costs
related to the Company's acquisitions. 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.
47
<PAGE>
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.
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 repayment 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.
48
<PAGE>
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.
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
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.
49
<PAGE>
Depreciation and amortization expenses increased from $235,000 in 1993 to
$772,000 in 1994, an increase of $537,000 or 228%. This increase was primarily
due to depreciation on the increased capital expenditures required to enter
the local and long distance businesses and the amortization of one time
installation costs associated with transferring customers' local line service
from the Regional Bell Operating Companies to the Company's telemanagement
service.
Interest income in 1993 was $163,000 compared to net interest expense of
$73,000 in 1994. The decrease resulted from an increase in interest expense of
$218,000 due to the need for additional secured debt in 1994 to fund the
Company's growth and operating losses and a decrease in interest income of
$18,000 resulting from reduced investment of funds due to the use of funds
needed to satisfy the Company's working capital needs.
The Company's net loss increased from $2.4 million in 1993 to $11.4 million
in 1994, an increase of $9 million. This increase was primarily due to the
Company's entry into the local and long distance businesses.
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
The Company's total assets increased from $453 million at December 31, 1996
to $1.4 billion at September 30, 1997, primarily due to the net proceeds of
approximately $508 million from the Company's private offerings of the Senior
Discount Notes and Senior Notes in March 1997 and July 1997, respectively, and
the acquisition of CCI in September 1997. At September 30, 1997, the Company's
current assets of $574.1 million exceeded its current liabilities of $141.2
million, providing working capital of $432.9 million, which represents an
increase of $246.9 million compared to December 31, 1996 primarily
attributable to the net proceeds from the Senior Discount Notes and the Senior
Notes. At December 31, 1996, the Company's current assets of $224.4 million
exceeded current liabilities of $38.4 million, providing working capital of
$186 million.
Net cash used in operating activities totaled $16.5 million for the nine
months ended September 30, 1997 and $10.5 million for the nine months ended
September 30, 1996. During the nine months ended September 30, 1997, cash for
operating activities was used primarily to fund the Company's net loss of
$53.6 million for such period. The Company also required cash to fund the
growth in accounts receivable and deferred line installation costs of $13.5
million and $6.7 million, respectively, as a result of the expansion of the
Company's local and long distance telecommunications services. During the nine
months ended September 30, 1996, cash for operating activities was used
primarily to fund the Company's net loss of $13.4 million for such period. The
Company also required cash to fund the growth in trade receivables and other
assets of $6.6 million and $2.7 million, respectively, offset by an increase
in accounts payable and accrued expenses of $4 million.
Net cash used in investing activities totaled $245.9 million during the nine
months ended September 30, 1997 and $208.4 million during the nine months
ended September 30, 1996. The expansion of the Company's local and long
distance telecommunications services, development and construction of the
Company's fiber optic telecommunications networks and other capital
expenditures resulted in purchases of equipment and fiber optic cable and
other property and equipment totaling $104.1 million and $39.7 million during
the nine months ended September 30, 1997 and 1996, respectively.
In April and June 1997, the FCC granted the Company 26 "D" and "E" block
frequency PCS licenses and in September 1997 the Company acquired the CCI PCS
License, giving the Company 27 PCS licenses in a total of 25 markets covering
areas of Iowa, Illinois, Minnesota, Nebraska and South
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Dakota. The Company paid the FCC an aggregate of approximately $32.8 million
for the 26 PCS licenses granted to the Company by the FCC in April and June
1997. The Company made a deposit of $4.8 million with the FCC at the beginning
of the bidding process in 1996 and paid approximately $28 million during the
nine months ended September 30, 1997 for the 26 PSC licenses. CCI paid the FCC
for the CCI PCS License prior to the CCI Acquisition. The Company will be
required to make significant additional expenditures to develop, construct and
operate a PCS system.
The Company used cash of $23.5 million to acquire Digital Communications and
ESI Communications in January 1997 and June 1997, respectively, and certain
telephone directories published by Fronteer (as defined herein), Indiana
Directories, Inc. and Smart Pages (as defined herein) in February 1997, March
1997 and September 1997, respectively.
On September 24, 1997, the Company issued 8,488,586 shares of Class A Common
Stock and paid approximately $155 million in cash to the shareholders of CCI
in exchange for all of the outstanding shares of CCI in a transaction
accounted for using the purchase method of accounting. The total purchase
price was approximately $381.8 million based on the average price of Company's
Class A Common Stock five days before and after the date of the Merger
Agreement. The total purchase price includes approximately $3.2 million of
estimated direct acquisition costs.
These uses of cash for investing activities during the nine months ended
September 30, 1997 were partially offset by net proceeds of $67.5 million from
the sales and maturities of available-for-sale securities.
Net cash received from financing activities was $502 million during the nine
months ended September 30, 1997, primarily as a result of the Company's
private offerings of the Senior Discount Notes in March 1997 and the Senior
Notes in July 1997. Cash received from financing activities during the nine
months ended September 30, 1996 was $257.6 million and was primarily obtained
from the Company's initial public offering of Class A Common Stock in June
1996. The Company paid off and canceled the Credit Facility with a portion of
the proceeds from its initial public offering.
On March 4, 1997, the Company completed a private offering of the Senior
Discount Notes. The Senior Discount Notes were issued at an original issue
discount in which the Company received approximately $289.6 million in net
proceeds. The Company filed a registration statement with the Commission on
May 22, 1997 for the registration of the Senior Discount Exchange Notes
offered in exchange for the Senior Discount Notes. The registration statement
was declared effective by the Commission on July 28, 1997 and the Senior
Discount Note Exchange Offer was commenced. The Senior Discount Note Exchange
Offer expired on August 24, 1997, and all of the Senior Discount Notes were
exchanged for the Senior Discount Exchange Notes. The form and terms of the
Senior Discount Exchange Notes are identical in all material respects to the
form and terms of the Senior Discount Notes except that (i) the Senior
Discount Exchange Notes have been registered under the Securities Act and (ii)
holders of the Senior Discount Exchange Notes are not entitled to certain
rights under a registration agreement relating to the Senior Discount Notes.
The Senior Discount Exchange Notes will accrete to an aggregate principal
amount of $500 million by March 1, 2002. Interest will not accrue on the
Senior Discount Exchange Notes prior to March 1, 2002. Thereafter, interest
will accrue at a rate of 10 1/2% per annum and will be payable in cash semi-
annually in arrears on March 1 and September 1 of each year, commencing
September 1, 2002. The Senior Discount 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 105.25% of their principal amount at maturity, plus accrued and
unpaid interest, declining to 100% of their principal amount at maturity, plus
accrued and unpaid interest, on or after March 1, 2005. In the event of
certain equity investments in the Company by certain strategic investors on or
before March 1, 2000, the Company may, at its option, use all or a portion of
the net proceeds therefrom to redeem up to a maximum of 33 1/3% of the
original principal amount of the Senior Discount Exchange Notes at a
redemption price of 110.5% of the accreted value thereof. In addition, in the
event of a Change of Control (as defined in
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the Senior Discount Note Indenture) of the Company, each holder of Senior
Discount Exchange Notes will have the right to require the Company to
repurchase all or any part of such holder's Senior Discount Exchange Notes at
a purchase 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. The Senior Discount Exchange
Notes will mature on March 1, 2007.
The Senior Discount Exchange Notes are senior unsecured obligations of the
Company ranking pari passu in right of payment with all other existing and
future senior unsecured obligations of the Company and rank senior to all
other existing and future subordinated debt of the Company. The Senior
Discount Exchange Notes are effectively subordinated to all existing and
future secured indebtedness of the Company and its subsidiaries to the extent
of the value of the assets securing such indebtedness. The Senior Discount
Exchange Notes also are effectively subordinated to all existing and future
third-party indebtedness and other liabilities of the Company's subsidiaries.
On July 21, 1997, the Company completed a private offering of the Senior
Notes in which the Company received net proceeds of approximately $218.5
million. Interest on the Senior Notes accrues at the rate of 9 1/4% per annum
and will be payable in cash semi-annually in arrears on July 15 and January
15, commencing January 15, 1998. The Senior Notes rank pari passu in right of
payment with all 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 September 30, 1997, the
Company had no outstanding subordinated indebtedness and, other than the
Senior Discount Exchange Notes, had no outstanding indebtedness that would
rank pari passu with the Senior Notes. The Senior Notes will mature on July
15, 2007. The Senior Notes have not been registered under the Securities Act
and therefore cannot 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. The Company has filed a
registration statement with the Commission for the registration of $225
million aggregate principal amount of Exchange Notes to be offered in exchange
for the Senior 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 have been registered under the Securities Act and (ii)
holders of the Exchange Notes will not be entitled to certain rights under the
Registration Agreement. As of September 30, 1997, the Exchange Offer had not
been commenced. The Notes will be redeemable at the option of the Company, in
whole or in part, at any time on or after July 15, 2002 at 104.625% of their
principal amount at maturity, plus accrued and unpaid interest, declining to
103.083% of their principal amount at maturity, plus accrued and unpaid
interest, on or after July 15, 2003, declining to 101.542% of their principal
amount at maturity, plus accrued and unpaid interest, on or after July 15,
2004, and declining to 100.000% of their principal amount at maturity, plus
accrued and unpaid interest, on or after July 15, 2005. In the event of
certain equity investments in the Company by certain strategic investors on or
before July 15, 2000, the Company may, at its option, use all or a portion of
the net proceeds from such sale to redeem up to 33 1/3% of the original
principal amount of the Notes at a redemption price equal to 109.25% of the
principal amount of the Notes plus accrued and unpaid interest thereon, if
any, to but excluding the redemption date, provided that at least 66 2/3% of
the original principal amount of the Notes would remain outstanding
immediately after giving effect to such redemption. In addition, in the event
of a Change of Control (as defined in the Senior Note Indenture) of the
Company, each holder of Notes shall have the right to require the Company to
repurchase all or any part of such holder's Notes at a purchase price equal to
101% of the principal amount of the Notes tendered by such holder plus accrued
and unpaid interest, if any, to any Change of Control Payment Date (as defined
in the Senior Note Indenture).
The Senior Discount Note Indenture and the Senior Note Indenture impose
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
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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" and "Description of Other Indebtedness." 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 interests of the Company.
As of September 30, 1997, the Company estimates that its aggregate capital
requirements for the remainder of 1997, 1998 and 1999 will be approximately
$404 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) developing, constructing and operating
a PCS system and (iv) completing construction of its new corporate
headquarters and associated buildings. These capital requirements are expected
to be funded, in large part, out of the approximately $218.5 million in net
proceeds from the Offering, approximately $174 million in net proceeds
remaining from the Company's March 1997 private offering of the Senior
Discount Notes, 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.
The Company's estimate of its future capital requirements is a "forward-
looking statement" within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. The Company's actual capital
requirements may differ materially as a result of regulatory, technological
and competitive developments (including new opportunities) in the Company's
industry.
The Company expects to meet its additional capital needs with the proceeds
from credit facilities and other borrowings, and additional debt and equity
issuances. The Company currently plans to obtain one or more lines of credit,
although no such lines of credit have yet been negotiated. There can be no
assurance, however, that the Company will be successful in producing
sufficient cash flows or raising sufficient debt or equity capital to meet its
strategic objectives or that such funds, if available at all, will be
available on a timely basis or on terms that are acceptable to the Company.
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 "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 ending after December 15, 1997. The
Company will adopt the statements effective December 31, 1997 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 in Iowa, Illinois, North Dakota, South Dakota,
Minnesota, Wisconsin, Indiana, Colorado and Wyoming and to residential
customers in Iowa, Illinois, North Dakota and South Dakota. 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 and telephone equipment sales,
service and installation, (iii) private line and data services, (iv) the sale
of advertising space in telephone directories, (v) local exchange services
through the operation of an independent local exchange company, ICTC, acquired
as part of the CCI Acquisition, and (vi) telemarketing services. As of
September 30, 1997, the Company served over 200,800 telecommunications
customers in 214 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 offers a variety of private line and data services to
large businesses, institutional customers and interexchange carriers. The
Company also sells, installs and services telephone equipment, primarily to
business customers in Iowa and Minnesota, and provides network maintenance
services for the State of Iowa's fiber optic network. In addition, the Company
annually publishes over 12 million competitive "white page" and "yellow page"
telephone directories in 19 states.
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. The Company is organized as a
holding company and operates primarily through wholly owned subsidiaries.
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. On September 24, 1997, the
Company acquired CCI, which offers a variety of communications services
including local exchange services and "white page" and "yellow page" telephone
directory publishing.
As of the date hereof, the Company is offering integrated telecommunications
services to business and residential customers in Iowa, Illinois, North Dakota
and South Dakota. The Company has recently begun sales of integrated
telecommunications services to business customers in a number of markets in
Minnesota, Wisconsin, Indiana, Colorado and Wyoming. Over the next several
years, depending on competitive and other factors, the Company also intends to
offer integrated telecommunications services in Idaho, Missouri, Montana,
Nebraska and Utah. The Company also offers long distance service in 48 states
in the continental United States.
In April and June 1997, the FCC granted the Company a total of 26 "D" and
"E" block frequency PCS licenses and in September 1997 the Company acquired
the CCI PCS License, giving the Company 27 PCS licenses in a total of 25
markets covering areas of Iowa, Illinois, Minnesota, Nebraska
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and South Dakota. The Company paid the FCC approximately $32.8 million for the
26 PCS licenses granted to the Company by the FCC in April and June 1997. CCI
paid the FCC for the CCI PCS License prior to the CCI Acquisition. The
Company's PCS licenses encompass approximately 110,000 square miles and a
population of approximately 6.9 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."
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 July 21, 1997, the FCC granted licenses to the Company 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 intends to use the frequency
blocks covered by the licenses to provide certain fixed services, such as
wireless local loop, Internet access or meter reading.
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. In areas other than those served by ICTC
(which operates its own lines and switches), the Company provides local
service using existing telephone lines and switches or unbundled network
elements (lines only) 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 long distance carriers or, in
central Illinios, by using its inter-city fiber optic network. Using the
Company's sophisticated proprietary software, known as Raterizer(R), most
business customers subscribing to the Company's integrated telecommunications
services receive 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. In ICTC's
sevice area, which includes 37 central office exchanges in east central
Illinois, local and long distance service is offered using facilities owned by
ICTC. The Company is currently constructing fiber optic networks in both Iowa
and Illinois to carry additional telecommunications services traffic on its
own network.
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 Iowa, Illinois, North Dakota
and South Dakota 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) in July 1996, the Company acquired Ruffalo,
Cody, which specializes in direct
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marketing and telemarketing services, to enhance the Company's marketing of
its telecommunications services; (iii) in September 1996, the Company acquired
McLeodUSA Publishing, which publishes and distributes competitive "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; (iv) the Company has constructed approximately 3,100 new route miles
of fiber optic network at a cost of approximately $66.9 million; (v) in May,
July and September 1997, the Company acquired a total of 27 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 September
1997, the Company acquired CCI, which offers a variety of communications
products and services including local exchange and long distance services and
"white page" and "yellow page" telephone directory publishing. See "--Recent
Transactions."
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 February 25, 1997, McLeodUSA Publishing acquired six telephone
directories published by Fronteer Financial Holdings, Inc. ("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 of Iowa,
Inc. ("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.
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On March 31, 1997, McLeodUSA Publishing acquired 26 telephone directories
published by Indiana Directories, Inc. at a purchase price of approximately
$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 September 22, 1997, McLeodUSA Publishing acquired two telephone
directories published by Smart Pages, Inc. and Yellow Pages Publishers, Inc.
(collectively, "Smart Pages") at a purchase price to be determined based on
the sum of the revenues derived from the last Smart Pages editions of the
directories. The purchase price is currently estimated to be approximately $2
million.
On September 24, 1997, the Company acquired CCI pursuant to the Merger
Agreement. As consideration for the acquisition, the Company issued an
aggregate of 8,488,596 shares of Class A Common Stock and paid approximately
$155 million in cash to the shareholders of CCI. CCI is a diversified
telecommunications holding company that as of September 30, 1997 served
telecommunications customers in 45 cities and towns, primarily in Illinois.
CCI's wholly owned subsidiary ICTC is an independent local exchange carrier
with 37 central office exchanges in east central Illinois serving over 89,000
access lines as of the date of this Prospectus. As a local exchange carrier,
ICTC is subject to rate of return regulation and certain provisions of the
Telecommunications Act to which the Company is not currently subject. CCI's
wholly owned subsidiary CCTS is a competitive local exchange carrier offering
integrated local, long distance and other telecommunications services in
central and southern Illinois and in Indiana. CCI's wholly owned subsidiary
CCD publishes and distributes annual "white page" and "yellow page" telephone
directories in 38 states and the United States Virgin Islands. CCI also
operates an operator service company, an inmate pay-phone company and a full
service telemarketing agency. In addition, CCI owns a majority interest in a
cable television company serving customers in Greene, Sangamon and Menard
counties in Illinois and Benton Harbor, Michigan, and owns minority interest
in a cellular telephone partnership serving parts of east central Illinois.
On September 25, 1997, and pursuant to the terms of the Merger Agreement,
Richard A. Lumpkin, the Chairman and Chief Executive Officer of CCI, and
Robert J. Currey, the President and Chief Operating Officer of CCI, were
elected directors of the Company and joined the Company's executive management
team. Mr. Lumpkin, certain members of his family and trusts for the benefit
thereof own approximately 13.8% of the shares of Class A Common Stock
outstanding as of October 31, 1997.
The Company believes that the business strategy of CCI is closely aligned
with that of the Company. The Company believes it can successfully leverage
the integrated local, long distance and other telecommunications services
offered by CCI to enhance the Company's efforts to offer similar services in
adjoining target markets. The combined competitive local exchange sales force
of CCI and the Company is approximately 560 persons as of the date of this
Prospectus. In addition, CCI currently owns approximately 900 route miles of
fiber optic network and three local and two long distance switches in eastern
and southern Illinois, St. Louis, Missouri and Indianapolis, Indiana, reducing
the Company's need to construct network and install switches in those regions.
Both CCI and the Company have focused, and intend to continue to focus, on
second and third tier cities in the Midwest. The Company believes that the CCI
Acquisition creates the first super-regional competitive local exchange
carrier, with six switches over 244,000 lines, 4,600 route miles of fiber
optic network and 4,600 employees.
The Company also believes that CCI's competitive "white page" and "yellow
page" telephone directory publishing operations can be successfully integrated
into the Company's telephone directory advertising and distribution activities
in nineteen states in the midwestern and Rocky Mountain regions
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of the United States. The Company currently publishes over 12 million
competitive telephone directories annually, including the over 3 million
competitive telephone directories published annually by CCI. The directory
sales force of the Company subsequent to the CCI Acquisition is approximately
610 persons as of the date of this Prospectus. The Company intends to use
CCI's competitive telephone directories together with its own directories to
help increase brand awareness of its telecommunications products.
The Company believes that the extensive experience of CCI's management and
employees in offering local services, and in interconnecting CCI's networks
with Ameritech in Champaign-Urbana, Decatur, Peoria, Bloomington, Fairview
Heights, and Springfield, Illinois, enhances the Company's ability to more
expeditiously enter the local service market through interconnection with the
incumbent Regional Bell Operating Company. The Company believes that
successful interconnection arrangements will be accompanied by concomitant
cost savings. In addition, the Company believes that the CCI Acquisition
enables the Company to more easily access capital markets at lower rates,
thereby strengthening the Company's competitive position in its target
markets.
The Company's beliefs as to the benefits to be derived from the CCI
Acquisition are "forward-looking statements" within the meaning of the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. The
benefits the Company will actually derive from the CCI Acquisition may differ
materially as a result of the difficulty of assimilating CCI's operations and
personnel, the possible inability of management to maximize the financial and
strategic position of the Company through the successful incorporation of CCI
into the Company's operations, particularly in view of the size and complexity
of CCI's operations, and the risks of entering markets in which the Company
has little or no direct prior experience. See "Risk Factors--Risks Associated
with Acquisitions".
The Company, including CCI, is involved in various ordinary routine legal
proceedings incidental to its business. See "--Legal Proceedings".
BUSINESS STRATEGY
The Company's objective is to become a leading provider of integrated
wireline and wireless telecommunications services in Iowa, Illinois, North
Dakota, South Dakota, Minnesota, Wisconsin, Indiana, Colorado, Missouri,
Montana, Idaho, Nebraska, Utah and Wyoming. 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
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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 17.3 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 and Illinois. As part of the CCI Acquisition, the
Company acquired approximately 900 route miles of fiber optic network in
central Illinois. 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 continue to 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 or rights-of-way (e.g., utilities, railroad
companies and cable operators). As of September 30, 1997, the Company
owned approximately 4,600 route miles of fiber optic network and,
subject to the foregoing factors, expects to construct approximately
5,800 additional route miles of fiber optic network during the next
three years. Through its strategic relationships with its electric
utility stockholders and other owners of infrastructure and rights-of-
way, 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 has achieved
and will be able to continue 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 creates an attractive
customer-focused platform for the provision of local, long distance,
wireless and enhanced services.
. TRANSITION INTO LOCAL SWITCHED SERVICES BUSINESS. Through a subsidiary
of CCI, the Company has two interconnection agreements with Ameritech
under which the Company provides facilities-based switched services to
over 8,000 local lines in central Illinois and in Indiana. When certain
judicial and regulatory proceedings are resolved, and assuming the
economics are favorable to the Company, the Company intends to begin
offering additional facilities-based switched services in other markets
by using its six existing high capacity digital switches 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 vacated by July and October 1997 court decisions and
may be subject to further judicial and regulatory proceedings. Although
these court decisions do not prevent the Company from negotiating
interconnection agreements, they do create uncertainty about the rules
governing pricing, terms and conditions of interconnection agreements.
If the Company can negotiate favorable interconnection agreements, and
subject to court and regulatory proceedings necessary to implement such
agreements, the Company believes that it could
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begin offering additional local facilities-based switched services in
other markets over the next three years. The Company has received state
regulatory approval in Iowa, Illinois, Indiana and Wisconsin to offer
local facilities-based switched services in all areas serviced by U S
WEST in Iowa and in certain cities in Illinois, Indiana and Wisconsin.
The Company intends to seek regulatory approval to provide such services
in other markets targeted by the Company when the economic terms of
interconnection with the incumbent local exchange carrier make the
provision of local facilities-based switched services cost-effective.
. EXPLORE POTENTIAL ACQUISITIONS AND STRATEGIC ALLIANCES. The Company
believes that its strategic alliances with two utilities in its Iowa
markets, one utility in Wisconsin and one utility and one railroad in
Illinois provide it with access to rights-of-way and other resources on
favorable terms. The Company believes that its acquisitions of Ruffalo,
Cody, McLeodUSA Publishing and CCI will increase the Company's
penetration of its current markets and accelerate its entry into new
markets. As part of its expansion strategy, the Company contemplates
additional acquisitions, joint ventures and strategic alliances with
businesses that are related or complementary to its current operations.
The Company believes that the addition of such related or complementary
businesses will help it to continue 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 eleven 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 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, 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
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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. CCI
is currently serving over 8,000 local lines through use of such "loop"
facilities. 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 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
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(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 or competitive local exchange carriers 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 interconnection agreements and guidelines
for review of such agreements by state public utilities commissions. In July
and October 1997, the U.S. Eighth Circuit Court of Appeals decided that the
FCC had exceeded its jurisdiction and vacated several provisions of the
Interconnection Decision, including provisions regarding pricing, provisions
permitting carriers to "pick and choose" among individual provisions of
arbitrated interconnection agreements, and certain provisions relating to the
purchase of unbundled access elements. The Interconnection Decision may be
subject to further judicial, regulatory and legislative proceedings. Although
these decisions do not prevent the Company from negotiating interconnection
agreements, as CCI has done with Ameritech in Illinois and Indiana, they do
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
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proceedings necessary to implement such agreements, the Company believes that
it could begin offering local facilities-based switched services in markets
outside of the markets in central Illinois and Indiana in which the Company
currently provides such services through a subsidiary of CCI.
As of September 30, 1997, a number of states, including Iowa, Illinois,
Minnesota, Wisconsin, Indiana 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 44 million as of
December 31, 1996, with a compound annual growth rate in excess of 50% from
1990 through 1996. Wireless communication revenues for the 12-month period
ended December 31, 1996 are estimated by CTIA to have totaled over $23.6
billion, a 24% 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 its telecommunications revenue from: (i) the sale of
"bundled" local, long distance and other telecommunications services to end
users, (ii) telecommunications network maintenance services and telephone
equipment sales, service and installation, (iii) private line and data
services, (iv) the sale of advertising space in telephone directories, (v)
local exchange services through the operation of an independent local exchange
company, ICTC, acquired as part of the CCI Acquisition, and (vi) telemarketing
services. For the nine months ended September 30, 1997, these services
represented 45%, 9%, 6%, 34%, 1% (representing ICTC's revenues from September
25, 1997 through September 30, 1997) and 5%, 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 September 30, 1997, the
Company was providing service, on a retail basis, to approximately 244,000
lines in its markets, primarily to small and medium-sized business customers
and to residential 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 for the year ended December
31, 1996. In order to provide integrated telecommunications services to most
of its business and residential customers, the Company, pursuant to agreements
with U S WEST for its customers located in U S WEST's service territories and
Ameritech for most of its customers located in Ameritech's service
territories, partitions part of the central office switches serving
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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 North Dakota, South Dakota, Minnesota, Colorado, and Wyoming from U S WEST
on a month-to-month basis. In September 1997, the Company exercised its right
to opt into an existing interconnection agreement with U S WEST that will
govern interconnection between the Company and U S WEST in Iowa. The agreement
was filed for approval with the Iowa Utilities Board on October 14, 1997 and
must be approved or rejected by January 12, 1998. Upon approval by the Iowa
Utilities Board, the Company will be entitled to purchase Centrex Plus service
(and other services) from U S WEST in Iowa at a wholesale discount retroactive
to September 8, 1997. In October 1997, the Company exercised its right to opt
into an existing interconnection agreement with U S WEST that will govern
interconnection between the Company and U S WEST in Minnesota. The agreement
was filed for approval with the Minnesota Public Utilities Commission on
October 24, 1997 and must be approved or rejected by January 22, 1998. Upon
approval by the Minnesota Public Utilities Commission, the Company will be
entitled to purchase Centrex service (and other services) from U S WEST in
Minnesota at a wholesale discount from retail prices.
The Company has five-year Centrex agreements with Ameritech that extend
through 2002 in Illinois and in Wisconsin, and has seven-year Centrex
agreements with Ameritech that extend through 2000 in Indiana. These
agreements provide for stabilized rates that may not be unilaterally increased
by Ameritech. In June 1997, the Company and Ameritech signed resale agreements
providing for wholesale rates for the services purchased by the Company from
Ameritech in Illinois and Wisconsin. These agreements have been approved by
the Illinois Commerce Commission and the Wisconsin Public Service Commission,
respectively.
In addition, in order to provide integrated telecommunications services to
some of its business and residential customers in central Illinois, the
Company, through a subsidiary of CCI, purchases unbundled "loop" elements
pursuant to an agreement with Ameritech and uses its own switching and network
facilities. In October 1996 and July 1997, CCI entered into interconnection
agreements with Ameritech which enable it to provide local service using
unbundled "loops" in Illinois and Indiana, respectively.
The Company provides long distance service by purchasing capacity, in bulk,
from national interexchange carriers, including WorldCom Network Services,
Inc., d/b/a WilTel ("WilTel"), a wholly owned subsidiary of WorldCom, and
routing its customers' long distance traffic over this
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capacity. In CCI service areas, some long distance traffic is carried on CCI's
own network facilities. 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.
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 most 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.
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.
Business customers served by CCI are on different long distance rate plans.
It is the Company's intention to transition these customers to the Company's
"lowest cost" rate plan. 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 additional cities and towns in Iowa and to certain
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cities and towns in Illinois, North Dakota and South Dakota. 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
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.
LOCAL EXCHANGE SERVICES. Through ICTC, the Company provides regulated local
exchange telephone service to subscribers in central Illinois. ICTC operates
in 37 "exchanges," or service areas, the largest of which are in Mattoon,
Charleston, and Effingham, Illinois. ICTC has over 89,000 local access lines
in its existing service areas and offers a broad range of local exchange
services, including interexchange carrier access service, intraLATA toll
service, local telephone service, local paging service, directory assistance,
and equipment leasing. Local telephone service consists of furnishing a "dial
tone" to local subscribers, at which time subscribers can make a local call or
a long distance call. ICTC also offers most of its local telephone subscribers
"custom calling features" such as call waiting, call forwarding, conference
calling, speed dialing, caller identification, and call blocking. The rates
for these and certain other local exchange services are regulated by the ICC
and the FCC.
To provide these services, ICTC owns and operates three central office
switches, and 34 remote switches.
SPECIAL ACCESS, PRIVATE LINE AND DATA SERVICES. The Company provides, on a
private carrier basis, a wide range of special access, private line and data
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.
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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 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 and CCD, the Company publishes
and distributes over 12 million annual competitive "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. CCD published over 3 million competitive telephone directories
annually prior to the CCI Acquisition. CCD also publishes approximately 4
million annual utility directories.
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 and CCD's combined sales force of 613 direct sales personnel and
telemarketers as of September 30, 1997 to sell both advertising space in the
Company's telephone directories and, where available, the Company's
telecommunications services. Furthermore, all of the
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Company's 181 full-time telemarketing sales personnel at its Ruffalo, Cody
subsidiary as of September 30, 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 and medium sized businesses in Iowa through Digital Communications,
which the Company acquired in January 1997, and in Minnesota through ESI, the
assets of which the Company acquired in June 1997. The Company believes these
services will provide valuable expertise for and complement its
telecommunications services offerings.
EXPANSION OF CERTAIN FACILITIES-BASED SERVICES
The Company, through its CCI subsidiaries, is currently offering facilities-
based service to over 8,000 local lines located in Champaign-Urbana, Decatur,
Peoria, Bloomington, Fairview Heights, and Springfield, Illinois pursuant to
an interconnection agreement with Ameritech and through use of approximately
900 miles of fiber optic network facilities owned by the Company. The Company
is constructing a fiber optic network that will enable it, when certain
judicial and regulatory proceedings are resolved, to serve additional end-user
customers on a local switched basis as well as to serve other wireline and
wireless carriers on a wholesale basis.
In March 1995 and November 1997, the Company received state regulatory
approval in Iowa to provide competitive switched local telephone service to
business and residential customers in Cedar Rapids, Iowa and in all other U S
WEST service territories in Iowa, respectively. In April 1997, the Company
received similar approval to offer such services in all areas of Wisconsin
served by Ameritech. The Company has also received approval to offer
facilities-based local service in certain cities in Illinois and Indiana. 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 July and October 1997, the U.S. Eighth
Circuit Court of Appeals vacated portions of the Interconnection Decision,
including provisions establishing a pricing methodology and a procedure
permitting new entrants to "pick and choose" among various provisions of
existing interconnection agreements. Although these decisions do not prevent
the Company from negotiating interconnection agreements with local exchange
carriers, they do create uncertainty about the rules governing pricing, terms
and conditions of interconnection agreements, and could make negotiating such
agreements more difficult and protracted. There can be no assurance that the
Company will be able to obtain interconnection agreements on terms acceptable
to the Company.
In addition to providing facilities based service in Champaign-Urbana,
Decatur, Peoria, Bloomington, Fairview Heights, and Springfield, Illinois, the
Company also intends 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
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more convenient and functional and wireless services become more diverse. The
Company also believes that wireline and wireless markets are converging, and
that providers of wireless services increasingly will offer, in addition to
products that supplement a customer's 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.
In April and June 1997, the FCC granted the Company a total of 26 "D" and
"E" block frequency PCS licenses and in September 1997 the Company acquired
the CCI PCS License, giving the Company 27 PCS licenses in a total of 25
markets covering areas of Illinois, Iowa, Minnesota, Nebraska and South
Dakota. The Company paid the FCC approximately $32.8 million for the 26 PCS
licenses granted to the Company by the FCC in April and June 1997. CCI paid
the FCC for the CCI PCS License prior to the CCI Aquisition. The Company's PCS
licenses encompass approximately 110,000 square miles and a population of
approximately 6.9 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.
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
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preparation, and installation services. The Company expects to begin selecting
and acquiring sites for transmitters by the end of 1998. 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, Illinois Power and
Illinois Central Railroad, 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 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
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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, Minnesota, Des Moines-Quad Cities,
Iowa/Illinois and Omaha, Nebraska. The Company filed an application for such
licenses on May 12, 1997 and the licenses were issued by the FCC on July 21,
1997. The Company expects to use the frequency blocks covered by such licenses
to provide certain fixed services, such as wireless local loop, Internet
access or meter reading.
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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 the upper Midwest.
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.
In September 1997, as a result of the CCI Acquisition, the Company acquired
approximately 900 route miles of fiber optic network facilities, parts of
which are currently connected to Ameritech unbundled loops pursuant to an
interconnection agreement. The Company believes that CCI's prior
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success in serving over 8,000 end user local lines under the interconnection
agreement will substantially assist the Company's technical abilities in
interconnection to the unbundled loops of incumbent local exchange carriers.
The Company has reached agreements with its electric utility stockholders
(MidAmerican and IES) and with Wisconsin Power and Light Company, Illinois
Power and Illinois Central Railroad that allow the Company to make use of
those companies' rights-of-way, 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 certain parts of Iowa, 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 and other companies that own rights-of-way and
infrastructure 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 and in east central and southern Illinois. Thus, the Company
believes it is well positioned to become the first facilities-based state-wide
integrated provider of competitive telecommunications services in the upper
Midwest.
As of September 30, 1997, the Company owned approximately 4,600 route miles
of fiber optic network and expects to construct approximately 5,800 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 September 30, 1997, marketing of the Company's integrated
telecommunications services to business customers was conducted by 359 direct
sales personnel, located at the Company's headquarters in Cedar Rapids, Iowa
and in 60 branch sales offices in Iowa, Illinois, North Dakota, South Dakota,
Minnesota, Wisconsin, Indiana, Colorado and Wyoming. The sales personnel make
direct calls to prospective and existing business customers, conduct analyses
of business customers'
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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 September 30, 1997 by 181 full-time
and 28 part-time telemarketers from the Company's Ruffalo, Cody subsidiary.
The Company plans to increase this number in the future. The telemarketers
emphasize the PrimeLine(R) integrated package of telecommunications services
and its flat-rated per minute pricing structure for long distance service. The
Company 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 and CCI in September 1997 enhances 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
(such as Indiana, 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 Idaho, Missouri, Montana and Utah). Second, the Company
believes that these acquisitions increase the Company's penetration of current
markets and accelerate its entry into new markets. The telephone directories
published and distributed by McLeodUSA Publishing and CCD serve as "direct
mail" advertising for the Company's telecommunications products. The
directories contain or 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 or CCD directory. By using the directories to market its products,
the Company can reach more customers than would be possible if these
acquisitions had not occurred. Third, the Company believes that combining the
McLeodUSA Publishing directories' distinctive black-and-yellow motif with the
trade name wMcLeodUSA strengthens brand awareness in all of the Company's
markets.
In 1997, the Company expanded its telecommunications sales and marketing
efforts primarily by (i) opening new branch sales offices in North Dakota,
South Dakota, Minnesota, Colorado, Missouri, and Wyoming, (ii) as a result of
the CCI Acquisition, acquiring new branch sales offices and sales personnel in
Illinois and Indiana, and (iii) continuing to expand its sales and marketing
efforts in Iowa and Illinois. 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
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Companies (primarily U S WEST and 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, 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 additional 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 vacated 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.
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."
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Competition for local and access telecommunications services is based
principally on price, quality, network reliability, customer service and
service features. The Company believes that its management expertise allows it
to compete effectively with the incumbent local exchange carriers. The Company
generally offers its business customers local exchange services at prices that
are substantially similar to the established retail local exchange carrier
rates for basic business service, while generally providing enhanced calling
features and a higher level of customer service. Using the Company's
sophisticated proprietary software, most business customers subscribing to the
Company's integrated telecommunications services receive 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 generally 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. There are over ten
principal cellular providers and over 20 principal PCS licensees in the
Company's proposed PCS markets.
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 currently
offer wireless 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."
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
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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 two of its wholly owned subsidiaries, McLeodUSA
Telecommunications and CCTS, 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 feasible point within
their networks, on nondiscriminatory terms, at
prices based on cost (which may include a
reasonable profit). At
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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 vacated by the U.S. Eighth Circuit Court of Appeals. In July and October
1997, the U.S. Eighth Circuit Court of Appeals vacated 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. 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.
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The Telecommunications Act imposes certain restrictions on the Regional Bell
Operating Companies in connection with the Regional Bell Operating Companies'
entry into long distance services. Among other things, the Regional Bell
Operating Companies must pursue such activities only through separate
subsidiaries with separate books and records, financing, management and
employees, and all affiliate transactions must be conducted on an arm's length
and nondiscriminatory basis. The Regional Bell Operating Companies are also
prohibited from jointly marketing local and long distance services, equipment
and certain information services unless competitors are permitted to offer
similar packages of local and long distance services in their market. Further,
the Regional Bell Operating Company must obtain in-region long distance
authority before jointly marketing local and long distance services in a
particular state. Additionally, AT&T and other major carriers serving more
than 5% of the nation's presubscribed long distance access lines are also
restricted, under certain conditions, from packaging their long distance
services and local services provided over Regional Bell Operating Company
facilities. These restrictions do not, however, apply to the Company because
it does not serve more than 5% of the nation's presubscribed access lines.
Prior to passage of the Telecommunications Act, the FCC had already
established different levels of regulations for dominant and non-dominant
carriers. For domestic common carrier telecommunications regulation, 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. Through its
subsidiaries, the Company 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 subsidiaries, McLeodUSA
Telecommunications and CCTS, have filed and maintain with the FCC a tariff for
their interstate and international services. All of the interstate and
international retail "basic" services (as defined by the FCC) provided by the
Company (through such subsidiaries) 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
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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.
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 released the
Interconnection Decision implementing the interconnection portions of the
Telecommunications Act. Certain provisions of the Interconnection Decision
were appealed to the U.S. Eighth Circuit Court of
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Appeals. In July and October 1997, the U.S. Eighth Circuit Court of Appeals
vacated 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. In November 1997, the FCC filed a petition for a writ of
certiorari with the U.S. Supreme Court challenging the decisions.
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 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 several 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.
In April and June 1997, the FCC granted the Company a total of 26 "D" and "E"
block frequency PCS licenses and in September 1997 the Company acquired the
CCI PCS License, giving the Company 27 PCS licenses in a total of 25 markets
covering areas of Iowa, Illinois, Minnesota, Nebraska and South Dakota. The
Company paid the FCC approximately $32.8 million for the 26 PCS licenses
granted by the FCC in April and June 1997. The Company's PCS licenses
encompass approximately 110,000 square miles and a population of approximately
6.9 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.
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. The Company was granted the WCS licenses on July 21,
1997. 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.
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.
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All PCS licenses are 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 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. As a result of its ownership of PCS licenses, the Company is
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, through its subsidiaries, 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
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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 two of its wholly owned subsidiaries, 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 from engaging in certain deceptive telemarketing
practices and require that telemarketers make certain disclosures. For
example, these telemarketing rules: prohibit the use of autodialers that
employ prerecorded voice messages without the prior express consent of the
dialed party; proscribe the facsimile transmission of unsolicited
advertisements; require telemarketers to disclose clear and conspicuous
information concerning quality, cost and refunds to a customer before a
customer makes a purchase; require telemarketers to compile lists of
individuals who desire not to be contacted; limit telemarketers to calling
residences between the hours of 8:00 a.m. and 9:00 p.m.; require telemarketers
to explicitly identify the seller and state that the purpose of the call is to
sell goods; and prohibit product misrepresentations.
STATE REGULATION. McLeodUSA Telecommunications and two CCI subsidiaries
provide intrastate common carrier services and are 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. The Company, through
CCTS, also holds certificates to offer facilities-based service in Illinois,
Indiana and Missouri. In March 1995 and November 1997, the Company received
state regulatory approval in Iowa to offer local switched services in Cedar
Rapids, Iowa and in all other U S WEST service territories in Iowa,
respectively. In April 1997, the Company received similar approval to offer
such services in all areas of Wisconsin served by Ameritech. The Company has
also received approval to provide facilities-based local service in certain
cities in Illinois and Indiana. The Company intends to seek regulatory
approval to provide such services in 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 Iowa, Illinois, North Dakota, South Dakota, Minnesota, Wisconsin, Colorado,
Montana, Idaho and Wyoming. The Company also is authorized to offer long
distance service in 48 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
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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. 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.
ICTC is subject to rate of return regulation by the ICC. Under such
regulation, ICTC is allowed to earn up to a fixed rate of return on its
equity. In the event that the ICC finds that ICTC has exceeded its authorized
rate of return on equity, ICTC could be required to lower its customer rates
or make refunds. While the Company believes ICTC is earning less than its
authorized rate of return, there is no assurance that the ICC will not, at
some future date, find that ICTC has earned more than its authorized rate of
return or that such a finding would not have a material adverse effect on the
Company.
In addition, a substantial proportion of ICTC's revenues are derived from
access charges imposed on inter-exchange carriers. Currently, both the FCC and
the ICC are reviewing, on an industry wide
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basis, whether the access charge rate structure related to such access charges
should be revised. If the FCC decides to revise the access charge rate
structure, such a revision could result in a reduction of ICTC's revenues and
gross margins and could have a material adverse effect on the Company.
ICTC, as well as other CCI subsidiaries, also holds state and federal
certificates and FCC licenses in connection with the operation of wireline
telecommunications services and paging services.
The Company, through Ruffalo, Cody, engages in various direct marketing,
telemarketing and fund-raising activities. Most states have laws that govern
either direct marketing, telemarketing or fund-raising activities. In states
that regulate such activities, several types of restriction have been imposed,
either singly or in combination, including: (i) pre-commencement and post-
completion registration requirements; (ii) posting of professional bonds;
(iii) filing of operational contracts; (iv) imposing statutory waiting
periods; (v) requiring employee registration; and (vi) prohibiting control
over funds collected from such activities.
LOCAL GOVERNMENT AUTHORIZATIONS. The Company is required to obtain street
use and construction permits and licenses and/or franchises to install and
expand its fiber optic networks using municipal rights-of-way. In some
municipalities where the Company has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenues or on a per linear foot basis. There can be no
assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, the local exchange carriers
do not pay such franchise fees or pay fees that are substantially less than
those required to be paid by the Company. To the extent that competitors do
not pay the same level of fees as the Company, the Company could be at a
competitive disadvantage. Termination of the existing franchise or license
agreements prior to their expiration dates or a failure to renew the franchise
or license agreements and a requirement that the Company remove its facilities
or abandon its network in place could have a material adverse effect on the
Company.
EMPLOYEES
As of September 30, 1997, the Company employed a total of 4,329 full-time
employees and 361 part-time employees. The Company believes that its future
success will depend on its continued ability to attract and retain highly
skilled and qualified employees. The Company believes that its relations with
its employees are good.
PROPERTY
The Company owns or 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 for the development of an office complex, known as the
McLeodUSA Technology Park, upon which the Company has constructed a one-story,
160,000 square foot building that serves as the Company's new headquarters. As
the second phase in the development of McLeodUSA Technology Park, the Company
has entered into contracts to construct a 36,000 square foot maintenance
building and warehouse, and to construct a two-story, 320,000 square foot
office building which will also house some of the Company's telephone
switching and computer equipment. 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 purchased approximately 120
acres of undeveloped land adjacent to the McLeodUSA Technology Park for a
purchase price of approximately $1.4 million in August 1997. As a result of
the CCI Acquisition, the Company also owns a 60,000 square foot office
building in Mattoon, Illinois, as well as other properties in central
Illinois. 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.
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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 or, in the case of customers served in
central Illinois, to local lines. The Company uses such access to partition
the local switch or transmit traffic over unbundled local line segments
("loops") and thereby provide local service to its customers.
The Company purchases access to local switches 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 to most
of its customers, 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.
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.
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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 the filing. 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
subsequently filed a petition for rehearing with the Minnesota Public
Utilities Commission. On July 29, 1997, the Minnesota Public Utilities
Commission denied 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 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.
In Utah, on September 26, 1996, the Public Service Commission rejected the U
S WEST Centrex Action and ordered U S WEST to continue the availability of
Centrex service for resale. Upon rehearing, however, the Utah Public Service
Commission issued an order on April 29, 1997 imposing temporary restrictions
on Centrex resale. The Company is currently evaluating its options regarding
these temporary restrictions.
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.
On October 1, 1997, the FCC issued a decision addressing the preemption of
certain statutory and regulatory provisions of Texas law which had been
challenged as impermissible under the Telecommunications Act. As part of its
decision, the FCC ruled that certain restrictions on the resale of
Southwestern Bell Telephone Company's Centrex service were preempted by the
Telecommunications Act. Specifically, the FCC held that the resale of Centrex
service could not be limited to "continuous property," as Southwestern Bell
Telephone Company had requested and the Texas Public Utility Commission had
approved, because such a limitation constituted a barrier to entry in
violation of Section 253(a) of the Telecommunications Act; was not
competitively neutral, and was therefore impermissible under Section 253(b) of
the Telecommunications Act; and was unreasonable and discriminatory
restriction on resale, in violation of Section 251(c)(4)(B) of the
Telecommunications Act. The FCC declined to preempt another limitation (which
contained a minimum station line requirement) on the grounds that an
arbitration decision in Texas made such a restriction "presumptively
unreasonable." While the Company believes that this decision supports its
position with respect to the resale of Centrex service, there can be no
guarantee that this decision will not be modified, if challenged on appeal, or
that it will be consistently applied without further litigation in the states
in which the Company offers telecommunications services or intends to offer
telecommunications services.
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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. On July 28, 1997, the Colorado Public Utilities
Commission issued a written order which concluded that the restrictions in U S
WEST's tariffs were inconsistent with both state and federal law, and required
that they be removed from the tariff. U S WEST's request for reconsideration
of the Colorado Public Utilities Commission decision to allow the resale of
Centrex service to residential customers was denied on September 9, 1997.
In January 1997, U S WEST proposed to implement certain interconnection
surcharges in several 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."
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 significant use of the Centrex product to serve its
customers in U S WEST's service territories, 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
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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. U S WEST has agreed to process the Company's
service orders within a standard five-day period. 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."
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 were appealed to the U.S. Eighth Circuit Court of
Appeals. In July and October 1997, the U.S. Eighth Circuit Court of Appeals
vacated portions of the Interconnection Decision, including provisions
establishing a pricing methodology and a procedure permitting new entrants to
"pick and choose" among various provisions of existing interconnection
agreements. Although the decisions vacating the Interconnection Decision do
not prevent the Company from negotiating interconnection agreements with local
exchange carriers, they do create uncertainty about the rules governing
pricing, terms and conditions of interconnection agreements, and could make
negotiating such agreements more difficult and protracted. In November 1997,
the FCC filed a petition for a writ of certiorari with the U.S. Supreme Court
challenging the decisions of the 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.
On September 24, 1997 the Company completed the CCI Acquisition. CCI is
involved in various routine legal proceedings incidental to its business.
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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 nine directors, divided into three classes of
directors serving staggered three-year terms. The Company intends to expand
the Board to up to eleven directors pursuant to an 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 September 30, 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
Richard A. Lumpkin...... 62 Vice Chairman and Director 1998
Stephen C. Gray......... 39 President, Chief Operating Officer 1999
and Director
Blake O. Fisher, Jr..... 53 Chief Financial Officer, Executive 2000
Vice President, Corporate
Administration, Treasurer and
Director
Robert J. Currey........ 52 Group President, Telecommunications 1998
Services and Director
Arthur L. 50
Christoffersen......... Group President, Publishing Services
Kirk E. Kaalberg........ 38 Executive Vice President, Network
Services
Stephen K. Brandenburg.. 45 Executive Vice President and Chief
Information Officer
David M. Boatner........ 49 Executive Vice President, Business
Services
Albert P. Ruffalo....... 50 Executive Vice President, Consumer
Services
Casey D. Mahon.......... 45 Senior Vice President, General
Counsel and Secretary
Russell E. 62 1998
Christiansen(1)........ Director
Thomas M. 69 1998
Collins(1)(2).......... Director
Paul D. Rhines(2)....... 54 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
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telecommunications company with nearly 6,000 employees. MCI purchased
Telecom*USA in August 1990 for $1.25 billion. See "--Investor Agreement and
Stockholders' Agreement."
Richard A. Lumpkin. Mr. Lumpkin has served as Vice Chairman and a director
of the Company since September 1997. Mr. Lumpkin was elected as a director of
the Company pursuant to the requirements of the Merger Agreement and the
Stockholders' Agreement (as defined herein). He also has served as Chairman
and Chief Executive Officer of ICTC since September 1997. Mr. Lumpkin served
as Chairman and Chief Executive Officer of CCI from 1990 to September 24,
1997, the date CCI was acquired by the Company. From its formation in 1984 to
1990, Mr. Lumpkin served as President of CCI. From 1968 to 1990, Mr. Lumpkin
held various executive positions at ICTC, including Vice President of
Operations and Treasurer. He is a director of CIPSCO Incorporated, an electric
utility holding company, its wholly owned subsidiary Central Illinois Public
Service Company, an electric utility, First Mid-Illinois Bancshares, Inc., a
bank holding company ("First Mid-Illinois Bancshares"), and its wholly owned
subsidiary First Mid-Illinois Bank & Trust, a bank. Mr. Lumpkin is Chairman of
the Board of Illuminet Holdings, Inc. ("Illuminet"), formerly USTN Holdings, a
telecommunications company. See "--Investor Agreement and Stockholders'
Agreement."
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."
Robert J. Currey. Mr. Currey has served as a director of the Company since
September 1997 and as Group President, Telecommunications Services since
October 1997. Mr. Currey was elected as a director of the Company pursuant to
the requirements of the Merger Agreement. Mr. Currey served as President of
CCI from March 1990 to September 24, 1997, the date CCI was acquired by the
Company. From June 1988 to March 1990, Mr. Currey served as Senior Vice
President--Operations and Engineering of Citizens Utility Co., a diversified
utility company. From 1987 to 1988, he served as Executive Vice President of
US SPRINT, an interexchange carrier, and from 1984 to 1987, he served as
Senior Vice President--Operations for United Telecommunications, Inc., a
telecommunications company. Prior to 1984, Mr. Currey served as an Assistant
Vice President with Ameritech, the regional holding company for Bell Companies
in five Midwestern states and also held a succession of management positions
in operations, personnel, labor relations and marketing. See "--Investor
Agreement and Stockholders' Agreement."
Arthur L. Christoffersen. Mr. Christoffersen has served as Group President,
Publishing Services since September 24, 1997. Mr. Christoffersen served as
Executive Vice President, Publishing Services from September 20, 1996, the
date the Company acquired McLeodUSA Publishing, until
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September 24, 1997. Mr. Christoffersen served as Chairman, President and Chief
Executive Officer of McLeodUSA Publishing from November 1990, the date Mr.
Christoffersen and other investors acquired McLeodUSA Publishing from MCI, to
September 1996. From December 1987 to August 1990, Mr. Christoffersen served
as Executive Vice President and Chief Financial Officer of Teleconnect. 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.
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 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.
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
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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 TelecomwUSA.
From March 1986 to August 1990, Ms. Mahon served as Senior Vice President,
General Counsel and Secretary of Teleconnect and its successor, TelecomwUSA.
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. Mr. Christiansen is a member of the Board of Directors of MidAmerican.
From July 1996 to May 31, 1997, Mr. Christiansen 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, TelecomwUSA, 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, TelecomwUSA, from 1982 to 1990. He is also a
director of American Safety Razor Company, a consumer product manufacturing
company.
Lee Liu. Mr. Liu has been a director of the Company since April 1993, during
which time he has been one of IES' nominees to the Board. Mr. Liu has served
since July 1993 as Chairman of IES. He has also served as 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
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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. These non-profit corporations have converted the shares of
Class B Common Stock into shares of Class A Common Stock. 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 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
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trust or enter into a voting agreement or other agreement of similar effect
with any other person prior to October 23, 1999.
On June 14, 1997, certain shareholders of CCI (collectively, the "CCI
Shareholders"), the Company and the Investor Stockholders entered into a
Stockholders' Agreement (as amended, the "Stockholders' Agreement"), which
became effective on September 24, 1997. Pursuant to the Stockholders'
Agreement, which amends and restates 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 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 Directors Stock Option Plan.
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<PAGE>
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 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
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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.
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."
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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.
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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.
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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 63 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 867,000 shares of Class A Common Stock at
exercise prices ranging from $17.75 to $20.00 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 (i) with respect to options to purchase 11,266
shares of Class A Common Stock (which are intended to qualify as incentive
stock options under the Code), vest one-half in July of the fourth year
following the date of grant and one-half seven months thereafter, and (ii) as
to the remaining options (which are not intended to qualify as incentive stock
options under the Code), options to purchase 2,034 shares vest in December of
the fourth year
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following the date of grant, options to purchase 2,034 shares vest in the
subsequent seven month period and options to purchase 7,666 shares vest seven
months thereafter.
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.
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CERTAIN TRANSACTIONS
CCI provides paging services, customer premise equipment ("CPE"), labor and
services for CPE, long distance service, 800 service and private lines to
First Mid-Illinois Bancshares. The Company estimates that First Mid-Illinois
Bancshares will pay the Company approximately $279,000 for these services in
1997. Richard A. Lumpkin, Margaret Lumpkin Keon and Mary Lumpkin Sparks own
approximately 13.4%, 7% and 7% of the capital stock of First Mid-Illinois
Bancshares, respectively. Richard A. Lumpkin also is a director of First Mid-
Illinois Bancshares. Mr. Lumpkin is a director, executive officer and
significant stockholder of the Company and Mrs. Keon and Mrs. Sparks are
significant stockholders of the Company.
The Company estimates that Illuminet will pay approximately $1.6 million in
1997 for the rental of building space and for DS-1 usage and transmission
facilities in the form of private leased lines. The Company also estimates
Illuminet will pay to the Company approximately $930,000 in 1997 for database
verification services and SS7 link services. Richard A. Lumpkin is a director
of Illuminet.
The Company estimates that CIPSCO Incorporated and Central Illinois Public
Service Company will collectively pay approximately $1.2 million to the
Company in 1997 for private line services and long distance services. Richard
A. Lumpkin is a director of CIPSCO Incorporated and Central Illinois Public
Service Company.
The Company estimates that the Sarah Bush Lincoln Health Center will pay
approximately $575,000 to the Company in 1997 for private line services,
paging services, CPE, long distance service, 800 service, private lines and a
wiring project. Richard A. Lumpkin was a director of Sarah Bush Lincoln Health
Center until October 1997.
CCI contributed approximately $150,000 in 1997 to The Lumpkin Foundation, a
not-for-profit foundation. Richard A. Lumpkin, Margaret Lumpkin Keon and Mary
Lumpkin Sparks serve as officers and directors of The Lumpkin Foundation.
Richard A. Lumpkin, Mary Lumpkin Sparks and Margaret Lumpkin Keon and
various trusts in their names have made loans to the Company at the domestic
prime rate at Harris Trust & Savings Bank minus two percent. From January 1,
1997 to September 24, 1997, the date of the CCI Acquisition, the total
interest paid on these loans was $1,356 on average outstanding loans of
$50,000. Since the date of the CCI Acquisition, no such loans have been
outstanding.
On July 23, 1997 the Company acquired certain real property consisting of
two condominiums, from Thomas M. Collins, for a total purchase price of
$171,000. The purchase price was determined by independent appraisal. Mr.
Collins is a director of the Company.
In June 1997, the Company acquired certain real property, including an
approximately 15,000 square foot building, located at 5617 West Locust Street,
Davenport, Scott County, Iowa, from MidAmerican. The Company intends to use
this property as a point of presence to support its fiber optic network
primarily in eastern and southeastern Iowa, Wisconsin and Illinois. The
facility will house certain equipment, including fiber optic transmission and
network monitoring equipment, a power back-up generator and battery plant and
related network equipment. The Company paid MidAmerican an aggregate cash
purchase price of $500,000 for the property. The purchase price was determined
by independent appraisal.
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
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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.
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
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determined in accordance with Internal Revenue Service regulations (a rate of
6.21% 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."
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Class A Common Stock as of October 31,
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)(4)......................... 10,278,288 16.3%
Clark E. McLeod(3)(5).............................. 9,301,031 15.0
MWR Investments Inc.(3)(6)......................... 8,262,615 13.4
Richard A. Lumpkin(3)(7)........................... 5,012,457 8.1
Mary E. McLeod(3)(8)............................... 4,571,530 7.4
Putnam Investments, Inc.(9)........................ 3,938,544 6.4
Blake O. Fisher, Jr.(10)........................... 100,471 *
Robert J. Currey(3)(11)............................ 2,552,120 4.1
Russell E. Christiansen(12)........................ 23,438 *
Thomas M. Collins(13).............................. 248,526 *
Paul D. Rhines(14)................................. 430,426 *
Lee Liu(15)........................................ 43,452 *
James L. Cram(16).................................. 377,753 *
Stephen C. Gray(17)................................ 679,070 1.1
Kirk E. Kaalberg(18)............................... 240,248 *
David M. Boatner(19)............................... 61,250 *
Directors and executive officers as a group (15
persons)(20)...................................... 19,414,132 30.7%
</TABLE>
- -------
*Less than one percent.
(1) In accordance with Rule 13d-3 under the Exchange Act of 1934, 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 October 31, 1997 and those shares of Class A Common Stock that may
be acquired by such stockholder within 60 days from October 31, 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) Richard A. Lumpkin, Benjamin I. Lumpkin, Elizabeth A. Lumpkin, Robert J.
Currey, David R. Hodgman, Margaret L. Keon, Pamela K. Vitale and Joseph
J. Keon, as trustees or settlors for 46 trusts for the benefit of members
of the family of Richard A. Lumpkin, MWR Investments Inc., Midwest
Capital Group, Inc., IES Investments Inc., Clark E. McLeod and Mary E.
McLeod are parties to the Stockholders' Agreement and, accordingly,
constitute a group within the meaning of Section 13(d)(3) of the Exchange
Act. As of October 31, 1997, the members of this group beneficially owned
an aggregate of 36,330,530 shares of Class A Common Stock, representing
an ownership percentage of 57.6%. Includes 1,300,688 shares of Class B
Common Stock that IES has the right to purchase pursuant to options and
240,001 shares of Class A Common Stock that Mr. McLeod has the right to
purchase within 60 days from October 31, 1997 pursuant to options.
(4) 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.
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(5) 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
trustee and over which Mr. McLeod has shared voting and investment power.
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 240,001 shares of Class A Common Stock that Mr. McLeod has the
right to purchase within 60 days from October 31, 1997 pursuant to
options.
(6) 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.
(7) Includes 5,012,457 shares of Class A Common Stock held by Richard A.
Lumpkin as trustee or settlor for various trusts for the benefit of the
family of Richard A. Lumpkin. Includes 4,228,337 shares of Class A Common
Stock over which Mr. Lumpkin has sole voting power and 501,680 shares of
Class A Common Stock over which Mr. Lumpkin has shared voting power.
Mr. Lumpkin's address is c/o McLeodUSA Incorporated, McLeodUSA Technology
Park, 6400 C Street, SW, P.O. Box 3177, Cedar Rapids, IA 54206-3177.
(8) 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 and
over which Mrs. McLeod has shared voting and investment power. 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.
(9) 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.
(10) Includes 82,033 shares of Class A Common Stock that Mr. Fisher has the
right to purchase within 60 days from October 31, 1997 pursuant to
options.
(11) Includes 2,552,120 shares of Class A Common Stock held by Robert J.
Currey and David R. Hodgman as trustees for various trusts for the
benefit of members of the family of Richard A. Lumpkin. Robert J. Currey
and David R. Hodgman have shared voting power over all such shares of
Class A Common Stock.
(12) Includes 23,438 shares of Class A Common Stock that Mr. Christiansen has
the right to purchase within 60 days from October 31, 1997 pursuant to
options.
(13) Includes 56,252 shares of Class A Common Stock that Mr. Collins has the
right to purchase within 60 days from October 31, 1997 pursuant to
options.
(14) Mr. Rhines' address is c/o Allsop Venture Partners III, L.P., 2750 1st
Ave., NE, Cedar Rapids, IA 52402. Includes 194,476 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
October 31, 1997 pursuant to options.
(15) Includes 31,252 shares of Class A Common Stock that Mr. Liu has the right
to purchase within 60 days from October 31, 1997 pursuant to options.
(16) Includes 78,133 shares of Class A Common Stock held of record by members
of James L. Cram's family.
(17) 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
617,524 shares of Class A Common Stock that Mr. Gray has the right to
purchase within 60 days from October 31, 1997 pursuant to options.
(18) Includes 220,248 shares of Class A Common Stock that Mr. Kaalberg has the
right to purchase within 60 days from October 31, 1997 pursuant to
options.
(19) Includes 56,250 shares of Class A Common Stock that Mr. Boatner has the
right to purchase within 60 days from October 31, 1997 pursuant to
options.
(20) Includes 1,655,406 shares of Class A Common Stock that such persons have
the right to purchase within 60 days from October 31, 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 an
indenture dated as of July 21, 1997 (the "Senior Note Indenture") between the
Company and United States Trust Company of New York, as trustee under the
Senior Note 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 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 Senior Note Indenture and those made a part of the
Senior Note Indenture by reference to the Trust Indenture Act of 1939 as in
effect on the date of the Senior Note Indenture (the "Trust Indenture Act").
The Exchange Notes are subject to all such terms, and Holders of the Exchange
Notes are referred to the Senior Note Indenture and the Trust Indenture Act
for a complete statement of such terms. A copy of the Senior Note Indenture is
available from the Company on request. The statements and definitions of terms
under this caption relating to the Exchange Notes and the Senior Note
Indenture are summaries and do not purport to be complete. Such summaries make
use of certain terms defined in the Senior Note Indenture and are qualified in
their entirety by express reference to the Senior Note Indenture. Certain
terms used herein are defined below under "--Certain Definitions."
The Exchange Notes rank pari passu in right of payment with the Senior
Discount Exchange Notes, 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 September 30, 1997, the Company had no outstanding subordinated
indebtedness and, other than the Senior Discount Exchange Notes and 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 September 30, 1997, the total secured
indebtedness of the Company and its subsidiaries was approximately $25.3
million.
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 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 September 30, 1997,
the total liabilities of the Company's subsidiaries (after the elimination of
loans and advances by the Company to its subsidiaries) were approximately
$217.8 million. 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 are limited in aggregate principal amount to $225 million
and will mature on July 15, 2007. Interest on the Exchange Notes will accrue
at the rate of 9 1/4% per annum and will be payable in cash semi-annually in
arrears on July 15 and January 15 of each year, commencing January 15, 1998.
Interest will be computed on the basis of a 360-day year comprised of twelve
30-day months.
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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 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 Senior Note Indenture) held in book-entry
form. The Exchange Notes will be deposited with the Trustee as custodian for
the Depository, and the Depository or its nominee will initially be the sole
registered Holder of the Exchange Notes for all purposes under the Senior Note
Indenture. Except as set forth below, a Global Security may not be transferred
except as a whole by the Depository to a nominee of the Depository or by a
nominee of the Depository to the Depository.
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, the Depository or its nominee will
credit, on its internal system, the accounts of persons holding through it
with the respective principal amounts of the individual beneficial interests
represented by such Global Security purchased by such persons in the Offering.
Ownership of beneficial interests in a Global Security will be limited to
persons that have accounts with the Depository ("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 the Depository 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 the Depository 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 Senior
Note 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 the Depository'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 the Depository's
records relating to such beneficial ownership interests or (ii) any other
matter relating to the actions and practices of the Depository or any of its
participants.
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The Company has been advised by the Depository that upon receipt of any
payment of principal of, premium, if any, on or interest on any Global
Security, the Depository 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
the Depository. 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 the Depository or its nominee is the registered owner or Holder
of such Global Security, the Depository 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 Senior Note
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 the Depository 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 Senior Note Indenture. Accordingly, each person owning
a beneficial interest in a Global Security must rely on the procedures of the
Depository 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 Senior Note 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 Senior Note Indenture, the Depository 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.
The Depository 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 the Depository
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.
The Depository has advised the Company that the Depository 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. The Depository 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. The
Depository'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
the Depository. Access to the Depository'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 the Depository and the
Depository'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.
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CERTIFICATED NOTES
The Exchange Notes represented by a Global Security are exchangeable for
certificated Exchange Notes only if (i) the Depository notifies the Company
that it is unwilling or unable to continue as a depository for such Global
Security or if at any time the Depository 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 Exchange 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 the Depository 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 the Depository 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 July 15, 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 July
15 of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2002.......................................................... 104.625%
2003.......................................................... 103.083%
2004.......................................................... 101.542%
2005 and thereafter........................................... 100.000%
</TABLE>
The Exchange Notes are redeemable prior to July 15, 2000 only in the event
that the Company receives net proceeds from the sale of its Common Stock in a
Strategic Equity Investment before July 15, 2000, in which case the Company
may, at its option, use all or a portion of any such net proceeds to redeem up
to 33 1/3% of the original principal amount of the Notes; provided, that at
least 66 2/3% of the original principal amount of the Notes would 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 equal to 109.25% of the principal
amount of the Notes so redeemed, plus accrued and unpaid interest thereon (if
any) 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.
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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.
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 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
principal amount of the Exchange Notes plus accrued and unpaid interest, if
any, to any Change of Control Payment Date.
Within 30 days following any Change of Control, the Company or the Trustee
(at the request and expense of the Company) shall mail a notice to each Holder
stating: (i) 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; (ii) 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; (iii) that any
Exchange Notes or portions thereof not tendered or accepted for payment will
continue to accrue interest; (iv) 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 accrue interest from and after the Change of Control Payment
Date; (v) 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; (vi) 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 its
election to have such Exchange Notes or portions thereof purchased; (vii) that
Holders electing to have Exchange Notes purchased pursuant to the Change of
Control Offer must specify the principal amount that is being tendered for
purchase, which principal amount must be $1,000 or an integral multiple
thereof; (viii) that Holders whose Exchange Notes are being purchased only in
part will be issued new Exchange 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 or an integral
multiple thereof; and (ix) any other information necessary to enable any
Holder to tender Exchange Notes and to have such Exchange Notes purchased
pursuant to the Senior Note Indenture.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws or 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 (i) accept for
payment Exchange Notes or portions thereof properly tendered pursuant to the
Change of Control Offer; (ii) 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 accepted; and
(iii) 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
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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 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, 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 at 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 Senior Note
Indenture. In addition, one of the events that constitutes a Change of Control
under the Senior Note Indenture is a sale, conveyance, transfer or lease of
all or substantially all of the property of the Company. The Senior Note
Indenture is 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 Senior
Note 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 Exchange 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 Exchange 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
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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 price (the "Offer Purchase Price") in cash equal to 100% of the
principal amount thereof plus accrued and unpaid interest, if any, to the
purchase date, in accordance with the procedures set forth in the Senior Note
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 or 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 Senior Note
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;
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(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;
(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
Senior Note 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;"
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(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 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 Senior
Note 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;"
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(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;
(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.
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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 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 Senior Note 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 Senior Note 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
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- --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 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 Senior Note Indenture and securing Indebtedness outstanding on the
date of the Senior Note 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
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is otherwise permitted under the Senior Note 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 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
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Subsidiary, except: (a) any encumbrance or restriction existing as of the
Issue Date pursuant to the Senior Note Indenture or any other agreement
relating to any Existing Indebtedness or any Indebtedness under a Qualified
Receivable Facility otherwise permitted under the Senior Note 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 (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 Senior Note 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 Senior Note 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
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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."
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
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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.
(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 or permit any other
Person to merge with or into the Company (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
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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 Senior Note 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;
(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 Senior
Note 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 Senior Note
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 Senior Note 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;
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(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
(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 (as defined herein)
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, provided that no judgement or
decree for the payment of money due on the Notes has been obtained by the
Trustee. The Default Amount shall equal 100% of the principal amount of the
Notes. 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.
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The Company will be required to deliver to the Trustee annually a statement
regarding compliance with the Senior Note 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 Senior Note Indenture (1) to evidence the succession of
another Person to the Company and the assumption by such successor of the
covenants of the Company in the Senior Note 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 Senior Note
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 Senior Note
Indenture of a successor Trustee; (6) to secure the Notes; (7) to cure any
ambiguity in the Senior Note Indenture, to correct or supplement any provision
in the Senior Note 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 Senior Note 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 Senior Note 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 Senior Note Indenture for the
purpose of adding any provisions to or changing in any manner or eliminating
any of the provisions of the Senior Note 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 Senior Note Indenture or certain
Defaults thereunder; (3) subordinate in right of payment, or otherwise
subordinate, the Notes to any other Indebtedness; or (4) 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 Senior Note 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 of the
Senior Note Indenture 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 Senior Note 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
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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 Senior Note
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
Senior Note Indenture.
The Company, at its election, shall (a) be deemed to have paid and
discharged its debt on the Notes and the Senior Note 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 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 Senior Note Indenture and (iv) certain
other specified provisions in the Senior Note 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 Senior Note 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 Senior Note
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 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 Senior Note Indenture. The Senior Note 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
Senior Note 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
Senior Note 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
Senior Note Indenture or for any claim based on, in respect of, or by reason
of, such
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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 Senior Note 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 Senior Note Indenture.
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.
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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 (the "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 two years 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 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 150 days after the Closing Date, the Registration Statement
has not been declared effective; (ii) within 180 days after the Closing Date,
neither the Exchange Offer has been consummated nor the Shelf Registration
Statement has been declared effective; or (iii) 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 (each such event referred to in clauses (i) through
(iii), a "Registration Default"), additional interest ("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
Senior Note Indenture. Reference is made to the Senior Note Indenture for the
full definition of all such terms, as well as any capitalized terms used
herein for which no definition is provided.
"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
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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.
"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
Senior Note 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 Senior Note
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
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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.
"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
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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 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.
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"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.
"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
Senior Note 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 Senior Note Indenture shall utilize GAAP as in effect on the
Issue Date.
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"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.
"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 as 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 Senior Note 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 Senior Discount Exchange 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.
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"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 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 were first
authenticated and delivered under the Senior Note 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
Senior Note Indenture, whether on the date specified in such Note as the fixed
date on which the principal of such Note is due and payable, a Change of
Control Payment Date or an Asset Sale Payment Date, 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
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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 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 Senior Note
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 Senior Note 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 Senior Note 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 Senior Note 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
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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 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.
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"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.
"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.
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"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.
"Stated Maturity" means, with respect to any security, the date specified in
such security as the fixed date on which the payment of principal of such
security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency unless such contingency has occurred), and, when used with respect
to any installment of interest on such security, the fixed date on which such
installment of interest is due and payable.
"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 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
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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 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 Senior
Note 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.
139
<PAGE>
DESCRIPTION OF OTHER INDEBTEDNESS
On March 4, 1997, the Company completed a private offering of $500 million
principal amount at maturity of 10 1/2% Senior Discount Notes due March 1,
2007. The Senior Discount Notes were issued at an original issue discount in
which the Company received approximately $289.6 million in net proceeds. The
Company filed a registration statement with the Commission for the
registration of $500 million principal amount at maturity of 10 1/2% Senior
Discount Exchange Notes due March 1, 2007 to be offered in exchange for the
Senior Discount Notes. The registration statement was declared effective by
the Commission on July 28, 1997 and the Senior Discount Note Exchange Offer
was commenced. The Senior Discount Note Exchange Offer expired on August 24,
1997, and all of the Senior Discount Notes were exchanged for the Senior
Discount Exchange Notes. The form and terms of the Senior Discount Exchange
Notes are identical in all material respects to the form and terms of the
Senior Discount Notes except that (i) the Senior Discount Exchange Notes have
been registered under the Securities Act and (ii) holders of the Senior
Discount Exchange Notes are not entitled to certain rights under a
registration agreement relating to the Senior Discount Notes. The Senior
Discount Exchange Notes accrete from March 4, 1997 at a rate of 10 1/2% per
year, compounded semi-annually, to an aggregate principal amount of $500
million by March 1, 2002. At September 30, 1997, the accreted balance of the
Senior Discount Exchange Notes was $318.3 million. Interest will not accrue on
the Senior Discount Exchange Notes prior to March 1, 2002. Thereafter,
interest on the Senior Discount Exchange Notes will accrue at a rate of 10
1/2% per annum, payable in cash semi-annually on March 1 and September 1
commencing September 1, 2002. The Senior Discount Note Indenture contains,
subject to certain exceptions and qualifications, 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 its 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 interests of the
Company.
The Senior Discount Exchange Notes are senior unsecured obligations of the
Company ranking pari passu in right of payment with all other existing and
future senior unsecured obligations of the Company and rank senior to all
other existing and future subordinated debt of the Company. The Senior
Discount Exchange Notes are effectively subordinated to all existing and
future secured indebtedness of the Company and its subsidiaries to the extent
of the value of the assets securing such indebtedness. The Senior Discount
Exchange Notes also are effectively subordinated to all existing and future
third-party indebtedness and other liabilities of the Company's subsidiaries.
140
<PAGE>
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.
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 three-year period ended December 31,
1996 and financial statement schedule included in this Prospectus 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.
141
<PAGE>
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 Prospectus 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
Prospectus 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 balance sheets of Consolidated Communications Inc. as of
December 31, 1996 and 1995, and the consolidated statements of income, changes
in stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1996 included in this Prospectus have been audited
by Arthur Andersen LLP, independent public accountants, 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).
142
<PAGE>
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, 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 Senior Discount Note Indenture
and the Senior Note Indenture to furnish the Trustee with annual reports
containing consolidated financial statements audited by their independent
public accountants and with quarterly reports containing unaudited condensed
consolidated financial statements for each of the first three quarters of each
fiscal year.
143
<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 vacated 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 September 30, 1997 (unaudited) and as
of December 31, 1996 and 1995........................................... F-3
Consolidated Statements of Operations for the nine months ended September
30, 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 nine months ended September
30, 1997 (unaudited).................................................... F-5
Consolidated Statements of Cash Flows for the nine months ended September
30, 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-24
Consolidated Statements of Income for the years ended December 31, 1995
and 1994................................................................ F-25
Consolidated Statements of Redeemable Common Stock and Warrants and
Common Stockholders' Equity (Deficit) for the years ended December 31,
1995 and 1994........................................................... F-26
Consolidated Statements of Cash Flows for the years ended December 31,
1995 and 1994........................................................... F-27
Notes to Consolidated Financial Statements............................... F-28
TELECOM*USA PUBLISHING GROUP, INC. AND SUBSIDIARIES
Independent Auditor's Report............................................. F-33
Consolidated Statements of Income for the years ended August 31, 1996,
1995 and 1994........................................................... F-34
Consolidated Statements of Stockholders' Equity for the years ended
August 31, 1996, 1995 and 1994.......................................... F-35
Consolidated Statements of Cash Flows for the years ended August 31,
1996, 1995 and 1994..................................................... F-36
Notes to Consolidated Financial Statements............................... F-37
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
Report of Independent Public Accountants................................. F-45
Consolidated Balance Sheets as of June 30, 1997 (unaudited) and as of
December 31, 1996 and 1995.............................................. F-46
Consolidated Statements of Income for the six months ended June 30, 1997
and 1996 (unaudited) and for the years ended December 31, 1996, 1995 and
1994.................................................................... F-47
Consolidated Statements of Changes in Stockholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994 and for the six months ended June
30, 1997 (Unaudited).................................................... F-48
Consolidated Statements of Cash Flows for the six months ended June 30,
1997 and 1996 (unaudited) and for the years ended December 31, 1996,
1995 and 1994........................................................... F-49
Notes to Consolidated Financial Statements............................... F-50
</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,
SEPTEMBER 30, -----------------
1997 1996 1995
------------- -------- -------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS (NOTE 4)
Current Assets
Cash and cash equivalents (Note 3)........... $ 336,074 $ 96,480 $ --
Investment in available-for-sale securities
(Note 3).................................... 84,395 80,518 --
Trade receivables, net (Note 2).............. 106,070 27,560 6,689
Inventory.................................... 3,781 1,600 1,598
Deferred expenses............................ 30,403 12,156 --
Prepaid expenses and other................... 13,346 6,087 220
---------- -------- -------
TOTAL CURRENT ASSETS....................... 574,069 224,401 8,507
---------- -------- -------
Property and Equipment
Land and building............................ 35,608 2,246 311
Telecommunication networks................... 171,885 32,041 8,056
Furniture, fixtures and equipment............ 62,953 22,302 5,742
Networks in progress (Note 5)................ 76,853 35,481 4,155
Building in progress (Note 5)................ 3,673 6,103 --
---------- -------- -------
350,972 98,173 18,264
Less accumulated depreciation................ 14,761 6,050 2,145
---------- -------- -------
336,211 92,123 16,119
---------- -------- -------
Investments, Intangibles and Other Assets
Investment in available-for-sale securities
(Note 3).................................... 5,421 47,474 --
Other investments............................ 30,913 -- --
Goodwill, net................................ 273,827 57,012 2,525
Customer lists, net.......................... 59,058 17,095 --
Noncompete agreements, net................... 15,089 6,737 --
Deferred line installation costs, net........ 7,533 2,083 1,424
PCS licenses (Note 5)........................ 32,807 4,800 --
Other........................................ 27,071 1,269 411
---------- -------- -------
451,719 136,470 4,360
---------- -------- -------
$1,361,999 $452,994 $28,986
========== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt (Note
4).......................................... $ 4,383 $ 793 $ --
Contracts and notes payable (Notes 4 and
11)......................................... 19,900 -- --
Accounts payable............................. 41,200 15,807 5,832
Checks issued not yet presented for pay-
ment........................................ -- -- 919
Accrued payroll and payroll related ex-
penses...................................... 22,952 7,259 1,955
Other accrued liabilities.................... 30,834 3,095 857
Deferred revenue, current portion............ 9,638 1,793 134
Customer deposits............................ 12,302 9,686 18
---------- -------- -------
TOTAL CURRENT LIABILITIES.................. 141,209 38,433 9,715
---------- -------- -------
Long-Term Debt, less current maturities (Note
4)........................................... 607,247 2,573 3,600
---------- -------- -------
Deferred Revenue, less current portion........ 12,882 8,559 713
---------- -------- -------
Other Long-term liabilities................... 21,205 -- --
---------- -------- -------
Commitments (Note 5)
Stockholders' Equity (Notes 4, 7, 8 and 9)
Capital stock:
Preferred, $.01 par value; authorized
2,000,000 shares; none issued; terms
determined upon issuance.................. -- -- --
Common, Class A, $.01 par value; authorized
250,000,000 shares; issued and outstanding
1997 61,429,429 shares; 1996 36,172,817
shares; 1995 16,387,081 shares............ 614 362 164
Common, Class B, convertible, $.01 par
value; authorized 22,000,000 shares;
issued and outstanding 1997 none; 1996 and
1995 15,625,929 shares.................... -- 156 156
Additional paid-in capital................... 680,223 450,736 40,117
Accumulated deficit.......................... (101,381) (47,825) (25,479)
---------- -------- -------
579,456 403,429 14,958
---------- -------- -------
$1,361,999 $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>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ ----------------------------
1997 1996 1996 1995 1994
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue (Note 2)............. $131,595 $ 45,497 $ 81,323 $ 28,998 $ 8,014
-------- -------- -------- -------- --------
Operating expenses:
Cost of service............ 80,680 31,693 52,624 19,667 6,212
Selling, general and
administrative............ 83,428 25,626 46,044 18,054 12,373
Depreciation and
amortization.............. 15,708 4,734 8,485 1,835 772
Other...................... 2,689 -- 2,380 -- --
-------- -------- -------- -------- --------
TOTAL OPERATING EX-
PENSES.................. 182,505 62,053 109,533 39,556 19,357
-------- -------- -------- -------- --------
OPERATING LOSS........... (50,910) (16,556) (28,210) (10,558) (11,343)
-------- -------- -------- -------- --------
Nonoperating income (ex-
pense):
Interest income............ 18,070 3,404 6,034 139 145
Interest (expense)......... (20,756) (544) (665) (910) (218)
Other income............... 40 278 495 -- --
-------- -------- -------- -------- --------
TOTAL NONOPERATING INCOME
(EXPENSE)............... (2,646) 3,138 5,864 (771) (73)
-------- -------- -------- -------- --------
LOSS BEFORE INCOME TAX-
ES...................... (53,556) (13,418) (22,346) (11,329) (11,416)
Income taxes (Note 6)........ -- -- -- -- --
-------- -------- -------- -------- --------
NET LOSS................. $(53,556) $(13,418) $(22,346) $(11,329) $(11,416)
======== ======== ======== ======== ========
Loss per common and common
equivalent share (Note 8)... $ (1.02) $ (0.33) $ (0.52) $ (0.31) $ (0.31)
======== ======== ======== ======== ========
Weighted average common and
common equivalent shares
outstanding (Note 8)........ 52,752 41,188 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
NINE MONTHS ENDED SEPTEMBER 30, 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)... -- -- -- -- (53,556) -- (53,556)
Issuance of 1,001,480
shares of Class A
common stock
(unaudited)........... -- 10 -- 600 -- -- 610
Release of 56,177
shares of Class A
common stock from
escrow (unaudited)
(Note 11) ............ -- -- -- 1,347 -- -- 1,347
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
Issuance of 8,488,596
shares of Class A
common stock in
connection with the
acquisition of
Consolidated
Communications, Inc.
(unaudited) (Note
11)................... -- 85 -- 223,590 -- -- 223,675
Conversion of
15,625,929 shares of
Class B common stock
to 15,625,929 shares
of Class A common
stock (unaudited)
(Note 8).............. -- 156 (156) -- -- -- --
Amortization of
compensation expense
related to stock
options (unaudited)
(Note 7) ............. -- -- -- 1,701 -- -- 1,701
----- ---- ---- -------- --------- ----- --------
Balance, September 30,
1997 (unaudited)....... $ -- $614 $-- $680,223 $(101,381) $ -- $579,456
===== ==== ==== ======== ========= ===== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ -----------------------------
1997 1996 1996 1995 1994
-------- -------- --------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash Flows from Operating
Activities
Net loss................... $(53,556) $(13,418) $ (22,346) $(11,329) $(11,416)
Adjustments to reconcile
net loss to net cash (used
in) operating activities:
Depreciation............... 8,290 2,243 3,944 1,299 633
Amortization............... 7,418 2,832 4,882 1,168 314
Accretion of interest on
senior discount notes..... 18,343 -- -- -- --
Changes in assets and
liabilities, net of
effects of acquisitions
(Note 11):
(Increase) in trade
receivables.............. (13,510) (6,598) (9,317) (3,575) (2,272)
(Increase) in inventory... (320) (2,694) (2) (269) (185)
(Increase) decrease in
deferred expenses........ (1,544) (730) 1,966 -- --
(Increase) in deferred
line installation
costs.................... (6,731) (842) (1,289) (806) (1,136)
Increase in accounts
payable and accrued
expenses................. 19,077 4,095 3,192 4,084 1,994
Increase in deferred
revenue.................. 6,661 6,354 9,505 9 716
Increase (decrease) in
customer deposits........ 2,616 1,027 1,366 11 6
Other, net................ (3,260) (2,727) (3,703) (70) (16)
-------- -------- --------- -------- --------
NET CASH (USED IN)
OPERATING ACTIVITIES.... (16,516) (10,458) (11,802) (9,478) (11,362)
-------- -------- --------- -------- --------
Cash Flows from Investing
Activities
Purchase of property and
equipment................. (104,138) (39,742) (70,290) (5,272) (3,363)
Available-for-sale
securities:
Purchases.................. (107,126) (123,012) (207,681) -- --
Sales...................... 88,177 39,047 17,577 -- --
Maturities................. 86,497 -- 62,389 -- --
Business acquisitions (Note
11)....................... (180,373) (78,868) (80,081) -- --
Deposits on PCS licenses
(Note 5).................. (28,007) (4,889) (4,889) -- --
Other...................... (892) (950) (133) (266) (79)
-------- -------- --------- -------- --------
NET CASH (USED IN)
INVESTING ACTIVITIES.... (245,862) (208,414) (283,108) (5,538) (3,442)
-------- -------- --------- -------- --------
Cash Flows from Financing
Activities
Increase (decrease) in
checks issued not yet
presented for payment..... -- (302) (919) 885 34
Proceeds from line of
credit agreements......... -- 50,238 55,925 42,200 8,400
Payments on line of credit
agreements................ -- (52,441) (59,825) (42,100) (4,900)
Payments on contracts and
notes payable............. (5,455) -- -- -- --
Proceeds from long-term
debt...................... 508,038 2,012 2,060 -- --
Payments on long-term
debt...................... (1,221) (8) (2,065) -- --
Net proceeds from issuance
of common stock........... 610 258,131 396,214 13,992 6,629
Reissuance (purchase) of
treasury stock............ -- -- -- 39 (33)
-------- -------- --------- -------- --------
NET CASH PROVIDED BY
FINANCING ACTIVITIES.... 501,972 257,630 391,390 15,016 10,130
-------- -------- --------- -------- --------
NET INCREASE (DECREASE)
IN CASH AND CASH
EQUIVALENTS............. 239,594 38,758 96,480 -- (4,674)
Cash and cash equivalents:
Beginning.................. 96,480 -- -- -- 4,674
-------- -------- --------- -------- --------
Ending..................... $336,074 $ 38,758 $ 96,480 $ -- $ --
======== ======== ========= ======== ========
Supplemental Disclosure of
Cash Flow Information
Cash payment for interest,
net of interest
capitalized 1997 $2,881;
1996 $204; 1995 $62; and
1994 none................. $ -- $ 761 $ 300 $ 261 $ 35
======== ======== ========= ======== ========
Supplemental Schedule of
Noncash Investing and
Financing Activities
Release of 56,177 shares of
Class A common stock from
escrow
(Note 11)................. $ 1,347
========
Capital leases incurred for
the acquisition of
property and equipment ... $ 2,988
========
Accounts payable incurred
for property and equipment
.......................... $ 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 NINE MONTHS ENDED SEPTEMBER 30, 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 in Iowa,
Illinois, North Dakota, South Dakota, Minnesota, Wisconsin, Indiana, Colorado
and Wyoming and residential customers in Iowa, Illinois, North Dakota and
South Dakota. The Company's services primarily include local and long-distance
telecommunications services, telecommunications network maintenance services
and telephone equipment sales, service and installation, private line and data
services, the sale of advertising space in telephone directories, the
operation of an independent local exchange company, Illinois Consolidated
Telephone Company ("ICTC"), acquired as part of the CCI Acquisition and
telemarketing services. The Company also provides telemarketing services to
businesses and nonprofit entities throughout the United States and publishes
and distributes telephone directories in nineteen states in the midwestern and
Rocky Mountain regions of the 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 September 30,
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 December 31, 1996, inventories of approximately $1.6
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 NINE MONTHS ENDED SEPTEMBER 30, 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 3 to 30 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 $3,200,000, $1,049,000
and $117,000, and accumulated amortization on customer lists totaled
$1,689,000, $432,000 and none at September 30, 1997, December 31, 1996 and
1995, respectively.
Noncompete agreements: Noncompete agreements primarily relate to directories
previously acquired by TelecomwUSA 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 $1,038,000, $250,000 and none at September 30,
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 $2,429,000,
$1,148,000 and $518,000 at September 30, 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 NINE MONTHS ENDED SEPTEMBER 30, 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 NINE MONTHS ENDED SEPTEMBER 30, 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 September 30, 1997, and for the nine-month periods
ended September 30, 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> <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 September 30, 1997, the Company held $224,354,000, $87,552,000 and
$29,372,000 in repurchase agreements, corporate debt securities and marketable
equity securities, respectively. At December 31, 1996, the Company held
$147,439,000, $54,759,000 and $7,850,000 in corporate debt securities, United
States Government and governmental agency securities and mortgage-backed
securities, respectively. The Company has classified these securities as
available-for-sale, and at September 30, 1997 and December 31, 1996, the debt
securities' amortized cost approximates fair value. The marketable equity
securities have been recorded at their fair market value at September 30,
1997. 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 $251,462,000,
$84,395,000 and $5,421,000, respectively, being recorded in each
classification at
F-10
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 3. INVESTMENTS--(CONTINUED)
September 30, 1997. At December 31, 1996, $82,056,000, $80,518,000 and
$47,474,000, respectively, were recorded in each classification.
The contractual maturities of the available-for-sale securities are as
follows (In thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
Due within one year............................... $335,857 $161,205
Due after one year through three years............ 5,421 40,731
Due after three years............................. -- 262
Mortgage-backed securities........................ -- 7,850
-------- --------
$341,278 $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, DEBT AND SUBSEQUENT EVENT
Debt offerings: On March 4, 1997, the Company completed a private offering
of 10 1/2% Senior Discount Notes (the "Senior Discount Notes") due March 1,
2007 at an original issue discount in which the Company received approximately
$289.6 million in net proceeds. The Senior Discount Notes 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 Senior Discount Notes for five years, after which time the Senior Discount
Notes will accrue interest at 10 1/2%, payable semi-annually. The Senior
Discount 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 Senior Discount Notes have not been registered under the
Securities Act of 1933, and therefore are not tradeable securities.
The Company filed a registration statement with the Securities and Exchange
Commission ("SEC") for the registration of $500 million principal amount at
maturity of 10 1/2% Senior Discount Notes due March 1, 2007 (the "Senior
Discount Exchange Notes") to be offered in exchange for the Senior Discount
Notes (the "Senior Discount Exchange Offer"). The registration statement was
declared effective by the SEC on July 28, 1997 and the Senior Discount
Exchange Offer was commenced. The Senior Discount Exchange Offer expired on
August 24, 1997, at which time all of the Senior Discount Notes were exchanged
for the Senior Discount Exchange Notes. The form and terms of the Senior
Discount Exchange Notes are identical in all material respects to the form and
terms of the Senior Discount Notes except that (i) the Senior Discount
Exchange Notes have been registered under the Securities Act of 1933 (the
"Securities Act") and (ii) holders of the Senior Discount Exchange Notes are
not entitled to certain rights under a registration agreement relating to the
Senior Discount Notes. The Senior Discount Exchange Notes rank pari passu in
right of payment with all 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 September 30, 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 Senior Discount Exchange Notes.
F-11
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 4. PLEDGED ASSETS, DEBT AND SUBSEQUENT EVENT--(CONTINUED)
On July 21, 1997, the Company completed a private offering of $225 million
aggregate principal amount of 9 1/4% Senior Notes due July 15, 2007 (the
"Senior Notes"). The Company received net proceeds of approximately $218.5
million from the Senior Note offering. Interest on the Senior Notes is payable
in cash semi-annually in arrears on July 15 and January 15 of each year at a
rate of 9 1/4% per annum, commencing January 15, 1998. The Senior Notes rank
pari passu in right of payment with all 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 September
30, 1997, the Company had no outstanding subordinated indebtedness and, other
than the Senior Discount Exchange Notes, had no outstanding indebtedness that
would rank pari passu with the Senior Notes. As of September 30, 1997, the
Senior Notes had not been registered under the Securities Act and therefore
cannot 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. The Company has filed a
registration statement with the SEC for the registration of $225 million
aggregate principal amount of 9 1/4% Senior Notes due July 15, 2007 (the
"Exchange Notes") to be offered in exchange for the Senior Notes (the
"Exchange Offer"). 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 have been registered under the Securities Act and (ii)
holders of the Exchange Notes will not be entitled to certain rights under a
registration agreement relating to the Senior Notes. As of September 30, 1997,
the registration statement has not been declared effective and the Exchange
Offer has not been commenced.
The indentures relating to the Senior Discount Exchange Notes, the Senior
Notes and the Exchange Notes impose operating and financial restrictions on
the Company and its subsidiaries.
The Company's debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, -------------
1997 1996 1995
------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Contracts payable, unsecured, non-interest
bearing, due in various installments with the
final payment to be made in the first half of
1998............................................ $ 1,400 $ -- $ --
Notes payable, banks, bearing interest at
6.1875%, due in various installments through
October 1997.................................... 18,500 -- --
-------- ----- -------
$ 19,900 $ -- $ --
======== ===== =======
Borrowings on line of credit agreements (A) and
(B)............................................. $ -- $ -- $ 3,600
10 1/2% Senior Discount Notes.................... 318,343 -- --
9 1/4% Senior Notes.............................. 225,000 -- --
Consolidated Communications, Inc. ("CCI"): (C)
Unsecured senior notes payable, with semiannual
interest payments at 7.75% payable April 1 and
October 1. Annual principal payments of
$1,428,571 are due beginning October 1, 1998
until maturity in October 2004................. 10,000 -- --
Series A Senior Unsecured Notes, with semiannual
interest payments at 6.83% payable June 1 and
December 1. Annual principal payments of
$909,091 are due beginning December 1, 2001
until maturity in December 2010................ 10,000 -- --
</TABLE>
F-12
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 IS
UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, -------------
1997 1996 1995
------------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Series B Senior Unsecured Notes, with
semiannual interest payments at 6.71% payable
June 1 and December 1. Annual principal
payments of $454,546 are due beginning
December 1, 2001 until maturity in December
2010.......................................... 5,000 -- --
Greene County Partners, Inc. senior notes due in
quarterly payments of $450,000 bearing interest
at 6.35% and maturing in April 2001. (D)....... 15,750 -- --
Illinois Consolidated Telephone Company
("ICTC"):
Series K, 8.620% First Mortgage Bonds due
September 2022 (E)............................ 10,000 -- --
Series L, 7.050% First Mortgage Bonds due
October 2013 (E).............................. 10,000 -- --
Other CCI long-term notes payable (F)........... 1,595 -- --
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.......................... 981 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 $60,000 at September 30,
1997........................................... 41 248 --
Contracts payable, to finance company, due in
various monthly payments, including interest at
3.90%, through March 2000, collateralized by
equipment with a depreciated cost of $2,915,000
at September 30, 1997.......................... 2,761 -- --
Note payable, individual, unsecured, bearing
interest at 5.0%, due in monthly payments of
$5,064 through December 2003................... 328 -- --
Contract payable, unsecured, non-interest
bearing, due in estimated quarterly
installments through May 2003.................. 149 -- --
Incentive compensation agreements, due in
various estimated amounts plus interest at 6.0%
through January 2001 (See Note 11)............. 1,610 1,610 --
Other........................................... 72 -- --
-------- ------ ------
611,630 3,366 3,600
Less current maturities......................... 4,383 793 --
-------- ------ ------
$607,247 $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
F-13
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 4. PLEDGED ASSETS, DEBT AND SUBSEQUENT EVENT--(CONTINUED)
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%).
(C) The Company completed its merger with CCI on September 24, 1997 (See Note
11) and assumed the long-term debt of CCI and its subsidiaries, including
ICTC, a wholly owned subsidiary, Greene County Partners, Inc., a majority-
owned subsidiary, Consolidated Communications Directories Inc. ("CCD"), a
wholly owned subsidiary and Consolidated Market Response Inc. ("CMR"), a
wholly owned subsidiary.
(D) ICTC's first mortgage bonds are collateralized by substantially all real
and personal property of the subsidiary. The bond indenture contains
various provisions restricting, among other things, the payment of
dividends and repurchase of its own stock. Early redemption of the Series
K and Series L Bonds is permitted.
(E) CCI, CCD and CMR have various notes payable outstanding due in varying
amounts through May 2006. The various notes payable bear interest at rates
ranging from 3.00% to 8.00%.
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.
F-14
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 5. LEASES AND COMMITMENTS--(CONTINUED)
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 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 and June 1997, the
Federal Communications Commission (FCC) awarded the Company a total of 26 "D"
and "E" block frequency PCS licenses in 24 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
F-15
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 5. LEASES AND COMMITMENTS--(CONTINUED)
the markets covered by the licenses. The Company paid the FCC an aggregate of
approximately $32.8 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 $25.4 million on
May 12, 1997. The Company made a final payment for these licenses on July 11,
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>
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>
F-16
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
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 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
F-17
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 7. STOCK-BASED COMPENSATION PLANS--(CONTINUED)
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.
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.
F-18
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 7. STOCK-BASED COMPENSATION PLANS--(CONTINUED)
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-19
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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. In May 1997, the Company's stockholders approved an
additional increase in the authorized Class A common stock from 75,000,000
shares of $.01 par value stock to 250,000,000 shares of $.01 par value stock.
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. In May 1997, the Company's
stockholders approved the cancellation of the Class A preferred stock.
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 September
30, 1997, the Company has employment, confidentiality and noncompetition
agreements with 63 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 867,000 shares of Class A common stock, at exercise
prices ranging from $17.75 to $20.00 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
F-20
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 9. EMPLOYMENT AGREEMENTS--(CONTINUED)
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.
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
F-21
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 11. ACQUISITIONS--(CONTINUED)
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.
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 $3.9 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 $10.0 million.
ESI Communications, Inc. (ESI): On June 10, 1997, the Company acquired
substantially all of the assets of ESI and related entities for an aggregate
of approximately $15.2 million.
Smart Pages, Inc. and Yellow Pages Publishers, Inc. (Smart Pages): On
September 22, 1997, McLeodUSA Publishing acquired 2 telephone directories
published by Smart Pages, Inc. and Yellow Pages Publishers, Inc. ("Smart
Pages") at a purchase price to be determined based on the sum of the revenues
derived from the last Smart Pages editions of the directories. The purchase
price is currently estimated to be approximately $2 million.
Consolidated Communications, Inc. (CCI): On September 24, 1997, pursuant to
the terms and conditions of that certain Agreement and Plan of Reorganization
dated as of June 14, 1997 (the "Merger Agreement"), the Company issued
8,488,586 shares of Class A Common Stock and paid approximately $155 million
in cash to the shareholders of CCI in exchange for all of the outstanding
shares of CCI in a transaction accounted for using the purchase method of
accounting. The total purchase price was approximately $381.8 million based on
the average price of the Company's Class A Common Stock five days before and
after the date of the Merger Agreement. The purchase price includes
approximately $3.2 million of estimated direct acquisition costs.
F-22
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
IS UNAUDITED)
NOTE 11. ACQUISITIONS--(CONTINUED)
The following table summarizes the purchase price allocations for the
Company's business acquisitions:
<TABLE>
<CAPTION>
RUFFALO, MCLEODUSA INDIANA SMART
MWR CODY PUBLISHING TCSI DCI FRONTEER DIRECTORIES ESI PAGES CCI
------ -------- ---------- ---- ------ -------- ----------- ------- ------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cash purchase price..... $ -- $ 4,808 $74,060 $534 $ -- $ 1,500 $6,000 $15,228 $ 749 $155,000
Acquisition costs....... -- 243 436 -- 29 -- -- -- -- 3,207
Incentive agreements.... -- -- 1,610 -- -- -- -- -- -- --
Stock issued............ 8,333 8,945 -- -- 2,250 -- -- -- -- 223,675
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 $15,228 $ 749 $381,822
====== ======= ======= ==== ====== ======= ====== ======= ====== ========
Working capital
acquired, net.......... $ 393 $ 758 $ 8,367 $ 13 $ 543 $ -- $ -- $ 2,170 $ -- $40,999
Fair value of other
assets acquired,
primarily
telecommunications
networks and
equipment.............. 5,298 1,379 4,408 30 658 -- 150 493 -- 182,799
Intangibles, primarily
goodwill, customer
lists, and noncompete
agreements............. 2,642 15,160 64,315 491 1,118 3,900 9,881 13,336 1,973 239,627
Liabilities assumed..... -- -- (984) -- (40) (1,900) (4,031) (771) (1,124) (81,543)
Option agreement........ -- -- -- -- -- (500) -- -- -- --
Promissory note......... -- -- -- -- -- -- -- -- (100) --
------ ------- ------- ---- ------ ------- ------ ------- ------ --------
$8,333 $17,297 $76,106 $534 $2,279 $ 1,500 $6,000 $15,228 $ 749 $381,822
====== ======= ======= ==== ====== ======= ====== ======= ====== ========
</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>
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-23
<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-24
<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-25
<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-26
<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-27
<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-28
<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-29
<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-30
<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-31
<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-32
<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-33
<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 MI-
NORITY
INTEREST IN CONSOLIDATED SUBSIDI-
ARY................................ 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-34
<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-35
<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-36
<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-37
<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-38
<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-39
<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-40
<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-41
<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-42
<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-43
<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-44
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Consolidated Communications Inc.:
We have audited the accompanying consolidated balance sheets of CONSOLIDATED
COMMUNICATIONS INC. AND SUBSIDIARIES as of December 31, 1996 and 1995, and the
related consolidated statements of income, changes in 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 financial statements referred to above present fairly,
in all material respects, the financial position of Consolidated
Communications Inc. and Subsidiaries as of December 31, 1996 and 1995, and the
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Chicago, Illinois March 14, 1997
F-45
<PAGE>
CONSOLIDATED COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, -------------------------
1997 1996 1995
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents.............. $ 7,163,172 $ 7,138,847 $ 11,429,936
Securities, at market value............ 22,780,583 18,844,130 20,136,683
Government agency securities and
municipal bonds....................... -- -- 6,999,553
Accounts receivable, net of allowance
of $5,446,794, $6,526,319 and
$8,298,064, respectively.............. 63,138,607 60,939,615 50,770,132
Notes receivable....................... 446,507 488,222 336,821
Interest receivable.................... 118,575 107,502 165,296
Materials and supplies, at average
cost.................................. 1,806,012 2,207,305 1,769,770
Current deferred charges............... 8,031,355 5,906,719 4,143,074
Other current assets................... 942,816 1,346,194 1,613,169
------------ ------------ ------------
TOTAL CURRENT ASSETS................. 104,427,627 96,978,534 97,364,434
------------ ------------ ------------
INVESTMENTS
Long-term notes receivable............. 411,194 540,823 700,998
Intangible assets, net................. 21,830,163 23,343,126 14,339,770
Other investments, at market value..... 33,286,943 32,056,795 23,887,580
------------ ------------ ------------
TOTAL INVESTMENTS.................... 55,528,300 55,940,744 38,928,348
------------ ------------ ------------
OTHER NONCURRENT ASSETS................. 2,791,699 3,490,175 2,480,379
------------ ------------ ------------
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment in
service and under construction........ 298,887,358 286,361,288 254,359,637
Less accumulated depreciation.......... 150,950,906 140,102,870 130,432,019
------------ ------------ ------------
Net property, plant and equipment...... 147,936,452 146,258,418 123,927,618
------------ ------------ ------------
TOTAL ASSETS......................... $310,684,078 $302,667,871 $262,700,779
============ ============ ============
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Current maturities of long-term debt... $ 5,781,996 $ 5,805,126 $ 1,113,749
Accounts payable....................... 15,427,008 19,116,618 19,261,043
Advance billings and deferred
revenues.............................. 7,283,097 7,858,796 3,045,917
Accrued payroll and payroll related
liabilities........................... 10,471,173 10,909,040 9,125,009
Accrued network access costs........... 5,829,387 5,371,757 4,480,231
Other accrued liabilities.............. 10,891,684 11,871,570 14,234,761
Short-term notes payable............... 12,435,000 9,062,000 1,401,000
Deferred income taxes.................. 4,091,698 2,984,938 202,143
Other current liabilities.............. 253,958 237,208 947,358
------------ ------------ ------------
TOTAL CURRENT LIABILITIES............ 72,465,001 73,217,053 53,811,211
------------ ------------ ------------
DEFERRED CREDITS
Deferred pension liability............. 13,403,995 12,245,570 12,977,848
Unamortized investment tax credits..... 1,983,156 2,137,578 2,446,418
Deferred income taxes, net............. 18,814,122 17,274,155 15,282,529
Regulatory liabilities, net............ -- 126,940 338,652
Other deferred credits................. 8,300,072 6,936,064 3,578,107
------------ ------------ ------------
TOTAL DEFERRED CREDITS............... 42,501,345 38,720,307 34,623,551
------------ ------------ ------------
CAPITALIZATION
Long-term debt, excluding current
maturities............................ 60,375,233 61,366,056 57,625,668
------------ ------------ ------------
Preferred stock........................ 20,169,100 20,169,100 20,169,100
------------ ------------ ------------
Minority interest...................... 838,426 534,215 298,921
------------ ------------ ------------
Stockholders' equity
Common stock, par value $5; 5,000,000
shares authorized,
1,559,149 shares issued and
outstanding.......................... 7,795,745 7,795,745 7,795,745
Retained earnings..................... 100,522,489 96,670,266 85,177,943
Unrealized investment gain............ 6,016,739 4,195,129 3,198,640
------------ ------------ ------------
TOTAL STOCKHOLDERS EQUITY............ 114,334,973 108,661,140 96,172,328
------------ ------------ ------------
TOTAL CAPITALIZATION................. 195,717,732 190,730,511 174,266,017
------------ ------------ ------------
TOTAL LIABILITIES AND
CAPITALIZATION...................... $310,684,078 $302,667,871 $262,700,779
============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements.
F-46
<PAGE>
CONSOLIDATED COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED DECEMBER 31,
-------------------------- ----------------------------------------
JUNE 30, JUNE 30,
1997 1996 1996 1995 1994
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue................. $127,563,975 $117,185,946 $250,974,186 $217,789,132 $187,436,202
Operating expenses:
Cost of service....... 64,574,951 59,115,472 123,952,129 109,390,255 92,570,958
Selling, general and
administrative....... 41,052,503 37,218,972 79,714,187 64,521,699 55,787,926
Depreciation and
amortization......... 12,208,913 10,235,150 22,517,234 20,441,922 18,277,593
------------ ------------ ------------ ------------ ------------
Total operating
expenses........... 117,836,367 110,569,594 226,183,550 194,353,876 166,636,477
------------ ------------ ------------ ------------ ------------
Operating income.... 9,727,608 10,616,352 24,790,636 23,435,256 20,799,725
Nonoperating income
(expense):
Interest income....... 1,233,953 515,739 909,505 2,000,271 1,554,537
Interest (expense).... (2,834,395) (2,556,729) (4,689,023) (4,551,631) (2,729,733)
Gain on sale of
securities........... 667,901 588,586 2,798,154 939,332 14,052,816
Other income.......... 44,399 41,752 141,990 187,428 --
------------ ------------ ------------ ------------ ------------
Total nonoperating
income (expense)... (888,142) (1,410,652) (839,374) (1,424,600) 12,877,620
------------ ------------ ------------ ------------ ------------
Income before income
taxes.............. 8,839,466 9,205,700 23,951,262 22,010,656 33,677,345
Income taxes............ 3,095,010 3,902,783 8,861,559 7,718,767 13,150,814
------------ ------------ ------------ ------------ ------------
Net income.......... 5,744,456 5,302,917 15,089,703 14,291,889 20,526,531
Preferred dividends..... 855,405 855,405 1,710,810 1,845,258 97,416
------------ ------------ ------------ ------------ ------------
Net income available
to common stock.... $ 4,889,051 $ 4,447,512 $ 13,378,893 $ 12,446,631 $ 20,429,115
============ ============ ============ ============ ============
Earnings per common
share.................. $ 3.14 $ 2.85 $ 8.58 $ 7.98 $ 9.26
============ ============ ============ ============ ============
Weighted average common
shares outstanding..... 1,559,149 1,559,149 1,559,149 1,559,149 2,207,246
============ ============ ============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements
F-47
<PAGE>
CONSOLIDATED COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
AND THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
UNREALIZED
COMMON PAID-IN RETAINED INVESTMENT
STOCK CAPITAL EARNINGS GAIN TOTAL
----------- ---------- ------------ ---------- ------------
<S> <C> <C> <C> <C> <C>
Balance, January 1,
1994................... $11,336,995 $5,191,850 $ 66,532,660 $ -- $ 83,061,505
Add (Deduct):
Net income............ -- -- 20,526,531 -- 20,526,531
Dividends paid:
Common.............. -- -- (2,267,399) -- (2,267,399)
Preferred........... -- -- (97,416) -- (97,416)
Preferred stock
recapitalization (See
Note 6).............. (3,541,250) (5,191,850) (10,248,000) -- (18,981,100)
Unrealized gain on
securities (See Note
7)................... -- -- -- 2,225,027 2,225,027
----------- ---------- ------------ ---------- ------------
Balance, December 31,
1994................... 7,795,745 -- 74,446,376 2,225,027 84,467,148
Add (Deduct):
Net income............ -- -- 14,291,889 -- 14,291,889
Dividends paid:
Common.............. -- -- (1,715,064) -- (1,715,064)
Preferred........... -- -- (1,845,258) -- (1,845,258)
Unrealized gain on
securities (See Note
7)................... -- -- -- 973,613 973,613
----------- ---------- ------------ ---------- ------------
Balance, December 31,
1995................... 7,795,745 -- 85,177,943 3,198,640 96,172,328
Add (Deduct):
Net income............ -- -- 15,089,703 -- 15,089,703
Dividends paid:
Common.............. -- -- (1,886,570) -- (1,886,570)
Preferred........... -- -- (1,710,810) -- (1,710,810)
Unrealized gain on
securities (See Note
7)................... -- -- -- 996,489 996,489
----------- ---------- ------------ ---------- ------------
Balance, December 31,
1996................... 7,795,745 -- 96,670,266 4,195,129 108,661,140
Add (Deduct):
Net income
(Unaudited).......... -- -- 5,744,456 -- 5,744,456
Dividends paid
(Unaudited):
Common.............. -- -- (1,036,828) -- (1,036,828)
Preferred........... -- -- (855,405) -- (855,405)
Unrealized gain on
securities
(Unaudited).......... -- -- -- 1,821,610 1,821,610
----------- ---------- ------------ ---------- ------------
Balance, June 30, 1997
(Unaudited)............ $ 7,795,745 $ -- $100,522,489 $6,016,739 $114,334,973
=========== ========== ============ ========== ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements
F-48
<PAGE>
CONSOLIDATED COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED DECEMBER 31,
------------------------- ----------------------------------------
JUNE 30, JUNE 30,
1997 1996 1996 1995 1994
----------- ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net income............ $ 5,744,456 $ 5,302,917 $ 15,089,703 $ 14,291,889 $ 20,526,531
Add (deduct)
adjustments to
reconcile net income
to net cash provided
by operating
activities:
Depreciation and
amortization......... 12,208,913 10,235,150 22,517,234 20,441,921 18,277,591
Non-cash gain on
investment........... (2,114,843) 1,761,295 2,289,042 1,471,231 (9,143,512)
Other noncurrent
assets............... 698,476 (233,325) (1,009,796) 68,635 (859,920)
Deferred income
taxes................ 2,646,727 313,690 4,774,421 (1,792,817) (1,699,061)
Other deferred
credits, net......... 2,368,011 2,231,043 2,316,842 1,460,330 1,844,707
Changes in current
assets and
liabilities other
than cash:
Accounts and notes
receivable.......... (2,157,277) (4,609,052) (10,160,709) (6,749,891) (9,880,486)
Interest receivable.. (11,073) 104,574 57,794 (121,747) 22,238
Accounts payable..... (3,689,610) 392,238 (144,425) (4,040,611) (258,783)
Advanced billings and
deferred revenues... (575,699) 3,346,154 4,812,879 (2,584,228) (180,039)
Accrued liabilities.. (960,123) (2,256,966) 312,366 8,664,567 5,205,506
Other, net........... (996,315) (4,858,146) (2,620,773) (252,412) 1,239,677
----------- ------------ ------------ ------------ ------------
NET CASH PROVIDED BY
OPERATING
ACTIVITIES......... 13,161,643 11,729,572 38,234,578 30,856,867 25,094,449
CASH FLOWS USED IN
INVESTING ACTIVITIES:
Construction
expenditures, net.... (12,373,984) (16,448,821) (39,501,999) (24,452,192) (27,533,833)
Investment in
government agency
securities and
municipal bonds...... -- 6,999,553 6,999,553 (6,787,247) 3,496,757
Investment in cellular
radio................ (589,985) (1,113,582) (2,190,654) (771,015) (881,944)
Acquisition of
intangible assets.... -- (13,099,391) (14,349,391) (7,955,103) (3,750,000)
Other................. (640,163) (1,936,016) (5,978,561) 28,091 121,729
----------- ------------ ------------ ------------ ------------
NET CASH USED IN
INVESTING
ACTIVITIES......... (13,604,132) (25,598,257) (55,021,052) (39,937,466) (28,547,291)
CASH FLOWS PROVIDED BY
FINANCING ACTIVITIES:
Issuance (retirements)
of short-term notes
payable, net......... 3,373,000 (958,500) 7,661,000 (1,808,992) (7,307,530)
Issuance/acquisition
of long-term debt.... -- 18,000,000 18,000,000 23,101,700 12,150,000
Retirements of long-
term debt............ (1,013,953) (8,358,376) (9,568,235) (1,054,020) (3,780,509)
Common dividends
paid................. (1,036,828) (943,285) (1,886,570) (1,715,064) (2,267,399)
Preferred dividends
paid................. (855,405) (855,405) (1,710,810) (1,845,258) (97,416)
----------- ------------ ------------ ------------ ------------
NET CASH PROVIDED BY
FINANCING
ACTIVITIES......... 466,814 6,884,434 12,495,385 16,678,366 (1,302,854)
Net increase (decrease)
in cash and cash
equivalents........... 24,325 (6,984,251) (4,291,089) 7,597,767 (4,755,696)
Cash and cash
equivalents at
beginning of year..... 7,138,847 11,429,936 11,429,936 3,832,169 8,587,865
----------- ------------ ------------ ------------ ------------
Cash and cash
equivalents at end of
year.................. $ 7,163,172 $ 4,445,685 $ 7,138,847 $ 11,429,936 $ 3,832,169
=========== ============ ============ ============ ============
SUPPLEMENTAL
DISCLOSURES OF CASH
FLOW INFORMATION:
CASH PAID DURING THE
YEAR FOR:
Interest (net of
amount capitalized).. $ 2,821,502 $ 2,233,759 $ 5,381,578 $ 3,987,249 $ 2,581,771
=========== ============ ============ ============ ============
Income taxes.......... $ 1,936,085 $ 6,974,162 $ 8,285,102 $ 10,987,810 $ 9,982,212
=========== ============ ============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements
F-49
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS ORGANIZATION:
Consolidated Communications Inc. (the "Company" or "CCI") is a privately-
held group of communications-related enterprises. CCI was formed in 1984 when
the stockholders of Illinois Consolidated Telephone Company ("ICTC") exchanged
their stock for stock in CCI, and ICTC became a wholly-owned subsidiary of
CCI. The Company has expanded by developing several start-up subsidiaries and
by strategic acquisitions. Following is a brief description of the
subsidiaries (all wholly-owned) of CCI.
Illinois Consolidated Telephone Company--Began operations as Mattoon
Telephone Company in 1894, and provides local telephone service to over 88,000
customers in 3,000 square miles of rural Central Illinois. Operations are
subject to regulation by the Illinois Commerce Commission and the Federal
Communications Commission.
Consolidated Communications Telecom Services Inc. ("CCTS")--Former separate
subsidiaries, Central Communications Company (CCC), Consolidated Network Inc.
(CNI), Consolidated Communications Mobile Services Inc. (CCMS), Midwest
Fibernet Inc. (MFI), and a former division of CCI, Consolidated Communications
Business Systems (CCBS) were legally merged in 1996, forming CCTS. For
operating purposes, this organization also includes ICTC, Consolidated
Communications Operator Services ("CCOS") and Consolidated Communications
Public Services ("CCPS"), although ICTC, CCOS, and CCPS remain separate legal
entities. CCTS's major product streams currently offered include local service
(ICTC and Operation First Choice (OFC), CCI's nonregulated local and long
distance product offering); wireless (cellular and paging), business systems
(PBX, key systems, centrex, wiring and data equipment); carrier services
(private line, carrier direct termination, and 800 origination); university
services (retail and wholesale); long distance services (1+ calling, toll free
service, calling card); data network services (private line, frame relay,
internet); operator services (see CCOS); and inmate services/public
communications (see CCPS).
Consolidated Communications Directories Inc. ("CCD")--CCD was formed as a
subsidiary of CCI in 1985 to publish yellow page telephone directories for
small and medium size independent telephone companies. CCD has evolved to a
full service publisher of paper and electronic products, representing its own
product and other independent publisher products.
Consolidated Market Response Inc. ("CMR")--Formed as a subsidiary in 1988,
CMR (formerly Consolidated Telemarketing of America Inc.) is an integrated
marketing support company offering its clients a wide array of services. CMR's
client base and product mix have migrated from primarily telecommunications
companies providing outbound/inbound teleservices to more diverse industries
offering integrated market support services including teleservices,
fulfillment and data base management.
Consolidated Communications Operator Services Inc.--CCOS was created in 1988
to provide operator services to regional long distance companies. Other
products offered include message services and directory advertising services.
Consolidated Communications Public Services Inc.--CCPS began operations in
1989. CCPS's primary business is provision of telephone services to Illinois
state prisons. Current contracts with the State of Illinois Department of
Corrections expire in 1998, with mutual provisions for a two year extension
through 2000. Other business activities include competitive payphone services
and telephone services to the major county inmate facilities in CCI's
operating territory.
F-50
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Consolidated Communications Systems & Services Inc. ("CCSS")--CCSS was
formed in 1994 to serve the information technology needs of CCI's switch-based
service providers and to provide end-to-end billing and operational support
systems and services to the communications industry through strategic
relationships. Since mid-1995, CCSS has pursued the development of software
that would meet the current and anticipated needs of the converging
communications industry.
In addition to the wholly-owned subsidiaries described above, CCI has
controlling investments in Greene County Partners, Inc. and CCD/Scripps,
L.L.C. Greene County Partners, Inc. (85.23% ownership) provides cable TV
services to over 16,000 subscribers in rural South Central Illinois (home
office located in Springfield) and Benton Harbor, Michigan. CCD/Scripps,
L.L.C. (85% ownership) sells advertising in and publishes non-utility
directories in the geographic regions where Scripps Howard, Inc. or its
affiliates operate.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(a) Principles of Consolidation--
These financial statements have been consolidated to include the accounts of
CCI, its wholly-owned subsidiaries, ICTC, CCTS, CCD, CMR, CCOS, CCPS, and CCSS
and its controlling investments in CCD/Scripps, L.L.C. and Greene County
Partners, Inc. ICTC is represented under "Telephone" and CCD is represented
under "Directory." CCTS's long distance and competitive local service product
lines and CCPS are represented under "Long Distance" while CCTS's business
systems product line and all other subsidiaries make up "Other
Telecommunications." Significant intercompany accounts and transactions have
been eliminated in consolidation.
(b) Use of Estimates--
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reported period. Actual results could differ from those estimates.
(c) Regulatory Accounting--
ICTC prepares its financial statements in accordance with the provisions of
Statement of Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation" ("Statement No. 71"). The provisions
of Statement No. 71 require, among other things, that regulated enterprises
reflect rate actions of regulators in their financial statements, when
appropriate. These rate actions can provide reasonable assurance of the
existence of an asset, reduce or eliminate the value of an asset, or impose a
liability on a regulated enterprise. Statement No. 71 also specifies that the
actions of a regulator can eliminate only liabilities imposed by the
regulator.
(d) Cash and Cash Equivalents--
Cash and cash equivalents include cash and those short-term, highly liquid
investments with an original maturity of three months or less.
F-51
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(e) Property, Plant and Equipment--
Property, plant and equipment, which is stated at cost is summarized as
follows:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Regulated operations:
Telephone plant--
In service........................................ $186,864,240 $181,624,525
Under construction................................ 3,348,983 2,240,075
------------ ------------
190,213,223 183,864,600
------------ ------------
Accumulated depreciation............................ (97,831,250) (96,952,143)
------------ ------------
Total regulated operations.......................... 92,381,973 86,912,457
------------ ------------
Nonregulated operations............................. 96,148,065 70,495,037
Accumulated depreciation............................ (42,271,620) (33,479,876)
------------ ------------
Total nonregulated operations....................... 53,876,445 37,015,161
------------ ------------
Property, plant and equipment, net.................. $146,258,418 $123,927,618
============ ============
</TABLE>
When regulated property, plant and equipment are retired, the original cost,
net of salvage, is charged against accumulated depreciation. The cost of
maintenance and repairs of property, plant and equipment including the cost of
replacing minor items not constituting substantial betterments is charged to
operating expense.
When nonregulated property, plant and equipment are retired, the original
cost and accumulated depreciation are removed from the accounts and any
resultant gain or loss is included in income.
(f) Depreciation--
The provision for depreciation of telephone plant is based upon remaining
life rates for plant placed in service through 1980 and equal life group rates
for property additions placed in service after 1980. The regulated provision
is equivalent to annual composite rates of 5.54% and 5.83% for 1996 and 1995,
respectively.
The provision for depreciation of nonregulated property, plant and equipment
is recorded utilizing the straight-line method based on useful lives. The
average useful lives for assets included in nonregulated property, plant and
equipment are as follows:
<TABLE>
<S> <C>
Buildings......................................................... 20 years
Fiber cable....................................................... 15 years
Rights-of-way and switching equipment............................. 10 years
Optronics, test equipment and office furniture.................... 5 years
Computers......................................................... 3 years
</TABLE>
The Company's overall provision is equivalent to annual composite rates of
6.76% and 6.96% for 1996 and 1995, respectively.
F-52
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(g) Income Taxes--
CCI and its subsidiaries file a consolidated Federal income tax return.
The components of the income tax provision charged to expense are as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ----------- -----------
<S> <C> <C> <C>
Current--
Federal................................ $4,134,261 $ 8,702,277 $ 7,797,730
State.................................. 596,938 1,810,773 1,886,204
Deferred--
Federal................................ 3,463,538 (2,574,569) 3,179,888
State.................................. 975,662 124,388 638,137
Deferred, investment tax credits--
Amortized.............................. (308,840) (344,102) (351,145)
---------- ----------- -----------
$8,861,559 $ 7,718,767 $13,150,814
========== =========== ===========
Recorded as expense (benefit) applicable
to--
Telephone operations (including
nonoperating) $3,396,948 $ 2,611,728 2,850,506
Nonregulated operations.............. 4,869,383 5,167,390 4,816,247
Parent............................... 595,228 (60,351) 5,484,061
---------- ----------- -----------
$8,861,559 $ 7,718,767 $13,150,814
========== =========== ===========
</TABLE>
The components of the deferred income tax provision arising from temporary
differences are as follows:
<TABLE>
<CAPTION>
1996 1995
---------- -----------
<S> <C> <C>
Tax deductions over (under) book expenses--
Accelerated tax depreciation methods, net........... $1,002,496 $ 244,914
Bad debts........................................... 803,378 (1,000,797)
Pension and early retirement expenses............... 443,310 397,853
Other differences in telephone expense recognition
for tax purposes................................... (118,597) (1,071,661)
Differences in investment gain recognition.......... (35,792) (1,022,679)
Differences in revenue recognition.................. 1,839,603 624,020
Differences in recognition of partnership
investments........................................ 65,694 315,787
Other, net.......................................... 439,108 (937,618)
---------- -----------
$4,439,200 $(2,450,181)
========== ===========
</TABLE>
The following is a reconciliation between the statutory federal income tax
rate for each of the past two years and the Company's overall effective tax
rate:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Statutory federal income tax rate............................ 35.0% 35.0% 35.0%
State income taxes, net of federal benefit................. 4.1 6.2 5.0
Reduction in tax expense due to amortization of investment
tax credits............................................... (1.2) (1.4) (1.0)
Other...................................................... (0.9) (4.6) --
---- ---- ----
Effective overall income tax rate............................ 37.0% 35.2% 39.0%
==== ==== ====
</TABLE>
F-53
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The temporary differences which give rise to significant portions of the net
deferred tax liability at December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Deferred income tax assets (liabilities) related
to:
Pension and early retirement expenses............ $ 5,386,594 $ 5,772,862
Investment tax credits........................... 1,316,669 1,500,323
Computer software................................ 1,665,170 1,725,254
Bad debts........................................ 2,002,630 2,806,008
Depreciable property............................. (18,158,686) (17,058,972)
Differences in recognition of partnership
investments..................................... (3,533,503) (3,467,811)
Differences in recognition of gain on
investments..................................... (6,386,915) (6,112,811)
Other differences in expense recognition......... 6,926,686 6,988,610
Other differences in revenue recognition......... (9,477,738) (7,638,135)
------------ ------------
Net deferred income tax liability.................. $(20,259,093) $(15,484,672)
============ ============
</TABLE>
(h) Pension Costs and Other Postretirement Benefits--
The Company maintains noncontributory defined pension and death benefit
plans covering substantially all salaried and hourly employees. The pension
benefit formula used in the determination of pension cost is based on the
highest five consecutive calendar years' base earnings within the last ten
calendar years immediately preceding retirement or termination. It is the
Company's policy to fund pension costs as they accrue subject to any
applicable Internal Revenue Code limitations.
The components of pension costs for 1996, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Service costs--benefits earned during
the period............................ $ 2,195,383 $ 1,738,239 $ 1,787,867
Interest cost on projected benefit
obligation............................ 3,326,721 3,050,052 2,801,672
Actual return on plan assets........... (6,468,343) (8,542,802) (49,950)
Net amortization and deferral.......... 3,186,464 5,754,649 (2,857,495)
----------- ----------- -----------
Net pension cost..................... $ 2,240,225 $ 2,000,138 $ 1,682,094
=========== =========== ===========
</TABLE>
The funded status of the pension plans as of December 31, 1996 and 1995, is
as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Actuarial present value of accumulated benefit
obligation
Vested............................................ $45,744,319 $42,606,282
Nonvested......................................... 1,431,151 1,021,150
----------- -----------
Total........................................... 47,175,470 43,627,432
Additional benefits................................. 12,320,128 10,745,140
----------- -----------
Actuarial present value of projected benefit
obligation......................................... 59,495,598 54,372,572
Plan assets at fair value........................... 55,256,640 48,313,867
----------- -----------
Projected benefit obligation in excess of plan
assets............................................. 4,238,958 6,058,705
Unrecognized transition obligation.................. (130,928) (142,794)
Unrecognized prior service cost..................... (4,793,573) (5,008,336)
Unrecognized gain on assets......................... 12,931,113 12,070,273
----------- -----------
Accrued liability for pensions.................. $12,245,570 $12,977,848
=========== ===========
</TABLE>
F-54
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The assets of the plans consist principally of equity and fixed income
securities. Actuarial assumptions used to calculate the projected benefit
obligation were a 6% discount rate for 1996 and 1995 and 6.5% for 1994 and an
estimated 5% future compensation level increase in 1996, 1995 and 1994. The
assumed long-term rate of return on plan assets was 7% for 1996, 1995 and
1994.
In addition to providing pension benefits, the Company provides an optional
retiree medical program to its salaried and union retirees and spouses under
age 65 and life insurance coverage for the salaried retirees. All retirees are
required to contribute to the cost of their medical coverage while the
salaried life insurance coverage is provided at no cost to the retiree. Cash
payments were approximately $231,000, $315,000 and $223,000 in 1996, 1995 and
1994, respectively.
The components of postretirement benefit costs for 1996, 1995 and 1994 are
as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Service costs--benefits and earned during the
period...................................... $ 571,820 $ 501,315 $ 508,917
Interest cost on projected benefit
obligation.................................. 540,089 514,913 466,206
Actual return on plan assets................. -- -- --
Net amortization and deferral................ 373,737 370,734 387,463
---------- ---------- ----------
Net postretirement benefit cost............ $1,485,646 $1,368,962 $1,362,586
========== ========== ==========
</TABLE>
The funded status of the postretirement benefit plans as of December 31,
1996 and 1995 is as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Fair value of plan assets........................... $ -- $ --
Accumulated benefit obligation:
Retirees and beneficiaries........................ 2,044,545 2,333,879
Fully eligible active employees................... 948,280 894,604
Other active employees............................ 6,912,125 5,981,420
----------- -----------
Total accumulated postretirement benefit
obligation......................................... 9,904,950 9,209,903
Accumulated benefit obligation in excess of plan
assets............................................. 9,904,950 9,209,903
Unrecognized transition obligation (being amortized
over 20 years)..................................... (6,199,406) (6,586,869)
Unrecognized net gain............................... 731,521 690,963
----------- -----------
Accrued postretirement benefit cost................. $ 4,437,065 $ 3,313,997
=========== ===========
</TABLE>
The postretirement benefit obligation is calculated assuming that health-
care costs will increase by 11% in 1997, and that the rate of increase
thereafter (the health-care cost trend rate) will decline to 6.5% in 2005 and
subsequent years. The health-care cost trend rate has a significant effect on
the amounts reported for costs each year as well as on the accumulated
postretirement benefit obligation. For example, a one percentage point
increase each year in the health-care trend rate would increase the
accumulated postretirement benefit obligation as of December 31, 1997 by
approximately $1,046,000 and the aggregate of the service and interest cost
components of the net periodic postretirement benefit cost by approximately
$218,000. The weighted average discount rate used in determining the benefit
obligation was 6% in 1996 and 1995 and 6.5% in 1994.
(i) Toll and Access Service Revenues--
Beginning in 1984, a restructuring of toll revenues was put into place
through the use of carrier access and end-user charges which replaced the
"Bell System's toll settlement process" then in place.
F-55
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Currently, toll revenue is being provided through a combination of billed
carrier access charges; traditional end-user billed toll revenues; interstate
tariffed subscriber line charges; and ICTC's share of revenues/expenses from
the non-traffic sensitive pool administered by the National Exchange Carrier
Association.
As allowed by the FCC, ICTC's presubscribed rate of return on interstate
access revenues for 1996, 1995 and 1994 was 11.25%. The FCC further restricted
overall interstate revenues to a maximum 11.50% rate of return on related
investments, or to a maximum 11.65% rate of return on related investments per
any individual rate element.
Toll revenues for 1996, 1995 and 1994 have been recorded in amounts which,
in management's opinion, will be realized from ICTC's various tariffs and
other regulatory arrangements.
(j) Investments in Cellular Limited Partnerships--
Included in Other Investments is the Company's interest in cellular limited
partnerships ($20,802,252 and $18,611,598 as of December 31, 1996 and 1995,
respectively). The Company follows the equity method of accounting, which
recognizes the Company's proportionate share of the income and losses accruing
to it under the terms of its partnership agreements.
The Company sold its 4.07% interest in Southern Illinois RSA Partnership
D/B/A First Cellular of Southern Illinois in November 1996. The remaining
cellular investment is CCI's 95% interest in Midwest Cellular Associates,
which owns an approximately 27.4% interest in Illinois SMSA Limited
Partnership.
(k) Lines of Credit--
The Company has entered into short-term agreements with several banks for
lines of credit totaling $25,000,000 of which $9,000,000 in borrowings were
outstanding at December 31, 1996. These lines of credit are available to meet
short-term cash needs of the Company, with interest rates negotiable at time
of borrowing.
(l) Reclassification--
Certain items relating to prior years have been reclassified, with no effect
in net income or retained earnings to conform to the presentation in the
current year.
(m) Interim Financial Information (unaudited)--
The financial statements and notes related thereto as of June 30,1997, and
for the six-month periods ended June 30, 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.
(3) LONG-TERM DEBT, EXCLUDING CURRENT MATURITIES:
ICTC's first mortgage bonds are collateralized by substantially all real and
personal property. The Company has agreed, among other things, to deposit
annually with a trustee one percent of the
F-56
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
highest aggregate principal amount of Series G Bonds at any time outstanding
(with certain adjustments), to be used for the retirement of a portion of the
Series G Bonds outstanding. The Series K Bonds and Series L Bonds have no such
provisions. The bond indenture contains various restrictions including the
payment of dividends on common stock (except stock dividends) and purchase of
its own common stock. Early redemption of the Series G Bonds is permitted, at
the election of the Company, at prescribed dates and with prices ranging from
100.75% of par to 100.0% of par depending on the date of the redemption.
Series K Bonds and Series L Bonds provide for the early redemption of the
bonds by payment of the principal amount to be redeemed, any accrued interest
and a make-whole amount as described in the indenture. As a result of the
Series K Bond and Series L Bond issues, ICTC maintains that it will not
declare or pay any dividend or make any distributions, with certain
exceptions, that would reduce the retained earnings balance below $914,088.
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
First Mortgage Bonds:
Series G, 6.375%, due August 1, 1997.................... $ -- $ 3,550,000
Series K, 8.620%, due September 1, 2022................. 10,000,000 10,000,000
Series L, 7.050%, due October 1, 2013................... 10,000,000 10,000,000
----------- -----------
$20,000,000 $23,550,000
=========== ===========
</TABLE>
On October 11, 1994, CCI issued $10,000,000 of unsecured senior notes
payable (primarily used for the repayment of short term notes payable). These
notes will mature on October 1, 2004 and pay interest semiannually on April 1
and October 1 at the annual rate of 7.75%. No payments of principal are
required until October 1, 1998, at which time a principal payment of
$1,428,571 will be due. Principal payments in the same amount will then be
required each October 1 until the due date.
On December 6, 1995, CCI completed the issuance of $15 million senior notes
in the following denominations: $10 million of 6.83% Series A notes and $5
million of 6.71% Series B notes. Both series of notes mature on December 1,
2010 and pay interest semiannually in arrears on June 1 and December 1.
Additionally, Series A and Series B require annual principal payments of
$909,091 and $454,546, respectively, beginning on December 1, 2000.
Greene County Partners, Inc. used proceeds from the issuance of $18,000,000
(fully guaranteed by CCI) senior notes on February 27, 1996 to repay existing
debt and to partially fund the Benton Harbor properties purchase. The notes
have an interest rate of 6.35%, pay interest quarterly on January 1, April 1,
July 1 and October 1, and require principal payments of $450,000 on those same
dates, beginning with the July 1, 1996 payment. The notes mature on April 1,
2001.
The analysis below provides further detail of long-term debt balances as of
December 31, 1996:
<TABLE>
<S> <C>
ICTC............................................................ $20,000,000
CCD-Office Building............................................. 84,419
CMR............................................................. 881,637
CCSS............................................................ 100,000
Greene County Partners, Inc. ................................... 15,300,000
CCI-Parent...................................................... 25,000,000
-----------
Total long-term debt.......................................... $61,366,056
===========
</TABLE>
F-57
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Current maturities, including sinking fund payments, relating to long-term
debt at December 31 are as follows:
<TABLE>
<CAPTION>
YEAR MATURITIES
---- ----------
<S> <C>
1997........................................................... $5,805,126
1998........................................................... 3,467,992
1999........................................................... 3,287,491
2000........................................................... 4,655,324
2001........................................................... 4,659,820
</TABLE>
(4) PREFERRED STOCK:
Preferred stock of CCI consisted of the following at December 31:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
CCI preferred stock, cumulative, $100 par value, Series
A, 8.2%--40,000 shares authorized, 11,880 shares
outstanding........................................... $ 1,188,000 $ 1,188,000
CCI preferred stock, cumulative, $100 par value, Series
B, 8.5%--189,811 shares authorized and outstanding.... 18,981,100 18,981,100
----------- -----------
Total preferred stock................................ $20,169,100 $20,169,100
=========== ===========
</TABLE>
(5) LEASES:
The Company has entered into several operating lease agreements. The terms
of these agreements generally range from three to five years. As lessee, these
agreements relate to the leasing of: buildings and office space; office
equipment; rights-of-way necessary for installation of the fiber optic
network; land and pole use for the provisioning of cable TV service; and for
various components of the computing network used for providing information
technology services to external customers as well as providing the necessary
computing resources for CCI. Rental expense under operating leases was
$5,681,613, $3,703,366 and $2,638,924, in 1996, 1995 and 1994 respectively.
Future minimum lease payments under existing agreements for each of the next
five years ending December 31 are as follows:
<TABLE>
<CAPTION>
LEASE
YEAR PAYMENTS
---- ----------
<S> <C>
1997........................................................... $7,063,492
1998........................................................... 6,536,896
1999........................................................... 4,593,259
2000........................................................... 790,599
2001........................................................... 497,128
</TABLE>
(6) CCI STOCK CONVERSION:
On December 1, 1994, CCI converted 708,250 common shares to a Series B
preferred stock. Under the terms of the recapitalization, 189,811 shares of
Preferred Series B, par value $100, 8.5%, ($18,981,100) were issued. CCI
reduced common stock by $3,541,250 (708,250 X $5 par value), eliminated the
paid-in-capital balance of $5,191,850, and reduced retained earnings by
$10,248,000.
F-58
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(7) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Cash and cash equivalents--The carrying amount approximates fair value
because of the short maturity of those instruments.
Marketable securities--The fair value of these investments are estimated
based on quoted market prices for those or similar investments.
Notes receivable--The fair value of the Company's notes receivable is
estimated based on quoted market rates for the same or similar issues or on
current rates offered by the Company for loans with similar maturities.
Other investments--The fair value of some investments are estimated based on
quoted market prices or market studies for these of or similar investments.
For other investments for which there are no quoted market prices, a
reasonable estimate of fair value could not be made without incurring
excessive costs. The $25.9 million carrying amount of unquoted investments at
December 31, 1996, represents original cost of the investment, which
management believes is not impaired.
Notes payable--The fair value approximates the carrying value because of the
current borrowing rate equalling the stated rates. Notes payable primarily
reflect short-term notes that CCI-Parent has with a bank.
Long-term debt, including current maturities--The fair value of the
Company's long-term debt is estimated based on the quoted market rates for the
same or similar issues or on the current rates offered to the Company for debt
with similar maturities.
Options written--The fair value of the Company's short position in options
based on quoted market prices from organized security exchanges.
The estimated fair values of the Company's financial instruments at December
31, 1996 are as follows:
<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
----------- -----------
<S> <C> <C>
Cash and cash equivalents.......................... $ 7,138,847 $ 7,138,847
Marketable securities.............................. 18,844,130 18,844,130
Notes receivable................................... 1,029,045 1,057,791
Other investments:
Practicable to estimate fair value............... 6,196,726 6,196,726
Not practicable to estimate fair value........... 25,860,069 25,860,069
Notes payable...................................... (9,062,000) (9,062,000)
Long-term debt, including current maturities....... (67,171,182) (63,413,223)
Options written.................................... -- (4,100)
</TABLE>
CCI's marketable securities are all available-for-sale securities. The
unrealized gain, net of tax, of $4,195,129 is recorded as a separate component
of stockholders' equity.
F-59
<PAGE>
CONSOLIDATED COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(8) CONSTRUCTION COMMITMENTS:
Expenditures for the expansion of telephone plant and fiber network are
expected to total approximately $12,306,000 and $6,131,000, respectively,
during 1996.
(9) GAIN ON INVESTMENT SALES:
In 1996, CCI sold its interest in the Southern Illinois RSA Partnership
D/B/A First Cellular of Southern Illinois. The gain recognized from this sale
was $986,865.
On April 14, 1994, CCI's investment in Powerfone was exchanged for shares of
Nextel. Nextel acquired all outstanding shares of Powerfone. As a result, CCI
recognized a gain on the exchange of $34,946,041. Subsequently, Nextel's stock
value decreased, causing CCI to realize a loss on their investment at year end
of $19,791,950. These transactions, net of related expenses, resulted in a net
gain of $13,474,042. After the exchange, CCI sold shares of Nextel resulting
in a gain of $219,687, net of commission. Additionally, during 1994, CCI sold
covered call options of Nextel. None of the options were exercised and at year
end CCI had options outstanding which subsequently expired. As a result, CCI
recognized income from these sales of $275,591.
CCI sold other securities and recognized gains of $1,558,716, $1,038,056 and
$241,340 in 1996, 1995 and 1994 respectively.
F-60
<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 AFFAIRS OF THE COMPANY SINCE THE DATE AS OF
WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS. THIS PROSPECTUS DOES NOT CON-
STITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OF-
FER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Incorporation of Certain Documents by Reference.......................... iv
Summary.................................................................. 1
Risk Factors............................................................. 13
The Exchange Offer....................................................... 28
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........................................................... 44
Business................................................................. 54
Management............................................................... 90
Certain Transactions..................................................... 102
Principal Stockholders................................................... 105
Description of the Exchange Notes........................................ 107
Description of Other Indebtedness........................................ 140
Plan of Distribution..................................................... 141
Legal Matters............................................................ 141
Experts.................................................................. 141
Changes in Accountants................................................... 142
Available Information.................................................... 143
Glossary................................................................. G-1
Index to Consolidated Financial Statements............................... F-1
</TABLE>
$225,000,000
MCLEODUSA
INCORPORATED
9 1/4% SENIOR NOTES DUE 2007
[LOGO OF MCLEODUSA]
PROSPECTUS
DATED DECEMBER 1, 1997
