<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 10, 1997
REGISTRATION NO. 333-16947
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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USN COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 4813 36-3947804
(STATE OR OTHER
JURISDICTION OF
INCORPORATION OR
ORGANIZATION)
(PRIMARY STANDARD INDUSTRIAL CLASSIFICATION CODE NUMBER)
(I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
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10 SOUTH RIVERSIDE PLAZA,
SUITE 401
CHICAGO, ILLINOIS 60606
(312) 906-3600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICE)
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COPY TO:
THOMAS A. MONSON, ESQ.VICE PRESIDENT GARY P. CULLEN, ESQ.
AND GENERAL COUNSEL SKADDEN, ARPS, SLATE, MEAGHER & FLOM
(ILLINOIS)
USN COMMUNICATIONS, INC. 333 WEST WACKER DRIVE
10 SOUTH RIVERSIDE PLAZA, SUITE 401
CHICAGO, ILLINOIS 60606 CHICAGO, ILLINOIS 60606
(312) 906-3600 (312) 407-0700
(NAME, ADDRESS, INCLUDING ZIP CODE,
AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR
SERVICE)
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF SECURITIES TO PUBLIC:
From time to time after the effective date of this Registration Statement.
---------------
If any securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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PROSPECTUS
LOGO
USN COMMUNICATIONS, INC.
9% CONVERTIBLE SUBORDINATED DISCOUNT NOTES DUE 2004
WARRANTS TO PURCHASE CLASS A COMMON STOCK
CLASS A COMMON STOCK
This Prospectus relates to (i) $36.0 million in aggregate principal amount
at maturity of 9% Convertible Subordinated Discount Notes due 2004 (the
"Convertible Notes"), (ii) 48,500 warrants to purchase 61,550 shares, subject
to adjustment under certain circumstances, of Class A Common Stock, par value
$.01 per share (the "Class A Common Stock") of USN Communications, Inc.,
formerly United USN, Inc. (the "Company") at an initial exercise price of $.01
per share (the "Initial Warrants") and (iii) up to 330,047 shares of Class A
Common Stock which includes (a) up to 268,496 shares of Class A Common Stock
issuable upon conversion of the Convertible Notes (the "Convertible Note
Shares") and (b) 61,550 shares of Class A Common Stock issuable upon exercise
of the Initial Warrants (the "Warrant Shares") which may be offered for sale
from time to time by the selling securityholders (the "Selling
Securityholders"). See "Selling Securityholders." This Prospectus also relates
to the initial issuance of the Warrant Shares by the Company. The Convertible
Notes, the Initial Warrants, the Convertible Note Shares and the Warrant
Shares are collectively referred to herein as the "Securities." The Company
will not receive any proceeds from the sale of the Securities by the Selling
Securityholders but will receive proceeds upon the exercise of the Initial
Warrants of $.01 per share.
The Convertible Notes were issued pursuant to the terms of an indenture,
dated as of September 30, 1996 (the "Convertible Note Indenture"), by and
between the Company and Harris Trust and Savings Bank, as trustee (the
"Trustee"). The Convertible Note Indenture provides that the Convertible Notes
may be converted into Class A Common Stock at a conversion price of $134.08
per share (the "Conversion Price"), subject to adjustment under certain
circumstances described herein. See "Description of Securities--Convertible
Notes--Conversion Rights." The Convertible Note Indenture also provides that
the Convertible Notes will accrete interest at a rate of 9% per annum,
compounded semiannually, to an aggregate principal amount of $36.0 million by
September 30, 1999, and thereafter will bear interest at a rate of 9% per
annum which will be payable in cash semiannually. For the period from
September 30, 1996 until September 30, 1999, the number of shares into which
the Convertible Notes are convertible will increase as the interest on the
Convertible Notes accretes. On September 30, 1996, the Convertible Notes were,
in the aggregate, convertible into 206,179 shares of Class A Common Stock. On
September 30, 1999, the Convertible Notes will be, in the aggregate,
convertible into 268,497 shares of Class A Common Stock, assuming no
adjustment to the Conversion Price and no conversion of any Convertible Notes
prior to that date.
The Convertible Notes are senior unsecured obligations of the Company which
are subordinated in right of payment to $48.5 million in aggregate principal
amount of Senior Notes (as defined herein). Otherwise, the Convertible Notes
rank pari passu in right of payment to all existing and future senior
indebtedness of the Company. The Convertible Notes are effectively
subordinated to all existing and future liabilities and obligations of the
Company's subsidiaries (approximately $11.4 million as of December 31, 1996,
excluding intercompany indebtedness). The Company's subsidiaries have no
obligation to pay amounts due on the Convertible Notes and have not guaranteed
the Convertible Notes as of the date hereof; however, if a subsidiary
guarantees any other
(cover page continued on next page)
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SEE "RISK FACTORS," BEGINNING ON PAGE 12, FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS IN THE SECURITIES.
----------------
THE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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The date of this Prospectus is , 1997.
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(cover page continued from previous page)
indebtedness of the Company, such subsidiary will be obligated to guarantee
the Convertible Notes. See "Description of Securities--Convertible Notes--
Certain Covenants." The Senior Note Indenture (as defined herein) permits the
Company and its subsidiaries to incur, under certain circumstances, additional
indebtedness, including indebtedness pursuant to a Credit Facility (as defined
herein) which shall not exceed $45 million in principal amount at any one time
outstanding. See "Certain Other Indebtedness."
There is currently no established trading market for the Securities nor any
assurance that any such market may develop.
The sale and/or distribution of the Securities by the Selling
Securityholders may be effected from time to time through brokers, agents,
dealers or underwriters in one or more transactions (which may involve crosses
and principal trades, including block transactions), in special offerings,
exchange distributions or secondary distributions, or otherwise, at market
prices prevailing at the time of the sale, at prices related to such
prevailing market prices or at negotiated prices. To the extent required, the
specific Securities to be sold, the name of the Selling Securityholders, the
purchase price, the public offering price, the name of any such brokers,
agents, dealers or underwriters, and any applicable commission or discount
with respect to a particular offer will be set forth in an accompanying
Prospectus Supplement. See "Plan of Distribution."
Upon any sale of the Securities, the Selling Securityholders and the
participating agents, brokers or dealers may be deemed to be underwriters as
that term is defined in the Securities Act of 1933, as amended (the
"Securities Act"), and commissions or discounts or any profit realized on the
resale of such Securities held by them may be deemed to be underwriting
commissions or discounts under the Securities Act.
No underwriter is initially being utilized in connection with this offering.
The Company will pay all expenses incurred in connection with this offering,
other than fees and expenses of the Selling Securityholders. See "Plan of
Distribution."
Prior to the date of this Prospectus, there has been no public market for
the Securities. The Company does not currently intend to list the Securities
on any securities exchange or to seek approval for quotation through any
automated quotation system. Accordingly, there can be no assurance as to the
development or liquidity of any public market for the Securities.
The Securities were sold by the Company on September 30, 1996 to Smith
Barney Inc., BT Securities Corporation, Chase Securities Inc. and CIBC Wood
Gundy Securities Corp. (collectively, the "Initial Purchasers"), who placed
the Securities with an institutional investor. The Initial Purchasers received
customary compensation in connection with such private placement. See "Certain
Relationships and Related Transactions."
The Company has been advised by the Initial Purchasers that they intend to
make a market for the Securities; however the Initial Purchasers are not
obligated to do so. Any market-making may be discontinued at any time, and
there is no assurance that an active public market for the Securities will
develop or, that if such a market develops, that it will continue. This
Prospectus has been prepared for use by the Initial Purchasers in connection
with offers and sales of the Securities which may be made by them from time to
time in market-making transactions at negotiated prices relating to prevailing
market prices at the time of sale. Such Initial Purchasers may act as
principal or agent in such transactions. See "Plan of Distribution."
In connection with the issuance of the Convertible Notes and the Initial
Warrants by the Company on September 30, 1996, the Company also issued and
sold $48.5 million in aggregate principal amount at maturity of Senior Notes.
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AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 (the "Registration Statement") under the Securities Act with respect to
the Securities covered by this Prospectus. This Prospectus does not contain
all of the information set forth in the Registration Statement and the
exhibits and schedules thereto, certain portions of which have been omitted
pursuant to the rules and regulations of the Commission. Statements made in
this Prospectus as to the contents of any contract, agreement or other
document are not necessarily complete. With respect to each such contract,
agreement or other document filed or incorporated by reference as an exhibit
to the Registration Statement, reference is made to such exhibit for a more
complete description of the matter involved, and each such statement is
qualified in its entirety by such reference.
The Registration Statement and the exhibits and schedules thereto may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and will also be available for inspection and copying at the
regional offices of the Commission located at 7 World Trade Center, New York,
New York 10048 and at 500 West Madison Street (Suite 1400), Chicago, Illinois
60661. Copies of such material may also be obtained from the Public Reference
Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at
prescribed rates. The Commission maintains a web site (http://www.sec.gov)
that contains reports, proxy statements and other information regarding
registrants that file electronically with the Commission. Under the terms of
the Convertible Note Indenture and a warrant agreement, dated as of September
30, 1996 (the "Warrant Agreement"), by and between the Company and Harris
Trust and Savings Bank, as warrant agent (the "Warrant Agent"), the Company
will be required to file with the Commission, and to furnish holders of the
Convertible Notes and the Initial Warrants with, the information, documents
and other reports specified in Sections 13 and 15(d) of the Exchange Act,
including reports on Forms 10-K, 10-Q and 8-K.
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[INSERT MAP]
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and consolidated financial statements and related notes appearing
elsewhere in this Prospectus. Unless the context indicates otherwise, all
references to the Company refer to USN Communications, Inc. and its
subsidiaries. Please refer to the Glossary for the definitions of certain
capitalized terms used herein and elsewhere in this Prospectus without
definition.
THE COMPANY
USN Communications, Inc., formerly United USN, Inc. ("USN" or the "Company")
is a rapidly growing provider of integrated local and long distance
telecommunications services in the United States. The Company resells
telecommunications services of certain regional Bell operating companies
("RBOCs") and certain long distance carriers to provide an integrated solution
of local and long distance services to the underserved small and medium-sized
business segment. The Company primarily focuses its marketing efforts on
businesses with telecommunications usage of less than $5,000 per month. The
Company's approach simplifies the subscriber's telecommunications procurement
and management tasks and provides for the easy addition of customized services,
such as special local and long distance pricing and enhanced and other value-
added calling and billing features designed to meet specific subscriber needs.
The Company's goal is to be more flexible, innovative and responsive to the
needs of its subscribers than the RBOCs and the large long distance carriers,
which primarily concentrate their sales and marketing efforts on residential
and large commercial subscribers. Market research combined with the Company's
experience indicates that its target subscribers would prefer a single source
and single bill for all of their telecommunications needs. The Company provides
local service obtained from the incumbent RBOCs at wholesale rates, which
allows subscribers to switch to local service provided by the Company without
changing their existing telephone numbers or adding new facilities or
equipment. The Company provides long distance services by purchasing bulk
capacity from long distance carriers and reselling those services to the
Company's subscribers. By providing an integrated, customized package of local,
long distance and enhanced and other value-added services on a single bill
through its proprietary software and responsive subscriber care systems, the
Company believes that it provides a differentiated and competitive product.
The Company provides its local resold services pursuant to comprehensive
local exchange resale agreements with Ameritech Corporation ("Ameritech") for
the greater metropolitan Chicago area, Ohio and Michigan (collectively, the
"Ameritech Resale Agreements") and with NYNEX Corporation ("NYNEX") for the
states of New York and Massachusetts, (the "NYNEX Resale Agreements"). The
Company has also entered into a limited service offering ("LSO") agreement with
NYNEX for the resale of Centrex services over a private local network which
provides access to the majority of business lines in Manhattan, New York. After
a nine month systems test period with Ameritech, the Company commenced service
in Illinois in August 1996, followed by Ohio in October 1996. The Company
completed a systems test period in New York in October 1996 and started
offering service in November 1996. The Company began service in Michigan at the
end of 1996 and commenced service in Massachusetts in March 1997. Additionally,
the Company has contracted with certain long distance carriers, including MCI
Communications Corporation ("MCI") and Sprint Corporation ("Sprint") to provide
capacity for its long distance traffic. The Company continuously seeks to enter
into agreements with additional RBOCs, long distance carriers and enhanced and
other value-added service providers in order to aggressively build its
subscriber base as well as to provide additional services to its existing
subscribers while reducing costs.
The Telecommunications Act of 1996 (the "Telecommunications Act") is expected
to result in a fundamental change in the competitive structure of the local
exchange market, greatly accelerating changes that have been under way for
several years as a result of policy initiatives of the Federal Communications
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Commission ("FCC") and ongoing deregulatory trends at the state level.
Specifically, the Telecommunications Act lifted regulatory barriers to entry
into the local market, required the resale of local services by the RBOCs and
put in place various measures designed to further the development of a
competitive market, all of which benefit the Company.
On September 30, 1996, the Company consummated a private placement (the
"Private Placement") under Rule 144A of the Securities Act, pursuant to which
the Company issued and sold to Merrill Lynch Global Allocation Fund, Inc. (i)
48,500 Units consisting of $48.5 million aggregate principal amount at maturity
of 14% Senior Discount Notes due 2003 (the "Senior Notes" and, together with
the Convertible Notes, the "Notes") and Initial Warrants to purchase 61,550
shares, subject to adjustment under certain circumstances, of Class A Common
Stock, at an initial exercise price of $.01 per share, and (ii) $36.0 million
in aggregate principal amount at maturity of Convertible Notes. The aggregate
purchase price of the Units was $30,203,375, and the aggregate purchase price
of the Convertible Notes was $27,644,400. The Senior Notes were issued pursuant
to the terms of an indenture, dated as of September 30, 1996, (the "Senior Note
Indenture"), by and between the Company and Harris Trust and Savings Bank, as
trustee, and the Convertible Notes were issued pursuant to the terms of the
Convertible Note Indenture. The Senior Note Indenture and the Convertible Note
Indenture are collectively referred to herein as the "Indentures." The
Indentures provide that (i) in the event that, on or prior to March 30, 1998,
the Company does not consummate a Qualified Public Offering (as defined
herein), or has not been sold pursuant to a Qualified Sale of the Company (as
defined herein), the Company will be obligated to issue to the Holders of the
Senior Notes Senior Note Contingent Warrants (the "Senior Note Contingent
Warrants") exercisable for Class A Common Stock representing up to 3% of the
Common Stock of the Company on a fully diluted basis after giving effect to the
issuance of such Senior Note Contingent Warrants and (ii) in the event that, on
or prior to September 30, 1999, the Company does not consummate a Qualified
Public Offering or has not been sold pursuant to a Qualified Sale of the
Company, the Company will be obligated to issue to the Holders of the
Convertible Notes Convertible Note Contingent Warrants (the "Convertible Note
Contingent Warrants" and, together with the Senior Note Contingent Warrants,
the "Contingent Warrants") exercisable for Class A Common Stock representing up
to 2.5% of the Common Stock of the Company on a fully diluted basis after
giving effect to the issuance of such Convertible Note Contingent Warrants. In
addition, under certain conditions, if the Company has not consummated a
Qualified Public Offering or a Qualified Public Sale of the Company has not
occurred by September 30, 1997, the Company will be required to offer to
Holders of Convertible Notes the right to acquire additional convertible
securities and warrants (the "Additional Warrants"). See "Description of
Securities--Convertible Notes." On January 30, 1997, the Company commenced an
exchange offer pursuant to which the Company exchanged its 14% Series B Senior
Discount Notes due 2003 (the "New Senior Notes") for all outstanding 14% Senior
Discount Notes due 2003 (the "Old Senior Notes"). The terms of the New Senior
Notes are identical in all material respects to the Old Senior Notes, except
that the New Senior Notes have been registered under the Securities Act and,
therefore, do not bear legends restricting their transfer and do not contain
certain terms providing for an increase in the interest rate on the Old Senior
Notes under certain circumstances relating to the timing of the exchange offer
as provided by the Senior Note Indenture.
The Company, a Delaware corporation, was formed and commenced operations in
April 1994. The Company's principal executive office is located at 10 S.
Riverside Plaza, Suite 401, Chicago, Illinois 60606, and its telephone number
is (312) 906-3600.
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SUMMARY DESCRIPTION OF THE SECURITIES
THE CONVERTIBLE NOTES
Convertible Notes......... $36,000,000 aggregate principal amount at
maturity of 9% Convertible Subordinated
Discount Notes due 2004.
Maturity Date............. September 30, 2004.
Yield..................... 9% per annum (computed on a semiannual bond
equivalent basis) and calculated from September
30, 1996.
Interest.................. The Convertible Notes accrete interest at a
rate of 9%, compounded semiannually to an
aggregate principal amount of $36,000,000 by
September 30, 1999. Thereafter, the Convertible
Notes will bear interest at the rate of 9% per
annum and will be payable in cash semiannually
on March 30 and September 30 of each year,
commencing March 30, 2000. See "Description of
Securities--Convertible Notes--Principal,
Maturity and Interest."
Original Issue Discount... For federal income tax purposes, the
Convertible Notes are treated as having been
issued with "original issue discount" generally
equal to the difference between the issue price
of the Convertible Notes and the sum of all
payments (whether designated as principal or
interest) to be made thereon. Each holder of a
Convertible Note must include in gross income
for federal income tax purposes a portion of
such original issue discount for each day
during each taxable year in which it holds such
Convertible Note. See "Certain Federal Income
Tax Considerations."
Sinking Fund.............. None.
Optional Redemption....... The Convertible Notes are not redeemable, in
whole or in part, at any time prior to
September 30, 2000. At any time from September
30, 2000 to September 30, 2002, the Company may
redeem all but not less than all of the
Convertible Notes if the Price (as defined in
the Convertible Note Indenture) of the Common
Stock is at least 150% of the Conversion Price
for the Convertible Notes for 30 consecutive
days, at a redemption price equal to 100% of
the principal amount thereof plus accrued and
unpaid interest, if any, and Special Interest
(as defined herein), if any, to the date of
redemption; provided, that if the Common Stock
is not traded on a U.S. national securities
exchange or approved for trading on an
established automated over-the-counter trading
market in the United States and not quoted on a
consolidated transaction reporting tape, the
Convertible Notes will not be redeemable during
such period. Thereafter, the Company may
redeem, in whole or in part, the Convertible
Notes at a redemption price equal to 100% of
the principal amount thereof, plus accrued and
unpaid interest, if any, and Special Interest,
if any.
Conversion Rights and
Initial Conversion
Price....................
The Convertible Notes are convertible into
Class A Common Stock (the "Convertible Note
Shares"), at the option of the holders of
Convertible Notes prior to redemption or final
maturity of the Convertible Notes, initially at
a conversion price of $134.08 per share,
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subject to adjustment as described below and as
described in "Description of Securities--
Convertible Notes." The right to convert
Convertible Notes that have been called for
redemption will terminate at the close of
business on the business day preceding the
redemption date.
Adjustment of Conversion In the event that the Company consummates a
Price.................... sale or sales of any class of Capital Stock for
an amount, individually or in the aggregate, in
excess of $5,000,000 (each, a "Reset Event")
and at the time of such sale or sales, the
equity valuation of the Company is less than
$122,500,000 based upon such sale or sales,
then on the date of the consummation of any
such Reset Event (the "Reset Date"), the
Conversion Price shall be adjusted (the
"Conversion Reset") to equal 115% of the price
(the "Conversion Reset Price") at which such
sale or sales were consummated; provided, that
if such sale or sales are consummated more than
nine months after a Qualified Public Offering
at a total equity valuation of the Company of
at least $122,500,000, then no Conversion Reset
will be required. In the event that the
Conversion Price before such calculation shall
be equal to or less than the Conversion Reset
Price, then no additional adjustment to the
Conversion Price shall be made. See
"Description of Securities--Convertible Notes--
Conversion Rights." The Conversion Price may be
adjusted if Convertible Note Contingent
Warrants are issued in 1999. See "Description
of Securities--Convertible Notes--Issuance of
Contingent Warrants." The Conversion Price may
also be adjusted under certain conditions on or
prior to September 30, 1997 if the Company has
not consummated a Qualified Public Offering or
a Qualified Sale of the Company has not
occurred. See "Description of Securities--
Convertible Notes--Additional Invested Equity."
Ranking................... The Convertible Notes are senior, unsecured
subordinated obligations of the Company. The
Convertible Notes are subordinated in right of
payment to the Senior Notes. Otherwise, the
Convertible Notes rank pari passu in right of
payment with all other existing and future
unsecured indebtedness of the Company. The
Convertible Notes are effectively subordinated
to any secured indebtedness of the Company to
the extent of the value of the assets securing
such indebtedness. As a holding company that
conducts virtually all of its business through
subsidiaries, the Company currently has no
source of operating cash flow other than from
dividends and distributions from its
subsidiaries. The Company's subsidiaries have
no obligation to pay amounts due on the
Convertible Notes and will not guarantee the
Convertible Notes; provided, that if a
subsidiary guarantees any Indebtedness of the
Company, such subsidiary will be obligated to
guarantee the Convertible Notes. Therefore, the
Convertible Notes are effectively subordinated
to all liabilities of the Company's
subsidiaries, including trade payables. Any
rights of the Company and its creditors,
including the holders of the Convertible Notes,
to participate in a distribution of the assets
of any of the Company's subsidiaries upon any
liquidation or reorganization of any such
subsidiary are subject to the prior claims of
that subsidiary's creditors (including trade
creditors). See "Risk
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outstanding Common Stock for a purchase price
of $.01 per share on a fully diluted basis
(subject to certain exceptions) after giving
effect to the issuance of such warrants, and
(iii) adjust the Conversion Price by dividing
the Conversion Price in effect immediately
prior to the issuance of such convertible
securities and warrants by 1.15.
Certain Covenants......... The Convertible Note Indenture contains certain
limited covenants which, among other things,
restrict the ability of the Company and certain
of its subsidiaries to sell assets or engage in
mergers or acquisitions. In addition, the
Convertible Note Indenture imposes
limits on the ability of certain of the
Company's subsidiaries to issue guarantees. See
"Description of Securities--Convertible Notes--
Certain Covenants," "--Assets Sales" and "--
Consolidation, Merger, Conveyance, Lease or
Transfer."
Registration Rights....... Under the terms of a registration rights
agreement dated as of September 30, 1996 by and
between the Company and the Initial Purchasers
(the "Registration Rights Agreement"), the
Company is required to keep the Registration
Statement of which this Prospectus forms a part
effective for a specified period. See
"Registration Rights."
For additional information concerning the Convertible Notes, see "Description
of Securities--Convertible Notes."
THE INITIAL WARRANTS
Initial Warrants.......... Initial Warrants, which, when exercised, would
entitle the holders thereof to purchase, in the
aggregate, 61,550 shares of Class A Common
Stock (equal to approximately 12% of the
outstanding shares of the Common Stock, on a
fully diluted basis as of the date of this
Prospectus).
Expiration of Warrants.... September 30, 2003 (the "Expiration Date").
Exercise.................. Each Initial Warrant entitles the holder
thereof to purchase approximately 1.27 shares
of Class A Common Stock (subject to adjustment
as described herein) at an initial exercise
price of $.01 per share. The Initial Warrants
may be exercised at any time beginning 180 days
after the date of original issuance thereof or
earlier upon the occurrence of certain
circumstances and on or prior to the Expiration
Date. See "Description of Securities--Initial
Warrants--Certain Terms."
Adjustments............... The number of shares of Class A Common Stock
for which an Initial Warrant is exercisable and
the purchase price thereof are subject to
adjustment from time to time upon the
occurrence of certain events, including, among
other things, certain issuances of options or
convertible securities, certain dividends and
distributions and certain changes in options
and convertible securities. An Initial Warrant
does not entitle the holder thereof to receive
any dividends paid on Class A Common Stock.
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Registration Rights....... Under the terms of the Registration Rights
Agreement, the Company is required to keep the
Registration Statement of which this Prospectus
forms a part effective for a specified period.
See "Registration Rights."
For additional information concerning the Initial Warrants, see "Description
of Securities--Initial Warrants."
THE CLASS A COMMON STOCK
Class A Common Stock...... 330,047 shares of Class A Common Stock of the
Company, par value $.01 per share.
Convertible Note Shares...
268,496 shares of Class A Common Stock available
for issuance by the Company upon conversion of the
Convertible Notes by the holders thereof.
Warrant Shares............ 61,550 shares of Class A Common Stock available for
issuance by the Company upon exercise of the
Initial Warrants by the holders thereof.
Voting Rights............. Shares of Class A Common Stock are entitled to one
vote per share on all matters submitted to a vote
of the stockholders.
Dividends................. Holders of Class A Common Stock have the right to
receive dividends when and as dividends are
declared by the Board of Directors of the Company,
subject to the rights of any holders of preferred
stock. See "Description of Capital Stock." The
Company intends to retain its earnings, if any, and
therefore does not anticipate paying dividends in
the foreseeable future. See "Dividend Policy." In
addition, the Senior Note Indenture includes
significant limitations on the Company's ability to
pay dividends to the holders of Common Stock. See
"Certain Other Indebtedness."
Conversion Rights......... Holders of Class A Common Stock have the right to
convert their shares of Class A Common Stock into
shares of Class B Common Stock on a one-to-one
basis at any time.
Liquidation Rights........ Upon any liquidation, dissolution or winding up of
the affairs of the Company, whether voluntary or
involuntary, any assets remaining after
satisfaction of the rights of creditors and the
rights of any holders of preferred stock will be
distributed to the holders of Common Stock. See
"Description of Capital Stock."
Registration Rights....... Under the terms of the Registration Rights
Agreement, the Company is required to keep the
Registration Statement of which this Prospectus
forms a part effective for a specified period. See
"Registration Rights."
For additional information concerning the Class A Common Stock, see
"Description of Capital Stock."
RISK FACTORS
Prospective investors in the Securities should carefully consider the matters
set forth under the caption "Risk Factors" prior to making a decision
concerning whether to purchase such Securities.
10
<PAGE>
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
The following summary historical consolidated financial data for the periods
from inception of the Company in April 1994 to December 31, 1994 and for the
fiscal years ended December 31, 1995 and December 31, 1996 was derived from,
and should be read in conjunction with, the consolidated audited financial
statements of the Company and the related notes thereto included elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
INCEPTION TO DECEMBER 31,
DECEMBER 31, ------------------
1994 1995 1996
------------ -------- --------
(IN THOUSANDS, EXCEPT PER SHARE
INFORMATION AND RATIOS)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net service revenue..................... $ 1,737 $ 7,884 $ 9,814
Cost of services........................ 1,455 9,076 9,256
-------- -------- --------
Gross margin............................ 282 (1,192) 558
Sales and marketing expense............. 2,869 5,867 12,612
General and administrative expense...... 4,686 11,100 20,665
Interest expense........................ 26 734 1,797
Interest and other income (1)........... 152 646 9,469
Minority interest....................... -- 150 --
-------- -------- --------
Net loss................................ $ (7,147) $(18,097) $(25,047)
======== ======== ========
Accumulated unpaid preferred dividends.. $ 707 $ 3,810 $ 225
Net loss to common shareholder.......... $ (7,854) $(21,907) $(25,272)
Net loss per common share............... $ (65.63) $ (72.42) $ (49.53)
Weighted average shares outstanding..... 119,678 302,520 510,233
<CAPTION>
DECEMBER 31,
-------------------------------
1994 1995 1996
------------ -------- --------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............... $ 5,979 $ 13,705 $ 60,569
Total assets............................ 12,747 20,471 78,052
Long-term debt (net of current
maturities)............................ 3,176 518 59,864
Redeemable preferred stock.............. 15,306 44,396 10,045
Common stockholders' deficit............ (7,830) (28,768) (3,606)
<CAPTION>
FISCAL YEAR ENDED
INCEPTION TO DECEMBER 31,
DECEMBER 31, ------------------
1994 1995 1996
------------ -------- --------
(IN THOUSANDS, EXCEPT PER SHARE
INFORMATION AND RATIOS)
<S> <C> <C> <C> <C>
OTHER DATA:
EBITDA (2).............................. $ (7,087) $(15,901) $(30,390)
Cash flows from Operating Activities.... (6,141) (14,308) (24,098)
Cash flows from Investing Activities.... (1,708) (2,556) 7,274
Cash flows from Financing Activities.... 13,828 24,589 63,689
Depreciation and amortization........... 186 2,258 2,329
Capital expenditures.................... 1,728 1,740 2,259
Ratio of earnings to fixed charges (3).. -- -- --
</TABLE>
- --------
(1) Interest and other income for the year ended December 31, 1996 includes a
gain of $8.1 million realized on the sale of the Company's switching
facilities in Ohio.
(2) EBITDA consists of operating income before depreciation and amortization.
While EBITDA should not be construed as a substitute for operating income
or a better indicator of liquidity than cash flow from operating
activities, which are determined in accordance with generally accepted
accounting principles, EBITDA is included because management believes that
certain investors find it to be a useful tool for measuring the ability of
the Company to service its debt. EBITDA is not necessarily a measure of the
Company's ability to fund its cash needs. See the Consolidated Statements
of Cash Flows of the Company and the related notes to the Consolidated
Financial Statements thereto included herein.
(3) The ratio of earnings to fixed charges is computed by dividing pretax
income (loss) from operations before interest charges by interest expense.
Earnings were insufficient to cover fixed charges for the periods ended
December 31, 1994, 1995 and 1996 by $7.0 million, $16.8 million and $22.6
million, respectively.
11
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, prospective
investors in the Securities should consider carefully the following factors.
NEGATIVE CASH FLOW AND OPERATING LOSSES; LIMITED OPERATING HISTORY
The Company has experienced pre-tax operating losses from its inception in
April 1994 through the date of this Prospectus, excluding the effect of a one-
time non-recurring gain, and has, to date, not generated positive cash flow.
For the nine months ended December 31, 1994 and the fiscal year ended December
31, 1995, the Company's pre-tax operating losses were $7.1 million and $18.1
million, respectively. These operating losses were primarily the result of the
one-time installation costs and fixed ongoing costs related to switching
facilities of the Company which were sold in February 1996, and the sales and
marketing and general and administrative expenses required to build the
Company's sales, customer, management information and marketing
infrastructure. Excluding an $8.1 million non-recurring gain on the sale of
such switching facilities, the Company would have lost $33.1 million for the
fiscal year ended December 31, 1996. The Company expects to realize additional
operating losses on a consolidated basis while it continues to expand and
develop its service offerings and its subscriber base. There can be no
assurance that the Company will be able to develop or expand its subscriber
base or that it will achieve profitability in future years.
The Company has a limited operating history. Prospective investors,
therefore, have limited historical financial information about the Company
upon which to base an evaluation of its performance and an investment in the
Securities. Given the Company's limited operating history, there can be no
assurance that the Company will be able to achieve or sustain positive cash
flow from operating activities or to implement its growth strategy.
SUBSTANTIAL LEVERAGE
The Company has and will continue to have consolidated indebtedness that is
substantial in relation to its stockholders' equity. As of December 31, 1996,
the Company had $59.9 million principal amount of long-term debt and a
stockholders' deficit of $3.6 million. See "Capitalization." Pursuant to the
terms of the Indentures, the Company has the ability to issue an additional
$72.0 million in aggregate principal amount at maturity of Senior Notes and an
additional $3.1 million in aggregate principal amount at maturity of
Convertible Notes, thus enabling the Company to issue additional indebtedness
in the amount of $75.1 million. As of the date hereof, it cannot be predicted
whether the Company will issue additional Senior Notes or Convertible Notes.
The Company's ability to make cash payments with respect to the Convertible
Notes, to repay its obligations on the Convertible Notes at maturity and to
satisfy its other debt obligations will depend on its future operating
performance, which will be affected by prevailing economic conditions and
financial, business and other factors, certain of which are beyond the
Company's control. The Company believes that the Company's cash flow will be
sufficient to permit the Company to meet its operating expenses and to service
its debt requirements as they become due. Significant assumptions underlie
this belief, including, among other things, that (i) the Company will succeed
in implementing its business strategy and (ii) there will be no material
adverse developments in the business, liquidity or capital requirements of the
Company. However, because the Company currently has a consolidated cash flow
deficit, there can be no assurance that the Company will be able to make cash
interest payments on the Convertible Notes commencing in 2000 or to repay its
obligations on the Convertible Notes. See "Description of Securities--
Convertible Notes." The issuance by the Company of additional Notes would
affect the Company's ability to make cash payments with respect to the
Convertible Notes, to repay its obligations on the Convertible Notes at
Maturity and to satisfy its other debt obligations. The Senior Note Indenture
will permit the Company and its subsidiaries to incur additional Indebtedness
under certain circumstances, including up to $45.0 million under a Credit
Facility, $30.0 million of which may be secured. If the Company is unable to
service its indebtedness, it will be forced to examine alternative strategies
that may include actions such as reducing or delaying capital expenditures,
restructuring or refinancing its indebtedness, the sale of assets or of the
Company's ownership interest in its subsidiaries or seeking additional equity
and/or
12
<PAGE>
debt financing. There can be no assurance that any of these strategies could
be effected on satisfactory terms, if at all. In addition, pursuant to the
terms of the Senior Note Indenture, the ability of the Company to sell assets
is restricted. See "Description of the Securities--Convertible Notes--Asset
Sales."
FUTURE CASH OBLIGATIONS
Since inception, the Company's consolidated cash flow from operations has
been negative. As a result, the Company has financed fixed charges (including
interest on existing indebtedness) and operating expenses with the proceeds
from private sales of its equity securities. Pursuant to the terms of the
Convertible Notes, the Company will, at such time as interest is payable on
the Convertible Notes, be required to satisfy substantially higher periodic
cash debt service obligations. Commencing September 30, 1999, cash interest on
the Convertible Notes will accrue semiannually at the rate of 9% per annum
(approximately $3.2 million per year). The fully accreted principal amount of
the Convertible Notes of $36.0 million, will become due on September 30, 2004.
In addition, commencing March 30, 2000, cash interest on the Senior Notes will
accrue semiannually at the rate of 14% per annum (approximately $6.8 million
per year), and the fully accreted principal amount of the Senior Notes of
$48.5 million will become due on September 30, 2003. Many factors, certain of
which are beyond the Company's control, will affect its performance and,
therefore, its ability to meet its ongoing obligations to repay the
Convertible Notes and other debt. There can be no assurance that the Company
will be able to generate sufficient cash flow or otherwise obtain funds in the
future to cover interest and principal payments associated with the
Convertible Notes and its other debt obligations. See "Dividend Policy."
HOLDING COMPANY STRUCTURE; SOURCE OF REPAYMENT OF CONVERTIBLE NOTES; EFFECTIVE
SUBORDINATION OF CONVERTIBLE NOTES TO INDEBTEDNESS OF SUBSIDIARIES
As a holding company that conducts virtually all of its business through
subsidiaries, the Company has no source of operating cash flow other than from
dividends and distributions from its subsidiaries. In order to pay cash
interest on the Convertible Notes and to repay the principal amount of the
Convertible Notes at maturity, or to redeem or repurchase the Convertible
Notes, the Company will be required to obtain dividends or distributions from
its subsidiaries, refinance its indebtedness or raise funds in a public or
private equity or debt offering. However, the Indentures limit the Company's
ability to incur additional indebtedness.
If the Company is required to conduct an offering of its capital stock or to
refinance the Convertible Notes, its ability to do so on acceptable terms, if
at all, will be affected by several factors, including financial market
conditions and the value and performance of the Company at the time of such
offering or refinancing, which in turn may be affected by many factors,
including economic and industry cycles. There can be no assurance that an
offering of the Company's capital stock or a refinancing of the Convertible
Notes can or will be completed on satisfactory terms, that such offering or
refinancing would be sufficient to enable the Company to make any payments
with respect to the Convertible Notes if required or that such offering or
refinancing would be permitted by the terms of the debt instruments of the
Company and its subsidiaries then in effect.
The Senior Notes are senior obligations of the Company, pari passu in right
of payment with certain other indebtedness of the Company and not secured by
any assets of the Company or its subsidiaries. The Convertible Notes are
subordinated to the Senior Notes. Otherwise, the Convertible Notes are pari
passu in right of payment with certain other indebtedness of the Company and
are not secured by any assets of the Company or its subsidiaries. The Senior
Note Indenture permits the Company to enter into a Credit Facility under which
the Company may incur up to $45.0 million of Indebtedness, $30.0 million of
which may be secured. If such Indebtedness is secured, the Convertible Notes
will be effectively subordinated to such Indebtedness to the extent of the
value of the assets securing such Indebtedness. The Company's subsidiaries
have no obligation to pay amounts due on the Convertible Notes and have not
guaranteed the Convertible Notes as of the date hereof; however, if a
subsidiary guarantees any Indebtedness of the Company, such subsidiary will be
obligated to guarantee the Convertible Notes. See "Description of Securities--
Convertible Notes--Certain Covenants" and "--Limitation on Issuances of
Guarantees by Restricted Subsidiaries." Therefore, the Convertible Notes, if
not guaranteed in the future, will be effectively subordinated to all existing
liabilities of the Company's subsidiaries,
13
<PAGE>
including trade payables. As of December 31, 1996, the total liabilities of
the Company's subsidiaries (after the elimination of loans and advances by the
Company to its subsidiaries) on a combined consolidated basis were
approximately $11.4 million. Pursuant to the Senior Note Indenture, the
Company's subsidiaries will not be able to incur Indebtedness other than $5
million of vendor financing and guarantees of the Credit Facility and the
Company's subsidiaries may guarantee the Company's obligations under the
Credit Facility. Any rights of the Company and its creditors, including the
holders of the Convertible Notes, to participate in a distribution of 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.
SUBORDINATION OF CONVERTIBLE NOTES
The Convertible Note Indenture does not permit the creation of any class of
Indebtedness other than the Senior Notes that will rank senior to the
Convertible Notes. By reason of the subordination of the Convertible Notes, in
the event of insolvency, bankruptcy, liquidation,, reorganization, dissolution
or winding up of the business of the Company or upon a default in payment with
respect to the Senior Notes or an event of default with respect to the Senior
Notes resulting in the acceleration thereof, the assets of the Company will be
available to pay the amounts due on the Convertible Notes only after all
Senior Notes have been paid in full or provision for such payment has been
made. In addition, holders of the Convertible Notes are effectively
subordinated to the claims of all existing and future third party liabilities
(including trade payables and other non-debt obligations) of the subsidiaries
of the Company, to the extent of the assets of such subsidiaries. In the event
of the insolvency, bankruptcy, liquidation, reorganization, dissolution or
winding up of the business of any subsidiary of the Company, creditors of such
subsidiary generally will have the right to be paid in full before any
distribution is made to the Company or the holders of the Convertible Notes.
See "Description of Securities--Convertible Notes--Subordination of
Convertible Notes."
In general, the covenants relating to the Convertible Notes are considerably
more limited in scope than the covenants in the Senior Note Indenture and
hence afford the holders of the Convertible Notes commensurately less
protection. While the Convertible Note Indenture contains a cross-default
provision to the Senior Note Indenture, the response by the holders of the
Convertible Notes to any default will largely be dictated by the response of
the holders of the Senior Notes, including any waiver or de-acceleration on
their part. See "Description of Securities--Convertible Notes--Events of
Default."
DEPENDENCE ON RELATIONSHIP WITH THIRD PARTY FACILITIES-BASED PROVIDERS
The Company does not own any part of a local exchange network or a long
distance network. As a result, the Company depends entirely on facilities-
based carriers for the transmission of subscriber phone calls. For each local
exchange market in which the Company operates, there currently is a single
provider from whom the Company can purchase local exchange services. Under the
Telecommunications Act, the Company is entitled to access to local exchange
services in such markets. Although the Company believes that its relations
with its underlying carriers are good, the termination of any of the Company's
contracts with its carriers or a reduction in the quality or increase in cost
of such carriers' services could have a material adverse effect on the
Company's results of operations. In addition, the accurate and prompt billing
of the Company's subscribers is dependent upon the timeliness and accuracy of
call detail records provided by the carriers whose service the Company
resells. There can be no assurance that the current carriers will continue to
provide, or that new carriers will provide, accurate information on a timely
basis, the failure of which could have a material adverse effect on the
Company's results of operations. In particular, there were a number of
provisioning and billing difficulties related to the local and long distance
services provided to business subscribers in Manhattan, New York pursuant to
the NYNEX LSO agreement. The problems included failure to provision
subscribers, losing subscriber traffic information and subscribers receiving
multiple billings for the same service. Much of the difficulty was due to the
nature of the private local network with dedicated facilities designed for
resale purposes. NYNEX required the services of a third party billing vendor
to help implement the billing portion of the arrangement. The Company has now
contracted directly with that vendor for billing and systems support in order
to avoid problems
14
<PAGE>
associated with such provisioning. However, because other RBOCs with which the
Company may enter into agreements do not have significant experience handling
large volumes of resold local exchange traffic, there can be no assurance as
to the quality of the service that the Company will receive or that similar
problems will not occur.
In addition, physical damage, power loss and software defects of the RBOCs
may cause interruption in service and/or reduced capacity for the Company's
subscribers. In the event that the Company's long distance carriers are unable
to handle the growth in subscriber usage, the Company could transfer such
traffic to a carrier that had sufficient capacity, but there can be no
assurance that additional capacity will be available. If any of the LECs are
unable to handle the provisioning or growth in subscriber usage, then the
Company would be required to use another local carrier, which could be
difficult in light of the limited development of facilities-based competitive
local exchange networks. In the event the Company otherwise elects to use
other carriers, the charges for such services may exceed those under the
existing contracts, which could have a material adverse effect on the
Company's financial condition and results of operations. See "Business--Vendor
Agreements."
COMPETITION
The Company operates in a highly competitive environment and has no
significant market share in any market in which it operates. The Company
expects that competition will intensify in the future due to regulatory
changes, including the enactment of the Telecommunications Act and the
increase in the size, resources and number of market participants. In each of
its markets, the Company faces competition for local service from larger,
better capitalized incumbent providers, including providers from whom the
Company purchases local exchange and long distance services, many of whom have
greater financial resources than the Company. Additionally, the long distance
market is significantly more competitive than the local exchange market
because the RBOC's have historically had a monopoly position within the local
exchange market. The incumbent LECs have long-established relationships with
their subscribers and provide those subscribers with various transmission and
switching services that the Company, in many cases, has only recently begun to
offer.
In the local exchange market, the Company also faces competition or
prospective competition from one or more CAPs, which have significantly
greater financial resources than the Company, and from other competitive
providers, including non-facilities-based providers like the Company. For
example, AT&T, MCI and Sprint, among other carriers, have each begun or
indicated their intention to begin offering local telecommunications services
in major U.S. markets using their own facilities or by resale of the LECs' or
other providers' services. In fact, certain competitors, including MCI, Sprint
and AT&T, have entered into interconnection agreements with Ameritech with
respect to the States of Illinois, Michigan and Ohio. These competitors either
have begun or will in the first half of 1997 likely begin offering local
exchange service in those states, subject to the joint marketing restrictions
under the Telecommunications Act described below. In addition, some of these
competitors have entered into interconnection agreements with NYNEX and either
have begun or in the first half of 1997 will likely begin offering local
exchange service in New York and Massachusetts, subject to such joint
marketing restrictions. In addition to these long distance service providers,
entities potentially capable of offering competitive switched services include
CAPs, cable television companies, electric utilities, other long distance
carriers, microwave carriers, wireless telephone system operators and large
subscribers who build private networks. Many facilities-based CAPs and long
distance carriers, for example, have committed substantial resources to
building their networks. By building a network, a facilities-based provider
can enter the local exchange market by using its own network or entering into
interconnection agreements or resale agreements with incumbent LECs, including
RBOCs. Such additional alternatives may provide the CAPs with greater
flexibility and a lower cost structure than the Company. In addition, those
competitive providers who enter the local exchange market by successfully
negotiating contracts with the RBOCs may have substantially greater financial
resources than the Company.
With respect to wireless telephone system operators, the FCC recently
authorized cellular, personal communications service, and other commercial
mobile radio service ("CMRS") providers to offer wireless
15
<PAGE>
services to fixed locations, rather than just to mobile subscribers, in
whatever capacity such CMRS providers choose. Previously, cellular providers
could provide service to fixed locations only on an ancillary or incidental
basis. This authority to provide fixed as well as mobile services will enable
CMRS providers to offer wireless local loop service and other services to
fixed locations (e.g. office and apartment buildings) in direct competition
with the Company and other providers of traditional fixed telephone service.
In addition, in August 1996 the FCC promulgated regulations that classify CMRS
providers as telecommunications carriers, thus giving them the same rights to
interconnection and reciprocal compensation under the Telecommunications Act
as other non-LEC telecommunications carriers, including the Company.
Under the Telecommunications Act and related federal and state regulatory
initiatives, barriers to local exchange competition are being removed. The
availability of broad-based local resale and introduction of facilities-based
local competition are required before the RBOCs may provide in-region
interexchange long distance services in the states where they offer local
telephone service ("in-region long distance authority"). Also, the largest
interexchange carriers (AT&T, MCI, Sprint and any other carrier with 5% or
more of the pre-subscribed access lines) are prevented under the
Telecommunications Act from bundling local services resold from an RBOC in a
particular state with their long distance services until the earlier of (i)
February 8, 1999 or (ii) the date on which the RBOC whose services are being
resold obtains in-region long distance authority in that state. The RBOCs are
currently allowed to offer certain in-region "incidental" long distance
services (such as cellular, audio and visual programming and certain
interactive storage and retrieval functions) and to offer virtually all out-
of-region long distance services.
In January 1997, Ameritech, the RBOC in three states where the Company
operates, filed and subsequently withdrew an application for in-region long
distance authority in Michigan. The Company anticipates that Ameritech will
again file an application with respect to Michigan as well as most or all of
its other states--including Illinois and Ohio. Other RBOCs, including NYNEX in
New York, are expected to file such applications as early as the first half of
1997. The FCC will have 90 days from the date such an application is filed to
decide whether to grant or deny the application. Once the RBOCs are allowed to
offer widespread in-region long distance services, both they and the largest
interexchange carriers will be in a position to offer single-source local and
long distance services similar to those offered by the Company. While new
business opportunities will be made available to the Company through the
Telecommunications Act and other federal and state regulatory initiatives,
regulators are likely to provide the incumbent LECs with an increased degree
of flexibility with regard to pricing of their services as competition
increases. Although the Ameritech and NYNEX Resale Agreements contain certain
pricing protections, including adjustments in the wholesale rates to be
consistent with any changes in the Ameritech and NYNEX retail rates, if the
incumbent LECs elect to lower their rates and are able to sustain lower rates
over time, this may adversely affect the revenues of the Company and place
downward pressure on the rates the Company can charge. While the Ameritech and
NYNEX Resale Agreements ensure that the Company will receive any lower rate
provided to any other reseller, under the NYNEX Resale Agreements if such
lower rate is provided to a reseller committing to both a longer term and a
greater volume commitment, the Company receives the lower rate, but must
negotiate with NYNEX a reasonable transition to similar commitments. If the
Company cannot successfully negotiate such a transition with NYNEX, then the
Company may be unable to maintain the lowest rate. The Company believes the
effect of lower rates may be offset by the increased revenues available by
offering new products and services to its target subscribers, but there can be
no assurance that this will occur. In addition, if future regulatory decisions
afford the LECs excessive pricing flexibility or other regulatory relief, such
decisions could have a material adverse effect on the Company.
Competition for the Company's products and services is based on price,
quality, network reliability, service features and responsiveness to
subscriber needs. While the Company believes that it currently has certain
advantages relating to the timing, ubiquity and cost savings resulting from
its resale agreements, there can be no assurance that the Company will be able
to maintain these advantages. A continuing trend toward business combinations
and alliances in the telecommunications industry may create significant new
competitors to the Company. Many of the Company's existing and potential
competitors have financial, technical and other resources significantly
greater than those of the Company.
16
<PAGE>
ABILITY TO MEET MINIMUM COMMITMENTS; TERMINATION OF AGREEMENTS
Substantially all of the resale agreements between the Company and local
exchange carriers or long distance carriers contain term and volume
commitments. The local exchange resale agreements typically provide a minimum
usage which requires the Company to have a minimum number of lines in place at
the end of the applicable measurement period (typically one year) (each, a
"Minimum Commitment"). The long distance resale agreements typically require
the Company to meet a minimum dollar threshold of usage in order to be
eligible for discounted rates. The inability of the Company to meet its
Minimum Commitments or thresholds may result in substantial underutilization
charges, and, in the case of the long distance agreements, a significant
increase in the rates charged to the Company. The majority of the resale
agreements also contain carryover provisions which permit the Company to
carryforward volume shortfalls and may serve to delay, or possibly eliminate,
the payment of a significant portion of any shortfall the Company may
experience. While these "carryover pools" may provide the Company with some
additional time to build its subscriber base, any underutilization charges or
rate increases could have a material adverse effect on the financial condition
and results of operations of the Company.
Historically, the Company has not met its minimum monthly threshold under
its original agreement with Sprint. As a result, the Company does not receive
the maximum discounted rates available from Sprint and therefore resells
Sprint long distance service at significantly lower margins. In addition, the
Company has not met its Minimum Commitment under the LSO agreement due to
NYNEX provisioning delays. Although the LSO agreement provides that
provisioning delays allow the Company to postpone its obligation to meet its
commitment, there can be no assurance that the failure to meet its commitment
will not result in a material adverse effect on the financial condition and
results of operations of the Company. See "Business--Vendor Agreements."
Each of the resale agreements contains termination provisions which, among
other things, require the Company to pay termination charges if the Company
terminates an agreement prior to the end of term. The incurrence of any
termination charges could have a material adverse effect on the Company's
financial condition and results of operations.
LACK OF EXPERIENCE OFFERING ADDITIONAL PRODUCTS AND SERVICES
The Company's strategy includes offering additional telecommunications
products and services, which may include, among others, resold paging and
cellular phone service and Internet access. Entry into new markets entails
risks associated with the state of development of the markets, intense
competition from companies already operating in those markets, potential
competition from companies that may have greater financial resources and
experience than the Company and increased selling and marketing expenses. The
Company has not provided any paging, cellular or Internet products or services
to date. There can be no assurance that the Company's products or services
will receive market acceptance in a timely manner, or at all, or that prices
and demand in new markets will be at a level sufficient to provide profitable
operations. See "Industry Overview: The Local Telecommunications Service
Industry," "Business--Competition."
REGULATION AND RISKS OF THE TELECOMMUNICATIONS ACT
The Company is currently subject to federal and state government regulation
of its telecommunications services. The Company is regulated at the federal
level by the FCC. It is required to obtain and maintain an FCC certificate in
connection with its international services, and to file and maintain both
domestic and international tariffs containing the currently effective rates,
terms and conditions of service for its resale long distance services. The FCC
recently issued regulations to eliminate this tariff filing requirement for
all interstate nondominant carriers, except for, under certain circumstances,
the RBOCs, effective in 1997.
The intrastate long distance telecommunications operations of the Company
are also subject to various state laws and regulations. The Company must
obtain and maintain certificates of public convenience and necessity
17
<PAGE>
from regulatory authorities in most states in which it offers service. In most
states, the Company must also file and obtain prior regulatory approval of
tariffs for intrastate services. In addition, the Company must update or amend
the tariffs and, in some cases, the certificates of public convenience and
necessity, when rates are adjusted or new products are added to the local and
long distance services offered by the Company. Challenges by third parties to
the Company's tariffs filed with the FCC or the state regulatory commissions
could cause the Company to incur substantial legal and administrative
expenses.
The Telecommunications Act has already resulted in comprehensive changes in
the regulatory environment for the telecommunications industry as a whole, and
will have a material impact on the local exchange industry and the competitive
environment in which the Company operates. The Company believes that the speed
with which competition in local exchange services develops will depend on a
number of factors, including the extent to which each incumbent LEC actively
attempts to maintain its local exchange market share or to enter new lines of
business, particularly, in the case of RBOCs, the in-region long distance
business. While each incumbent LEC now has the duty to negotiate on a good-
faith basis access and interconnection agreements with facilities-based
competitors and resale agreements with competitors such as the Company, the
timing and terms of such agreements are at least in part within the control of
the LEC. A LEC that places the highest priority on maintaining its market
share in local exchange service may have less incentive to negotiate such
agreements swiftly or on terms favorable to potential competitors. Indeed,
numerous potential competitors, including AT&T, have requested, under the
provisions of the Telecommunications Act, that various state regulatory
authorities mediate their negotiations with various RBOCs because they have
been unable to reach agreement with those RBOCs for access and interconnection
to provide competitive local exchange services. The speed with which
competition in local exchange services develops will also depend on the effect
of the rules and policies recently adopted by the FCC and individual states in
implementing the relevant provisions of the Telecommunications Act and on the
outcome of judicial review of those rules and policies. In that event, the
ability of the Company to compete may be adversely affected. In addition,
resale and long distance agreements must be submitted to and approved by the
relevant state public service commission.
The concept of resale of local exchange services is a new development in the
telecommunications industry, and the Company cannot predict how the relevant
provisions of the Telecommunications Act will be interpreted and implemented
by the FCC, state regulators, courts and the incumbent LECs. In August 1996,
the FCC issued regulations that, among other things, established pricing
methodologies and interim default rates for resold incumbent LEC services and
unbundled LEC network elements. A number of parties have filed court appeals
challenging these and other regulations implementing the Telecommunications
Act. All of the court appeals have been consolidated before the U.S. Court of
Appeals for the Eighth Circuit, which has stayed the effect of certain of the
rules (including the provisions establishing pricing methodologies and default
rates for resold services and unbundled network elements). The U.S. Supreme
Court declined to dissolve the stay, and the court of appeals' decision is not
expected before the middle of 1997. Some of the same parties and certain other
parties also have asked the FCC to reconsider these and other regulations
implementing the Telecommunications Act. The Company cannot predict the
outcome of the FCC's reconsideration proceeding or the court appeals, either
of which could have a material adverse impact on the Company. In addition, no
assurance can be given that changes in current federal or state legislation or
regulations would not materially adversely affect the Company. See "Business--
Government Regulation" and "--Competition."
ABILITY TO MANAGE GROWTH; RAPID EXPANSION OF OPERATIONS
The Company's officers have had limited experience in managing companies as
large and as rapidly growing as the Company. Although the Company has not
generated significant revenue from the Ameritech and NYNEX Resale Agreements
since they have only recently been executed, the Company anticipates that such
agreements will constitute a significant source of revenue. The Company's
strategy of continuing its growth and expansion will place additional demands
upon the Company's current management and other resources and will require
additional working capital, information systems and management, operational
and other financial resources. The continued growth of the Company will depend
on various factors, including, among others,
18
<PAGE>
federal and state regulation of the telecommunications industry, competition,
and on the ability of LECs, including the RBOCs, to provision the Company's
additional subscribers. In particular, the Company faced a number of problems
with its LSO agreement with NYNEX which has historically provided a substantial
portion of the Company's revenue. Although the Company believes that the
majority of the provisioning and billing problems have been resolved by
replacing the billing vendor, there can be no assurance that the RBOCs with
which the Company has resale agreements will be able to provision new
subscribers or handle the volume of traffic and billing. Not all of the
foregoing factors are within the control of the Company. The Company's ability
to manage growth successfully will require the Company to continue to enhance
its operational, managerial, financial and information systems and controls.
The Company has modified its billing and subscriber care systems to address the
resale of local services under the Ameritech and NYNEX agreements. However,
there can be no assurance that such systems will be adequate to manage the
Company's anticipated expansion. No assurance can be given that the Company
will be able to manage its expanding operations and, if the Company's
management is unable to manage growth effectively, the Company's business,
operating results and financial condition could be materially adversely
affected. Furthermore, there can be no assurance that the growth experienced by
the Company in the past will continue.
DEPENDENCE ON KEY PERSONNEL
The Company believes that its continued success will depend to a significant
extent upon the abilities and continued efforts of its senior management,
particularly members of its senior management team. The Company has employment
agreements with many senior management employees but does not maintain key man
life insurance on any of its employees except Mr. J. Thomas Elliott, President
and Chief Executive Officer of the Company. The beneficiaries of such policies
are the Initial Investors (as defined herein). Many of the Company's executive
officers and other key employees have only recently joined the Company. The
loss of the services of any of such individuals could have a material adverse
effect on the Company's results of operations. The success of the Company will
also depend, in part, upon the Company's ability to find, hire and retain
additional key management personnel, including senior management, who are also
being sought by other businesses. Competition for qualified personnel in the
telecommunications industry is intense. The inability to find, hire and retain
such personnel could have a material adverse effect on the Company's results of
operations. See "Management--Executive Officers and Directors."
IMPACT OF TECHNOLOGICAL CHANGE
The telecommunications industry has been characterized by rapid technological
change, frequent new service introductions and evolving industry standards. For
example, increases in technological capabilities or efficiencies could create
an incentive for more entities to enter the facilities-based local exchange
business. Similarly, such changes could result in lower retail rates for
telecommunications services, which could have a material adverse effect on the
Company's ability to price its services competitively. Although the effect of
technological change on the future business of the Company cannot be predicted,
it could have a material adverse effect on the Company's business, results of
operations and financial condition.
ORIGINAL ISSUE DISCOUNT; POSSIBLE TAX AND OTHER LEGAL CONSEQUENCES FOR HOLDERS
OF CONVERTIBLE NOTES AND THE COMPANY
The Convertible Notes were issued at a substantial discount from their
principal amount at maturity. Cash payments of interest on the Convertible
Notes will not be paid prior to 2000. However, original issue discount (i.e.,
the difference between the "stated redemption price at maturity" of the
Convertible Notes and the "issue price" of the Convertible Notes) has accrued
from the Issue Date of the Convertible Notes and will be includable as interest
income periodically in a holder's gross income for federal income tax purposes
in advance of receipt of the cash payments to which the income is attributable.
See "Certain Federal Income Tax Considerations--Taxation of the Convertible
Notes--Original Issue Discount." Similar results may apply under state tax
laws. In addition, to the extent the Convertible Notes constitute corporate
acquisition indebtedness under Section 279
19
<PAGE>
of the Internal Revenue Code, the maximum amount of interest or original issue
discount the Company can deduct with respect thereto may be limited. See
"Certain Federal Income Tax Considerations--Certain Potential Federal Income
Tax Consequences to the Company." To the extent the rules applicable to
corporate acquisition indebtedness apply, the Company's after-tax cash flow
may be less than if such original issue discount were deductible when accrued
or the Convertible Notes did not constitute corporate acquisition
indebtedness.
If a bankruptcy case were to be commenced by or against the Company under
the United States Bankruptcy Code, the claim of a holder of the Convertible
Notes with respect to the principal amount thereof may be limited to an amount
equal to the sum of (i) the initial offering price and (ii) that portion of
the original issue discount that is not deemed to constitute "unmatured
interest" for purposes of the United States Bankruptcy Code. Any original
issue discount that had not amortized as of the date of any such bankruptcy
filing would constitute "unmatured interest."
ABSENCE OF A PUBLIC MARKET; VOLATILITY OF STOCK PRICE
There is currently no public market for the Securities. There can be no
assurance as to the liquidity of any markets that may develop for the
Securities, the ability of holders of Securities to sell their Securities or
the price at which holders would be able to sell their Securities. Future
trading prices of the Securities will depend on many factors, including, among
other things, prevailing interest rates, the Company's operating results and
the market for similar securities. Each of the Initial Purchasers has advised
the Company that it intends to make a market in some or all of the Securities.
However, the Initial Purchasers are not obligated to do so and any market
making may be discontinued at any time without notice. Therefore, there can be
no assurance that an active trading market for the Securities will develop, or
if one does develop, that it will be sustained. The Company does not intend to
apply for listing of any of the Securities on any securities exchange or for
quotation through the National Association of Securities Dealers Automated
Quotation System.
Historically, the market price for securities of emerging companies have
been highly volatile. Future announcements concerning the Company or its
competitors, technological innovations or government regulations may
significantly impact the market price of the Securities.
ABSENCE OF DIVIDENDS
The Company has never paid dividends on its Common Stock and does not
anticipate paying any such dividends in the foreseeable future. Earnings, if
any, which might be generated from operations of the Company will be used to
finance growth of the Company. See "Dividend Policy." The Senior Note
Indenture includes significant limitations on the Company's ability to pay
dividends to the holders of Common Stock. In addition, the terms of the 9%
Preferred Stock and the Purchase Agreements (each as defined herein) entered
into in connection with the sale of Common Stock and Preferred Stock to the
Original Investors (as defined herein) restrict the payment of dividends. See
"Certain Relationships and Related Transactions."
SHARES ELIGIBLE FOR FUTURE SALE
Sales of shares of Class A Common Stock in the public market or the
perception that such sales could occur could have a material adverse effect on
the price of the Class A Common Stock. In the event that all of the
Convertible Notes and Initial Warrants that are outstanding as of March 31,
1997 are converted or exercised, as the case may be, the Company will have
outstanding 994,531 shares of Class A Common Stock. All of the shares of Class
A Common Stock issuable upon the conversion of the Convertible Notes (215,455
as of March 31, 1997 and accreting to 268,496 from and after September 30,
1999) and the 61,550 shares of Class A Common Stock issuable upon exercise of
the Initial Warrants will be available for immediate sale without restriction
under the Securities Act, subject in the case of certain holders to the
restrictions applicable to affiliates pursuant to Rule 144 ("Rule 144") under
the Securities Act. The 717,526 shares of Class A Common Stock outstanding as
of the date of this Prospectus are restricted shares ("Restricted Shares")
under the Securities Act and may be sold only
20
<PAGE>
if they are registered or qualify for an exemption from registration under
Rule 144. In addition, as of the date of this Prospectus, the Company has
outstanding 10,450 shares of 9% Preferred Stock, which are convertible into
73,801 shares of Class A Common Stock at the current conversion ratio, and
options to purchase 115,899 shares of Class A Common Stock. Pursuant to a
registration agreement dated April 20, 1994, as amended and restated on June
22, 1995, the Company has granted certain registration rights to the Original
Purchasers (as defined herein). See "Certain Relationships and Related
Transactions--Formation of the Company" and "Registration Rights."
In addition, the Company is obligated, under certain circumstances, to issue
to holders of the Convertible Notes and the Senior Notes Contingent Warrants
exercisable for Class A Common Stock representing up to 5.5% in the aggregate
of the Class A Common Stock on a fully diluted basis after giving effect to
the issuance of such Contingent Warrants. See "Description of Securities--
Convertible Notes" and "Certain Other Indebtedness." Under certain
circumstances, the Company will be required to offer to holders of Convertible
Notes the right to acquire additional convertible securities and warrants. See
"Description of Securities--Convertible Notes--Additional Invested Equity."
Pursuant to the terms of the Indentures under which the Company may become
obligated to issue the foregoing Contingent Warrants and additional
convertible securities and warrants, the Company must register such securities
for resale.
CONTROL BY EXISTING STOCKHOLDERS; CERTAIN ANTITAKEOVER MATTERS
As of the date of this Prospectus, over 90% of the outstanding Class A
Common Stock is owned by the management of the Company and Chase Venture
Capital Associates, L.P., CIBC Wood Gundy Ventures, Inc., Hancock Venture
Partners IV--Direct Fund, L.P., Northwood Capital Partners LLC, Northwood
Ventures, BT Capital Partners, Inc. and Enterprises & Transcommunications,
L.P. (collectively, the "Original Purchasers"). Five of the Original
Purchasers have stock holdings that exceed five percent ownership of the Class
A Common Stock of the Company. Each of these stockholders has exercised its
right to appoint one director to the Board of Directors of the Company. See
"Stock Ownership." Consequently, management and the Original Purchasers have
the ability to control the election of all the members of the Company's Board
of Directors and the outcome of all corporate actions requiring stockholder
approval. In addition, the Original Purchasers have certain contractual
preemptive rights upon issuance of any shares of capital stock of the Company.
Further, as a result of the Private Placement, Merrill Lynch Global Allocation
Fund, Inc. ("MLGAFI") holds Convertible Notes which were convertible into
215,455 shares of Class A Common Stock as of March 31, 1997 (representing
approximately 18% of the outstanding Class A Common Stock on a fully diluted
basis as of March 31, 1997) and will be convertible into 268,496 shares of
Class A Common Stock as of September 30, 1999, assuming no prior conversion of
Convertible Notes and subject to adjustment as described herein (representing
approximately 21% of the outstanding Common Stock (on a fully diluted basis)
as of the date of this Prospectus). In addition, MLGAFI holds Warrants which
are exercisable for 61,550 shares of Class A Common Stock and, in certain
circumstances, may be issued additional Warrants to purchase Class A Common
Stock, as described herein.
Section 203 ("Section 203") of the Delaware General Corporation Law (the
"DGCL") restricts certain business combinations with any "interested
stockholder," as defined by such statute. The Company has expressly decided
not to be governed by Section 203 but may in the future change such election.
In addition, the Company may adopt certain procedural and other requirements
and/or amend its Certificate of Incorporation and/or By-laws that could
further have the effect of delaying, deterring or preventing a change in
control of the Company and/or make it more difficult for stockholders to
effect certain corporate actions, including the ability to replace incumbent
directors and to accomplish transactions opposed by the incumbent Board of
Directors. See "Description of Capital Stock."
CHANGE OF CONTROL
In the event of a Change of Control, the Company will be required to offer
to repurchase all of the outstanding Convertible Notes at 101% of the Accreted
Value or 101% of principal amount, as the case may be, of the Convertible
Notes plus any accrued and unpaid interest thereon, and Special Interest, if
any, to the date of
21
<PAGE>
repurchase. The exercise by the holders of the Convertible Notes of their
rights to require the Company to offer to purchase Convertible Notes upon a
change of control could also cause a default under other indebtedness of the
Company, even if the change of control itself does not, because of the
financial effect of such repurchase on the Company. The Company's ability to
pay cash to any of the holders of Convertible Notes upon a repurchase may be
limited by the Company's then existing capital resources. There can be no
assurance that in the event of a change of control, the Company will have, or
will have access to, sufficient funds or will be contractually permitted under
the terms of outstanding indebtedness to pay the required purchase price for
any Convertible Notes. See "Description of Securities--Convertible Notes."
USE OF PROCEEDS
The Company will not receive any proceeds from the sale of the Securities by
the Selling Securityholders, but will receive proceeds upon the exercise of
the Initial Warrants of $.01 per share.
DIVIDEND POLICY
The Company anticipates substantial net losses and negative cash flow for
the foreseeable future. It is anticipated that earnings, if any, which might
be generated from operations of the Company will be used to finance the growth
of the Company and that cash dividends will not be paid to holders of Common
Stock. The Senior Note Indenture includes significant limitations on the
Company's ability to pay dividends to the holders of Common Stock. See
"Certain Other Indebtedness." In addition, the terms of the 9% Preferred Stock
and the Purchase Agreements entered into in connection with the sale of Common
Stock and Preferred Stock to the Original Purchasers restrict the payment of
dividends. See "Certain Relationships and Related Transactions."
22
<PAGE>
CAPITALIZATION
The following table sets forth the total cash and cash equivalents and
capitalization of the Company as of December 31, 1996. This table should be
read in conjunction with the consolidated financial statements and related
notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1996
--------------------
(IN THOUSANDS EXCEPT
SHARE INFORMATION)
<S> <C>
Cash and cash equivalents................................. $ 60,569
========
Long term liabilities
14% Senior Discount Notes due 2003....................... $ 48,500
Original Issue Discount--Senior Notes.................... (17,257)
9% Convertible Subordinated Discount Notes due 2004...... 36,000
Original Issue Discount--Convertible Notes............... (7,741)
Notes and leases payable................................. 362
--------
Total long term liabilities........................... 59,864
Redeemable Preferred Stock
9% Preferred Stock, par value $1.00 per share, 30,000
shares authorized; 10,000 shares issued and outstanding;
liquidation value $1,000 per share...................... 10
Accumulated unpaid dividends............................. 225
Additional paid-in capital............................... 9,810
--------
Total Preferred Stock................................. 10,045
Common stockholders' deficit:
Class A Common Stock, $.01 par value, 2,500,000 shares
authorized, shares issued and outstanding at March 30,
1997 (/1/).............................................. 7
Class A Common Stock held in Treasury.................... (1)
Additional paid-in capital............................... 54,180
Accumulated deficit...................................... (57,791)
--------
Total common stockholders' deficit.................... (3,605)
--------
Total capitalization................................ $ 66,304
========
</TABLE>
- --------
(1) Excludes 115,899 shares reserved for issuance upon exercise of options
outstanding at March 31, 1997, and 61,550 shares reserved for issuance upon
exercise of the Initial Warrants.
23
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table presents selected historical consolidated financial data
for the period from inception of the Company in April 1994 to December 31,
1994 and for the fiscal years ended December 31, 1995 and 1996. The data has
been derived from consolidated financial statements (including those set forth
elsewhere in this Prospectus) which have been audited by Deloitte & Touche
LLP, independent auditors. The information set forth below should be read in
conjunction with the consolidated financial statements of the Company and the
related notes appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
INCEPTION TO DECEMBER 31,
DECEMBER 31, -------------------
1994 1995 1996
------------ -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
INFORMATION AND RATIOS)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net service revenue........................ $ 1,737 $ 7,884 $ 9,814
Cost of services........................... 1,455 9,076 9,256
-------- -------- ---------
Gross margin............................... 282 (1,192) 558
Sales and marketing expense................ 2,869 5,867 12,612
General and administrative expense......... 4,686 11,100 20,665
Interest expense........................... 26 734 1,797
Interest and other income (1).............. 152 646 9,469
Minority interest.......................... -- 150 --
-------- -------- ---------
Net loss................................... $ (7,147) $(18,097) $ (25,047)
======== ======== =========
Accumulated unpaid preferred dividends..... $ 707 $ 3,810 $ 225
Net loss to common shareholders............ $ (7,854) $(21,907) $ (25,272)
Net loss per common share.................. $ (65.63) $ (72.42) $ (49.53)
Weighted average shares outstanding........ 119,678 302,520 510,233
<CAPTION>
DECEMBER 31,
--------------------------------
1994 1995 1996
------------ -------- ---------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................. $ 5,979 $ 13,705 $ 60,569
Total assets............................... 12,747 20,471 78,052
Long-term debt (net of current maturities). 3,176 518 59,864
Redeemable preferred stock................. 15,306 44,396 10,045
Common stockholders' deficit............... (7,830) (28,768) (3,606)
<CAPTION>
FISCAL YEAR ENDED
INCEPTION TO DECEMBER 31,
DECEMBER 31, -------------------
1994 1995 1996
------------ -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
INFORMATION AND RATIOS)
<S> <C> <C> <C>
OTHER DATA:
EBITDA (2)................................. $ (7,087) $(15,901) $ (30,390)
Cash flows from operating activities....... (6,141) (14,308) (24,098)
Cash flows from investing activities....... (1,708) (2,556) 7,274
Cash flows from financing activities....... 13,828 24,589 63,689
Depreciation and amortization.............. 186 2,258 2,329
Capital expenditures....................... 1,728 1,740 2,259
Ratio of earnings to fixed charges (3)..... -- -- --
</TABLE>
- --------
(1) Interest and other income for the year ended December 31, 1996 includes a
gain of $8.1 million realized on the sale of the Company's switching
facilities in Ohio.
(2) EBITDA consists of operating income before depreciation and amortization.
While EBITDA should not be construed as a substitute for operating income
or a better indicator of liquidity than cash flow from operating
activities, which are determined in accordance with generally accepted
accounting principles, EBITDA is included because management believes that
certain investors find it to be a useful tool for measuring the ability of
the Company to service its debt. EBITDA is not necessarily a measure of
the Company's ability to fund its cash needs. See the Consolidated
Statements of Cash Flows of the Company and the related notes to the
Consolidated Financial Statements thereto included herein.
(3) The ratio of earnings to fixed charges is computed by dividing pretax
income (loss) from operations before interest charges by interest expense.
Earnings were insufficient to cover fixed charges for the periods ended
December 31, 1994, 1995 and 1996 by $7.0 million, $16.8 million and $22.6
million, respectively.
24
<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
"Selected Historical Consolidated Financial and Operating Data" and the
consolidated financial statements and notes thereto included elsewhere in this
Prospectus.
OVERVIEW
The Company commenced operations in April 1994 as a provider of local and
long distance telecommunications services to meet the needs of small and
medium-sized business subscribers, through the purchase of US Network
Corporation ("US Network"). US Network had four months of operations prior to
being acquired by the Company. Operations during this four month period
included limited administrative expenses and no revenues, and assets consisted
primarily of cash and organization costs. The Company, through a newly formed
wholly owned acquisition subsidiary, Quest United, Inc. ("Quest"), acquired
certain assets and assumed certain liabilities of Quest America, L.P., a
telecommunications reseller and consulting firm, in October 1995 (the "Quest
Acquisition").
Initially, the Company entered the local telecommunications market as a
facilities-based CAP with network facilities in Ohio. Due to the high costs
associated with the initial construction, installation and expansion of each
local network facility, including right-of-way costs, franchise fees,
interconnection charges and other operating expenses and in anticipation of
the impact of the passage of the Telecommunications Act, the Company refocused
its operations. The Company sold its existing facilities in Ohio and certain
other assets in February 1996, and transferred certain liabilities with
respect to those facilities, to pursue a non-facilities-based approach to the
local telecommunications market.
The Company negotiated for the first broad based resale agreement with
Ameritech for local services which was signed in November 1995 and negotiated
with NYNEX for a comprehensive local resale agreement which was signed in July
1996. The Company also consummated various other agreements in 1996 with
certain carriers for the resale of long distance and enhanced and other value-
added services. The Company commenced the marketing and provisioning of
services under those agreements during the latter half of 1996. Although
management believes that its current strategy will have a positive effect on
the Company's results of operations over the long-term, by continuing to seek
other providers of local, long distance and enhanced and other value-added
services in order to increase its subscriber base and product offerings and
reduce expenses, this strategy is expected to have a negative effect on the
Company's results of operations over the short-term. The Company anticipates
losses and negative cash flow for the foreseeable future, attributable in part
to significant investments in operating, sales, marketing, management
information systems and general and administrative expenses. To date, the
Company's growth, including capital expenditures, has been funded primarily by
the capital contributions of Chase Venture Capital Associates, L.P., CIBC Wood
Gundy Ventures, Inc., Hancock Venture Partners IV--Direct Fund, L.P., BT
Capital Partners, Inc., Northwood Capital Partners LLC, Northwood Ventures and
Enterprises & Transcommunications, L.P. (the "Original Purchasers") and by the
proceeds of the Private Placement.
The Company's net service revenue, which is recognized on a resale basis,
primarily consists of sales revenue from telecommunications services. The
Company bills its subscribers for local and long distance usage based on the
type of service utilized, the number, time and duration of calls, the
geographic location of the terminating phone numbers and the applicable rate
plan in effect at the time of the call. Net service revenue for the Quest
operations, which is recognized on an agency basis, primarily consists of
commissions earned from carriers on telecommunications services provided to
their subscribers.
Cost of services includes the cost of local and long distance services
charged by carriers for recurring charges, per minute usage charges and
feature charges, as well as the cost of fixed facilities for dedicated
services
25
<PAGE>
and special regional calling plans. In 1995, cost of services also included
fixed and one-time charges associated with the Ohio switching facilities owned
by the Company. These costs were transferred to a third party subsequent to
December 31, 1995, when the obligations with respect to the switching
facilities were effectively transferred.
Sales and marketing expense consists of the costs of providing sales and
other support services for subscribers. General and administrative expense
consists of the costs of the billing and information systems and personnel
required to support the Company's operations and growth as well as all
depreciation and amortization expenses.
The Company has experienced significant growth in the past and, depending on
the extent of its future growth, may experience significant strain on its
management, personnel and information systems. To accommodate this growth, the
Company will continue to implement and improve operational, financial and
management information systems. In an effort to support its growth, the
Company added several senior management positions and over 250 employees in
1996. Also, the Company is implementing new information systems that will
provide improved recordkeeping for subscriber information and management of
uncollectible accounts and fraud control.
RESULTS OF OPERATIONS
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net service revenue increased to $9.8 million for the year ended December
31, 1996 from $7.9 million for the year ended December 31, 1995. The increase
in net service revenue was due primarily to a 36% increase in the subscriber
base in the Company's geographic markets (from approximately 1,250 customers
at the end of 1995 to approximately 1,700 customers at the end of 1996) and
the revenues attributable to the Quest Acquisition which primarily consist of
commissions earned from carriers on telecommunications services provided to
their subscribers. Approximately $1.4 million in increased revenues is
attributable to the addition of new customers, primarily in Ohio, and
approximately $0.5 million is attributable to revenues gained from the Quest
Acquisition.
Gross margin of $0.6 million for the year ended December 31, 1996 improved
from the negative margin of $1.2 million for the year ended December 31, 1995
due primarily to the elimination of fixed costs upon the sale of the switching
facilities in Ohio and a $1.4 million sales and related margin adjustment for
1995 revenue purportedly not billed by NYNEX to the Company's customers under
the billing and collection agreement. In 1996, the Company recovered
approximately $0.9 million from NYNEX and is continuing to pursue additional
amounts.
Sales and marketing expenses increased $6.7 million, or 114%, from $5.9
million for the year ended December 31, 1995 to $12.6 million for the year
ended December 31, 1996. The increase was due primarily to an increase in the
number of sales and marketing employees from approximately 115 at the end of
1995 to over 300 at the end of 1996, which resulted in increases to salaries
and benefits of $3.9 million, travel, training and entertainment costs of $1.0
million and recruitment costs of $0.8 million. Additionally, advertising costs
increased $0.9 million due to product launches in the Company's target
markets.
General and administrative expenses increased $9.6 million, or 86%, to $20.7
million for the year ended December 31, 1996 versus $11.1 million for the year
ended December 31, 1995. The increase was due primarily to an increase in the
number of operations and administrative employees from approximately 90 at the
end of 1995 to approximately 160 at the end of 1996, which resulted in
increases to salaries and benefits of $2.5 million and facility costs of $1.2
million. Additionally, fees paid to consultants and other professionals
increased over $1.0 million, primarily relating to the development and
expansion of the Company's customer service, billing and administrative
information systems and facilities. Amortization expense increased $0.8
million due primarily
26
<PAGE>
to a full year of amortization expense related to the Quest Acquisition in
1996 versus eight months in 1995. Additionally, $1.7 million of expense was
incurred relating to the settlement of a derivative action filed by a minority
shareholder.
Interest and other income increased to $9.5 million for the year ended
December 31, 1996 from $646,000 for the year ended December 31, 1995 due
primarily to an $8.1 million non-recurring gain on the sale of the Company's
switching facilities in Ohio in February 1996.
Interest expense increased to $1.8 million for the year ended December 31,
1996 from $734,000 for the year ended December 31, 1995. This increase was due
primarily to interest expense attributable to the Senior Notes and Convertible
Notes issued in the Private Placement.
As a result of the factors described above, the Company's net loss increased
to $25.1 million for the year ended December 31, 1996 from $18.1 million for
the year ended December 31, 1995.
Year Ended December 31, 1995 versus Inception to December 31, 1994
The results for fiscal 1995 are not comparable with the results for fiscal
1994 as fiscal 1995 represents a full fiscal year and fiscal 1994 represents
approximately eight months of operations since the Company's inception in
April 1994.
Net service revenue increased to $7.9 million in fiscal 1995 from $1.7
million in fiscal 1994. This increase was due to a full year of operations and
a 34% increase in the subscriber base (from approximately 930 customers at
December 31, 1994 to approximately 1,250 customers at December 31, 1995).
Cost of services increased to $9.1 million in fiscal 1995 from $1.5 million
in fiscal 1994. The increase was due to the one-time installation costs and
fixed ongoing costs related to the Ohio switching facilities, as well as
increased costs associated with an increase in the number of subscribers.
Sales and marketing expenses increased $3.0 million, or 103%, to $5.9
million in fiscal 1995 from $2.9 million in fiscal 1994. Approximately $1.5
million of the increase is due to the impact of a full year of operation in
1995 versus approximately eight months in 1994. The inclusion of expenses
related to the operations of Quest in 1995 contributed an additional $0.8
million to the increase.
General and administrative expenses increased $6.4 million, or 136%, to
$11.1 million in fiscal 1995 from $4.7 million in fiscal 1994. Approximately
$2.0 million of the increase is due to the impact of a full year of operation
in 1995 versus approximately eight months in 1994. An additional $2.0 million
was attributable to depreciation and amortization and other expenses related
to the Quest Acquisition. The remaining increase is a result of increased
personnel and expenses required to build the Company's customer service and
administrative information systems and office facilities.
Interest and other income increased to $646,000 in fiscal 1995 from $152,000
in fiscal 1994, due to significantly higher investable cash balances in fiscal
1995 resulting from the proceeds of the issuance of $26.3 million of preferred
and common stock, as well as fiscal 1995 being a full year.
Interest expense increased to $734,000 in fiscal 1995 from $26,000 in fiscal
1994. This increase was due to interest expense associated with the
capitalized leases for the Ohio switch sites which began in December 1994.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has funded its operations primarily through
cash from its investors. As of December 31 1996, the Company had cash and cash
equivalents of $60.6 million and working capital of $52.4 million. The
Company's operating activities utilized cash of approximately $24.1 million
for the year ended
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December 31, 1996, $14.3 million for the year ended December 31, 1995 and $6.1
million for the period ended December 31, 1994.
The Company's investing activities have consisted primarily of property and
equipment purchases of $2.3 million, $1.7 million and $1.7 million for the
years ended December 31, 1996 and 1995 and for the period ended December 31,
1994, respectively. In 1996, these expenditures were primarily related to the
buildout of new office space. In 1995 and 1994, these expenditures were
primarily for fiber optic rings, leasehold improvements and furniture in Ohio
that were sold in February 1996. In addition, the Company entered into capital
leases of $0.6 million, $3.4 million and $3.1 million in 1996, 1995 and 1994,
respectively, related to furniture and equipment and, in 1995 and 1994, the
Ohio switch sites. The Company remains contingently liable on the 1994 and
1995 Ohio leases, but the Company believes that it has secured adequate
protection from the assignee. In February 1996, the Company received $9.5
million in proceeds from the December 1995 sale of the Ohio facilities.
In 1997, the Company anticipates having approximately $12.0 million of
capital expenditures. A substantial portion of the capital plan has been
allocated to investments in information technology to support the growth of
the subscriber base with more robust billing and subscriber care systems. The
anticipated continued high growth in the subscriber base in 1998 will require
a continued high level of investment in information technology in 1998.
On September 30, 1996, the Company raised $10 million through the sale to
Chase Venture Capital Associates, L.P., CIBC Wood Gundy Ventures, Inc.,
Hancock Venture Partners IV--Direct Fund, L.P., Northwood Capital Partners
LLC, Northwood Ventures, BT Capital Partners, Inc. and Enterprises &
Transcommunications, L.P. of 10,000 shares of 9% Cumulative Convertible Pay-
In-Kind Preferred Stock (the "9% Preferred Stock"). Also on September 30,
1996, the Company raised approximately $55 million, net of issuance costs,
through the sale to Merrill Lynch Global Allocation Fund, Inc. of (i) 48,500
Units consisting of $48.5 million in aggregate principal amount at maturity of
Senior Notes and Initial Warrants to purchase 61,550 shares, subject to
adjustment under certain circumstances, of Class A Common Stock, at an initial
exercise price of $.01 per share, and (ii) $36.0 million in aggregate
principal amount at maturity of Convertible Notes. The aggregate purchase
price of the Units was $30,203,375, and the aggregate purchase price of the
Convertible Notes was $27,644,400. In 1995 and 1994, the Company's financing
activities consisted primarily of raising capital in the form of Common Stock
and Preferred Stock placements to venture capital organizations. During 1995
and 1994, the Company raised $26.3 million and $14.2 million, respectively,
net of issuance costs. In 1995, the Company also assumed notes payable to
investors in the Quest Acquisition.
Although at December 31, 1996, the Company had working capital of
approximately $52.4 million and total redeemable preferred stock and common
stockholders' equity of approximately $6.4 million, projected cash usage in
1997 combined with an anticipated net loss in 1997, absent the infusion of
additional capital resources, is anticipated to fully deplete the Company's
working capital prior to December 31, 1997. Such events would place
substantial doubt about the Company's ability to continue as a going concern.
Although the Company's management believes that the Company will be able to
raise sufficient funds, through capital contributions or additional equity or
debt financings, to meet its operating expenses and other cash requirements,
there can be no assurance that the Company would be able to complete such
contributions or financing or that any such contributions or financing would
be completed on terms satisfactory to the Company.
The Company incurred net losses of $25.1 million, $18.1 million and $7.1
million in 1996, 1995 and 1994, respectively. Accordingly, no provision for
current Federal or state income taxes has been made to the financial
statements. At December 31, 1996, the Company and its subsidiaries had net
operating loss carry-forwards for Federal income tax purposes of approximately
$46.1 million. The ability of the Company or the Company's subsidiaries, as
the case may be, to utilize their net operating loss carry-forwards to offset
future taxable income may be subject to certain limitations contained in the
Internal Revenue Code of 1986, as amended (the "Code"). These operating losses
begin to expire in 2009 for Federal income tax purposes. Of the net operating
loss carry-
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forwards remaining at December 31, 1996, $12.3 million can be applied only
against future taxable income of the Company's subsidiary USN Communications
Northeast, Inc. (formerly United Telemanagement Services, Inc.).
INFLATION
Management believes that inflation has not had a material effect on the
Company's results of operations.
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INDUSTRY OVERVIEW:
THE LOCAL TELECOMMUNICATIONS SERVICE INDUSTRY
The current structure of the U.S. telecommunications market resulted largely
from the divestiture of AT&T, then referred to as the "Bell System." Pursuant
to the Divestiture, the RBOCs were separated from the long distance provider
AT&T, resulting in the creation of two distinct industries: local exchange and
interexchange (commonly known as long distance). Following the Divestiture,
each RBOC continued to offer local telephone and other telecommunications
services only within Local Access and Transport Areas ("LATAs"), and was
generally prohibited from providing telecommunications services between LATAs.
Prior to the Divestiture, the Bell operating companies and other LECs not
affiliated with the Bell System had government-regulated monopolies for most
local telephone services. The Divestiture encouraged the growth of competition
for long distance services and terminal network equipment by prohibiting the
RBOCs from entering these markets, but the RBOCs retained monopoly control
over the market for local telephone services. Since the Divestiture in 1984,
competition in the long distance market has rapidly increased, and by 1995
AT&T had lost approximately 40% of its long distance market share to MCI,
Sprint and a number of other long distance competitors.
The Divestiture did not directly provide for competition in local markets.
After the Divestiture, however, a number of factors served to promote
competition in the local telecommunications market, including (i) increasing
subscriber desire for alternatives to the services provided by the LECs,
particularly among business subscribers, prompted in part by competition in
the long distance market; (ii) technological advances in the transmission of
data and video requiring greater capacity and reliability levels than the
existing copper-based LEC networks were able to accommodate; (iii) a monopoly
position and rate of return-based pricing structure which provided little
incentive for the LECs to upgrade their networks or meet specialized
subscriber needs; (iv) the development of fiber optics and digital electronic
technology, which combined the ability to economically build a high-capacity
digital network with the ability to transmit voice, data and video signals at
high speeds; and (v) the significant "access charges" that long distance
carriers were required to pay to originate and terminate long distance
telephone calls on the RBOCs' networks.
The first competitors in the local market were the CAPs, which provided
special access services by installing fiber optic facilities connecting long
distance carriers' "points of presence" (or "POPs") within a metropolitan area
and, in some cases, connecting subscribers (primarily large businesses) to
long distance carriers' POPs. CAPs also provided private line services
connecting multiple locations of a single subscriber within a local market
area with dedicated fiber optic lines. CAPs used the technological advantage
and substantial capacity and economies of scale inherent in fiber optic
technology to offer subscribers service that initially was generally less
expensive and of higher quality than could be obtained from the LECs, due in
part to the LECs' more antiquated copper-based facilities and higher overhead
costs. In addition, CAPs generally offered shorter installation and repair
intervals and improved reliability in comparison to the LECs. In recent years,
the LECs have been steadily upgrading the technology of their networks,
including increasing the amount of fiber used in such networks, thereby
decreasing the competitive advantage held by the CAPs in the special access
and private line markets. As CAPs proliferated during the latter part of the
1980's, federal and some state regulators issued rulings which permitted and
sometimes encouraged local competition and opened some local market segments
to new entrants. However, legal and tariff restrictions historically prevented
entry on a resale basis and limited competitive local entry to facilities-
based providers.
The Telecommunications Act, which was enacted on February 8, 1996, is
considered to be the most comprehensive reform of the nation's
telecommunications laws and will substantially affect the development of
competition for local telecommunications services. Specifically, certain
provisions of the Telecommunications Act provide for: (i) the removal of legal
barriers to entry to the local telecommunications services market; (ii) the
interconnection of incumbent LEC networks with competitors' networks; (iii)
the establishment of procedures and requirements to be followed by the RBOCs,
including the requirement that RBOCs offer local services for resale in order
to enter into the long distance and telecommunications equipment manufacturing
markets; and
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(iv) the relaxation of the regulation of certain telecommunications services
provided by LECs and others. The Company believes the Telecommunications Act
will promote significant growth in the local telecommunications market as new
market entrants, including resellers, provide expanded service offerings and
increased levels of subscriber service.
In addition to the Telecommunications Act and other FCC actions and
proposals, an increasing number of states have encouraged competition in
various aspects of the local telecommunications market. While the majority of
state initiatives were originally limited to private line and special access
services, many states are in the process of changing their statutes or
regulations to permit competition for switched services, including basic local
exchange telephone services. By the time the Telecommunications Act was
enacted, approximately half the states had removed legal prohibitions on the
provision of competitive local exchange service. Those states that have not
made these changes are required to do so under the Telecommunications Act. The
Company believes, based on data compiled by the FCC, that the passage of the
Telecommunications Act combined with earlier state regulatory developments,
has expanded the market for competitive local providers from dedicated
services, which was estimated to have been approximately $5 billion in 1995,
to include the local switched access market for business subscribers, which
was estimated to have comprised approximately $55 billion of the approximately
$96 billion represented by local exchange services in 1995.
The Telecommunications Act further increases the opportunities available to
competitive local providers by requiring the RBOCs and other incumbent LECs to
offer various network elements such as switching, transport and loops (i.e.,
the facilities connecting a subscriber's premises to a LEC central office) on
an unbundled and non-discriminatory basis. RBOCs also are required to offer
their retail services at wholesale rates for resale by other companies,
including the Company. By offering such services, the RBOCs are also meeting
certain of the requirements contained in the Telecommunications Act in order
to gain FCC approval to provide in-region long distance services. The Company
believes regulatory reform, together with increased demand from the large
underserved small and medium-sized business market, will provide growth
opportunities for local telecommunications resellers who meet the RBOCs'
requirements for integrated billing and information systems and have
significant management and operational expertise. This new market opportunity
will permit competitive providers who can manage the operational and marketing
implementation to offer a full range of local telecommunications services,
including local calling, custom calling features and intra-LATA toll services
to virtually any subscriber in the United States. The Company believes that
carriers such as the Company reselling local exchange services have the
opportunity to gain market share in the local exchange market just as long
distance resellers have gained market share in the long distance market. In
addition, competitors other than the Company, including the major
interexchange carriers, will be able to take advantage of the unbundling and
resale requirements imposed on the RBOCs and other incumbent LECs under the
Telecommunications Act, thereby facilitating entry of competitors that
previously have not invested in local distribution facilities.
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BUSINESS
INTRODUCTION
The Company is a rapidly growing provider of integrated local and long
distance telecommunications services in the United States. The Company resells
telecommunications services of certain RBOCs and certain long distance
carriers to provide an integrated solution of local and long distance services
to the underserved small and medium-sized business segment. The Company
primarily focuses its marketing efforts on businesses with telecommunications
usage of less than $5,000 per month. The Company's approach simplifies the
subscriber's telecommunications procurement and management tasks and provides
for the easy addition of customized services, such as special local and long
distance pricing and enhanced and other value-added calling and billing
features designed to meet specific subscriber needs.
The Company's goal is to be more flexible, innovative and responsive to the
needs of its subscribers than the RBOCs and the large long distance carriers,
which primarily concentrate their sales and marketing efforts on residential
and large commercial subscribers. Market research combined with the Company's
experience indicates that its target subscribers prefer a single source and
single bill for all of their telecommunications needs. The Company provides
local service obtained from the incumbent RBOCs at wholesale rates, which
allows subscribers to switch to local service provided by the Company without
changing their existing telephone numbers or adding new facilities or
equipment. The Company provides long distance services by purchasing bulk
capacity from long distance carriers and reselling those services to the
Company's subscribers. By providing an integrated, customized package of
local, long distance and enhanced and other value-added services on a single
bill through its proprietary software and responsive subscriber care systems,
the Company believes that it provides a differentiated and competitive
product.
The Company obtains its resold local services pursuant to comprehensive
local exchange resale agreements, including the Ameritech Resale Agreements
for the greater metropolitan Chicago area, Ohio and Michigan and the NYNEX
Resale Agreements for the states of New York and Massachusetts. The Company
has also entered into an LSO agreement with NYNEX for the resale of Centrex
services over a private local network which provides access to the majority of
business lines in Manhattan, New York. After a nine month systems test period
with Ameritech, the Company commenced service in Illinois in August 1996,
followed by Ohio in October 1996. The Company completed a systems test period
in New York in October 1996 and started offering service in November 1996. The
Company began service in Michigan at the end of 1996 and commenced service in
Massachusetts in March 1997. Additionally, the Company has contracted with
certain long distance carriers, including MCI and Sprint to provide capacity
for its long distance traffic. The Company continuously seeks to enter into
agreements with additional RBOCs, long distance carriers and enhanced and
other value-added service providers in order to aggressively build its
subscriber base as well as to provide additional services to its existing
subscribers while reducing costs. See "--Vendor Agreements."
MARKET OPPORTUNITY
The Telecommunications Act is expected to result in a fundamental change in
the competitive structure of the local exchange market, greatly accelerating
changes that have been under way for several years as a result of FCC policy
initiatives and ongoing deregulatory trends at the state level. Specifically,
the Telecommunications Act lifted regulatory barriers to entry into the local
market, required the resale of local services by the RBOCs and put in place
various measures designed to further the development of a competitive market,
all of which benefit the Company.
SUBSCRIBERS AND MARKETING
The Company's subscribers include small and medium-sized businesses which
principally have telecommunications usage of less than $5,000 per month. The
Company believes that the RBOCs and large interexchange carriers historically
have chosen not to concentrate their sales and marketing efforts on this
business segment, which the Company believes represents a significant portion
of the telecommunications
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market. Through radio and newspaper advertising, as well as various marketing
programs, the Company has sought to establish itself as a recognized brand
name for its products and services emphasizing responsive subscriber support
systems, competitive product and pricing packages and a targeted sales and
marketing strategy. The Company had approximately 1,700 customers as of
December 31, 1996.
The Company's services are currently sold through a direct sales effort, but
the Company plans to expand its sales efforts to a multi-channel marketing
approach, which combines both direct and indirect sales efforts. The Company
believes this marketing approach would increase market coverage and reduce
marketing costs and subscriber acquisition costs. The Company focuses on the
structuring, management and control of its marketing programs in order to
effectively integrate with the billing and information systems of the RBOCs.
The Company has recruited and continues to recruit a direct sales force in
each of the markets in which it operates. The Company recruits salespeople
with experience in selling competitive telecommunications services in the
markets where they are based. The Company's sales force is trained in-house
with a rigorous subscriber-focused training program that promotes activity-
based selling with a uniquely designed program for subscriber acquisition. The
sales force makes calls to prospective subscribers from potential subscriber
modules created by acquiring business databases sorted by target
characteristics (e.g. size of business and number of telephone lines).
Salespeople are given an incentive through a commission structure, with a
target of 50% of a salesperson's compensation based on such person's
performance.
MANAGEMENT INFORMATION SYSTEMS
Introduction
The Company is committed to the continued development and successful
implementation of billing and subscriber care systems that provide accurate
and timely information to both the Company and its subscribers. The
proprietary interfaces of the Company's management information systems for the
provisioning of services to the Company's customers have been developed in
cooperation with Ameritech and NYNEX, with which the Company has entered into
resale agreements. The Company believes this method of development is a
critical element to successfully providing local telecommunications services
and is an advantage, as the RBOCs have an economic and strategic incentive to
work with resellers that have sophisticated information systems that can
interface efficiently with the RBOCs' systems. The Company believes its
experience in developing these systems will allow it to offer services quickly
in new markets. The subscriber care systems have been developed and continue
to be enhanced in a client/server environment allowing for flexibility to
accommodate an expanding subscriber base, efficient entry into new markets and
rapid development of additional functionality.
As a result of the Ameritech Resale Agreements and the NYNEX Resale
Agreements, as well as changes in the Company's subscriber base and product
mix, the Company has modified its billing and subscriber care systems. The new
systems were developed to run in a multi-site wide area network configuration
allowing the Company to decentralize certain data processing and subscriber
care activities as desired. Due to the modular nature of this hardware and
software setup, new centers may be added by the Company to accommodate
subscriber growth and entry into additional territories.
The systems are designed to provide access to a broad range of information
on individual subscribers, including their call volume, patterns of usage and
billing history. This same information is used by the Company to identify
subscriber trends and will allow for proactive support of the Company's
marketing efforts.
The Company expects to continue to pursue a strategy of growth and
expansion, which will place additional demands on the Company's billing and
subscriber care systems. In the past the Company has experienced a number of
billing and provisioning problems under its LSO agreement with NYNEX. Although
the Company believes that the NYNEX-related problem has been substantially
resolved and that its billing and subscriber care systems have been adequate
to date for its business, there can be no assurance that the problems will not
recur or that new billing and provisioning difficulties will not arise in the
course of the Company's execution of its
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business strategy. Such difficulties, if they were to occur, could have a
material adverse effect on the Company's business, operating results and
financial condition.
The anticipated high growth in the subscriber base in 1997 and 1998
following the recent significant expansion of the field sales organization is
expected to put substantial stress on the legacy billing and subscriber care
systems. The Company intends to invest a substantial portion of its capital
plan for 1997 and 1998 to develop more robust billing and subscriber care
systems.
Billing and Management Systems
The Company currently outsources the rating, printing and mailing of
subscriber bills. Since these functions require a high volume of processing in
a limited time frame, the Company has determined that the most economical way
currently to process bills is to share the hardware resources with others. The
subscriber usage information for billing and the tables and procedures used in
the rating of call records are maintained separately by the Company to manage
the ongoing needs of each subscriber. Standard management reports are
generated for every billing cycle.
Provisioning and Subscriber Information/Subscriber Care
Provisioning of service to subscribers is accomplished through the Company's
proprietary systems. The provisioning gateway systems are designed to
interface with the RBOCs' systems through a variety of delivery mechanisms,
including Internet mail, direct connect, fax and network data mover.
Information regarding new subscribers is electronically requested from the
RBOCs and long-distance carriers, evaluated by the Company in terms of credit
risk and potential revenue and subsequently processed into the Company's
subscriber care system. In addition, the Company's information systems
generate margin analysis reports on existing businesses of the Company and
accounts receivable information.
VENDOR AGREEMENTS
Introduction
The Company has executed comprehensive local exchange resale agreements,
including the Ameritech Resale Agreements for the greater metropolitan Chicago
area, Ohio and Michigan, and the NYNEX Resale Agreements for the states of New
York and Massachusetts. Additionally, the Company has entered into an LSO
agreement with NYNEX for the resale of Centrex over a private local network
which provides access to a majority of the business lines in Manhattan, New
York. The Company estimates, based on data compiled by the FCC, that the
regions covered by the Ameritech Resale Agreements and the NYNEX Resale
Agreements include access to over 10 million business access lines and over 25
million residential access lines. The Company continuously evaluates
opportunities to enter into agreements with additional RBOCs, long distance
carriers and enhanced and other value-added service providers in order to
aggressively build its subscriber base as well as to provide additional
services to its existing subscribers while reducing costs.
The Company currently has long distance resale agreements with MCI and
Sprint. Such agreements allow the Company to offer its subscribers integrated
local and long distance telecommunications services. In addition, such
agreements have allowed the Company to enter and establish itself as a
telecommunications provider in strategically targeted markets prior to
establishing a local exchange resale agreement.
Ameritech Resale Agreements
Pursuant to the Ameritech Resale Agreements, the Company purchases local
exchange services at discounted rates based on a ten-year term. These
agreements contain pricing protections designed to maintain the
competitiveness of the Company's discounted rates and position the Company to
purchase capacity at rates at least as favorable as those of competitors that
have or may eventually negotiate a resale agreement. The level
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of discounts of the resold services provided under these agreements vary based
on the state and the nature of services resold (i.e., access lines, local
calls, toll calls or features).
Services offered for resale include most of the telecommunications products
and services engineered and provided by Ameritech, such as local exchange
calling and attendant features including call waiting, call forwarding, caller
ID and three-way calling. The rates for these services are filed with the
public utilities commission of each respective state. The Company also has an
agreement with Ameritech for the resale of certain non-tariffed services to
its subscribers, including inside wire maintenance.
The Ameritech Resale Agreements include a Minimum Commitment of resold
access lines per region covered. The Minimum Commitment in Illinois is 150,000
business access lines and in Ohio and Michigan, 100,000 business access lines
and 10,000 residential lines. The Minimum Commitment is not a limitation on
the Company's overall ability to sell access lines at discounted rates.
However, if the Company fails to meet its Minimum Commitment, the Company is
subject to an underutilization charge equal to the number of unutilized lines
multiplied by a fixed average business line rate. The measurement period of
the Minimum Commitment does not commence, however, until the completion of a
three month trial or "beta period" and an 18 month "ramp up" period which
gives the Company the ability to build its subscriber base. In addition, the
Ameritech Resale Agreements provide a "carryforward" provision designed to
minimize the potential for any liability resulting from a failure to meet the
Minimum Commitment by carrying forward underutilization amounts which may be
met in the future.
If the Company does not meet its Minimum Commitment by the end of the ten-
year term, with the benefit of the carryforward provision, the Company has the
option to either pay a penalty based on the aggregate number of unutilized
lines or subscribe on a monthly basis to an equivalent number of lines during
the next three-year period. In the event the Company terminates any of the
Ameritech Resale Agreements prior to their expiration without cause, the
Company is subject to a termination charge.
NYNEX Resale Agreements
On July 9, 1996, the Company executed a resale agreement with NYNEX to
provide for the resale of local exchange services for the state of New York at
discounted rates based on a ten-year term. The New York NYNEX Resale Agreement
contains pricing protections designed to maintain the competitiveness of
discounted rates provided to the Company. Under the New York NYNEX Resale
Agreement, the Company receives the lowest rate and/or most favorable term
provided to any reseller; however, if a lower rate is provided to a reseller
committing to both a longer term and a greater volume commitment, the Company
receives the lower rate but must negotiate with NYNEX a reasonable transition
to similar commitments. If the Company cannot successfully negotiate such a
transition with NYNEX, then the Company may be unable to maintain the lowest
rate. The level of discounts of resold services varies based on the nature of
the services. The New York NYNEX Resale Agreement contains a Minimum
Commitment of 100,000 business access lines. In the event the Company does not
satisfy the Minimum Commitment after a beta period and ramp-up period, the
Company is subject to an underutilization charge. However, the NYNEX Resale
Agreement also contains a carryforward provision designed to minimize the
potential of an underutilization charge. The Company has also executed an
interim resale agreement with NYNEX for Massachusetts. This agreement does not
contain a term and volume commitment, but was designed to allow the Company to
begin reselling services in Massachusetts expeditiously in a manner consistent
with state regulatory developments. It is expected that the Company and NYNEX
will enter into a long-term resale agreement for Massachusetts similar to the
New York NYNEX Resale Agreement.
NYNEX Limited Service Offering
Since 1994, the Company has offered Centrex over a private local network,
which allows the Company to provide integrated local exchange service and long
distance service, on a resale basis to the majority of business lines of
Manhattan, New York. The Company has access to 23 NYNEX switches over a
private local network and dedicated lines at discounted rates based on volume
of traffic. The Company believes the LSO agreement
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will complement services provided under the NYNEX Resale Agreement by allowing
the Company to package specifically tailored telecommunications services. The
LSO agreement contains a Minimum Commitment of 10,000 local exchange access
lines. The Company has not met this Minimum Commitment due to NYNEX
provisioning delays. The LSO Agreement provides that provisioning delays allow
the Company to postpone its obligation to meet the Minimum Commitment.
Long Distance Agreements
The Company primarily uses MCI to provide a wide range of long distance
telecommunications services to its customers. Services offered for resale from
MCI include a variety of inbound, outbound, calling card and international
services. In addition, the Company also resells teleconferencing, debit cards,
branded operator services and private line services.
The Company's primary long distance carrier agreement is with MCI, became
effective August 1, 1996 and contains a 33-month term. It requires the Company
to achieve certain monthly dollar targets in order to qualify for discounted
rates on carrier services. After a nine-month "ramp-up" period, the agreement
provides for an annual commitment for each of the two years following the
"ramp-up" period. If the Company does not meet its annual commitment during
any annual period of the term, an underutilization charge shall apply in an
amount equal to 15% of the difference between the committed amount and the
actual usage. However, the Company may carry forward up to 10% of the initial
annual commitment for a period of up to three months in the following annual
period.
Enhanced and Other Value-Added Telecommunications Services
The Company is in the process of negotiating agreements to offer on a resale
basis enhanced and other value-added services such as Internet access, paging
and voicemail. In addition, the Company has entered into an agreement for the
exclusive rights in the United States and Canada to distribute a Windows-based
teleconferencing product which allows the conference host to conduct a
conference call using point and click graphics directly from a personal
computer without having to make teleconference reservations.
COMPETITION
The Company operates in a highly competitive environment and has no
significant market share in any market in which it operates. The Company
expects that competition will intensify in the future due to regulatory
changes, including the enactment of the Telecommunications Act and the
increase in the size, resources and number of market participants. In each of
its markets, the Company faces competition for local service from larger,
better capitalized incumbent providers, many of whom have greater financial
resources than the Company. Additionally, the long distance market is already
significantly more competitive than the local exchange market, because the
RBOCs have historically had a monopoly position within the local exchange
market. The incumbent LECs have long-established relationships with their
subscribers and provide those subscribers with various transmission and
switching services that the Company, in many cases, has only recently begun to
offer.
In the local exchange market, the Company also faces competition or
prospective competition from one or more CAPs, which have significantly
greater financial resources than the Company, and from other competitive
providers, including non-facilities-based providers like the Company. For
example, AT&T, MCI and Sprint, among other carriers, have each begun or
indicated their intention to begin offering local telecommunications services
in major U.S. markets using their own facilities or by resale of the LECs' or
other providers' services. In fact, certain competitors, including MCI, Sprint
and AT&T, have entered into interconnection agreements with Ameritech with
respect to the States of Illinois, Michigan and Ohio. These competitors either
have begun or will in the first half of 1997 likely begin offering local
exchange service in those states, subject to the joint marketing restrictions
under the Telecommunications Act described below. In addition, some of these
competitors have entered into interconnection agreements with NYNEX and either
have begun or in the first half of 1997 will likely begin offering local
exchange service in New York and Massachusetts, subject to such joint
marketing
36
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restrictions. In addition to these long distance service providers, entities
potentially capable of offering switched services include CAPs, cable
television companies, electric utilities, other long distance carriers,
microwave carriers, wireless telephone system operators and large subscribers
who build private networks. Many facilities-based CAPs and long distance
carriers, for example, have committed substantial resources to building their
networks. By building a network, a facilities-based provider can enter the
local exchange market by using its own network, or entering into
interconnection agreements or resale agreements with incumbent LECs, including
RBOCs. Such additional alternatives may provide the CAPs with greater
flexibility and a lower cost structure than the Company.
With respect to wireless telephone system operators, the FCC recently
authorized cellular, PCS, and other CMRS providers to offer wireless services
to fixed locations, rather than just to mobile subscribers, in whatever
capacity such CMRS providers choose. Previously, cellular providers could
provide service to fixed locations only on an ancillary or incidental basis.
This authority to provide fixed as well as mobile services will enable CMRS
providers to offer wireless local loop service and other services to fixed
locations (e.g., office and apartment buildings) in direct competition with
the Company and other providers of traditional fixed telephone service. In
addition, in August 1996 the FCC promulgated regulations that classify CMRS
providers as telecommunications carriers, thus giving them the same rights to
interconnection and reciprocal compensation under the Telecommunications Act
as other non-LEC telecommunications carriers, including the Company.
Under the Telecommunications Act and related federal and state regulatory
initiatives, barriers to local exchange competition are being removed. The
availability of broad-based local resale and introduction of facilities-based
local competition are required before the RBOCs may provide in-region
interexchange long distance services. Also, the largest long distance carriers
(AT&T, MCI, Sprint and any other carrier with 5% or more of the pre-subscribed
access lines) are prevented under the Telecommunications Act from bundling
local services resold from an RBOC in a particular state with their long
distance services until the earlier of (i) February 8, 1999 or (ii) the date
on which the RBOC whose services are being resold obtains in-region long
distance authority in that state. The RBOCs are currently allowed to offer
certain in-region "incidental" long distance services (such as cellular, audio
and visual programming and certain interactive storage and retrieval
functions) and to offer virtually all out-of-region long distance services.
In January 1997, Ameritech, the RBOC in three states where the Company
operates, filed and subsequently withdrew an application for in-region long
distance authority in Michigan. The Company anticipates that Ameritech will
again file an application with respect to Michigan as well as most or all of
its other states--including Illinois and Ohio. Other RBOCs, including NYNEX in
New York, are expected to file such applications as early as the first half of
1997. The FCC will have 90 days from the date such an application is filed to
decide whether to grant or deny the application. Once the RBOCs are allowed to
offer widespread in-region long distance services, both they and the largest
interexchange carriers will be in a position to offer single-source local and
long distance services similar to those offered by the Company. While new
business opportunities will be made available to the Company through the
Telecommunications Act and other federal and state regulatory initiatives,
regulators are likely to provide the incumbent LECs with an increased degree
of flexibility with regard to pricing of their services as competition
increases. Although the Ameritech Resale Agreements and the NYNEX Resale
Agreements contain certain pricing protections, including adjustments in the
wholesale rates to be consistent with any changes in the Ameritech and NYNEX
retail rates, if the incumbent LECs elect to lower their rates and sustain
lower rates over time, this may adversely affect the revenues of the Company
and place downward pressure on the rates the Company can charge. While the
Ameritech and NYNEX Resale Agreements ensure that the Company will receive any
lower rate provided to any other reseller, under the NYNEX Resale Agreement if
such lower rate is provided to a reseller committing to both a longer term and
a greater volume commitment, the Company receives the lower rate, but must
negotiate with NYNEX a reasonable transition to similar commitments. If the
Company cannot successfully negotiate such a transition with NYNEX, then the
Company may be unable to maintain the lowest rate. The Company believes the
effect of lower rates may be offset by the increased revenues available by
offering new products and services to its target subscribers, but there can be
no assurance that this will occur. In addition, if future regulatory decisions
afford the LECs excessive pricing flexibility or other regulatory relief, such
decisions could have a material adverse effect on the Company.
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Competition for the Company's products and services is based on price,
quality, network reliability, service features and responsiveness to
subscriber needs. While the Company believes that it currently has certain
advantages relating to the timing, ubiquity and cost savings resulting from
its resale agreements, there is no assurance that the Company will be able to
maintain these advantages. A continuing trend toward business combinations and
alliances in the telecommunications industry may create significant new
competitors to the Company. Many of the Company's existing and potential
competitors have financial, technical and other resources significantly
greater than those of the Company.
GOVERNMENT REGULATION
The Company is subject to varying degrees of federal, state, local and
international regulation. In the United States, the Company is most heavily
regulated by the states, especially for the provision of local exchange
services. The Company must be separately certified in each state to offer
local exchange services. No state, however, subjects the Company to price cap
or rate-of-return regulation. FCC approval is required for the resale of
international facilities and services. The FCC has determined that nondominant
carriers, such as the Company, are required to file interstate tariffs on an
ongoing basis, setting forth the Company's rates and operating procedures.
Such tariffs can currently be modified on one day's notice. The FCC recently
issued regulations to eliminate this tariff filing requirement for all
nondominant carriers, such as the Company and all other nondominant
interexchange carriers (except possibly the RBOCs in certain circumstances),
effective in late 1997. The FCC has recently ruled, subject to its
consideration of the issue in another pending FCC proceeding, that RBOCs
providing out-of-region long distance service through separate subsidiaries
from their local telephone operations qualify for nondominant treatment. Out-
of-region RBOC services provided through unseparated entities, however, are
subject to full dominant carrier regulation, including the requirement to
submit cost support with tariffs and to file tariffs on at least 15 to 45
days' notice, depending on various factors. The FCC has not yet indicated
whether RBOC in-region service, when authorized, will be subject to dominant
or nondominant regulatory status. See "Risk Factors--Regulation and Risks of
the Telecommunications Act."
Legislation. On February 8, 1996, President Clinton signed into law the
Telecommunications Act, comprehensive federal telecommunications legislation
affecting all aspects of the telecommunications industry. The
Telecommunications Act establishes a national policy that promotes local
exchange competition. The Telecommunications Act requires that local and state
barriers to entry into the local exchange market be removed and establishes
broad uniform standards under which the FCC and the state commissions are to
implement local competition and co-carrier arrangements in the local exchange
market. Under certain conditions and subject to reasonable exceptions,
incumbent LECs will be required to make available for resale to new entrants
all services offered by the LEC on a retail basis. The Telecommunications Act
also imposes significant obligations on the RBOCs and other incumbent LECs,
including the obligation to interconnect their networks with the networks of
competitors. Each incumbent LEC would be required not only to open its network
but also to "unbundle" the network. The FCC issued regulations in August 1996
defining a minimum set of elements which must actually be unbundled, and each
state may augment this list if it wishes. The pricing of these unbundled
network elements and services will determine whether it is economically
attractive to use these elements.
In addition to the required network unbundling applicable to all incumbent
LECs, the RBOCs have an added incentive to open their local exchange networks
to facilities-based competition because the Telecommunications Act provides
for the removal of the current ban on RBOC provision of in-region inter-LATA
toll service and equipment manufacturing. This ban will be removed only after
the RBOC demonstrates to the FCC, which must consult with the Department of
Justice and the relevant state commissions, that the RBOC has (1) met the
requirements of the Telecommunications Act's 14-point competitive checklist
and (2) entered into an approved interconnection agreement with at least one
unaffiliated, facilities-based competitor in some portion of the state
pursuant to which such competitor provides both business and residential
service (or that by a date certain no such competitors have "requested"
interconnection as defined in the Telecommunications Act). RBOC in-region
services must be provided through a separate subsidiary for three years,
unless extended by the FCC. In January 1997, Ameritech, the RBOC in three
states where the Company operates, filed and subsequently withdrew an
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application for in-region long distance authority in Michigan. The Company
anticipates that Ameritech will again file an application with respect to
Michigan as well as most or all of its other states--including Illinois and
Ohio. Other RBOCs, including NYNEX in New York, are expected to file such
applications as early as the first half of 1997. If the FCC determines that
the RBOC's entry into in-region provision of long distance in that state is in
the public interest and that the RBOC has met the 14-point checklist, it must
authorize the RBOC to provide such services.
Under the 14-point competitive checklist, in order to obtain in-region long
distance authority an RBOC must first demonstrate to the FCC, among other
things, that, within a particular state, it offers competing LECs the
following: interconnection as required under the Telecommunications Act; non-
discriminatory access to unbundled network elements at just and reasonable
rates; non-discriminatory access to its poles, ducts, conduits, and rights-of-
way; unbundled local loop transmission, unbundled local transport, and
unbundled local switching; non-discriminatory access to 911 services;
directory assistance, operator call completion services, and white pages
directory listings for competing local carriers' subscribers; non-
discriminatory access to call routing databases; number portability (i.e., the
ability of a subscriber to keep the same telephone number when switching local
telephone service providers); dialing parity (i.e., the ability of subscribers
of one telephone service provider to call subscribers of other providers
without dialing access codes); reciprocal compensation arrangements for the
termination of calls between competing local networks; and permitting resale
of its telecommunications services.
While state-by-state regulatory activity has to date brought resale co-
carrier arrangements or initiatives to various degrees of completion in nearly
all states, the Telecommunications Act is intended to accelerate the process
and create a competitive environment in all markets, eliminating state and
local statutory and regulatory barriers to entry. This preemption of state
laws barring local competition and the relaxation of regulatory restraints
should enhance the Company's ability to expand its service offerings
nationwide. In contrast, by removing barriers to entry into the local exchange
market and at the same time enabling multiple carriers to compete with the
Company in the provision of local and long distance services, ultimately
allowing the RBOCs and large interexchange carriers to offer their own
packages of single-source local/long distance services, the Telecommunications
Act will substantially increase the competition the Company will face.
In addition to providing the Company with a national framework to achieve
local exchange resale carrier status in local exchange markets, the
Telecommunications Act permits the Company, as a telecommunications carrier
with less than 5% of nationwide presubscribed access lines, to continue to
offer single-source combined packages of local and long distance services. In
contrast, AT&T, MCI and Sprint may not bundle in an RBOC's territory their
local services resold from an RBOC and in-region long distance service until
the earlier of (i) February 8, 1999 or (ii) the date the RBOC is authorized to
enter the inter-LATA long distance market in that state.
The Telecommunications Act also creates a new Federal-State Joint Board for
the purpose of making recommendations to the FCC regarding the implementation
of a largely revised universal service program. All telecommunications
carriers, including the Company, that provide interstate services are required
to contribute, on an equitable and nondiscriminatory basis, to the
preservation and advancement of universal service pursuant to a specific and
predictable universal service mechanism to be established by the FCC. The
Federal-State Joint Board issued recommendations regarding the scope and
funding of universal service in December 1996, but those recommendations are
not binding. The FCC may exempt certain classes of carriers from having to
contribute to the universal service fund. The Company is unable to predict the
final formula for universal service contribution or its own level of
contribution.
Federal Regulation. The Telecommunications Act in some sections is self-
executing, but in most cases the FCC must issue regulations that identify
specific requirements before the Company and its competitors can proceed to
implement the changes the Telecommunications Act prescribes. The FCC already
has commenced several of these rulemaking proceedings. The outcome of these
various ongoing FCC rulemaking proceedings could materially affect the
Company's operations.
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<PAGE>
The Company actively monitors all pertinent FCC proceedings and has
participated in some of these proceedings. The Telecommunications Act provides
that individual state utility commissions can, consistent with FCC
regulations, prohibit resellers from reselling a particular service to
specific categories of subscribers to whom the incumbent LEC does not offer
that service at retail. In August 1996, the FCC issued detailed regulations
providing that many such limitations are presumptively unreasonable and that
states may enact such prohibitions on resale only in certain limited
circumstances. In particular, the FCC concluded that while it would be
permissible to prohibit the resale of certain residential or other subsidized
services to end users that would be ineligible to receive such services
directly from the LEC, all other "cross-class" selling restrictions, including
those on volume discount and flat-rated offerings to business customers, would
be presumed unreasonable. An incumbent LEC may rebut this presumption,
however, by demonstrating that the class restriction is reasonable and
nondiscriminatory. The FCC also rejected claims by several incumbent LECs to
provide for several exceptions to the general resale obligation. For instance,
it refused to create a general exception for all promotional or discounted
offerings, including contract and customer-specific offerings. The FCC did,
however, conclude that short-term promotional prices (i.e., those offered for
90 days or less) are not "retail rates" and thus are not subject to the
wholesale rate obligation. Incumbent LECs may not offer consecutive 90-day
promotions to avoid these resale obligations.
The Telecommunications Act also provides that state commissions shall be
given an opportunity to determine the wholesale rates for local
telecommunications services (i.e., the rates charged by incumbent LECs to
resellers such as the Company) on the basis of retail rates less "avoided
costs," i.e., marketing, billing, collection and other administrative costs
avoided by the incumbent LEC when it sells at wholesale. In August 1996 the
FCC issued detailed regulations identifying such avoided costs, and also
included in such category "avoidable" costs. To determine the specific value
of avoided and avoidable costs applicable to each service of a particular
incumbent LEC, the FCC required the state public service commissions to
conduct detailed cost studies consistent with the FCC regulations governing
what constitutes avoided and avoidable costs. Until such time that these costs
studies are completed, the FCC established an interim default discount of
between 17% and 25%. Accordingly, until such time that a state determines the
actual level of avoided and avoidable costs pursuant to the FCC's regulations,
it may require incumbent LECs to discount their retail offerings by 17% to
25%, provided that actual cost studies are completed within a reasonable time.
The Telecommunications Act also provides that state commissions shall
determine the rates charged for unintegrated elements of the incumbent LEC's
network on the basis of cost plus a reasonable profit. In August 1996, the FCC
declined to issue detailed regulations governing the relationship between
these two pricing standards, leaving the interpretation and implementation of
the two standards to the states. The Company is unable to predict the final
form of such state regulation, or its potential impact on the Company or the
local exchange market in general.
In August 1996, the FCC also issued regulations that, among other things,
set minimum standards governing the terms and prices of interconnection and
access to unbundled incumbent LEC network elements. These regulations
indirectly affect the price at which the Company's new facilities-based
competitors may ultimately provide service. At the same time, the FCC imposed
minimum obligations regarding the duty of incumbent LECs to negotiate
interconnection or resale arrangements in good faith.
A number of RBOCs, state regulatory commissions and other parties have filed
requests for reconsideration by the FCC of various parts of the rules
announced by the FCC in August 1996, including those provisions (a) limiting
competitors' ability to purchase for resale certain types of service that the
RBOC is no longer marketing to new customers ("grandfathered services"), and
(b) establishing pricing methodologies and interim default rates for resold
services and unbundled network elements. The FCC is conducting a proceeding to
consider the various petitions for reconsideration, and a decision is expected
in the first half of 1997. In addition, many of the same parties and certain
other parties have filed court appeals challenging the same FCC rules. All the
court appeals have been consolidated before the Eighth Circuit Federal Court
of Appeals, which has stayed the effect of certain parts of the rules
(including the provisions establishing pricing methodologies and default rates
for resold services and unbundled network elements) pending its decision in
the appeals. The U.S. Supreme Court declined to dissolve the stay, and the
court of appeals' decision is not expected before the middle of 1997. The
Company cannot predict at this time the outcome of the appeals or
reconsideration processes.
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In July 1996, the FCC mandated that over the course of the next year
responsibility for administering and assigning local telephone numbers be
transferred from the RBOCs and a few other LECs to a neutral entity. In August
1996, the FCC issued regulations which address certain of these issues, but
leave others for decision by the states and the still-to-be selected neutral
numbering plan administrator. The new FCC numbering regulations (a) prohibit
states from creating new area codes that could unfairly hinder LEC competitors
(including the Company) by requiring their customers to use 10 digit dialing
while existing incumbent LEC customers use 7 digit dialing, and (b) prohibit
incumbent LECs (which are still administering central office numbers pending
selection of the neutral administrator) from charging "code opening" fees to
competitors (such as the Company) unless they charge the same fee to all
carriers including themselves. In addition, each carrier is required to
contribute to the cost of numbering administration through a formula based on
net telecommunications revenues. In July 1996, the FCC released rules to
permit both residential and business consumers to retain their telephone
numbers when switching from one local service provider to another (known as
"number portability"). RBOCs are required to implement number portability in
the top 100 markets by October 1, 1997 and to complete it by December 31,
1998. In smaller markets, RBOCs must implement number portability within six
months of a request therefor commencing December 31, 1998. Other LECs,
including the Company, are required to implement number portability by October
31, 1997 only in those of the top 100 markets where the feature is requested
by another LEC. Similarly, the Company and other non-RBOC LECs are only
required to implement number portability by December 31, 1998 in those
additional markets where the feature is requested by another LEC. The Company
already offers number portability as it provides local service obtained from
the incumbent RBOCS. This allows subscribers to switch to the Company's
services and still retain their existing telephone numbers.
In addition, the FCC recently authorized cellular and other CMRS to provide
for other wireless services to fixed locations (rather than to mobile
subscribers), including offering wireless local loop service, in whatever
capacity such provider determines. Previously, many CMRS providers could
provide fixed services on only an ancillary or incidental basis. In addition,
in August 1996 the FCC promulgated regulations that classify CMRS providers as
telecommunications carriers, thus giving them the same rights to
interconnection and reciprocal compensation under the Telecommunications Act
as other non-LEC telecommunications carriers, including the Company.
State Regulation. Historically, certain of the Company's resold local and
long distance services were classified as intrastate and therefore subject to
state regulation. As its local service business and product lines has
expanded, the Company has offered more intrastate service and become
increasingly subject to state regulation. The Telecommunications Act maintains
the authority of individual state utility commissions to impose their own
regulation of local exchange services so long as such regulation is not
inconsistent with the requirements of the Telecommunications Act. In all
states where certification is required, the Company's operating subsidiaries
are certificated as common carriers. In all states, the Company believes that
it operates with the appropriate state regulatory authorization. The Company
currently is authorized to provide intrastate toll or a combination of local
and intrastate toll service in more than 40 states. These authorizations vary
in the scope of the intrastate services permitted.
The Telecommunications Act provides that the Company's resale agreements
must be submitted to the applicable state utility commission for approval, and
it places strict limitations on the bases on which a state commission can
reject such an agreement. If the state commission does not act within 90 days
after the agreement is submitted for approval, then the agreement is deemed
approved. In addition, if a state commission fails to act to enforce an
agreement, the FCC can (upon request of a party) take jurisdiction over the
matter. A state commission's decisions regarding implementation and
enforcement of an agreement are appealable to the federal district court in
that state.
PROPERTIES
The Company leases twenty-seven facilities, principally sales facilities, in
Boston, Massachusetts, Chicago, Illinois, Detroit, Michigan, Cleveland and
Columbus, Ohio and New York City, as well as in a number of areas
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surrounding such cities and in other significant urban areas in Michigan, New
York and Ohio. The Company maintains its corporate headquarters in Chicago,
Illinois. Although the Company's facilities are adequate at this time, the
Company believes that it may have to lease additional facilities, particularly
in new metropolitan areas where the Company enters RBOC resale agreements.
EMPLOYEES
As of December 31, 1996, the Company employed approximately 450 people. The
Company's employees are not unionized, and the Company believes its relations
with its employees are good. In connection with its marketing and sales
efforts and the conduct of its other business operations, the Company uses
third party contractors, some of whose employees may be represented by unions
or collective bargaining agreements. The Company believes that its success
will depend in part on its ability to attract and retain highly qualified
employees.
LEGAL MATTERS
From time to time the Company is party to routine litigation and proceedings
in the ordinary course of its business. The Company and its subsidiaries are
not aware of any current or pending litigation that the Company believes would
have a material adverse effect on the Company's results of operations or
financial condition. The Company and its subsidiaries continue to participate
in regulatory proceedings before the FCC and state regulatory agencies
concerning the authorization of services and the adoption of new regulations.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table provides certain information regarding the executive
officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITIONS
---- --- ---------
<S> <C> <C>
Richard J. Brekka....... 36 Chairman of the Board
J. Thomas Elliott....... 50 President, Chief Executive Officer and Director
Ronald W. Gavillet...... 37 Executive Vice President, Strategy & External Affairs
Gerald J. Sweas......... 49 Executive Vice President and Chief Financial Officer
Ryan Mullaney........... 40 Executive Vice President, Sales
Steven J. Parrish....... 41 Executive Vice President, Operations
Thomas A. Monson........ 37 Vice President, General Counsel and Secretary
Thad J. Pellino......... 35 Vice President, Marketing
Neil A. Bethke.......... 37 Vice President, Information Systems
Thomas C. Brandenburg... 60 Director
Dean M. Greenwood....... 53 Director
Donald J. Hofmann, Jr... 39 Director
William A. Johnston..... 45 Director
Paul S. Lattanzio....... 33 Director
Eugene A. Sekulow....... 65 Director
</TABLE>
Each director serves until his successor is duly elected and qualified.
Officers serve at the discretion of the Board of Directors.
Richard J. Brekka, Chairman of the Board, has been a director of the Company
since April 1994. He is a Managing Director of CIBC Wood Gundy Capital, the
merchant banking division of Canadian Imperial Bank of Commerce, and is a
director and the President of CIBC Wood Gundy Ventures, Inc. ("CIBC"), an
indirect wholly owned subsidiary of Canadian Imperial Bank of Commerce. Mr.
Brekka joined CIBC in February 1992. Currently, Mr. Brekka serves on the board
of directors of Orion Network Systems, Inc., MultiTechnology Corp., Telesystem
International Wireless N.V., and Epoch Networks, Inc. (formerly HLC-Internet,
Inc.), and on the Board of Advisors of Telecom Partners L.P. Mr. Brekka
received a B.S. in finance from the University of Southern California, and an
M.B.A. from the University of Chicago.
J. Thomas Elliott, President and Chief Executive Officer, has been the Chief
Executive Officer since April 1996. Mr. Elliott joined the Company in 1995 as
a result of the acquisition of certain assets and assumption of certain
liabilities of Quest, a company which he co-founded. From 1991 to 1993, Mr.
Elliott was Senior Vice-President of Sales and Marketing of Wiltel
Communications Systems. From 1990 to 1991, Mr. Elliott was President and Chief
Executive Officer of Call Net Inc. (Canada's first alternative long distance
company) and Lightel Inc., its affiliate fiber optic facility provider.
Subsequently, these companies were combined to form Sprint Canada. Mr. Elliott
holds a bachelor's and master's degree in economics from the University of
Windsor.
Ronald W. Gavillet, Executive Vice President, Strategy & External Affairs,
has performed the Company's legal, regulatory and strategic functions since
1994. Prior to joining the Company, Mr. Gavillet spent more than four years,
from 1985 to 1987 and from 1992 to 1994, with MCI in a number of senior legal
and regulatory positions. While at MCI, Mr. Gavillet developed and implemented
the firm's regulatory policies in Illinois, Indiana, Michigan, Ohio and
Wisconsin and negotiated sales agreements with national accounts. Mr. Gavillet
holds a B.A. and B.S. from Southern Illinois University, a J.D. from Catholic
University of America's Columbus School of Law and a Master of Management
degree from Northwestern University's Kellogg School of Management and serves
on the Telecommunications Resellers Association Local Services Council.
Gerald J. Sweas, Executive Vice President and Chief Financial Officer,
joined the Company in November 1996. From 1989 to 1996, Mr. Sweas was Vice
President Finance and Administration, Treasurer and Chief
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Financial Officer of Norand Corporation, a wireless data communications
networks company. Mr. Sweas holds a B.B.A. from Loyola University in Chicago,
Illinois and an M.B.A. from the University of Wisconsin (Madison) and is a
Certified Public Accountant.
Ryan Mullaney, Executive Vice President, Sales, joined the Company in
October 1996. From 1995 to 1996, Mr. Mullaney served as Vice President, Sales,
USA West for Citizens Telecom, a medium-sized telecommunications company,
where he managed sales in 13 states. From 1993 to 1995, Mr. Mullaney was
Director of Member Development for McLeod Telemanagement Organization, where
his duties included management of the company's field sales and service
organization. From 1991 to 1993, Mr. Mullaney was National Sales Director of
Centex Telemanagement, responsible for developing sales in the national
market. Mr. Mullaney has a B.A. from the University of Nevada, Las Vegas.
Steven J. Parrish, Executive Vice President, Operations, joined the Company
in January 1996 initially as a consultant and assumed a full-time position.
Prior to joining the Company, Mr. Parrish spent more than 12 years with
Illinois Bell in various planning and operations positions. Mr. Parrish moved
to Ameritech in 1991 where he helped start the Information Industry Services
business unit as Vice President of Business Development and Vice President of
Marketing and Sales for Network Providers. Mr. Parrish holds a bachelor's
degree in electrical engineering from the University of Illinois and an MBA
from the Illinois Institute of Technology.
Thomas A. Monson, Vice President, General Counsel and Secretary, joined the
Company in January 1997. From 1989 to 1996, Mr. Monson was Associate General
Counsel of Envirodyne Industries, Inc., a $650 million public company, where
he performed various corporate law, securities regulation, litigation and
corporate operations support activities. Mr. Monson holds a B.S. from the
University of Illinois and a J.D. from Harvard Law School.
Thad J. Pellino, Vice President, Marketing, joined the Company in August
1995. From 1988 through 1995, Mr. Pellino was with MCI where he held a variety
of marketing and business development positions, which included responsibility
for the design of customized telecommunication packages for mid-size and long
distance carriers. Mr. Pellino received his bachelor's degree in
marketing/business administration from the University of Illinois.
Neil A. Bethke, Vice President, Information Systems, joined the Company
initially as a consultant in 1995 and assumed a full-time position in May
1996. From 1994 to 1996 Mr. Bethke served as principal for New Resources
Corporation, a medium-sized consulting company specializing in client/server
technology development for large service-oriented companies. From 1988 to
1994, Mr. Bethke served at Quantum Chemical Corporation and Sara Lee
Corporation as Director of MIS, responsible for the reengineering of business
processes through document routing and wide area network database management.
Mr. Bethke holds a B.S. from the University of Wisconsin.
Thomas C. Brandenburg, Director, has been a director of the Company since
founding the Company in 1994. Prior to joining the Company, Mr. Brandenburg
was the co-founder and principal of a telecommunications consulting firm with
a service bureau-based enhanced service company. In 1983, Mr. Brandenburg was
the co-founder and principal of LiTel Communications, Inc. (now LCI
International). Mr. Brandenburg is a graduate of the University of Notre Dame.
Dean M. Greenwood, Director, was elected as a director of the Company in
February 1997. Mr. Greenwood is Vice President of Prime Management Group and
has been an officer of that company since 1992. Mr. Greenwood holds a B.B.A.
and a J.D. from the University of Texas at Austin.
Donald J. Hofmann, Jr., Director, has been a director of the Company since
April 1994. Mr. Hofmann has been a General Partner of Chase Capital Partners
(formerly known as Chemical Venture Partners) since 1992. Chase Capital
Partners is the sole general partner of Chase Venture Capital Associates, L.P.
Prior to joining Chase Capital Partners, he was head of MH Capital Partners,
Inc., the equity investment arm of Manufacturers Hanover.
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William A. Johnston, Director, was elected a director of the Company in June
1994. Mr. Johnston has been a Managing Director of HVP Partners, LLC since
January 1997. HVP Partners, LLC was formed to acquire Hancock Venture
Partners, Inc. where Mr. Johnston has served in various capacities since 1983.
Currently, Mr. Johnston serves on the advisory boards of The Centennial Funds,
Austin Ventures, and Highland Capital Partners, as well as on the board of
directors of Centennial Security, Inc., HLC-Internet, Inc., MultiTechnology
Corp., The Marks Group, Inc., and Masada Security Corporation.
Internationally, he serves on the board of directors of Telesystem
International Wireless Corporation and Esprit Telecom. Mr. Johnston received a
bachelor's degree from Colgate University and a master's degree from Syracuse
University School of Management.
Paul S. Lattanzio, Director, was appointed a director of the Company in
August 1995. Currently, Mr. Lattanzio is a Managing Director of BT Capital
Partners, Inc., an affiliate of Bankers Trust New York Corp. Mr. Lattanzio has
been employed by BT Capital Partners, Inc. or an affiliate since 1984. Mr.
Lattanzio received his B.S. in economics from the University of Pennsylvania's
Wharton School of Business.
Eugene A. Sekulow, Director, was elected a director of the Company in August
1995. Mr. Sekulow served as Executive Vice President of NYNEX Corporation from
December 1991 to 1993. From 1986 to 1991, he served as President of NYNEX
International Company. Since his retirement from NYNEX in 1993, Mr. Sekulow
has founded his own telecommunications consultancy where he has been retained
by European, U.S., Japanese, Southeast Asian and Canadian companies. Mr.
Sekulow attended the University of Stockholm and the University of Oslo. He
earned an M.A. in political science and economics and a Ph.D. from Johns
Hopkins University.
The Board of Directors of the Company consists of eight persons, including
one outside director, one appointed by each of the Initial Investors, one
appointed by BT and one appointed by Enterprises.
DIRECTORS' COMPENSATION
The Company's policy is not to pay compensation to its directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company's Compensation Committee consists of Messrs. Brekka, Johnston
and Lattanzio, none of whom is currently an employee or officer of the
Company. No executive officer of the Company served during fiscal year 1996 as
a member of a compensation committee or as a director of any entity of which
any of the Company's directors serves as an executive officer.
45
<PAGE>
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information concerning the cash and
non-cash compensation during fiscal year 1996 earned by or awarded to the
Chief Executive Officer and to the four other most highly compensated
executive officers of the Company whose combined salary and bonus exceeded
$100,000 during the fiscal year ended December 31, 1996 (the "Named Executive
Officers").
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION
---------------- ALL OTHER
YEAR SALARY BONUS COMPENSATION
---- -------- ------- ------------
<S> <C> <C> <C> <C>
J. Thomas Elliott..................... 1996 $182,500 $97,500(1) --
President and Chief Executive Officer 1995(2) 139,165 -- $75,000
1994 -- -- --
Ronald W. Gavillet.................... 1996 167,600 92,500(1) --
Executive Vice President, Strategy 1995 135,000 50,000(3) --
& External Affairs 1994(4) 7,788 -- --
Thad J. Pellino....................... 1996 96,700 33,000(1) --
Vice President, Marketing 1995(5) 31,058 33,125(5) --
1994 -- -- --
Neil A. Bethke........................ 1996(6) 69,711 31,250(1) --
Vice President, Information Systems 1995 -- -- --
1994 -- -- --
Thomas C. Brandenburg................. 1996 190,000 -- --
Former Chief Executive Officer 1995 167,692 -- --
1994 174,615 -- --
Robert J. Luth........................ 1996 150,000 -- 50,000(7)
Former Chief Financial Officer 1995 141,635 37,500(3) 69,806(7)
1994 89,170 -- --
Kevin J. Burke........................ 1996 101,000 -- --
Former Vice President, Network
Engineering 1995 123,808 -- --
and Technical Support 1994 -- -- --
</TABLE>
- --------
(1) Represents the bonus that was earned with respect to 1996 and paid in
1997.
(2) Includes Mr. Elliott's compensation as an officer of Quest America, LP
prior to the acquisition of its business by the Company. The $75,000
included as other compensation represents the amount Mr. Elliott received
for consulting service to the Company prior to the Company's acquisition
of the business of Quest America, LP.
(3) Represents amounts paid in 1996 with respect to bonuses earned in prior
periods, primarily in 1995.
(4) Mr. Gavillet commenced employment with the Company in November 1994.
(5) Mr. Pellino commenced employment with the Company in August 1995.
(6) Mr. Bethke commenced employment with the Company in June 1996.
(7) Includes amounts reimbursed by the Company for life and disability
insurance premiums and temporary living expenses.
46
<PAGE>
OPTION GRANTS
The following table sets forth the aggregate number of stock options granted
to each of the Named Executive Officers during the fiscal year ended December
31, 1996. Options are exercisable for Class A Common Stock, par value $.01 per
share, of the Company.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATE OF STOCK
NUMBER OF PERCENT OF PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM ($)(1)
OPTIONS EMPLOYEES IN PRICE EXPIRATION ---------------------
NAME GRANTED(#) FISCAL YEAR ($/SHARE) DATE 5% 10%
---- ---------- ------------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
J. Thomas Elliot........ 7,500 7.3% $1.50 6/28/96 $1,105,725 $1,686,450
29,925 29.0% 1.50 9/30/96 4,411,843 6,728,936
Ronald W. Gavillet...... 6,150 6.0% 1.50 6/28/96 906,695 1,382,889
21,859 21.2% 1.50 9/30/96 3,222,672 4,915,215
Thad J. Pellino......... 2,000 1.9% 1.50 6/28/96 294,860 449,720
1,494 1.4% 1.50 9/30/96 220,260 335,941
Neil A. Bethke.......... 2,000 1.9% 1.50 6/28/96 294,860 449,720
1,494 1.4% 1.50 9/30/96 220,260 335,941
</TABLE>
- --------
(1) The information disclosed assumes, solely for purposes of demonstrating
potential realizable value of the options, that the per share fair market
value of the Class A Common Stock is $96.00 per share as of December 31,
1996 and increases at the rate indicated, effective as of December 31 of
each subsequent year during the option term. However, there is no
established trading market for the Class A Common Stock, and no
representation is made that the Class A Common Stock actually has such
value or that the rates of increase in value can or will be achieved.
The following table sets forth certain information concerning the exercise
of stock options by the Named Executive Officers during the fiscal year ended
December 31, 1996 and the December 31, 1996 aggregate value of unexercised
options held by each of the Named Executive Officers.
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES(1)
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY OPTIONS
UNEXERCISED OPTIONS AT AT FISCAL
SHARES FISCAL YEAR-END (#) YEAR-END ($)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ----------- ----------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
J. Thomas Elliot........ -- -- 1,875/35,550 177,188/3,359,475
Ronald W. Gavillet...... -- -- 5,388/26,471 510,706/2,501,510
Thad J. Pellino......... -- -- 500/ 2,994 47,250/ 282,933
Neil A. Bethke.......... -- -- 500/ 2,994 47,250/ 282,933
Robert J. Luth.......... 2,000 189,000 1,850/ 0 175,565/ 0
</TABLE>
- --------
(1) The information disclosed assumes, solely for purposes of illustrating the
value of in-the-money options, that the per share fair market value of the
Class A Common Stock is $96.00 as of December 31, 1996. However, there is
no established trading market for the Class A Common stock, and no
representation is made that the Class A Common Stock actually has such
value.
BENEFIT PLANS
1994 Stock Option Plan
In September 1994, the Board of Directors adopted the 1994 Stock Option Plan
(the "1994 Plan"), which was subsequently approved by the stockholders in
September 1994. A total of 100,452 shares of Class A
47
<PAGE>
Common Stock have been reserved for issuance under the 1994 Plan. The purposes
of the 1994 Plan are to attract and retain qualified personnel, to provide
additional incentives to employees, officers and directors of the Company and
its affiliates and to promote the success of the Company's business. Under the
1994 Plan, the Company may grant incentive or non-qualified stock options to
employees, officers and directors. However, to the extent that the aggregate
fair market value of the Class A Common Stock issued to any person exceeds
$100,000, such options must be treated as nonqualified stock options.
Options granted under the 1994 Plan generally become exercisable six months
after the date of the grant at a rate of 25% of the shares subject to the
option and thereafter, at a rate of 25% at the end of each six month period
for a total of two years, except that certain options granted to Messrs.
Sweas, Mullaney and Monson in connection with their employment agreements
become exercisable with respect to 50% on the one-year anniversary of the date
of grant and with respect to 25% on the 18-month and 24-month anniversaries of
the date of grant. The maximum term of a stock option under the 1994 Plan is
ten years. If an optionee terminates his or her service for reasons other than
death, disability, retirement, resignation or discharge for cause, the
optionee may exercise only those option shares vested as of the date of
termination. If, however, an optionee retires without prior Board of Directors
approval or is terminated for cause, all options previously not exercised
expire and are forfeited. In addition, the Company has the option to
repurchase all or any part of the shares issued or issuable upon exercise, if
an optionee's employment terminates for any reason whatsoever.
The 1994 Plan may be amended at any time by the Board of Directors, although
certain amendments require the consent of the participants of the 1994 Plan.
The 1994 Plan will terminate in September 2004, unless earlier terminated by
the Board of Directors.
1996 Option Grants Outside of the 1994 Stock Option Plan
In connection with the issuance of the 9% Preferred Stock and the
consummation of the Private Placement, Messrs. Elliott, Gavillet, Parrish,
Pellino and Bethke were granted 18,234, 11,996, 600, 312 and 312 additional
options, respectively, and certain other employees were granted a total of
1,111 additional options, to purchase a corresponding number of shares of
Class A Common Stock at an exercise price of $1.50 per share. Such options are
exercisable only upon conversion from time to time of the 9% Preferred Stock,
in the case of all such employees, or, as the case may be with respect to
Messrs. Elliott and Gavillet, of the Convertible Notes, into shares of Class A
Common Stock.
401(k) Plan
In January 1995, the Company adopted the Employee 401(k) Profit Sharing Plan
(the "401(k) Plan") covering all of the Company's employees. Pursuant to the
401(k) Plan, employees may elect to reduce their current compensation by up to
the lesser of 15% of eligible compensation or the statutorily prescribed
annual limit ($9,500 in 1996) and have the amount of such reduction
contributed to the 401(k) Plan. The 401(k) Plan permits, but does not require,
additional contributions to the 401(k) Plan by the Company on behalf of all
participants. The Company has not made any contributions to date. The 401(k)
Plan is intended to qualify under Section 401 of the Code so that
contributions by employees or by the Company to the 401(k) Plan, and income
earned on plan contributions, are not taxable to employees until withdrawn,
and contributions by the Company, if any, will be deductible by the Company
when made.
EMPLOYMENT AGREEMENTS
In July 1996, Messrs. J. Thomas Elliott, President and Chief Executive
Officer, and Ronald W. Gavillet, Executive Vice President, Strategy & External
Affairs, entered into employment agreements with the Company. In November
1996, Mr. Gerald J. Sweas entered into an agreement with the Company pursuant
to which he became the Company's Executive Vice President and Chief Financial
Officer. The terms of such agreements are for a period of three years subject
to automatic one-year renewals at each anniversary unless otherwise notified
by the Company. The agreements establish a base salary to be paid each year
which may be increased annually
48
<PAGE>
at the discretion of the Board of Directors. The annual base salaries of
Messrs. Elliott, Gavillet and Sweas are $195,000, $185,000 and $150,000,
respectively. In addition, subject to the attainment of certain performance
objectives, each is entitled to an annual bonus. With respect to Messrs.
Elliott and Gavillet, the agreements provide certain preemptive rights such
that, if the Company raises capital by selling shares of any class of stock,
each executive will have a right to purchase a certain percentage (3.8% for
Mr. Elliott and 2.5% for Mr. Gavillet) of such shares on the same terms and
conditions as the shares are being sold to others. Each of Messrs. Elliott's
and Gavillet's agreements also provides that if the current shareholders sell
any of their shares of Company stock to a third party under certain
circumstances, each executive has a right to sell the same percentage of his
shares of Company stock as the percentage of their shares that the current
shareholders are selling, on the same terms and for the same consideration.
With respect to each of Messrs. Elliott and Gavillet, if their employment is
terminated by the Company without "Cause" or by either executive with "Good
Reason" or during a "Window Period" (each as defined in the respective
agreement): (i) all amounts earned, accrued or owing to the executive shall be
paid as soon as practicable, (ii) the Company must pay a lump sum equal to one
year's base salary and, if the executive complies with the noncompete and
nonsolicitation provisions of the agreement for the two-year period following
termination, will pay the executive an additional one year's base salary in
equal installments over that two-year period, and (iii) the Company must
maintain in full force and effect all employee benefit plans for the benefit
of the executive for the longer of a two-year period or the remaining term of
the executive's agreement. With respect to Mr. Sweas, if his employment is
terminated by the Company without "Cause" or by him with "Good Reason" (each
as defined in his agreement): (i) all amounts earned, accrued or owing to him
shall be paid as soon as practicable; (ii) the Company must pay a lump sum
equal to the sum of (A) any annual bonus paid to Mr. Sweas for a fiscal year
completed prior to the date of termination, plus (B) a pro rata portion of the
annual bonus that would have been payable to Mr. Sweas in the year of such
termination, assuming the achievement of all performance goals, plus (C) if
Mr. Sweas complies with the noncompete and nonsolicitation provisions of his
agreement for the 18-month period following termination, the greater of the
amount of Mr. Sweas' highest annual base salary during the term of his
agreement or the aggregate amount of base salary payable to Mr. Sweas through
the end of the term of such agreement; and (iii) the Company must maintain in
full force and effect all employee benefit plans for the benefit of Mr. Sweas
for the longer of a one-year period or the remaining term of his agreement. If
the executive's employment is terminated under any other circumstances, the
executive will not receive any of the above-described severance pay and
benefits. With respect to Messrs. Elliott and Gavillet, upon a Change in
Control the executive's options will become exercisable and the restrictions
on Mr. Elliott's Restricted Shares will lapse. With respect to Mr. Sweas, upon
a Change of Control the Company shall pay, in exchange for the cancellation of
any options and the surrender of any shares held by him, an amount equal to
the fair market value of the shares held by Mr. Sweas or issuable upon
exercise of any such options (less the applicable exercise price). Upon a
Change of Control, the Company shall pay to each of Messrs. Elliott, Gavillet
and Sweas, within the 10-day period following such Change of Control, an
amount equal to the pro rata portion of the annual bonus that would have been
payable to such executive during such year, assuming the achievement of all
performance goals. Under each employment agreement, a "Change in Control"
occurs if (i) a person or entity becomes the beneficial owner of 35% or more
of the combined voting power of the Company's securities, (ii) the current
directors, or individuals who are approved by two-thirds of the current
directors, cease to constitute a majority of the board of the Company or (iii)
certain mergers or liquidations of the Company occur. Messrs. Elliott and
Gavillet have agreed not to compete with the Company in the network
telecommunications services business or to solicit customers or employees of
the Company for their term of employment with the Company and for an
additional period of two years thereafter and Mr. Sweas has agreed to similar
restrictions for the term of his employment with the Company and for an
additional period of 18 months thereafter.
In January 1997, Mr. Ryan Mullaney entered into an employment agreement with
the Company. Mr. Mullaney's agreement provides for a base salary of $125,000
and an annual bonus (targeted at $75,000) based upon certain performance
standards established by the Board of Directors of the Company. The agreement
also provides that Mr. Mullaney will be entitled to receive certain payments
in the event that his employment is terminated other than for cause. Mr.
Mullaney has agreed not to compete with the Company during the term of his
employment and for a specified period thereafter.
49
<PAGE>
Each of the other key employees (including Steven J. Parrish, Executive Vice
President, Operations, Thomas A. Monson, Vice President, General Counsel and
Secretary, Thad J. Pellino, Vice President of Marketing and Neil A. Bethke,
Vice President of Information Systems) have also entered into employment
agreements with the Company as of July 18, 1996 with respect to Messrs.
Parrish, Pellino and Bethke, and as of January 6, 1997 with respect to Mr.
Monson. The terms of the employment agreements are for a period of two years
subject to automatic one-year renewal upon each anniversary unless otherwise
notified by the Company. Each agreement specifies the base salary to be
received by the executive, and provides for annual adjustment of base salary
by the Board of Directors. The following annual base salaries were approved
effective July 31, 1996: Mr. Parrish - $140,000, Mr. Bethke - $125,000 and Mr.
Pellino - $110,000. The annual base salary for Mr. Monson, provided in his
employment agreement, is $143,000. Each of these executives is also entitled
to annual bonuses in the range of 15% to 30% of base salary, subject to the
attainment of certain performance objectives. If the Company terminates the
employment of any such officer without "Cause" or, if, the officer terminates
his employment with "Good Reason" (both as defined in the respective
agreements), the officer is entitled to receive benefits and payments similar
to those discussed above for Messrs. Elliott and Gavillet. No "Window Period"
will apply to such officers. Upon a Change in Control, the executive's options
will become exercisable. Each officer has agreed not to compete with the
Company in the network telecommunications services business or to solicit
customers or employees of the Company during the term of his employment and
for a period of one year following voluntary or involuntary termination.
50
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On September 30, 1996, BT Securities Corporation, Chase Securities Inc. and
CIBC Wood Gundy Securities Corp. purchased securities from the Company which
were immediately resold to Merrill Lynch Global Allocation Fund, Inc. pursuant
to Rule 144A of the Securities Act (the "Private Placement"). BT Securities
Corporation, Chase Securities Inc. and CIBC Wood Gundy Securities Corp. are
affiliates of BT Capital Partners, Inc., Chase Venture Capital Associates,
L.P. and CIBC Wood Gundy Ventures, Inc., respectively, which are stockholders
of the Company. See "Stock Ownership." BT Securities Corporation, Chase
Securities Inc. and CIBC Wood Gundy Securities Corp., in connection with the
Private Placement, each received commissions of approximately $188,000 of the
$1,880,053 paid to the Initial Purchasers.
In September 1996, in connection with the Private Placement, the Certificate
of Incorporation of the Company was amended to provide for the authorization
of two classes of Common Stock, Class A Common Stock and Class B Common Stock
(collectively, the "Common Stock"). The rights of such classes are identical,
except that Class A Common Stock is entitled to one vote per share, while
Class B Common Stock is not entitled to any voting rights, except as required
by law. In addition, each outstanding share of Common Stock of the Company
existing on the date of the Private Placement was converted into one share of
Class A Common Stock. See "Description of Capital Stock--Common Stock."
In connection with the Private Placement, by requisite vote, the Original
Purchasers waived their Preemptive Rights and Registration Rights held by them
pursuant to agreements entered into with respect to earlier investments in the
Company. The Original Purchasers also approved, and the Company took all
necessary action to effect prior to the consummation of the Private Placement,
the amendment of the terms of the Series A Preferred Stock and Series A-2
Preferred Stock to provide for and effectuate the conversion of the shares of
each such series of Preferred Stock into newly issued shares of Class A Common
Stock, which conversion was consummated on September 30, 1996.
Also in connection with the Private Placement, the Original Purchasers
purchased from the Company shares of its newly created 9% Cumulative
Convertible PIK Preferred Stock, par value $1.00 per share (the "9% Preferred
Stock"), for an aggregate purchase price of $10 million. For a description of
certain of the terms of the 9% Preferred Stock, see "Description of Capital
Stock--Preferred Stock."
In March 1996, the Company effected a recapitalization pursuant to which the
Company issued an aggregate of 110,157 shares of Common Stock to the Original
Purchasers for no consideration in order to settle a dispute relating to the
price per share of the Common Stock paid by the Original Purchasers for Common
Stock purchased in 1995. The dispute stemmed from, in part, the Company's
operating performance as compared with the operating performance projected by
the Company at the time of such investment. As part of the recapitalization,
the Company also caused the Series A-2 Preferred Stock to be senior to the
Series A Preferred Stock with respect to redemption, dividends and liquidation
in further settlement of the dispute referred to above.
In December 1995, Mr. J. Thomas Elliott, President and Chief Executive
Officer of the Company, executed a promissory note in favor of the Company in
the principal amount of $75,000. Such promissory note was originally payable
by January 2, 1997, but such date has been extended to a date as yet
undetermined.
51
<PAGE>
STOCK OWNERSHIP
The following table sets forth as of February 28, 1997, the number of shares
of Class A Common Stock and the percentage of the outstanding shares of such
class that are beneficially owned by (i) each person that is the beneficial
owner of more than 5% of the outstanding shares of Class A Common Stock, (ii)
each of the directors and the Named Executive Officers of the Company and
(iii) all of the current directors and executive officers of the Company as a
group.
<TABLE>
<CAPTION>
CLASS A
COMMON STOCK
---------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER(1) SHARES OWNED OF CLASS
- --------------------------------------- ------------ --------
<S> <C> <C>
Merrill Lynch Global Allocation Fund, Inc. (2)........... 333,505 31.73%
800 Scudders Mill Road
Plainsboro, New Jersey 08536
BT Capital Partners, Inc. (3)............................ 129,043 17.67%
130 Liberty Street
New York, New York 10017-2070
Chase Venture Capital Associates, L.P. (3)............... 174,257 23.72%
380 Madison Ave., 12th Floor
New York, New York 10017-2070
CIBC Wood Gundy Ventures, Inc. (3)....................... 174,257 23.72%
425 Lexington Avenue
New York, New York 10017-3903
Hancock Venture Partners IV--Direct Fund, L.P. (3)....... 172,248 23.45%
One Financial Center, 44th Floor
New York, New York 10017-3903
Enterprises & Transcommunications, L.P. (3).............. 43,003 5.96%
600 Congress Suite 3000
One American Center
Austin, Texas 78701
Thomas C. Brandenburg (4)(5)............................. 22,216 3.10%
Richard J. Brekka (5).................................... 174,257 23.72%
J. Thomas Elliott ....................................... 12,875 1.79%
Ronald W. Gavillet (6)................................... 5,388 *
Robert J. Luth........................................... 3,850 *
Dean M. Greenwood (5).................................... 43,003 5.96%
Donald J. Hofmann, Jr. (5)............................... 174,257 23.72%
William A. Johnston (5).................................. 172,248 23.45%
Paul S. Lattanzio (5).................................... 129,043 17.67%
Eugene A. Sekulow........................................ -- --
All directors and executive officers of the Company as a
group (15 persons)...................................... 737,637 92.76%
</TABLE>
- --------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting and investment
power with respect to the shares. As to each stockholder, the percentage
ownership is calculated by dividing (i) the sum of the number of shares of
Class A Common Stock owned by such stockholder plus the number of shares
of Class A Common Stock that such stockholder would receive upon the
exercise of warrants or the conversion of convertible securities held by
such stockholder (the "Conversion Shares") by (ii) the sum of the total
number of outstanding shares of Class A Common Stock plus the number of
Conversion Shares held by such stockholder.
(2) Represents shares for which Warrants are exercisable after March 29, 1996
and shares into which Convertible Notes are convertible. Also, Merrill
Lynch Global Allocation Fund, Inc. is entitled to receive additional
warrants to purchase common stock under certain circumstances pursuant to
the Indentures.
(3) BT Capital Partners, Inc., Chase Venture Capital Associates, L.P., CIBC
Wood Gundy Ventures, Inc., Hancock Venture Partners IV and Enterprises &
Transcommunications, L.P. are affiliates of Bankers Trust New York
Corporation, Chase Manhattan Corporation, Canadian Imperial Bank of
Commerce, Hancock Venture Partners, Inc. and Prime Cable Income Partners
LP, respectively.
(4) Includes 11,108 shares subject to a voting trust for David Montville. Mr.
Brandenburg, as the voting trust agent, disclaims beneficial ownership
with respect to the shares held in trust.
(5) Each director disclaims beneficial ownership of any shares of Common Stock
or Preferred Stock which it does not directly own.
(6) These shares are subject to exercisable options held by Mr. Gavillet.
52
<PAGE>
DESCRIPTION OF SECURITIES
For purposes of this description of the Securities, the term "Company"
refers to USN Communications, Inc. and does not include its subsidiaries
except for purposes of financial data determined on a consolidated basis.
CONVERTIBLE NOTES
GENERAL
The Convertible Notes were issued pursuant to the Convertible Note
Indenture. The terms of the Convertible Notes include those stated in the
Convertible Note Indenture and those made a part of the Convertible Note
Indenture by reference to the Trust Indenture Act of 1939 as in effect on the
date of the Indenture (the "Trust Indenture Act"). The following summaries of
certain provisions of the Convertible Note Indenture do not purport to be
complete and are subject to, and are qualified in their entirety by reference
to, the provisions of the Convertible Note Indenture. The Convertible Notes
are subject to all such terms, and holders of the Convertible Notes are
referred to the Convertible Note Indenture and the Trust Indenture Act for a
complete statement of such terms. Copies of the Convertible Note Indenture are
available from the Company upon request. The statements and definitions of
terms under this caption relating to the Convertible Notes and the Convertible
Note Indenture are summaries and do not purport to be complete. Such summaries
make use of certain terms defined in the Convertible Note Indenture and are
qualified in their entirety by express reference to the Convertible Note
Indenture. Certain terms used herein are defined below under "--Certain
Definitions."
The Convertible Notes are general unsecured obligations of the Company
limited in aggregate principal amount at Stated Maturity to $46 million, are
subordinated in right of payment to the Senior Notes and rank pari passu in
right of payment with all other existing and future indebtedness of the
Company to the extent of the assets securing that indebtedness (including up
to $30 million of indebtedness under a future Credit Facility). The Company's
Subsidiaries have no direct obligation to pay amounts due on the Convertible
Notes and have not guaranteed the Convertible Notes as of the date hereof;
however, if a Restricted Subsidiary guarantees any indebtedness of the
Company, such Restricted Subsidiary will be obligated to guarantee the
Convertible Notes on a senior subordinated basis. See "--Certain Covenants--
Limitation on Issuances of Guarantees by Restricted Subsidiaries." As a
result, the Convertible Notes effectively will be subordinated to all existing
and future third-party indebtedness and other liabilities of the Company's
Subsidiaries (including trade payables). As of December 31, 1996, the total
outstanding indebtedness and other liabilities (including trade payables and
other non-debt obligations) of the Company that would rank pari passu in right
of payment with the Convertible Notes was approximately $11.7 million. As of
December 31, 1996, the total outstanding indebtedness and other liabilities
(including trade payables and other non-debt obligations) of the Company's
Subsidiaries on a combined consolidated basis (after the elimination of loans
and advances by the Company) was approximately $11.4 million. Of that amount,
approximately $0.6 million in indebtedness was secured by Liens on the assets
of the borrowing Subsidiaries.
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. Any rights (other than claims based upon valid pari passu
loans and advances made by the Company) of the Company and its creditors,
including the holders of Convertible Notes, to participate in the distribution
of 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). Accordingly, the
Company anticipates that the primary source of cash to pay the Company's
obligations under the Convertible Notes will be derived from the operations of
the Restricted Subsidiaries. The Indentures permit under limited circumstances
the creation of, or the designation of existing Restricted Subsidiaries as,
Unrestricted Subsidiaries. Such Unrestricted Subsidiaries will not generally
be subject to the covenants applicable to the Company and the Restricted
Subsidiaries. See "Risk Factors--Substantial Leverage" and "--Holding Company
Structure; Source of Repayment of Convertible Notes; Effective Subordination
of Notes to Indebtedness of Subsidiaries."
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The Convertible Note Indenture does not contain any restrictions on the
payment of dividends or the making of distributions, investments or certain
other restricted payments or any financial covenants and contains no covenants
or other provisions against a dramatic decline in credit quality of the
Convertible Notes, except as described below in "--Right to Require Repurchase
of Convertible Notes Upon a Termination of Trading."
PRINCIPAL, MATURITY AND INTEREST
The Convertible Notes are limited in aggregate principal amount at Stated
Maturity to $46 million and will mature on September 30, 2004. The Convertible
Notes were issued at a discount to their aggregate principal amount to
generate gross proceeds to the Company of approximately $28 million. In
addition to the Convertible Notes issued as of September 30, 1996, an
additional $3.1 million aggregate principal amount at Stated Maturity of
Convertible Notes may be issued pursuant to the Convertible Note Indenture.
The Convertible Notes will accrete interest at the rate of 9% per annum,
compounded semiannually, to an aggregate principal amount of $36.0 million by
September 30, 1999. Although for U.S. federal income tax purposes a
significant amount of original issue discount, taxable as ordinary income,
will be recognized by a holder as such discount accretes from the Issue Date
of the Convertible Notes, no interest will be payable on the Convertible Notes
prior to September 30, 1999. See "Certain Federal Income Tax Considerations--
Taxation of the Convertible Notes--Original Issue Discount." From and after
September 30, 1999, interest on the Convertible Notes will accrue at the rate
of 9% per annum and will be payable in cash semiannually on March 30 and
September 30, of each year commencing March 30, 2000, to the holders of record
of Convertible Notes at the close of business on March 15 and September 15
immediately preceding such interest payment date. Interest on the Convertible
Notes will accrue from the most recent date to which interest has been paid
or, if no interest has been paid, from September 30, 1999. Interest will be
computed on the basis of a 360-day year comprised of twelve 30-day months.
Principal of, premium, if any, and interest and Special Interest, if any, on
the Convertible Notes is payable at the office or agency of the Company
maintained for such purpose, which office shall be maintained in the Borough
of Manhattan, The City of New York. At the option of the Company, interest and
Special Interest may be paid by check mailed to the registered holders at
their registered addresses. The Convertible Notes were issued without coupons
and in fully registered form only, in denominations of $1,000 and integral
multiples thereof.
CONVERSION RIGHTS OF CONVERTIBLE NOTES
The Convertible Notes are convertible into the Convertible Note Shares, at
the option of the holders of Convertible Notes, at any time after the 60th day
following the date of original issuance of the Convertible Notes and prior to
redemption or final maturity of the Convertible Notes, initially at a
conversion price of $134.08 per share, subject to adjustment (the "Conversion
Price") as described below and as described in "--Additional Invested Equity."
The right to convert Convertible Notes which have been called for redemption
will terminate at the close of business on the business day preceding the
redemption date. In the event that the Company consummates a sale or sales of
any class of Capital Stock for an amount, individually or in the aggregate, in
excess of $5,000,000 (each, a "Reset Event") and at the time of such sale or
sales, the equity valuation of the Company based upon such sale or sales (as
evidenced by a Board Resolution delivered to the Convertible Note Trustee) is
less than $122,500,000, then on the date of the consummation of any such Reset
Event (the "Reset Date"), the Conversion Price shall be adjusted (the
"Conversion Reset") to equal 115% of the price (the "Conversion Reset Price")
at which such sale or sales were consummated; provided, that if such sale or
sales are consummated more than nine months after a Qualified Public Offering
at a total equity valuation of the Company of at least $122,500,000, then no
Conversion Reset will be required. In the event that the Conversion Price
before such calculation shall be equal to or less than the Conversion Reset
Price, then no additional adjustment to the Conversion Price shall be made.
Subject to certain exceptions, the Conversion Price will be subject to
adjustment on the occurrence of certain events including: (i) the payment by
the Company of dividends (or the making of other distributions) with respect
to any class of Capital Stock payable in Common Stock or other shares of the
Company's Capital Stock, (ii)
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subdivisions, combinations and reclassifications of Common Stock, (iii) the
issuance to all holders of Common Stock of rights, options or warrants
entitling them to subscribe for Common Stock, or of securities convertible
into or exchangeable for shares of Common Stock, in either case for
consideration per share of Common Stock which is less than the Current Market
Price per share of Common Stock (determined as provided in the Convertible
Note Indenture), (iv) the issuance or sale of shares of Common Stock, or
securities convertible into or exchangeable for shares of Common Stock, for
consideration per share of Common Stock which is less than the Current Market
Price per share of Common Stock (determined as provided in the Convertible
Note Indenture), other than the Warrants, (v) the distribution to all holders
of Common Stock of any of the Company's assets, debt securities or any rights
or warrants to purchase securities (excluding those rights and warrants
referred to in clause (iii) above and excluding cash dividends or other cash
distributions from current or retained earnings) and (vi) certain other events
which could have the effect of depriving holders of the Convertible Notes of
all or any of the conversion rights in respect of any Convertible Note.
No adjustment in the Conversion Price will be required unless such
adjustment would require an increase or decrease of at least 1.0% in the
Conversion Price; provided, that any adjustment which is not made will be
carried forward and taken into account in any subsequent adjustment.
In addition to the foregoing adjustments, the Company will be permitted to
reduce the Conversion Price as it considers to be advisable in order that any
event treated for United States federal income tax purposes as a dividend of
stock or stock rights will not be taxable to the holders of the Common Stock
or, if that is not possible, to diminish any income taxes that are otherwise
payable because of such event. In the case of any consolidation or merger of
the Company with any other Person (other than one in which no change is made
in the Common Stock), or any sale or transfer of all or substantially all of
the assets of the Company, the holder of any Convertible Note then outstanding
will have the right thereafter to convert such Convertible Note only into the
kind and amount of securities, cash and other property receivable upon such
consolidation, merger, sale or transfer by a holder of the number of shares of
Common Stock into which such Convertible Note might have been converted
immediately prior to such consolidation, merger, sale or transfer; and
adjustments will be provided for events subsequent thereto that are as nearly
equivalent as practical to the Conversion Price adjustments described above.
Fractional shares of Common Stock will not be issued upon conversion, but,
in lieu thereof, the Company will pay a cash adjustment based upon the then
Closing Price (determined as provided in the Convertible Note Indenture) at
the close of business on the day of conversion. If any Convertible Notes are
surrendered for conversion during the period from the close of business on any
regular record date through and including the next succeeding interest payment
date (except any such Convertible Notes called for redemption), such
Convertible Notes when surrendered for conversion must be accompanied by
payment in next day funds of an amount equal to the interest thereon which the
registered Holder on such record date is to receive. Except as described in
the preceding sentence, no interest will be payable by the Company on
converted Convertible Notes with respect to any interest payment date
subsequent to the date of conversion. No other payment or adjustment for
interest or dividends is to be made upon conversion.
SUBORDINATION OF CONVERTIBLE NOTES
The payment of the principal of and premium, if any, and interest (including
Special Interest, if any) on the Convertible Notes will, to the extent set
forth in the Convertible Note Indenture, be subordinated in right of payment
to the prior payment in full of the Senior Notes and all other obligations of
the Company and the Guarantors, if any, under the Senior Notes, the Senior
Note Guarantees, if any, and the Senior Note Indenture (the "Senior
Indebtedness"). If there is a payment or distribution of assets to creditors
upon any liquidation, dissolution, winding up, reorganization, assignment for
the benefit of creditors, marshalling of assets or any bankruptcy, insolvency
or similar proceedings of the Company or a Guarantor, as applicable, the
holders of all Senior Indebtedness will be entitled to receive payment in full
of all amounts due or to become due thereon or provision for such payment in
money or money's worth must be made before the holders of the Convertible
Notes will be entitled to receive any payment in respect of the principal of
or premium, if any, or interest
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(including Special Interest, if any) on the Convertible Notes. In the event of
the acceleration of the Maturity of the Convertible Notes, the holders of all
Senior Indebtedness will first be entitled to receive payment in full in cash
of all amounts due thereon or provision for such payment in money or money's
worth before the holders of the Convertible Notes will be entitled to receive
any payment for the principal of or premium, if any, or interest (including
Special Interest, if any) on the Convertible Notes. No payments on account of
principal of or premium, if any, or interest (including Special Interest, if
any) on the Convertible Notes or on account of the purchase or acquisition of
Convertible Notes may be made if there has occurred and is continuing a
default in any payment with respect to Senior Indebtedness, any acceleration
of the maturity of any Senior Indebtedness or if any judicial proceeding is
pending with respect to any such default.
ADDITIONAL INVESTED EQUITY
If the Company does not achieve consolidated total revenues (calculated in
accordance with GAAP) of at least $8.5 million for the period from June 1,
1997 through June 30, 1997 and if, by September 30, 1997, the Company has not
either (i) consummated a Qualified Public Offering or (ii) been sold pursuant
to a Qualified Sale of the Company, the Company shall by such date be required
to either (A) obtain $10.0 million of Additional Invested Equity or (B) (i)
grant to the holders of the Convertible Notes the right to purchase for
$10.0 million additional convertible securities of the Company convertible
into 16 2/3% of the Common Stock on a fully diluted basis (subject to certain
exceptions) after giving effect to the issuance of such additional convertible
securities, (ii) grant to the holders of the Convertible Notes the right to
purchase warrants (the "Additional Warrants") exercisable for Common Stock
representing up to 5% of the Common Stock of the Company at a purchase price
of $.01 per share (subject to certain adjustments, if required) on a fully
diluted basis (subject to certain exceptions) after giving effect to the
issuance of such warrants, and (iii) adjust the Conversion Price for the
Convertible Notes shall be adjusted by dividing the Conversion Price in effect
immediately prior to the issuance of such convertible securities and warrants
by 1.15.
OPTIONAL REDEMPTION
The Convertible Notes are not redeemable prior to September 30, 2000. During
the period from September 30, 2000 to September 30, 2002 the Company may
redeem all but not less than all of the Convertible Notes, upon not less than
30 nor more than 60 days' notice, if the Closing Price (as defined in the
Convertible Note Indenture) of the Common Stock is at least 150% of the
Conversion Price for thirty consecutive days, at a redemption price equal to
100% of the principal amount at Stated Maturity thereof plus accrued and
unpaid interest, if any, and Special Interest, if any; provided, that if the
Common Stock is not traded on a U.S. national securities exchange or approved
for trading on an established automated over-the-counter trading market in the
United States and not quoted on a consolidated transaction reporting tape, the
Convertible Notes will not be redeemable during such period. On or after
September 30, 2002, the Convertible Notes will be subject to redemption at the
option of the Company, in whole or in part, upon not less than 30 nor more 60
days' notice, at 100% of the principal amount thereof at Stated Maturity, plus
accrued and unpaid interest, if any, and Special Interest, if any.
MANDATORY REDEMPTION
Except as set forth under "--Repurchase at the Option of Holders upon a
Change of Control," "--Asset Sales," and "--Right to Require Repurchase of
Convertible Notes Upon a Termination of Trading," the Company is not required
to make mandatory redemption payments or sinking fund payments with respect to
the Convertible Notes.
REPURCHASE AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each holder of Convertible Notes
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 Convertible Notes pursuant to an irrevocable and unconditional offer
described below (the
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"Change of Control Offer") at a purchase price (the "Change of Control
Purchase Price") equal to 101% of the Accreted Value of such Convertible Notes
(or portions thereof) on any Change of Control Payment Date (as defined
herein) occurring prior to March 30, 2000, plus accrued and unpaid interest,
if any, and Special Interest, if any, thereon to such Change of Control
Payment Date, or 101% of the principal amount at Stated Maturity of such
Convertible Notes (or portions thereof), on any Change of Control Payment Date
occurring on or after March 30, 2000 plus accrued and unpaid interest, if any,
and Special Interest, if any, to such Change of Control Payment Date.
Within 30 days following any Change of Control, the Company or the Trustee
(at the expense of the Company) shall mail a notice to each holder stating,
among other things: (1) that a Change of Control Offer is being made pursuant
to the covenant in the Convertible Note Indenture entitled "Repurchase at the
Option of Holders upon a Change of Control" and that all Convertible Notes
properly tendered will be accepted for payment; (2) the Change of Control
Purchase Price and the purchase date (the "Change of Control Payment Date"),
which shall be no earlier than 30 days nor later than 60 days from the date
such notice is mailed; (3) that any Convertible Notes or portions thereof not
properly tendered will continue to accrete in value or accrue interest, as the
case may be, and accrue Special Interest, if applicable; (4) that, unless the
Company defaults in the payment of the Change of Control Purchase Price, all
Convertible Notes or portions thereof accepted for payment pursuant to the
Change of Control Offer shall cease to accrete in value or accrue interest, as
the case may be, and accrue Special Interest, if applicable, from and after
the Change of Control Payment Date; (5) that holders electing to have any
Convertible Notes or portions thereof purchased pursuant to a Change of
Control Offer will be required to surrender the Convertible Notes, with the
form entitled "Option of Holder to Elect Purchase" on the reverse of the
Convertible Notes completed, to a paying agent (the "Paying Agent") at the
address specified in the notice prior to the close of business on the third
Business Day preceding the Change of Control Payment Date; (6) that holders
will be entitled to withdraw their election if the Paying Agent receives, not
later than the close of business on the second Business Day preceding the
Change of Control Payment Date, a telegram, telex, facsimile transmission or
letter setting forth the name of the holder, the principal amount of
Convertible Notes delivered for purchase, and a statement that such holder is
withdrawing his election to have such Convertible Notes or portions thereof
purchased; (7) that holders whose Convertible Notes are being purchased only
in part will be issued new Convertible Notes equal in principal amount to the
unpurchased portion of the Convertible Note or Notes surrendered, which
unpurchased portion must be equal to $1,000 in principal amount at Stated
Maturity or an integral multiple thereof; and (8) the instructions and any
other information necessary to enable holders to accept a Change of Control
Offer or effect withdrawal of such acceptance.
The Company will comply with the requirements of Section 14(e) under the
Securities Exchange Act of 1934, as amended, and any other securities laws and
regulations, to the extent such laws and regulations are applicable, in
connection with the repurchase of Convertible Notes pursuant to a Change of
Control Offer.
On the Change of Control Payment Date, the Company will (1) accept for
payment Convertible Notes or portions thereof properly tendered pursuant to
the Change of Control Offer, (2) deposit with the Paying Agent in immediately
available funds an amount equal to the Change of Control Purchase Price in
respect of all Convertible Notes or portions thereof so tendered, including
accrued and unpaid interest, if any, and Special Interest, if any, thereon and
(3) deliver, or cause to be delivered, to the Trustee the Convertible Notes so
accepted together with an Officers' Certificate listing the Convertible Notes
or portions thereof tendered to the Company and accepted for payment. The
Paying Agent shall promptly mail to each holder of Convertible Notes so
accepted payment in an amount equal to the Change of Control Purchase Price,
including interest and Special Interest, if applicable, for such Convertible
Notes and the Trustee shall promptly authenticate and mail to each holder a
new Convertible Note equal in principal amount at Stated Maturity to any
unpurchased portion of the Convertible Notes surrendered, if any; provided,
that each such new Convertible Note shall be in a principal amount at Stated
Maturity of $1,000 or any integral multiple thereof. The Company will announce
publicly the results of a Change of Control Offer on or as soon as practicable
after the Change of Control Payment Date.
The existence of the holders' right to require, subject to certain
conditions, the Company to repurchase Convertible Notes upon a Change of
Control may deter a third party from acquiring the Company in a transaction
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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 Convertible 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 Convertible 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
Convertible Notes tendered pursuant to such offer or at a time when the
Company is prohibited from purchasing the Convertible 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 (as defined
herein) would occur under the Convertible Note Indenture. In addition, one of
the events that constitutes a Change of Control under the Convertible Note
Indenture is a sale, conveyance, transfer or lease of all or substantially all
of the assets of the Company or of the Company and its Restricted Subsidiaries
taken as a whole. The Convertible Note Indenture will be governed by New York
law, and there is no established quantitative definition under New York law of
"substantially all" of the assets of a corporation. Accordingly, if the
Company and/or its Restricted Subsidiaries were to engage in a transaction in
which it or they disposed of less than all of the assets of the Company or
less than all of the assets of the Company and its Restricted Subsidiaries
taken as a whole, a question of interpretation could arise as to whether such
disposition was of "substantially all" of its or their assets, as the case may
be, and whether the Company was required to make a Change of Control Offer.
Except as described herein with respect to a Change of Control and except
for the covenant described below in "--Right to Require Repurchase of
Convertible Notes Upon a Termination of Trading," the Convertible Note
Indenture does not contain any other provisions that permit holders of
Convertible Notes to require that the Company repurchase or redeem Convertible
Notes in the event of a takeover, recapitalization or similar restructuring.
The foregoing provisions may not necessarily afford the holders of the
Convertible Notes protection in the event of a highly leveraged transaction,
including a reorganization, restructuring, merger or other similar transaction
involving the Company, that may adversely affect the holders because (i) such
transactions may not involve a shift in voting power or beneficial ownership
or, even if they do, may not involve a shift of the magnitude required under
the definition of Change of Control to require the Company to make a Change of
Control Offer or (ii) such transactions may include an actual shift in voting
power or beneficial ownership to a Strategic Investor or to a Permitted Holder
which is excluded under the definition of Change of Control from the amount of
shares involved in determining whether or not the transaction involves a shift
of the magnitude required to trigger the provisions.
ASSET SALES
The Company will not, and will not permit any Restricted Subsidiary to,
consummate an Asset Sale (as defined herein) unless (i) no Event of Default
under the Convertible Note Indenture shall have occurred and be continuing or
shall occur as a consequence thereof; (ii) the Company or such Restricted
Subsidiary, as the case may be, receives net consideration at the time of such
Asset Sale at least equal to the Fair Market Value (as evidenced by a Board
Resolution of the Company delivered to the Trustee) of the Property or assets
sold or otherwise disposed of; (iii) at least 75% of the consideration
received by the Company or such Restricted Subsidiary for such Property or
assets consists of Cash Proceeds; and (iv) 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 below.
Within 270 days after any Asset Sale, the Company or such Restricted
Subsidiary, as the case may be, may at its option reinvest an amount equal to
the Net Cash Proceeds (or any portion thereof) from such Asset Sale in
Telecommunications Assets 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 pari passu in right of payment with the Convertible Notes
or to the permanent reduction of Indebtedness of any Restricted Subsidiary
that is pari passu in right of payment with such Restricted Subsidiary's
Guarantee, if applicable (other than Indebtedness to the Company or another
Restricted Subsidiary). Any Net Cash Proceeds from any Asset Sale that are not
used to reinvest in Telecommunications Assets and/or reduce
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pari passu Indebtedness of the Company or Indebtedness 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, on a date (the "Asset Sale Payment
Date") which shall be no earlier than 30 days nor later than 40 days
subsequent to the date on which the Company sends notice to Holders of the
Asset Sale Offer, which shall be within 30 days of the date on which such
Excess Proceeds exceed $5 million, use such Excess Proceeds to make offers (A)
to purchase (each an "Asset Sale Offer") (i) first, on a pro rata basis from
all holders of Senior Notes in an aggregate principal amount equal to the
maximum principal amount that may be purchased out of the then-existing Excess
Proceeds, at a purchase price (the "Asset Sale Purchase Price") in cash equal
to 100% of the Accreted Value of such Senior Notes on any Asset Sale Payment
Date occurring prior to March 30, 2000, plus accrued and unpaid interest, if
any, and Special Interest, if any, to the Asset Sale Payment Date, or 100% of
the principal amount at Stated Maturity of such Senior Notes on any Asset Sale
Payment Date occurring on or after March 30, 2000, plus accrued and unpaid
interest, if any, and Special Interest, if any, to such Asset Sale Payment
Date, and (ii) thereafter, if any Excess Proceeds remain upon completion of
such purchases of the Senior Notes, on a pro rata basis from all holders of
Convertible Notes, in an aggregate principal amount equal to the maximum
principal amount that may be purchased out of Excess Proceeds, at an Asset
Sale Purchase Price in cash equal to 100% of the Accreted Value of such
Convertible Notes on any Asset Sale Payment Date occurring prior to September
30, 1999, plus accrued and unpaid interest, if any, and Special Interest, if
any, to the Asset Sale Payment Date, or 100% of the principal amount at Stated
Maturity of such Convertible Notes on any Asset Sale Payment Date occurring on
or after September 30, 1999, plus accrued and unpaid interest, if any, and
Special Interest, if any, to such Asset Sale Payment Date, in accordance with
the procedures set forth in the applicable Indenture and (B) to the
substantially concurrent repayment or redemption of Pari Passu Indebtedness
(if any) if required by the instruments relating to such Pari Passu
Indebtedness (which repayment or redemption, in the case of a revolving credit
arrangement or multiple advance arrangement, reduces the commitment
thereunder). The Excess Proceeds to be so applied may be applied such that the
portion to be applied to the repayment or redemption of Pari Passu
Indebtedness shall not exceed an amount equal to the product obtained by
multiplying such Excess Proceeds by a fraction, the numerator of which is the
outstanding principal amount of Pari Passu Indebtedness that, pursuant to the
instruments relating thereto, is required to be repaid or redeemed with
proceeds from such Asset Sale or Asset Sales and the denominator of which is
the sum of the (i) aggregate principal amount of the Senior Notes then
outstanding plus (ii) the aggregate principal amount of outstanding Pari Passu
Indebtedness that, pursuant to the instruments relating thereto, is required
to be repaid or redeemed with proceeds from such Asset Sale or Asset Sales.
Upon completion of any Asset Sale Offer (including payment of the Asset Sale
Purchase Price), any surplus Excess Proceeds that were the subject of such
offer shall cease to be Excess Proceeds, and the Company may then use such
amounts for general corporate purposes.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws and regulations, to the extent such
laws and regulations are applicable, in connection with the repurchase of
Notes pursuant to an Asset Sale Offer.
RIGHT TO REQUIRE REPURCHASE OF CONVERTIBLE NOTES UPON A TERMINATION OF TRADING
In the event of any Termination of Trading occurring after the Issue Date
and on or prior to Maturity, each holder of Convertible Notes will have the
right, at the holder's option, to require the Company to repurchase all or any
part of such holder's Convertible Notes on the date (the "Repurchase Date")
that is 30 days after the date the Company gives notice of the Termination of
Trading as described below at a price (the "Repurchase Price") equal to 100%
of the Accreted Value of such Convertible Notes on any Repurchase Date
occurring prior to September 30, 1999, together with accrued and unpaid
interest, if any, and Special Interest, if any, thereon to the Repurchase
Date, or 100% of the principal amount at Stated Maturity of such Convertible
Notes on any Repurchase Date occurring on or after September 30, 1999,
together with accrued and unpaid interest, if any, and Special Interest, if
any, thereon to the Repurchase Date. On or prior to the Repurchase Date, the
Company shall deposit with the Trustee or a Paying Agent an amount of money
sufficient to pay the Repurchase Price of the Convertible Notes which are to
be repaid on or promptly following the Repurchase Date.
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Failure by the Company to provide timely notice of a Termination of Trading,
as provided for below, or to repurchase the Convertible Notes when required
under the preceding paragraph will result in an Event of Default under the
Convertible Note Indenture whether or not such repurchase is permitted by the
subordination provisions of the Convertible Note Indenture.
On or before the 15th day after the occurrence of a Termination of Trading,
the Company is obligated to mail to all holders of Convertible Notes a notice
of the occurrence of such Termination of Trading, the Repurchase Date, the
date by which the repurchase right must be exercised, the Repurchase Price for
Convertible Notes and the procedures which the holder must follow to exercise
this right. To exercise the repurchase right, the holder of a Convertible Note
must deliver, on or before the close of business on the Repurchase Date,
irrevocable written notice to the Company (or an agent designated by the
Company for such purpose) and to the Convertible Note Trustee of the holder's
exercise of such right, together with the certificates evidencing the
Convertible Notes with respect to which the right is being exercised, duly
endorsed for transfer. Such written notice is irrevocable.
A "Termination of Trading," shall occur if the Common Stock (or other common
stock into which the Convertible Notes are then convertible) had been listed
for trading on a U.S. national securities exchange or approved for trading on
an established automated over-the-counter trading market in the United States
and are thereafter neither so listed nor so approved.
The right to require the Company to repurchase Convertible Notes as a result
of the occurrence of a Termination of Trading could create an Event of Default
under the Senior Note Indenture, as a result of which any repurchase could,
absent a waiver, be blocked by the subordination provisions of the Convertible
Notes. Failure by the Company to repurchase the Convertible Notes when
required will result in an Event of Default under the Convertible Note
Indenture whether or not such repurchase is permitted by the subordination
provisions. The Company's ability to pay cash to the holders of Convertible
Notes upon a repurchase may be limited by certain financial covenants
contained in the other then existing Indebtedness of the Company.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws and regulations, to the extent such
laws and regulations are applicable, in connection with the repurchase of
Convertible Notes pursuant to an offer to repurchase upon a Termination of
Trading.
The foregoing provisions would not necessarily afford holders of the
Convertible Notes protection in the event of highly leveraged or other
transactions involving the Company or the Restricted Subsidiaries that may
adversely affect such holders. In addition, the foregoing provisions may
discourage open market purchases of the Common Stock or a non-negotiated
tender or exchange offer for such Common Stock and, accordingly, may limit a
stockholder's ability to realize a premium over the market price of the Common
Stock in connection with any such transaction.
CERTAIN COVENANTS
Set forth below are certain covenants contained in the Convertible Note
Indenture. Certain terms capitalized below but not defined shall have the
meanings ascribed to them under the caption "Certain Definitions."
Limitation on Issuances of Guarantees by Restricted Subsidiaries
The Convertible Note Indenture and the Senior Note Indenture provide that
the Company may not permit any Restricted Subsidiary, directly or indirectly,
to guarantee any Indebtedness of the Company ("Guaranteed Indebtedness")
unless (i) such Restricted Subsidiary simultaneously executes and delivers a
supplemental indenture to the Senior Note Indenture providing for a Guarantee
of payment of the Senior Notes by such Restricted Subsidiary (a "Senior Note
Guarantee") and a supplemental indenture to the Convertible Note Indenture
providing for a Guarantee of payment of the Convertible Notes by such
Restricted Subsidiary (a "Convertible Note Guarantee") and (ii) such
Restricted Subsidiary waives and will not in any manner whatsoever claim or
take the benefit or advantage of, any rights of reimbursement, indemnity or
subrogation or
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any other rights against the Company or any other Restricted Subsidiary as a
result of any payment by such Restricted Subsidiary under its Guarantee,
provided, that any Restricted Subsidiary may guarantee any Credit Facility so
long as such Restricted Subsidiary enters into a Guarantee ranking pari passu
with its guarantee under such Credit Facility. The Convertible Note Indenture
further provides that if the Guaranteed Indebtedness is pari passu with the
Convertible Notes, then the guarantee of such Guaranteed Indebtedness shall be
pari passu with or subordinated to the Guarantee; and if the Guaranteed
Indebtedness is subordinated to the Convertible Notes, then the guarantee of
such Guaranteed Indebtedness shall be subordinated to the Guarantee at least
to the extent that the Guaranteed Indebtedness is subordinated to the
Convertible Notes. In addition, each Convertible Note Guarantee of a
Restricted Subsidiary will be subordinated to the Senior Note Guarantee of
such Restricted Subsidiary.
Notwithstanding the foregoing, any Guarantee by a Restricted Subsidiary
shall provide by its terms that it shall be automatically and unconditionally
released and discharged upon the release or discharge of the guarantee which
resulted in the creation of such Restricted Subsidiary's Guarantee, except a
discharge or release by, or as a result of, payment under such guarantee.
Restricted and Unrestricted Subsidiaries
The Indentures provide that 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; provided, that
so long as the Senior Notes remain outstanding and the Senior Note Indenture
has not been satisfied or discharged, (i) immediately after giving effect to
the transaction, the Company could incur $1.00 of additional Indebtedness
pursuant to the provision of the Senior Note Indenture which places a
limitation on indebtedness and (ii) such designation is at the time permitted
under the provision in the Senior Note Indenture governing restricted
payments. Notwithstanding any provisions of this covenant, all Subsidiaries of
an Unrestricted Subsidiary will be Unrestricted Subsidiaries. As of the date
hereof, all of the Company's Subsidiaries are Restricted Subsidiaries and,
accordingly, are subject to all of the covenants relating to Restricted
Subsidiaries set forth in the Senior Note Indenture.
Issuance of Contingent Warrants
The Convertible Note Indenture provides that, in the event that the Company
has not, on or prior to September 30, 1999, (i) consummated a Qualified Public
Offering or (ii) been sold pursuant to a Qualified Sale of the Company, the
Company will be obligated to issue to the holders of the Convertible Notes
Convertible Note Contingent Warrants exercisable for Class A Common Stock
representing up to 2.5% of the Common Stock of the Company on a fully diluted
basis (subject to the exceptions set forth in clauses (i), (ii) and (iii) of
the immediately preceding sentence) after giving effect to the issuance of
such Convertible Note Contingent Warrants. All Contingent Warrants will be
issued pursuant to the Warrant Agreement with the same rights thereunder as
the Initial Warrants, and holders will have the benefit of the Registration
Rights Agreement.
Reports
The Convertible Note Indenture provides that, whether or not the Company is
subject to Section 13(a) or 15(d) of the Exchange Act, or any successor
provision thereto, the Company shall file with the Commission the annual
reports, quarterly reports and other documents which the Company would have
been required to file with the Commission pursuant to such Section 13(a) or
15(d) or any successor provision thereto if the Company were subject thereto,
such documents to be filed with the Commission on or prior to the respective
dates (the "Required Filing Dates") by which the Company would have been
required to file them. The Company shall also (whether or not it is required
to file reports with the Commission), within 30 days of each Required Filing
Date, (i) transmit by mail to all holders of Notes, as their names and
addresses appear in the applicable Security Register, without cost to such
holders or Persons, and (ii) file with the Trustees, copies of the annual
reports, quarterly reports and other documents (without exhibits) which the
Company has filed or would have filed with
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the Commission pursuant to Section 13(a) or 15(d) of the Exchange Act, any
successor provisions thereto or this covenant. The Company shall not be
required to file any report with the Commission if the Commission does not
permit such filing.
CONSOLIDATION, MERGER, CONVEYANCE, LEASE OR TRANSFER
The Convertible Note Indenture provides that 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 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 and Special Interest, if
any, on all the related Notes and the performance of the Company's
covenants and obligations under the applicable 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 Default or
Event of Default under the Convertible Note Indenture, as applicable, shall
have occurred and be continuing or would result therefrom;
(iii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis, the Company (or the Surviving Entity, if
the Company is not continuing) shall have a Consolidated Net Worth equal to
or greater than the Consolidated Net Worth of the Company immediately prior
to such transaction.
In connection with any consolidation, merger, transfer of assets or other
transactions contemplated by this provision, the Company shall deliver, or
cause to be delivered, to the Trustee, in form and substance reasonably
satisfactory to the Trustee, an Officers' Certificate and an opinion of
counsel, each stating that such consolidation, merger, sale, assignment,
conveyance or transfer and the supplemental indenture in respect thereto
comply with the provisions of the Convertible Note Indenture and that all
conditions precedent in the Convertible Note Indenture relating to such
transactions have been complied with.
Upon any transaction or series of transactions that are of the type
described in, and are effected in accordance with, the foregoing paragraphs,
the Surviving Entity shall succeed to, and be substituted for, and may
exercise every right and power of, the Company under the Convertible Note
Indenture and the related Convertible Notes with the same effect as if such
Surviving Entity had been named as the Company in the Convertible Note
Indenture; and when a Surviving Person duly assumes all of the obligations and
covenants of the Company pursuant to the Convertible Note Indenture and the
Convertible Notes, except in the case of a lease, the predecessor Person shall
be relieved of all such obligations.
EVENTS OF DEFAULT
Each of the following is an "Event of Default" under the Convertible Note
Indenture:
(a) default in the payment of interest (or Special Interest, if any) on
any Convertible Note issued pursuant to the Convertible Note Indenture when
the same becomes due and payable, and the continuance of such default for a
period of 30 days;
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(b) default in the payment of the principal of (or premium, if any, on)
any Convertible Note issued pursuant to the Convertible Note Indenture at
its maturity, upon optional redemption, required repurchase (including
pursuant to a Change of Control Offer, an Asset Sale Offer, or a repurchase
offer upon a Termination of Trading of the Common Stock) or otherwise or
the failure to make an offer to purchase any such Convertible Note as
required;
(c) failure by the Company to perform or comply with the provisions
described under "--Repurchase at the Option of the Holders upon a Change of
Control," "--Asset Sales," "--Issuances of Contingent Warrants," "--
Consolidation, Merger, Conveyance, Lease or Transfer," "--Right to Require
Repurchase of Convertible Notes upon a Termination of Trading" or "--
Additional Invested Equity;"
(d) default in the performance, or breach, of any covenant or warranty of
the Company in the Convertible 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 45 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 at Stated
Maturity of the outstanding Convertible 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 $5 million;
(f) the entry by a court of competent jurisdiction of one or more final
nonappealable judgments against the Company or any Restricted Subsidiary in
an uninsured or unindemnified aggregate amount in excess of $5 million
which is not discharged, waived, appealed, stayed, bonded or satisfied for
a period of 60 consecutive days;
(g) the entry by a court having jurisdiction in the premises of (i) a
decree or order for relief in respect of the Company or any Significant
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 Significant 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 Significant 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 Significant
Restricted Subsidiary or of any substantial part of the Property or assets
of the Company or any Significant Restricted Subsidiary, or ordering the
winding up or liquidation of the affairs of the Company or any Significant
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;
(h) (i) the commencement by the Company or any Significant 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 Significant Restricted Subsidiary to the entry of a
decree or order for relief in respect of the Company or any Significant
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 Significant Restricted Subsidiary; or (iii) the
filing by the Company or any Significant 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 Significant 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 Significant Restricted Subsidiary or
of any substantial part of the Property or assets of the Company or any
Significant Restricted Subsidiary, or the
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making by the Company or any Significant Restricted Subsidiary of an
assignment for the benefit of creditors; or (v) the admission by the
Company or any Significant 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 Significant Restricted Subsidiary
in furtherance of any such action; or
(i) the occurrence and continuation of an Event of Default under the
Senior Note Indenture for a period of 30 consecutive days after written
notice of the occurrence of such Event of Default has been given to the
Company by the Trustee or a holder or holders of Convertible Notes, which
notice states that such an event constitutes a Default under the
Convertible Note Indenture.
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 at Stated Maturity of the Convertible Notes may declare the
Default Amount, premium, if any, and any accrued and unpaid interest (and
Special Interest, if any) on all such Convertible 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 such Convertible Notes), and upon any such
declaration all amounts payable in respect of the Convertible Notes will
become and be immediately due and payable. If any Event of Default specified
in clause (g) or (h) above occurs, the Default Amount, premium, if any, and
any accrued and unpaid interest (and Special Interest, if any) on the
Convertible 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 such Convertible 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 judgment or decree for the payment of the money due on the Convertible
Notes has been obtained by the Trustee as provided in the Convertible Note
Indenture. In the event of a declaration of acceleration because an Event of
Default set forth in clause (i) above has occurred and is continuing, such
declaration of acceleration shall be automatically rescinded and annulled (A)
if the Senior Notes have been repaid, (B) if the Event of Default under the
Senior Note Indenture triggering such Event of Default pursuant to clause (i)
above shall be remedied or cured, or waived by the holders of the Senior
Notes, or (C) if the Senior Notes have been accelerated, then the acceleration
of the Senior Notes shall have been rescinded within 60 days of the occurrence
of such Event of Default under the Senior Note Indenture, and, in the case of
clauses (A), (B) or (C) above, the Senior Note Trustee so certifies to the
Convertible Note Trustee, provided that any such event described in clause
(A), (B) or (C) above must occur prior to the commencement of enforcement
proceedings with respect to the Convertible Note Indenture. Until September
30, 1999, the "Default Amount" shall equal the Accreted Value of the
Convertible Notes. Thereafter, the Default Amount shall equal 100% of
principal amount at Stated Maturity of the Convertible Notes. Under certain
circumstances, the holders of a majority in principal amount at Stated
Maturity of the outstanding Convertible Notes, by notice to the Company and
the Trustee, may rescind an acceleration and its consequences. Subject to all
provisions of the Convertible Note Indenture and applicable law, the holders
of a majority in aggregate principal amount at Stated Maturity of the
Convertible Notes at the time outstanding have the right to direct the time,
method and place of conducting any proceeding for any remedy available to the
Trustee, or exercising any trust or power conferred on the Trustee.
The holders of a majority in aggregate principal amount at Stated Maturity
of the Convertible Notes then outstanding by notice to the Trustee may on
behalf of the holders of all such Convertible Notes waive any existing Default
or Event of Default and its consequences under the Convertible Note Indenture
except a continuing Default or Event of Default in the payment of interest
(and Special Interest, if any) on, premium, if any, on or the principal of,
such Convertible Notes. Subject to the provisions of the Convertible Note
Indenture relating to the duties of the Trustee, the Trustee is under no
obligation to exercise any of its rights or powers under the Convertible Note
Indenture at the request, order or direction of any of the holders, unless
such holders have offered to the Trustee reasonable security or indemnity.
Subject to the provisions of the Convertible Note Indenture and applicable
law, the holders of a majority in aggregate principal amount at Stated
Maturity of the
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Convertible Notes at the time outstanding have the right to direct the time,
method and place of conducting any proceeding for any remedy available to the
Trustee, or exercising any trust or power conferred upon the Trustee.
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Convertible Note Indenture, and the Company is
required within five Business 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.
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 Convertible Notes, enter into one or
more indentures supplemental to the Convertible Note Indenture, (i) to
evidence the succession of another Person to the Company and the assumption by
such successor of the covenants and obligations of the Company in the
Convertible Note Indenture and the Convertible Notes; (ii) 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 Convertible Note Indenture;
(iii) to add any additional Events of Default; (iv) to provide for
uncertificated Convertible Notes in addition to or in place of certificated
Convertible Notes; (v) to evidence and provide for the acceptance of
appointment under the Convertible Note Indenture of a successor Trustee; (vi)
to cure any ambiguity in the Convertible Note Indenture, to correct or
supplement any provision in the Convertible 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 Indenture; provided,
that such actions shall not adversely affect the interests of the holders in
any material respect; (vii) to secure the Convertible Notes; (viii) to provide
for Guarantees as required under the Convertible Note Indenture; (ix) to make
provision with respect to the conversion rights of the holders of Convertible
Notes in the event of a consolidation, merger or sale of assets involving the
Company; or (x) to comply with the requirements of the Commission in order to
effect or maintain the qualification of the Convertible Note Indenture under
the Trust Indenture Act.
With the consent of the holders of not less than a majority in aggregate
principal amount at Stated Maturity of the outstanding Convertible Notes, the
Company and the Convertible Note Trustee may enter into one or more indentures
supplemental to the Convertible Note Indenture for the purpose of adding any
provisions to or changing in any manner or eliminating any of the provisions
of the Convertible 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 Convertible Note: (i) change the
Stated Maturity of the principal of, or any installment of interest (including
Special Interest, if any) on, any Convertible Note, or reduce the Accreted
Value or principal amount thereof at Stated Maturity (or premium, if any), or
the interest thereon that would be due and payable upon Stated Maturity
thereof, or reduce the Default Amount that would be due and payable upon
Stated Maturity thereof, or change the place of payment where, or the coin or
currency in which, any Convertible Note, or any premium or interest (including
Special Interest, if any) thereon is payable, or impair the right to institute
suit for the enforcement of any such payment on or after the Stated Maturity
thereof; (ii) reduce the percentage in principal amount of the outstanding
Convertible 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 Convertible Note Indenture or any Convertible Note
Guarantees or certain Defaults thereunder; (iii) make any changes in the
subordination provisions of the Convertible Notes or any Convertible Note
Guarantees that would adversely affect the holders of the Convertible Notes;
(iv) modify the obligations of the Company to make offers to purchase
Convertible Notes upon a Change of Control or from the proceeds of Asset Sales
or, in the case of a Termination of Trading of the Common Stock, the
obligation of the Company to repurchase the Convertible Notes; or (v) modify
any provision of this paragraph (except to increase any percentage set forth
herein).
The holders of not less than a majority in aggregate principal amount at
Stated Maturity of the outstanding Convertible Notes may, on behalf of the
holders of all such Convertible Notes, waive any past Default under the
Convertible Note Indenture and its consequences, except Default in the payment
of the principal of (or premium, if any) or interest on any Convertible Note,
or in respect of a covenant or provision hereof which under the proviso to the
prior paragraph cannot be modified or amended without the consent of the
holder of each outstanding Convertible Note affected.
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The holders of not less than 75% in aggregate principal amount at Stated
Maturity of the outstanding Convertible Notes may, on behalf of the holders of
all such Convertible Notes, waive any right to require the Company to issue to
the holders of the Convertible Notes either Convertible Note Contingent
Warrants or Additional Warrants.
SATISFACTION AND DISCHARGE OF THE CONVERTIBLE NOTE INDENTURE, DEFEASANCE
The Company may terminate its obligations under the Convertible Notes and
the Convertible Note Indenture when (i) either (A) all outstanding Convertible
Notes have been delivered to the Convertible Note Trustee for cancellation or
(B) all such Convertible Notes not theretofore delivered to the Convertible
Note Trustee for cancellation have become due and payable within one year or
are to be called for redemption within one year under irrevocable arrangements
satisfactory to the Convertible Note Trustee for the giving of notice of
redemption by the Convertible Note Trustee in the name and at the expense of
the Company, and the Company has irrevocably deposited or caused to be
deposited with the Convertible Note Trustee funds or U.S. Government
Obligations in an amount sufficient to pay and discharge the entire
indebtedness on the Convertible Notes not theretofore delivered to the
Convertible Note Trustee for cancellation, for principal of (premium, if any,
on) and interest (including Special Interest, if any) to the date of deposit
or maturity or date of redemption; (ii) the Company has paid or caused to be
paid all sums then due and payable by the Company under the Convertible 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
Convertible Note Indenture; provided, that notwithstanding the provisions
above, the holders of Convertible Notes will retain their conversion rights
until the applicable redemption date.
The Company, at its election, shall (a) be deemed to have paid and
discharged its debt on the Convertible Notes, and the Convertible Note
Indenture shall cease to be of further effect as to all outstanding
Convertible Notes (except as to (i) rights of registration of transfer,
substitution and exchange of the Convertible Notes and the Company's right of
optional redemption, (ii) rights of holders to receive payments of principal
of, premium, if any, and interest (including Special Interest, if applicable)
on the Convertible Notes (but not the Change of Control Purchase Price or the
Asset Sale Purchase Price) and any rights of the holders with respect to such
amounts, (iii) the rights, obligations and immunities of the Trustee under the
Convertible Note Indenture, (iv) conversion rights under the Convertible Note
Indenture, and (v) certain other specified provisions in the Convertible 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 Stated Maturity of the
Convertible 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 such Convertible
Notes, money in an amount, or (C) a combination thereof sufficient to pay and
discharge the principal of, and interest (including Special Interest, if
applicable) on, such Convertible Notes then outstanding on the dates on which
any such payments are due in accordance with the terms of the Convertible Note
Indenture and of such Convertible 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 outside counsel 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
Harris Trust and Savings Bank is the Trustee under the Convertible Note
Indenture and its current address is 111 West Monroe, Chicago, Illinois 60603.
The holders of not less than a majority in aggregate principal amount at
Stated Maturity of the outstanding Convertible Notes have the right to direct
the time, method and place of conducting any proceeding for
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exercising any remedy available to the Trustee, subject to certain exceptions.
Except during the continuance of an Event of Default under the Convertible
Note Indenture, the Trustee will perform only such duties as are specifically
set forth in the Convertible Note Indenture. The Convertible 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 Convertible 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 Convertible Note Indenture at the request of any of
the holders of the Convertible Notes, as the case may be, unless such holders
shall have offered to the Trustee indemnity satisfactory to it against any
loss, liability or expense.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company,
as such, shall have any liability for any obligations of the Company under the
Convertible Notes or the Convertible Note Indenture or for any claim based on,
in respect of, or by reason of, such obligations or their creation, solely by
reason of its status as a director, officer, employee, incorporator or
stockholder of the Company. Pursuant to the terms of the Convertible Note
Indenture, by accepting a Convertible Note each holder waives and releases all
such liability (but only such liability). The Convertible Note Indenture
provides that the waiver and release are part of the consideration for
issuance of the Convertible 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 as
expressed in the Securities Act and is therefore unenforceable.
GOVERNING LAW
The Convertible Note Indenture and the Convertible Notes are governed by the
laws of the State of New York, without regard to principles of conflicts of
law.
TRANSFER AND EXCHANGE
A holder may transfer or exchange Convertible Notes in accordance with the
Convertible 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 Convertible Note Indenture.
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Convertible Note Indenture. Reference is made to the Convertible Note
Indenture for the full definition of all such terms, as well as any
capitalized terms used herein for which no definition is provided.
"Accreted Value" means, for any Specified Date, the amount provided below
for each $1,000 principal amount at Stated Maturity of the Convertible Notes:
(a) If the Specified Date occurs on one of the following dates (each a
"Convertible Note Semi-Annual Accrual Date"), the Accreted Value will equal
the amount set forth below for such Convertible Note Semi-Annual Accrual
Date:
<TABLE>
<CAPTION>
SEMI-
ANNUAL
ACCRUAL ACCRETED
DATE VALUE
------- ---------
<S> <C>
March 30,
1997..... $ 802.45
September
30, 1997. 838.56
March 30,
1998..... 876.30
September
30, 1998. 915.73
March 30,
1999..... 956.94
September
30, 1999. 1,000.00
</TABLE>
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(b) if the Specified Date occurs before the first Convertible Note Semi-
Annual Accrual Date, the Accreted Value will equal the sum of (i) $767.90
and (ii) an amount equal to the product of (y) the Accreted Value of the
first Convertible Note Semi-Annual Accrual Date less the original issue
price multiplied by (z) a fraction, the numerator of which is the number of
days from the Issue Date to the Specified Date, using a 360-day year of
twelve 30-day months, and the denominator of which is the number of days
elapsed from the Issue Date to the first Convertible Note Semi-Annual
Accrual Date, using a 360-day year of twelve 30-day months;
(c) if the Specified Date occurs between two Convertible Note Semi-Annual
Accrual Dates, the Accreted Value will equal the sum of (i) the Accreted
Value for the Convertible Note Semi-Annual Accrual Date immediately
preceding such Specified Date and (ii) an amount equal to the product of
(y) the Accreted Value for the immediately following Convertible Note Semi-
Annual Accrual Date less the Accreted Value for the immediately preceding
Convertible Note Semi-Annual Accrual Date multiplied by (z) a fraction, the
numerator of which is the number of days from the immediately preceding
Convertible Note Semi-Annual Accrual Date to the Specified Date, using a
360-day year of twelve 30-day months, and the denominator of which is 180;
or
(d) if the Specified Date occurs after the last Convertible Note Semi-
Annual Accrual Date, the Accreted Value will equal $1,000.
"Acquired Indebtedness" means, with respect to any specified Person,
Indebtedness of any other Person existing at the time such other Person merged
with or into or became a Subsidiary of such specified Person, including
Indebtedness incurred in connection with, or in 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.
"Additional Invested Equity" means the net cash proceeds from the sale to
Persons, other than holders of the Convertible Notes, of Capital Stock not
maturing and not redeemable prior to September 30, 2004; provided, that the
terms of any such Capital Stock do not provide for any redemption or
repurchase, whether pursuant to a sinking fund or otherwise, or permit any
cash dividend prior to the Stated Maturity of the Convertible Notes.
"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 that any lender under a Credit Facility shall not be deemed to be an
Affiliate solely as the result of the Credit Facility; and provided, further,
that neither the Company nor any of its Wholly-Owned 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"), and 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; provided, that beneficial ownership of 10% or more of the Voting
Stock of a Person (on a fully diluted basis) shall be deemed to be control.
"Asset Sale" means, with respect to any Person, any transfer, conveyance,
sale, lease or other disposition (including, without limitation, dispositions
pursuant to any consolidation or merger) by such Person or any of its
Restricted Subsidiaries to any Person other than to such Person or a
Restricted Subsidiary of such Person, in one transaction or a series of
related transactions (each hereinafter referred to as a "Disposition"), of (a)
Capital Stock of or other equity interests in any Restricted Subsidiary (other
than director's qualifying shares) except as provided in clause (iv) of this
definition, (b) all or substantially all of the assets of any division or line
of business of such Person or of any of the Restricted Subsidiaries or (c)
Property or assets of such Person or any of its Restricted Subsidiaries, the
Fair Market Value of which exceeds $500,000, other than (i) a Disposition of
Property in the ordinary course of business and consistent with industry
practice, (ii) a Disposition of Eligible Cash Equivalents, (iii) a Disposition
of an Investment that constitutes a Restricted Payment under the Senior
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Note Indenture permitted under the first paragraph of the covenant described
in "--Restricted Payments," (iv) a Disposition of no more than ten percent of
the Common Stock of USN Solutions, Inc. on a fully diluted basis pursuant to
the exercise of the USN Solutions Option, (v) a Disposition by the Company in
connection with a transaction permitted under "--Consolidation, Merger,
Conveyance, Lease or Transfer" and (vi) contribution of assets to any
Unrestricted Subsidiary constituting an Investment permitted by the Indenture.
"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 such Person) of the payments during the remaining
term of the lease (including any period for which such lease has been extended
or may, at the option of the lessor, be extended) or until the earliest date
on which the lessee may terminate such lease without penalty or upon payment
of a penalty (in which case the rental payments shall include such penalty).
"Average Life" means, as of any date, with respect to any debt security or
Disqualified Stock, the quotient obtained by dividing (i) the sum of the
products of (x) the number of years from such date to the dates of each
scheduled principal payment or redemption payment (including any sinking fund
or mandatory redemption payment requirements) of such debt security or
Disqualified Stock multiplied in each case by (y) the amount of such principal
or redemption payment, by (ii) the sum of all such principal or redemption
payments.
"Board of Directors" means, with respect to any Person, the Board of
Directors (or similar governing body) of such Person or any committee of the
Board of Directors (or similar governing body) duly authorized to act on
behalf of such Board (or similar governing body).
"Board Resolution" means a duly adopted resolution of the Board of Directors
in full force and effect at the time of determination and certified as such.
"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 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 acquire an equity interest in
such Person.
"Cash Proceeds" means, with respect to any Asset Sale or issuance or sale of
Capital Stock by any Person, the aggregate consideration received in respect
of such sale or issuance by such Person in the form of cash or Eligible Cash
Equivalents; provided that with regard to an Asset Sale, any liabilities (as
shown on the Company's or such Restricted Subsidiary's most recent balance
sheet or in the notes thereto) of the Company or any Restricted Subsidiary
(other than liabilities that are by their terms subordinated to the Notes or
Guarantees, if any) which are assumed by the transferee of any such assets and
from which the Company and such Restricted Subsidiary are completely released
shall be deemed Cash Proceeds.
"Change of Control" shall be deemed to occur if (i) the sale, conveyance,
transfer, or lease (other than to the Company or any Wholly-Owned Restricted
Subsidiary of the Company), whether direct or indirect, of all or
substantially all of the assets of the Company or of the Company and its
Restricted Subsidiaries taken as a whole 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) 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
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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 or Permitted Holders, 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 or
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 of the Company (together with any new directors whose election or
appointment by such board 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 of the
Company then in office.
"Common Stock" of any Person means all Capital Stock of such Person that is
generally entitled to vote in the election of directors of such Person and any
rights (other than Indebtedness convertible into such Capital Stock), warrants
or options to acquire such Capital Stock of such Person.
"Consolidated Interest Expense" means, with respect to any Person for any
period, without duplication (A) the sum of (i) the aggregate amount of cash
and non-cash interest expense (including capitalized interest) of such Person
and its Restricted Subsidiaries for such period as determined on a
consolidated basis in accordance with GAAP in respect of Indebtedness
(including, without limitation, (v) any amortization of debt discount, (w) net
costs associated with Interest Hedging Obligations (including any amortization
of discounts), (x) the interest portion of any deferred payment obligation
calculated in accordance with the effective interest method, (y) all accrued
interest and (z) all commissions, discounts and other fees and charges owed
with respect to letters of credit, bankers' acceptances or similar facilities)
paid or accrued, or scheduled to be paid or accrued, during such period; (ii)
dividends or distributions with respect to Preferred Stock or Disqualified
Stock of such Person (and of its Restricted Subsidiaries if paid to a Person
other than such Person or its Restricted Subsidiaries) declared and payable in
cash; (iii) the portion of any rental obligation of such Person or its
Restricted Subsidiaries in respect of any Capital Lease Obligation allocable
to interest expense in accordance with GAAP; (iv) the portion of any rental
obligation of such Person or its Restricted Subsidiaries in respect of any
Sale and Leaseback Transaction allocable to interest expense (determined as if
such were treated as a Capital Lease Obligation); and (v) to the extent any
Indebtedness of any other Person is guaranteed by such Person or any of its
Restricted Subsidiaries, the aggregate amount of interest paid or accrued, or
scheduled to be paid or accrued, by such other Person during such period
attributable to any such Indebtedness, less (B) to the extent included in (A)
above, amortization or write-off of deferred financing costs of such Person
and its Restricted Subsidiaries during such period and any charge related to
any premium or penalty paid in connection with redeeming or retiring any
Indebtedness of such Person and its Restricted Subsidiaries prior to its
Stated Maturity; in the case of both (A) and (B) above, after elimination of
intercompany accounts among such Person and its Restricted Subsidiaries and as
determined in accordance with GAAP. For purposes of clause (ii) above,
dividend requirements attributable to any Preferred Stock or Disqualified
Stock shall be deemed to be an amount equal to the amount of dividend
requirements on such Preferred Stock or Disqualified Stock times a fraction,
the numerator of which is the amount of such dividend requirements, and the
denominator of which is one minus the applicable combined federal, state,
local and foreign income tax rate of the Company and its Restricted
Subsidiaries (expressed as a decimal), on a consolidated basis, for the fiscal
year immediately preceding the date of the transaction giving rise to the need
to calculate Consolidated Interest Expense.
"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, unusual or nonrecurring, (ii) the net
income of any Person that is not a Restricted Subsidiary or that is accounted
for by the equity method of accounting which shall be included only to the
extent of the amount of dividends or distributions paid to such Person or its
Restricted Subsidiaries, (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
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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 (but not net losses) in respect of Asset Sales by such Person or its
Restricted Subsidiaries, (vi) the net income (but not 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,
and (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).
"Consolidated Net Worth" of any Person means the consolidated stockholders'
equity of such Person and its Restricted Subsidiaries, as determined on a
consolidated basis in accordance with GAAP, less amounts attributable to
Disqualified Stock of such Person.
"Credit Facility" means one or more credit agreements, loan agreements or
similar agreements providing for working capital advances, term loans, letter
of credit facilities or similar advances, loans or facilities to the Company,
which may, pursuant to the terms of the Senior Note Indenture, be guaranteed
by the Restricted Subsidiaries, with a bank or syndicate of banks or other
financial institutions, as such may be amended, renewed, extended,
supplemented, refinanced and replaced or refunded from time to time; provided,
that for purposes of the Senior Note Indenture, the aggregate principal amount
of Indebtedness under the Credit Facility shall not exceed $45 million at any
one time outstanding less the amount of any mandatory or permitted principal
payments or payments from the proceeds of Asset Sales made under the Credit
Facility that, in each case, permanently reduce the borrowing capacity of the
Company thereunder.
"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, on or prior to the date on
which the Convertible Notes mature.
"EBITDA" means, with respect to any Person for any period, the sum for such
Person for such period of Consolidated Net Income plus, to the extent
reflected in the income statement of such Person for such period from which
Consolidated Net Income is determined, without duplication, (i) Consolidated
Interest Expense, (ii) income tax expense of such Person and its consolidated
Subsidiaries, (iii) depreciation expense, (iv) amortization expense, (v) any
non-cash expense related to the issuance to employees of such Person of
options to purchase Capital Stock of such Person and (vi) any charge related
to any premium or penalty paid in connection with redeeming or retiring any
Indebtedness prior to its Stated Maturity and minus, to the extent reflected
in such income statement, any noncash credits that had the effect of
increasing Consolidated Net Income of such Person for such period. This
definition of EBITDA is used only for the purpose of the description of the
Securities and the Senior Note Indenture.
"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,
certificates of deposit or Eurodollar deposits 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 ninety days after
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the date of acquisition thereof and, at the time of acquisition, having a
rating of A or better from Standard & Poor's or A-2 or better from Moody's,
(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 of Standard & Poor's or Moody's and in each
case maturing within 270 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).
"Exchange Rate Obligation" means, with respect to any Person, any currency
swap agreements, forward exchange rate agreements, foreign currency futures or
options, exchange rate collar agreements, exchange rate insurance and other
agreements or arrangements, or combination thereof, designed to provide
protection against fluctuations in currency exchange rates.
"Existing Indebtedness" means Indebtedness outstanding on the date of the
Senior Note Indenture and disclosed in a schedule attached to the Senior Note
Indenture.
"Fair Market Value" means, with respect to any asset or Property, the sale
value that could 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 of the Company or a Restricted Subsidiary, as applicable.
"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 Indentures shall utilize GAAP as in effect on the Issue
Date.
"guarantee" means any direct or indirect obligation, contingent or
otherwise, of a Person guaranteeing or having the economic effect of
guaranteeing any Indebtedness of any other Person in any manner (and
"guaranteed," "guaranteeing" and "guarantor" shall have meanings correlative
to the foregoing).
"Guarantee" means a guarantee of the payment of the Senior Notes and/or the
Convertible Notes, as applicable, executed and delivered by a Restricted
Subsidiary as required by the covenant described under "--Limitation on
Issuances of Guarantees by Restricted Subsidiaries" and "Guarantees" means,
collectively, the Senior Note Guarantees and the Convertible Note Guarantees,
if any.
"Guarantor" means a Restricted Subsidiary that executes and delivers a
Guarantee.
"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 or the recording, as required pursuant to GAAP or
otherwise, of any such Indebtedness or 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.
Indebtedness otherwise incurred by a Person before it becomes a Restricted
Subsidiary of the Company shall be deemed to have been incurred at the time at
which it becomes a Restricted Subsidiary.
"Indebtedness" means at any time (without duplication), with respect to any
Person, whether recourse is to all or a portion of the assets of such Person,
and whether or not contingent, (i) any obligation of such Person for
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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 acquisition of
Property, assets or businesses, excluding trade accounts payable made in the
ordinary course of business which are not more than 90 days overdue or which
are being contested in good faith and by appropriate proceedings, (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, assets 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 90 days overdue or which are being
contested in good faith and by appropriate proceedings, and for which adequate
reserves are being maintained on the books of the Company in accordance with
GAAP), (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 other Persons, the maximum fixed redemption or repurchase
price of Disqualified Stock of such Person's Restricted Subsidiaries, at the
time of determination, (vii) the notional amount of any Interest Hedging
Obligations or Exchange Rate Obligations of such Person at the time of
determination, (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 the maximum liability of any guarantees at such date;
provided, that for purposes of calculating the amount of Notes outstanding at
any date, the amount of such Notes shall be the Accreted Value thereof as of
such date, unless cash interest has commenced to accrue pursuant to the
applicable Indenture, in which case the amount of such Notes outstanding will
be the aggregate principal amount thereof at Stated Maturity; and provided,
further, that for purposes of calculating the amount of any non-interest
bearing or other discount security (other than the Notes), such Indebtedness
shall be deemed to be the principal amount thereof that would be shown on the
balance sheet of the issuer dated such date prepared in accordance with GAAP
but that such security shall be deemed to have been incurred only on the date
of the original issuance thereof.
"Indebtedness to Operating Cash Flow Ratio" means, as at any date of
determination, the ratio of (i) the aggregate amount of Indebtedness of the
Company and its Restricted Subsidiaries on a consolidated basis as of the date
of determination to (ii) the aggregate amount of EBITDA of the Company and its
Restricted Subsidiaries for the four preceding fiscal quarters for which
financial information is available immediately prior to the date of
determination; provided that any Indebtedness incurred or retired by the
Company or any of its Restricted Subsidiaries during the fiscal quarter in
which the date of determination occurs shall be calculated as if such
Indebtedness was so incurred or retired on the first day of the fiscal quarter
in which the date of determination occurs; and provided, further, that (x) if
the transaction giving rise to the need to calculate the Indebtedness to
Operating Cash Flow Ratio would have the effect of increasing or decreasing
Indebtedness or EBITDA in the future, Indebtedness or EBITDA shall be
calculated on a pro forma basis as if such transaction had occurred on the
first day of such four fiscal quarter period preceding the date of
determination, and (y) if during such four fiscal quarter period, the Company
or any of its Restricted Subsidiaries shall have engaged in any Asset Sale,
EBITDA for such period shall be reduced by an amount equal to the EBITDA (if
positive), or increased by an amount equal to the EBITDA (if negative),
directly attributable to the assets which are the subject of such Asset Sale
and any related retirement of Indebtedness as if such Asset Sale and related
retirement of Indebtedness had occurred on the first day of such four fiscal
quarter period or (z) if during such four fiscal quarter period the Company or
any of its Restricted Subsidiaries shall have acquired any material assets
outside the ordinary course of business, EBITDA shall be calculated on a pro
forma basis as if such asset acquisition and related financing had occurred on
the first day of such four fiscal quarter period.
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"Interest Hedging Obligation" means, with respect to any Person, an
obligation of such Person pursuant to any interest rate swap agreement,
interest rate cap, collar or floor agreement or other similar agreement or
arrangement designed to protect against or manage such Person's or any of its
Restricted Subsidiaries' exposure to fluctuations in interest rates.
"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) acquisition of any shares of Capital
Stock, bonds, notes, debentures or other securities of such Person, or (iii)
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 accounts receivable and other
extensions of trade credit on commercially reasonable terms in accordance with
normal trade practices. The amount of an 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 or assets other
than cash, such Property or assets shall be valued at its Fair Market Value at
the time of such transfer. The Company shall be deemed to make an "Investment"
in the amount of the Fair Market Value of the assets of a Subsidiary at the
time that such Subsidiary is designated as an Unrestricted Subsidiary.
"Issue Date" means the date on which the Convertible Notes were first
authenticated and delivered under the Convertible Note Indenture.
"Joint Venture" means a Telecommunications Company of which less than 50
percent of the Voting Stock is held by the Company; provided that the
management and operations of such Person are controlled by a Strategic
Investor or by the Company pursuant to (i) the charter documents of such
Person, or (ii) an agreement among the holders of the Voting Stock of such
Person, or (iii) a management agreement between the Company and such Person.
"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 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
applicable Indenture, whether at Stated Maturity, on the Change of Control
Payment Date or purchase date established pursuant to the terms of the
applicable Indenture with regard to a Change of Control Offer, an Asset Sale
Offer or an offer to repurchase upon a Termination of Trading of the Common
Stock of the Company, as applicable, or by declaration of acceleration, call
for redemption or otherwise.
"Net Cash Proceeds" means, with respect to the sale of any Property or
assets by any Person or any of its Restricted Subsidiaries, Cash Proceeds
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 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 and (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
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as a result of such transaction; 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; 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
Indentures.
"Officers' Certificate" means a certificate signed by the Chairman of the
Board, a Vice Chairman of the Board, the President, the Chief Executive
Officer, the Chief Operating Officer or a Vice President, and by the Chief
Financial Officer, the Chief Accounting Officer, the Treasurer, an Assistant
Treasurer, the Secretary or an Assistant Secretary of the Company or a
Restricted Subsidiary and delivered to the Trustee, which shall comply with
the applicable Indenture.
"Pari Passu Indebtedness" means any Indebtedness (secured or unsecured) of
the Company or any Guarantor that ranks pari passu in right of payment with
the Senior Notes or the Senior Note Guarantees, as applicable.
"Permitted Holders" means Thomas C. Brandenburg, J. Thomas Elliott and
Ronald W. Gavillet and Chase, CIBC, Hancock, BT, the Northwood Entities,
Enterprise and Merrill Lynch Global Allocation Fund, Inc., and any of their
respective Subsidiaries (or a wholly-owned Subsidiary of the sole stockholder
of any of the foregoing Persons).
"Permitted Investments" means (i) Eligible Cash Equivalents; (ii)
Investments in Property used in the ordinary course of business; (iii)
Investments in the Company or in any Restricted Subsidiary or any Person as a
result of which such Person becomes a Restricted Subsidiary in compliance with
the Senior Note Indenture; (iv) Investments pursuant to certain agreements or
obligations of the Company or a Restricted Subsidiary, in effect on the Issue
Date, to make such Investments, and disclosed in a schedule attached to the
Senior Note Indenture; (v) Investments in prepaid expenses, negotiable
instruments held for collection and lease, utility and workers' compensation,
performance and other similar deposits; (vi) Interest Hedging Obligations 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 on
the Issue Date; and (ix) Investments in securities of trade creditors,
wholesalers or customers received pursuant to any plan of reorganization or
similar arrangements.
"Permitted Liens" means (i) Liens created by the Senior Note Indenture or
that otherwise secure the payment of the Senior Notes or the Senior Note
Guarantees, if any, and Liens created by the Convertible Note Indenture or
which otherwise secure the payment of the Convertible Notes or the Convertible
Note Guarantees, if any; (ii) Liens on Property or assets of a Person existing
at the time such Person is merged into or consolidated with the Company or any
Restricted Subsidiary of the Company or becomes a Restricted Subsidiary of the
Company, provided that such Liens were in existence prior to the contemplation
of such merger or consolidation and do not secure any Property or assets of
the Company or any of its Restricted Subsidiaries other than the Property or
assets subject to the Liens prior to such merger or consolidation; (iii) Liens
on Property or assets existing at the time of acquisition thereof by the
Company or any Restricted Subsidiary, provided that such Liens were not given
in contemplation of such acquisition; (iv) Liens to secure the payment of all
or a part of the purchase price or construction cost of Property or assets
acquired or constructed in the ordinary course of business after the Issue
Date, provided that the Indebtedness secured by such Liens shall not exceed
the lesser of 100% of the cost or the Fair Market Value of the Property or
assets acquired or constructed and such Liens shall not extend to any other
Property or assets; (v) Liens incurred or deposits made to secure the
performance of tenders, bids, leases not constituting Capitalized Lease
Obligations, statutory or regulatory obligations, surety or appeal bonds,
performance bonds or other obligations of a like nature incurred in the
ordinary course of business consistent with industry practice; (vi) Liens
existing as of the Issue Date and disclosed in a schedule attached to
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the Senior Note Indenture; (vii) any Lien on Property of the Company in favor
of the United States of America or any state thereof, or any instrumentality
of either, to secure certain payments pursuant to any contract or statute;
(viii) any Lien for taxes or assessments or other governmental charges or
levies not then due and payable (or which, if due and payable, are being
contested in good faith and for which adequate reserves are being maintained,
to the extent required by GAAP); (ix) easements, rights-of-way, licenses and
other similar restrictions on the use of Properties or minor imperfections of
title that, in the aggregate, are not material in amount and do not in any
case materially detract from the Properties subject thereto or interfere with
the ordinary conduct of the business of the Company or its Restricted
Subsidiaries; (x) any Lien to secure obligations under workers' compensation
laws or similar legislation, including any Lien with respect to judgments
which are not currently dischargeable; (xi) any statutory warehousemen's,
materialmen's or other similar Liens for sums not then due and payable (or
which, if due and payable, are being contested in good faith and with respect
to which adequate reserves are being maintained, to the extent required by
GAAP); (xii) Liens in favor of the Company; (xiii) Liens on Property or assets
of the Company securing not more than $30 million aggregate principal amount
at any one time outstanding of Indebtedness incurred under clause (a) of the
second paragraph of the covenant described under "--Limitation on
Indebtedness"; (xiv) Liens securing any Vendor Financing, provided that such
Liens do not extend to any Property or assets other than the Property or
assets the acquisition of which was financed by such Indebtedness; (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; and (xvi) Liens to secure any permitted
extension, renewal, refinancing or refunding (or successive extensions,
renewals, refinancings or refundings), in whole or in part, of any
Indebtedness secured by Liens referred to in the foregoing clauses (ii), (iii)
and (xiv), provided that such Liens do not extend to any other Property or
assets and the principal amount of the Indebtedness secured by such Liens is
not increased.
"Person" means any individual, corporation, partnership, joint venture,
limited liability company, trust, unincorporated organization or government or
any agency or political subdivision thereof or other entity.
"Preferred Stock" means any Capital Stock of a Person, however designated,
which entitles the holder thereof to a preference with respect to dividends,
distributions or liquidation proceeds of such Person over the holders of other
Capital Stock issued by such Person.
"Property" means, with respect to any Person, any interest of such Person in
any kind of property or asset, whether real, personal or mixed, or tangible or
intangible, excluding Capital Stock in any other Person.
"Public Equity Offering" means an underwritten public offering of Capital
Stock (other than Disqualified Stock) of the Company pursuant to an effective
registration statement filed under the Securities Act.
"Qualified Public Offering" means a Public Equity Offering resulting in net
proceeds to the Company of at least $35 million.
"Qualified Sale of the Company" means a sale of the Capital Stock or a
merger or consolidation involving the Company, pursuant to which the holders
of Capital Stock of the Company receive cash proceeds and/or publicly traded
securities having a fair market value in each case of at least $122,500,000 in
the aggregate, or a sale of assets of the Company pursuant to which the
Company receives net cash proceeds and/or publicly traded securities having a
fair market value of at least $122,500,000 in the aggregate.
"Qualified Stock" of any Person means a class of Capital Stock other than
Disqualified Stock.
"Refinancing Indebtedness" means any Indebtedness incurred in connection
with the Refinancing of other Indebtedness.
"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 to the
Company or any Restricted Subsidiary of the Company on the Capital Stock of
any Restricted
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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 (and other than pro rata dividends, distributions or payments
declared or paid on the Common Stock of USN Solutions, Inc. to any Person not
otherwise an Affiliate of the Company holding such Common Stock as a result of
the exercise of the USN Solutions Option; provided, that the Company shall
receive pro rata dividends, distributions or payments at the same time and in
the same form and composition of consideration as the dividends, distributions
or payments paid to such minority stockholders), (ii) a payment made by the
Company or any of its Restricted Subsidiaries (other than to the Company or
any Restricted Subsidiary of the Company) to purchase, redeem, acquire or
retire any Capital Stock of the Company or of a Restricted Subsidiary of the
Company, (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, or any Guarantees,
as applicable, or (iv) an Investment in any Person, including an Unrestricted
Subsidiary or the designation of a Subsidiary as an Unrestricted Subsidiary,
other than a Permitted Investment.
"Restricted Subsidiary" means (i) with respect to any Person other than the
Company and its Subsidiaries, a Subsidiary of such Person and (ii) with
respect to the Company and its Subsidiaries, any Subsidiary of the Company
that has not been classified 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.
"Significant Restricted Subsidiary" means a Restricted Subsidiary that is a
"significant subsidiary" as defined in Rule 1-02(w) of Regulation S-X under
the Securities Act and the Exchange Act.
"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 Investor" means, with respect to any relevant transaction, a
Telecommunications Company which, both as of the Business Day immediately
before the day of the closing of such transaction and the Business Day
immediately after the day of closing of such transaction, has, or whose parent
has, an equity market capitalization, a net asset value or annual revenues of
at least $2 billion on a consolidated basis. For purposes of this definition,
the term "parent" means any Person of which the relevant Strategic Investor is
a Subsidiary.
"Subsidiary" means, with respect to any Person, (i) any corporation more
than 50% of the outstanding shares of Voting Stock of which is owned, directly
or indirectly, by such Person, or by one or more other Subsidiaries of such
Person, or by such Person and one or more other Subsidiaries of such Person,
(ii) any general partnership, joint venture or similar entity, more than 50%
of the outstanding partnership or similar interests of which are owned,
directly or indirectly, by such Person, or by one or more other Subsidiaries
of such Person, or by such Person and one or more other Subsidiaries of such
Person and (iii) any limited partnership of which such Person or any
Subsidiary of such Person is a general partner.
"Telecommunications Assets" means, with respect to any Person, assets
(including, without limitation, rights of way, trademarks and licenses to use
copyrighted material) that are utilized by such Person, directly or
indirectly, for the design, development, construction, installation,
integration, operation, management or
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provision of telecommunications systems and/or services, including without
limitation, any businesses or services in which the Company is currently
engaged and including any computer systems used in a Telecommunications
Business. Telecommunications Assets shall also include stock, joint venture or
partnership interests in another Person, provided that substantially all of
the assets of such other Person consist of Telecommunications Assets, and
provided, further, that if such stock, joint venture or partnership interests
are held by the Company or a Restricted Subsidiary, such other Person either
is, or immediately following the relevant transaction shall become, a
Restricted Subsidiary of the Company pursuant to the applicable Indenture
unless such Person is a Joint Venture. The determination of what constitutes
Telecommunication Assets shall be made by the Board of Directors and evidenced
by a Board Resolution delivered to the applicable Trustee.
"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, voice, video or data
through owned or leased transmission facilities, (ii) creating, developing or
marketing communications related network equipment, software and other devices
for use in (i) above or (iii) evaluating, participating or pursuing any other
activity or opportunity that is related to those specified in (i) or (ii)
above and includes, without limitation, any business in which the Company and
its Restricted Subsidiaries are currently engaged.
"Telecommunications Company" means any Person substantially all of the
assets of which consist of Telecommunications Assets.
"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.
"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
Indentures.
"Vendor Financing" means, with respect to any Person, an obligation owed by
such Person to a vendor of Telecommunications Assets solely in respect of the
purchase price of such assets, provided that the amount of such Indebtedness
does not exceed the Fair Market Value of such assets, and provided, further,
that such Indebtedness is incurred within 90 days of the acquisition of such
assets.
"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" means any Restricted Subsidiary, all of
the outstanding Capital Stock (other than directors' qualifying shares) of
which is owned, directly or indirectly, by the Company; provided, that for
purposes of the Senior Note Indenture, other than for purposes of the
definition of "Consolidated Net Income," USN Solutions, Inc. shall not cease
to be a Wholly-Owned Restricted Subsidiary merely as a result of the exercise
of the USN Solutions Option.
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INITIAL WARRANTS
GENERAL
The Initial Warrants were issued pursuant to a Warrant Agreement, dated as
of September 30, 1996 (the "Warrant Agreement"), between the Company and
Harris Trust and Savings Bank, as warrant agent (the "Warrant Agent"). The
Initial Warrants are subject to all terms in the Warrant Agreement and holders
of Initial Warrants are referred to the Warrant Agreement, a copy of which is
available from the Company on request, for a complete statement of such terms.
The statements and definitions of terms under this caption relating to the
Initial Warrants are summaries and do not purport to be complete. Such
summaries make use of certain terms defined in the Warrant Agreement and are
qualified in their entirety by express reference to the Warrant Agreement.
Each Initial Warrant is evidenced by a Warrant Certificate and entitles the
holder thereof to purchase 1.269311203 shares of Class A Common Stock (each a
"Warrant Share") from the Company at a price (the "Exercise Price") of $.01
per share, subject to adjustment as described below. Subject to certain
limitations, the Initial Warrants may be exercised at any time beginning 180
days from the date of original issuance thereof and on or prior to the close
of business on a date eight years following the Issue Date (the "Expiration
Date"). Initial Warrants that are not exercised by the Expiration Date will
expire. The Company will give notice of expiration not less than 90 nor more
than 120 days prior to the Expiration Date to registered holders of the then
outstanding Initial Warrants.
The aggregate number of Warrant Shares issuable upon exercise of the Initial
Warrants is equal to approximately 5% of the outstanding shares of Common
Stock, on a fully diluted basis as of March 31, 1997.
CERTAIN TERMS
Exercise
In order to exercise all or any of the Initial Warrants represented by a
Warrant Certificate, the holder thereof is required to surrender to the
Warrant Agent the Warrant Certificate, a duly executed copy of the
subscription form set forth in the Warrant Certificate and payment in full of
the Exercise Price for each Warrant Share or other security as to which an
Initial Warrant is being exercised. Payment for securities upon exercise of an
Initial Warrant may be made in cash or by certified check, official bank check
or bank cashier's check payable to the order of the Company. Upon the exercise
of any Initial Warrant in accordance with the Warrant Agreement, the Warrant
Agent shall instruct the Company to transfer promptly to, or upon the written
order of, the holder of such Initial Warrant appropriate evidence of ownership
of any Warrant Share or other securities or property to which such holder is
entitled, registered or otherwise placed in such name or names as such holder
may direct in writing, and the Company shall deliver such evidence of
ownership to the person or persons entitled to receive the same, including,
without limitation, any cash payable to adjust for fractional interests in
Warrant Shares issuable upon such exercise. If less than all of the Initial
Warrants evidenced by a Warrant Certificate are to be exercised, a new Warrant
Certificate will be issued for the remaining number of Initial Warrants. All
Warrant Shares or other securities issuable by the Company upon the exercise
of the Initial Warrants shall be validly issued, fully paid and nonassessable.
No fractional Warrant Shares will be issued upon exercise of the Initial
Warrants. If any fraction of a Warrant Share would, except for the foregoing
provision, be issuable upon the exercise of any Initial Warrants (or specified
portion thereof), the Company will pay an amount in cash equal to the Current
Market Price (as defined in the Warrant Agreement) per share of Class A Common
Stock, as determined on the trading day immediately preceding the date the
Initial Warrant is presented for exercise, multiplied by such fraction,
computed to the nearest whole cent.
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Certificates for Initial Warrants will be issued in global form or
registered form as definitive warrant certificates and no service charge will
be made for registration of transfer or exchange upon surrender of any Warrant
Certificate at the office of the Warrant Agent maintained for that purpose.
The Company may require payment of a sum sufficient to cover any tax or other
governmental charge that may be imposed in connection with any registration or
transfer or exchange of Warrant Certificates.
Holders of Initial Warrants will be able to exercise their Initial Warrants
only if a registration statement relating to the Warrant Shares is then
effective under, or the exercise of such Initial Warrants is exempt from the
registration requirements of, the Securities Act. See "Registration Rights."
Adjustments
Subject to certain exceptions, including the issuance of the Initial
Warrants, the Contingent Warrants and Additional Warrants and conversion of
the Convertible Notes, the Exercise Price and the number of Warrant Shares
issuable upon exercise of the Initial Warrants will be subject to adjustment
on the occurrence of certain events including: (i) the payment by the Company
of dividends (or the making of other distributions) with respect to Common
Stock payable in Common Stock or other shares of the Company's capital stock,
(ii) subdivisions, combinations and reclassifications of Common Stock, (iii)
the issuance to all holders of Common Stock of rights, options or warrants
entitling them to subscribe for Common Stock, or of securities convertible
into or exchangeable for shares of Common Stock, in either case for
consideration per share of Common Stock which is less than the Current Market
Price per share of Common Stock, (iv) the issuance or sale of shares of Common
Stock for consideration per share of Common Stock which is less than the
Current Market Price per share of Common Stock and (v) the distribution to all
holders of Common Stock of any of the Company's assets, debt securities or any
rights or warrants to purchase securities (excluding those rights and warrants
referred to in clause (iii) above and excluding cash dividends or other cash
distributions from current or retained earnings).
No adjustment in the Exercise Price will be required unless such adjustment
would require an increase or decrease of at least 1.0% in the Exercise Price;
provided, that any adjustment which is not made will be carried forward and
taken into account in any subsequent adjustment.
Mergers, Consolidations and Certain Other Transactions
Except as otherwise provided herein, in the event the Company consolidates
with, merges with or into, or sells all or substantially all of its property
and assets to another Person, each Initial Warrant thereafter shall entitle
the holder thereof to receive upon exercise thereof the number of shares of
capital stock or other securities or property which the holder of a share of
Common Stock is entitled to receive upon completion of such consolidation,
merger or sale of assets. If the Company merges or consolidates with, or sells
all or substantially all of its property and assets to, another Person and, in
connection therewith, consideration to the holders of Common Stock in exchange
for their shares is payable solely in cash, or in the event of the
dissolution, liquidation or winding-up of the Company, then the holders of the
Initial Warrants will be entitled to receive distributions on an equal basis
with the holders of Common Stock or other securities issuable upon exercise of
the Initial Warrants, as if the Initial Warrants had been exercised
immediately prior to such event, less the Exercise Price. Upon receipt of such
payment, if any, the Initial Warrants will expire and the rights of the
holders thereof will cease.
In case of any such merger, consolidation or sale of assets, the surviving
or acquiring Person and, in the event of any dissolution, liquidation or
winding-up of the Company, the Company, shall deposit promptly with the
Warrant Agent the funds or other consideration, if any, necessary to pay the
holders of the Initial Warrants. After such funds and the surrendered Warrant
Certificate are received, the Warrant Agent shall make payment by delivering a
check in such amount as is appropriate (or, in the case of consideration other
than cash, shall transfer such other consideration as is appropriate) to such
Person or Persons as it may be directed in writing by the holders surrendering
such Initial Warrants.
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No Rights as Stockholders
The holders of unexercised Initial Warrants are not entitled, as such, to
receive dividends or other distributions with respect to the Common Stock,
receive notice of any meeting of the stockholders of the Company, consent to
any action of the stockholders of the Company, receive notice of any other
stockholder meetings, or to any other rights as stockholders of the Company.
RESERVATION OF SHARES
The Company has authorized and reserved for issuance such number of shares
of Common Stock as shall be issuable upon the exercise of all outstanding
Initial Warrants. Such shares of Class A Common Stock, when paid for and
issued, will be duly and validly issued, fully paid and non-assessable, free
of preemptive rights and free from all taxes, liens, charges and security
interests with respect to the issue thereof.
AMENDMENT
From time to time, the Company and the Warrant Agent, without the consent of
the holders of the Initial Warrants, may amend or supplement the Warrant
Agreement for certain purposes, including, without limitation, curing defects
or inconsistencies or making any change that does not materially adversely
affect the rights of any holder. Any amendment or supplement to the Warrant
Agreement that has a material adverse effect on the interests of the holders
of the Initial Warrants shall require the written consent of the holders of a
majority of the then outstanding Initial Warrants. The consent of each holder
of the Initial Warrants affected shall be required for any amendment pursuant
to which the Exercise Price would be increased or the number of Warrant Shares
purchasable upon exercise of Initial Warrants would be decreased (other than
pursuant to adjustments provided in the Warrant Agreement).
CLASS A COMMON STOCK
See "Description of Capital Stock" for a description of the Class A Common
Stock.
REGISTRATION RIGHTS
With respect to the Convertible Notes, the Initial Warrants, the Warrant
Shares and the Convertible Note Shares, the Company has entered into a
registration rights agreement with the Initial Purchasers, dated as of
September 30, 1996 (the "Registration Rights Agreement"), for the benefit of
the holders of the Convertible Notes and the Initial Warrants. Pursuant to the
Registration Rights Agreement, the Company is required to keep the
Registration Statement, of which this Prospectus forms a part, effective for a
specified time period. If the Registration Statement ceases to be effective or
fails to be usable for its intended purpose without being succeeded
immediately by a post-effective amendment to such Registration Statement that
cures such failure and that is itself declared effective for a period of more
than 30 consecutive business days, then commencing on the day following the
date on which such default occurs, the Company agrees to pay to each holder of
the Convertible Notes during the first 90-day period immediately following the
default Special Interest. The amount of Special Interest payable to each
holder shall increase by an additional 0.5% per annum for each subsequent 90-
day period during which such default continues, up to a maximum rate of 1.5%
per annum. Special Interest shall cease to be payable when the Registration
Statement again becomes effective or usable. A holder of Convertible Notes who
is not entitled to the benefits of the Registration Statement (i.e., such
holder has not elected to include information in the Registration Statement)
shall not be entitled to such Special Interest. Reference is made to the
Registration Rights Agreement, a copy of which can be obtained from the
Company upon request, for further information with respect to the provisions
of such agreement. In addition, the Company has entered into the Investors
Registration Agreement, pursuant to which the Original Purchasers may, subject
to certain limitations, require the Company to register for public resale all
or part of the Common Stock held by the Original Purchasers. See "Risk
Factors--Shares Eligible for Future Sale" and "Certain Relationships and
Related Transactions--Formation of the Company."
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CERTAIN OTHER INDEBTEDNESS
On September 30, 1996, the Company issued $48.5 million in aggregate
principal amount at maturity of 14% Senior Discount Notes due 2003 (the
"Senior Notes"). The Senior Notes are general, unsecured obligations of the
Company and rank pari passu in right of payment with all existing and future
senior unsecured indebtedness of the Company, and will be senior in right of
payment to all existing and future subordinated indebtedness of the Company.
The terms of the Senior Notes are as set forth in an indenture, dated as of
September 30, 1996 (the "Senior Note Indenture"), by and between the Company
and Harris Trust and Savings Bank, as trustee, and are similar in many
respects to the terms of the Convertible Notes.
Under the terms of the Senior Note Indenture, the Company may not, and may
not permit its Restricted Subsidiaries to, directly or indirectly, incur any
Indebtedness (including Acquired Indebtedness), and the Company may not issue
any Disqualified Stock; provided, that the Company may incur Indebtedness or
issue Disqualified Stock if, after giving effect to such issuance or
occurrence on a pro forma basis, the Indebtedness to Operating Cash Flow Ratio
of the Company does not exceed 5 to 1.0. The Senior Note Indenture provides
certain exceptions to the foregoing limitation, including, among other things,
up to $45 million of indebtedness under the Credit Facility (as defined
herein), up to $30 million of which may be secured, Vendor Financing (as
defined herein) not to exceed a certain amount and Refinancing Indebtedness
(as defined herein).
The Senior Note Indenture limits the Company's ability to repurchase or pay
dividends on the Class A Common Stock. Until the Company's obligations under
the Senior Note Indenture are defeased, the Company cannot declare or pay any
dividend on its Capital Stock (other than dividends, distributions or payments
made solely in Qualified Stock of the Company) or purchase, redeem, acquire or
retire any of its Capital Stock unless (i) no Default or Event of Default
under the Senior Note Indenture shall have occurred and be continuing or shall
occur as a consequence thereof; (ii) after giving effect, on a pro forma
basis, to such payment and the incurrence of any Indebtedness the net proceeds
of which are used to finance such payment, the Company could incur at least
$1.00 of additional Indebtedness pursuant to the Senior Note Indenture and
(iii) after giving effect to such payment on a pro forma basis, the aggregate
amount expended or declared for all such payments (as well as other 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
immediately preceding the date of such payment, plus (B) 100% of the aggregate
Net Cash Proceeds received by the Company subsequent to the Issue Date from
the issuance or sale (other than to a Subsidiary) of shares of its Qualified
Stock, including Qualified Stock issued upon the conversion of convertible
debt (other than the conversion of the Convertible Notes) or the exercise of
options, warrants or rights to purchase Qualified Stock, plus (C) 100% of the
amount of any Indebtedness of the Company or any of its Restricted
Subsidiaries (as expressed on the face of a balance sheet in accordance with
GAAP), or the carrying value of any Disqualified Stock, which has been
converted into, exchanged for or satisfied by the issuance of shares of
Qualified Stock of the Company subsequent to the Issue Date, less the amount
of any cash or the value of any other Property distributed by the Company or
its Restricted Subsidiaries upon such conversion, exchange or satisfaction,
plus (D) 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 by the
Company or any Restricted Subsidiary in such Person and in each such case
which was treated as a Restricted Payment under the Senior Note Indenture,
minus (E) 100% of the amount of certain Investments made by the Company,
including, among others, pursuant to clause (iii) of the following paragraph
subsequent to the Issue Date of the Senior Notes.
Notwithstanding the foregoing limitations, the Company may (i) pay 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
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dividend in compliance with the Senior Note Indenture; (ii) retire any Capital
Stock of the Company in exchange for or out of the proceeds of the
substantially concurrent sale of Qualified Stock of the Company; and (iii)
purchase, redeem, retire or acquire any Common Stock of the Company held by
any member or former member of the Company's (or any of its Subsidiaries')
management pursuant to any management agreement or stock option plan in effect
on the Issue Date of the Senior Notes or upon the death, disability,
retirement or termination of employment of such management, so long as no
Default or Event of Default under the Senior Note Indenture shall have
occurred and be continuing or shall result as a consequence thereof.
The Senior Note Indenture provides that the Company will be obligated to
issue to holders of the Senior Notes Senior Note Contingent Warrants,
exercisable for Class A Common Stock representing up to 3% of the Common Stock
on a fully diluted basis as of the date of such issuance (without including
(i) Common Stock issued for fair market value subsequent to the Closing Date
(as determined in the Warrant Agreement), (ii) Common Stock issuable pursuant
to any options, or shares of Common Stock granted to or purchased by
management of the Company, pursuant to agreements or stock plans existing on
the date of the Senior Note Indenture and either disclosed in a schedule
attached thereto or described herein, or (iii) certain additional shares of
Common Stock issuable pursuant to options, or shares of Common Stock issuable
pursuant to agreements or stock plans, as disclosed in a schedule attached to
the Senior Note Indenture) after giving effect to the issuance of such Senior
Note Contingent Warrants, in the event that, on or prior to March 30, 1998,
the Company does not effect a Qualified Public Offering or has not been sold
pursuant to a Qualified Sale of the Company. The Senior Note Contingent
Warrants will be issued pursuant to the Warrant Agreement with the same rights
thereunder as the Initial Warrants, and holders will have the benefit of the
Registration Rights Agreement.
In addition, the Senior Note Indenture contains certain other covenants,
including (i) a limitation on the creation or assumption of liens with respect
to the property or assets of the Company, (ii) a limitation on the ability of
the Company to enter into any Sale and Leaseback Transactions (as defined
herein), (iii) a limitation on the ability of the Company to make any
Restricted Payments (as defined herein), (iv) a limitation on the issuance of
any capital stock of any Restricted Subsidiary of the Company, (v) a
limitation on the ability of the Company to enter into any Affiliate
Transactions (as defined herein) and (vi) a limitation on the lines of
business in which the Company may engage. Reference is made to the Senior Note
Indenture, a copy of which can be obtained from the Company upon request, for
further information with respect to the foregoing covenants.
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 2,650,000 shares of
capital stock, consisting of 2,550,000 shares of Common Stock, par value $.01
per share, of which 2,500,000 shares are designated as Class A Common Stock
and 50,000 shares are designated as Class B Common Stock, and 100,000 shares
are designated as Preferred Stock, par value $1.00 per share.
COMMON STOCK
The holders of Common Stock are entitled to receive dividends when and as
dividends are declared by the Board of Directors of the Company out of funds
legally available therefor, provided that if any shares of Preferred Stock are
at the time outstanding, the payment of dividends on the Common Stock or other
distributions may be subject to the declaration and payment of full cumulative
dividends on outstanding shares of Preferred Stock. If stock dividends are
declared, holders of Class A Common Stock will receive shares of Class A
Common Stock and holders of Class B Common Stock will receive shares of Class
B Common Stock.
Except for matters where applicable law requires the approval of one or both
classes of Common Stock voting as separate classes, holders of Class A Common
Stock are entitled to one vote per share on all matters submitted to a vote of
the stockholders, including the election of directors. Unless required by law,
holders of Class B Common Stock are not entitled to voting rights.
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Shares of Class A Common Stock are convertible into Class B Common Stock on
a one-to-one basis at any time at the option of the holders thereof.
Upon any liquidation, dissolution or winding up of the affairs of the
Company, whether voluntary or involuntary, any assets remaining after the
satisfaction in full of the prior rights of creditors and the aggregate
liquidation preference of any Preferred Stock then outstanding will be
distributed to the holders of Class A Common Stock and Class B Common Stock,
ratably as a single class in proportion to the number of shares held by them.
In the event of a reorganization, consolidation or merger of the Company,
each holder of a share of Class A Common Stock shall be entitled to receive
the same kind and amount of property receivable by a holder of a share of
Class B Common Stock and each holder of a share of Class B Common Stock shall
be entitled to receive the same kind and amount of property receivable by a
holder of Class A Common Stock.
TRANSFER AGENT AND REGISTRAR OF CLASS A COMMON STOCK
The transfer agent and registrar for the Class A Common Stock is Harris
Trust and Savings Bank.
PREFERRED STOCK
The authorized but unissued Preferred Stock may be issued by the Board of
Directors of the Company from time to time in one or more series with such
preferences, terms and rights as the Board of Directors may determine without
further action by the stockholders of the Company. Accordingly, the Board of
Directors has the power to fix the dividend rate and to establish the
provisions, if any, relating to dividends, voting rights, redemption rates,
sinking funds, liquidation preferences and conversion rights for any series of
Preferred Stock issued in the future. Currently, the Company has 30,000 shares
of Preferred Stock authorized for issuance, all of which has been designated
as 9% Cumulative Convertible PIK Preferred Stock (the "9% Preferred Stock").
In connection with the Private Placement, the Company issued 10,000 shares
of its 9% Preferred Stock. The 9% Preferred Stock has a liquidation preference
and stated value of $1,000 per share. Dividends will accrue semiannually at a
rate of 9% per annum and be fully cumulative. Dividends are payable in
additional shares of 9% Preferred Stock. In the event of any liquidation,
dissolution or winding up of the Company, holders of the 9% Preferred Stock
will be entitled to receive their full liquidation preference per share,
together with accrued and unpaid dividends, prior to the distribution of any
assets of the Company to holders of Common Stock.
Shares of 9% Preferred Stock are not redeemable at the option of the
Company, but are subject to mandatory redemption in 2006 at the stated value,
together with all accrued and unpaid dividends to the redemption date.
The shares of 9% Preferred Stock are convertible into shares of Class A
Common Stock, at any time, in whole or from time to time in part, at the
option of the holders thereof.
One of the effects of undesignated Preferred Stock may be to enable the
Board of Directors to render more difficult or to discourage an attempt to
obtain control of the Company by means of a tender offer, proxy contest,
merger or otherwise, and thereby to protect the continuity of the Company's
management. The issuance of shares of the Preferred Stock pursuant to the
Board of Directors' authority described above may adversely affect the rights
of the holders of Common Stock. For example, Preferred Stock issued by the
Company may rank prior to the Common Stock as to dividend rights, liquidation
preference or both, may have full or limited voting rights and may be
convertible into shares of Common Stock. Accordingly, the issuance of shares
of Preferred Stock may discourage bids for the Common Stock or may otherwise
adversely affect the market price of the Common Stock.
LIMITATION OF LIABILITY OF DIRECTORS
The Certificate of Incorporation provides that a director of the Company
will not be personally liable for monetary damages to the Company or its
stockholders for breach of fiduciary duty as a director, except for
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liability, (i) for any breach of the director's duty of loyalty to such
corporation or its stockholders, (ii) for acts or omissions not in good faith
or which involve intentional misconduct or a knowing violation of law, (iii)
for unlawful payments of dividends or unlawful stock repurchases or redemption
as provided in Section 194 of the Delaware General Corporation Law (the
"DGCL") or (iv) for any transaction from which the director derived an
improper personal benefit.
This provision is intended to afford directors additional protection and
limit their potential liability from suits alleging a breach of the duty of
care by a director. As a result of the inclusion of such a provision,
stockholders may be unable to recover monetary damages against directors for
actions taken by them that constitute negligence or gross negligence or that
are otherwise in violation of their fiduciary duty of care, although it may be
possible to obtain injunctive or other equitable relief with respect to such
actions. If equitable remedies are found not to be available to stockholders
in any particular situation, stockholders may not have an effective remedy
against a director in connection with such conduct.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Bylaws provide that directors and officers of the Company shall be
indemnified against liabilities arising from their service as directors and
officers. Additionally, the Company has entered into indemnification
agreements with each of its executive officers and directors to reimburse them
for certain liabilities incurred in connection with the performance of their
fiduciary duties. Section 145 of the DGCL ("Section 145") empowers a
corporation to indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other
than an action by or in the right of the corporation) by reason of the fact
that he is or was a director, officer, employee or agent of the corporation or
is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation or enterprise, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action, suit
or proceeding if he acted in good faith and in a manner he reasonably believed
to be in, or not opposed to, the best interests of the corporation, and, with
respect to any criminal action or proceeding, had no reasonable cause to
believe his conduct was unlawful.
Section 145 also empowers a corporation to indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action or suit by or in the right of the corporation to procure a
judgment in its favor by reason of the fact that such person acted in any of
the capacities set forth above, against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection with the defense or
settlement of such action or suit if he acted under similar standards, except
that no indemnification may be made in respect of any claim, issue or matter
as to which such person shall have been adjudged to be liable to the
corporation unless, and only to the extent that, the Court of Chancery or the
court in which such action was brought shall determine that despite the
adjudication of liability such person is fairly and reasonably entitled to
indemnity for such expenses which the court shall deem proper.
Section 145 further provides that to the extent that a director or officer
of a corporation has been successful in the defense of any action, suit or
proceeding referred to above or in the defense of any claim, issue or matter
therein, he shall be indemnified against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection therewith; that
indemnification provided for by Section 145 shall not be deemed exclusive of
any other rights to which the indemnified party may be entitled; and that the
corporation is empowered to purchase and maintain insurance on behalf of a
director or officer of the corporation against any liability asserted against
him in any such capacity, or arising out of his status as such, whether or not
the corporation would have the power to indemnify him against such liabilities
under Section 145.
There has not been in the past and there is not presently pending any
litigation or proceeding involving a director, officer, employee or agent of
the Company which could give rise to an indemnification obligation on the part
of the Company. In addition, except as described herein, the Board of
Directors is not aware of any threatened litigation or proceeding which may
result in a claim for indemnification.
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Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or persons controlling the Company
pursuant to the foregoing provisions, the Company has been informed that in
the opinion of the Commission such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following summary describes the material United States federal income
tax consequences of an investment in the Securities, as well as certain
potential federal income tax consequences to the Company with respect to the
Securities. Except where noted, it deals only with Convertible Notes, and
Initial Warrants held as capital assets by United States holders and does not
deal with special situations, such as those of foreign persons, dealers in
securities, financial institutions, life insurance companies, holders whose
"functional currency" is not the U.S. dollar, or special rules with respect to
integrated transactions of which the ownership of common stock is a part (such
as certain hedging transactions), or certain "straddle" transactions.
Furthermore, the discussion below is based upon the provisions of the Internal
Revenue Code of 1986, as amended (the "Code"), and regulations, rulings and
judicial decisions thereunder as of the date hereof, and such authorities may
be repealed, revoked or modified so as to result in federal income tax
consequences different from those discussed below. PROSPECTIVE PURCHASERS
CONSIDERING AN INVESTMENT IN THE CONVERTIBLE NOTES, INITIAL WARRANTS OR COMMON
STOCK ARE URGED TO CONSULT THEIR TAX ADVISORS CONCERNING THE FEDERAL INCOME
TAX CONSIDERATIONS THAT MAY BE SPECIFIC TO THEM AS WELL AS ANY TAX
CONSEQUENCES ARISING UNDER THE LAWS OF ANY OTHER TAXING JURISDICTION.
TAXATION OF THE CONVERTIBLE NOTES
Original Issue Discount. The Convertible Notes were issued with original
issue discount ("OID") for federal income tax purposes. Accordingly, each
holder of Convertible Notes generally will be required to include OID in
income as it accrues on a yield-to-maturity basis over the term of the
Convertible Notes in advance of cash payments attributable to such income
(regardless of whether the holder is a cash or accrual basis taxpayer). The
amount of OID with respect to a Convertible Note equals the excess of the
stated redemption price at maturity of such Convertible Note over its issue
price. The stated redemption price at maturity includes all payments required
to be made on the Convertible Notes whether denominated as principal or
interest (other than payments subject to remote or incidental contingencies).
The Company intends to treat the payment of Special Interest and the issuance
of Contingent Warrants as subject to such contingencies, which treatment is
binding on holders unless a holder explicitly discloses on its tax return for
the taxable year that includes the acquisition date of Convertible Notes that
its treatment is different. The Company's treatment is not, however, binding
on the Internal Revenue Service (the "IRS"). The issue price of the
Convertible Notes was the initial price at which a substantial portion of the
Convertible Notes were sold (not including sales to bond houses, brokers or
similar persons or organizations acting in the capacity of underwriters or
wholesalers) which was $767.90 per Convertible Note.
A holder of a debt instrument that bears OID is required to include in gross
income an amount equal to the sum of the daily portions of OID for each day
during the taxable year in which the holder holds the debt instrument. The
daily portions of OID are determined by allocating to each day in an accrual
period the pro rata portion of the OID that is allocable to the accrual
period. The amount of OID that is allocable to an accrual period with respect
to the Convertible Notes is generally equal to the product of the adjusted
issue price of the Convertible Notes at the beginning of the accrual period
(the issue price of the Convertible Notes determined as described above,
generally increased by all prior accruals of OID) and the Convertible Notes'
yield-to-maturity (the discount rate, which, when applied to all payments
under the Convertible Notes, results in a present value equal to the issue
price of the Convertible Notes). In the case of the final accrual period, the
allocable OID generally is the difference between the amount payable at
maturity and the adjusted issue price at the beginning of the accrual period.
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The Company will furnish annually to the IRS and to holders (other than with
respect to certain exempt holders, including, in particular, corporations)
information with respect to the OID accruing while the Convertible Notes were
held by the holders.
Premium. If a holder purchases a Convertible Note for an amount that is
greater than such Convertible Note's stated redemption price at maturity, such
holder will be considered to have purchased such Convertible Note with
"amortizable bond premium" equal in amount to such excess, and generally will
not be required to include OID in income. A holder may elect to amortize such
premium, using a constant yield method, over the remaining term of such
Convertible Note with reference to either the amount payable on maturity or,
if it results in a smaller premium attributable to the period through the
earlier call date, with reference to the amount payable on the earlier call
date. An election to amortize bond premium applies to all taxable debt
obligations then owned and thereafter acquired by the holder and may be
revoked only with the consent of the IRS.
If a holder of a Convertible Note (including an original purchaser)
purchases the Convertible Note for an amount greater than the Convertible
Note's adjusted issue price but less than such Convertible Note's stated
redemption price at maturity, then the holder will be required to include
annual accruals of OID in gross income in accordance with the rules described
above; however, the amount of OID includable in income will be reduced to
reflect such acquisition premium. The includable OID (as otherwise determined)
will be reduced by an amount equal to the OID multiplied by a fraction, the
numerator of which is such excess and the denominator of which is the OID for
the period from the date of acquisition until the maturity date.
Market Discount. If a holder purchases a Convertible Note for an amount that
is less than its adjusted issue price, by at least .025% of its adjusted issue
price times the number of remaining whole years to maturity, then such holder
will be considered to have purchased such Convertible Note with "market
discount" equal in amount to such difference between the adjusted issue price
and purchase price. In that event, gain realized by the holder upon the sale,
retirement or certain other dispositions of the Convertible Note will be
treated as ordinary interest income to the extent of the accrued market
discount. Market discount on a Convertible Note will be treated as accruing
ratably over such Note's term, or, at the holder's election, under a constant
yield method. In addition, such holder will be required to defer the deduction
of a portion of the interest paid on any indebtedness incurred or continued to
purchase or carry the Convertible Note (unless such holder elects to include
market discount in income currently as it accrues, on either a ratable or
constant yield basis). Such election, once made, applies to all market
discount bonds acquired by the taxpayer on or after the first day of the
taxable year to which such election applies, and may not be revoked without
the consent of the IRS.
Convertible Note Contingent Warrants. In the event that within the
applicable period following the date of original issuance of the Convertible
Notes, the Company does not effect a Qualified Public Offering or if there has
not been a Qualified Sale of the Company, the Convertible Note Indenture will
require the Company to issue Convertible Note Contingent Warrants to the
holders of the Convertible Notes. The issuance of the Contingent Warrants
should not result in a deemed taxable exchange of the Convertible Notes for
federal income tax purposes. The Company intends to treat the issuance of
Contingent Warrants, if any, as interest for federal income tax purposes in an
amount equal to their fair market value on the date of issuance.
Disposition of Convertible Notes. A holder will generally recognize gain or
loss upon the sale, exchange, retirement or other disposition of Convertible
Notes equal to the difference between the amount realized on the disposition
and the holder's adjusted tax basis in the Convertible Notes. A holder's
adjusted tax basis in a Convertible Note will generally be the cost of the
Convertible Note, increased by any OID previously included in income by such
holder (and the accrual of market discount, if any, which the holder has
previously included in income) and decreased by the amount of any deductions
for amortizable bond premium. Except as described above under "Market
Discount," such gain or loss generally would be capital gain or loss and would
be long-term capital gain or loss if the holding period for the Convertible
Notes is more than one year.
Backup Withholding. Under certain circumstances, a holder may be subject to
backup withholding at a 31% rate on payments received with respect to the
Convertible Notes. This withholding generally applies only if the
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holder (i) fails to furnish his or her social security or other taxpayer
identification number ("TIN"), (ii) furnishes an incorrect TIN, (iii) is
notified by the IRS that he or she has failed to report payment of interest
and dividends properly and the IRS has notified the Company that he or she is
subject to backup withholding or (iv) fails, under certain circumstances, to
provide a certified statement, signed under penalty of perjury, that the TIN
provided is his or her correct number and that he or she is not subject to
backup withholding. Any amount withheld from a payment to a holder under the
backup withholding rules is allowable as a credit against such holder's
federal income tax liability, provided that the required information is
furnished to the IRS. Certain holders (including, among others, corporations
and foreign individuals who comply with certain certification requirements)
are not subject to backup withholding. Holders should consult their tax
advisors as to their qualification for exemption from backup withholding and
the procedure for obtaining such an exemption.
CERTAIN POTENTIAL FEDERAL INCOME TAX CONSEQUENCES TO THE COMPANY.
The Convertible Notes may constitute "corporate acquisition indebtedness"
if, among other things, the proceeds of the Notes are used to pay for the
purchase of stock or at least two-thirds of the operating assets of another
corporation. To the extent the Convertible Notes constitute corporate
acquisition indebtedness, under Section 279 of the Code the maximum amount of
interest or original issue discount the Company can deduct with respect
thereto in any taxable year is $5 million, reduced by any interest incurred on
indebtedness to acquire stock or operating assets but which does not qualify
as corporate acquisition indebtedness.
WARRANTS
Exercise. No gain or loss will be recognized for federal income tax purposes
upon exercise of a Warrant (except that gain will be recognized to the extent
cash is received in lieu of fractional shares). A holder's initial tax basis
in an Initial Warrant will be equal to the price the holder pays for such
Warrant. A holder's initial tax basis in a Contingent Warrant will be equal to
the fair market value on the date of issuance, assuming such holder receives
the Contingent Warrant from the Company as a result of the failure by the
Company to consummate a Qualified Public Offering or Qualified Sale of the
Company. The tax basis of shares of Common Stock acquired upon exercise of a
Warrant will be equal to the sum of (i) the holder's tax basis in such Warrant
and (ii) the exercise price. The holding period of such Common Stock acquired
upon exercise of the Warrants will begin on the date of exercise of the
Warrant, unless the Warrant is treated as stock for federal income tax
purposes (as discussed below). In the event the Warrant is treated as stock,
the holding period of the Common Stock acquired upon exercise will include the
period during which the Warrants were held.
Disposition. In general, the sale, exchange or other taxable disposition of
a Warrant will result in gain or loss to the holder in an amount equal to the
difference between the amount realized on such sale, exchange or other
disposition and the holder's tax basis in the Warrant. Such gain or loss
generally will be long-term capital gain or loss if the Warrant is held by the
holder for more than one year at the time of the disposition and the Common
Stock issuable upon exercise of such Warrant would have been a capital asset
if acquired by the holder. However, the IRS might assert that the sale of a
Warrant to the Company does not constitute a sale or exchange and that the
holder should recognize ordinary income or loss. The IRS also could contend
that the Warrants represent an equity interest in the Company because, among
other things, the Warrants are exercisable for nominal consideration. In the
event the Warrants are treated as stock for Federal income tax purposes, the
sale of Warrants to the Company should be governed by the stock redemption
provisions of Section 302 of the Code. In such a case, redemptions of Warrants
by the Company would be treated as a dividend and taxed as ordinary income to
the extent of the Company's current and accumulated earnings and profits,
unless, taking into account certain constructive ownership rules, the holder
terminated his entire equity interest in the Company or the redemption was
"not essentially equivalent to a dividend." In a published ruling, the IRS has
indicated that a holder whose actual and constructive stock ownership in an
issuer was minimal and who exercised no control over corporate affairs was
generally entitled to capital gain or loss treatment upon the redemption of
his stock so long as his percentage stock ownership was thereby reduced.
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Expiration. The expiration of a Warrant should generally result in a long-
term capital loss to the holder equal to the holder's tax basis in the Warrant
if the Warrant is held by the holder for more than one year at the time of the
expiration and the Common Stock issuable upon exercise of the Warrant would
have been a capital asset if acquired by him.
Adjustments to Conversion Ratio. Adjustments made to the number of shares
that may be acquired upon the exercise of a Warrant, or the failure to make
such adjustments, may result in a taxable distribution to the holders of
Warrants pursuant to Section 305 of the Code.
CONVERSION OF CONVERTIBLE NOTES
Exercise. A holder's conversion of Convertible Notes into Class A Common
Stock generally will not be a taxable event (except with respect to cash
received in lieu of a fractional share of Class A Common Stock) for federal
income tax purposes. A holder's basis in the Class A Common Stock received
upon conversion generally will be the same as the holder's basis (exclusive of
any tax basis allocable to a fractional share) in the underlying Convertible
Note. A holder's holding period in the Class A Common Stock received upon
conversion generally will include the holding period in the underlying
Convertible Note.
Adjustments to Conversion Ratio. Adjustments made to the number of shares
that may be acquired upon the conversion of the Convertible Notes, or the
failure to make such adjustments, may result in a taxable distribution to the
holders of Convertible Notes pursuant to Section 305 of the Code.
PLAN OF DISTRIBUTION
The Securities may be offered by the Selling Securityholders from time to
time in transactions for their own account at negotiated prices. The Selling
Securityholders may effect the sale of the Securities by selling the
Securities to or through broker-dealers, and such broker-dealers may receive
compensation in the form of discounts, concessions or commissions from the
Selling Securityholders or the purchasers of Securities for whom such broker-
dealers may act as agent or to whom they sell as principal, or both (which
compensation as to a particular broker-dealer might be in excess of customary
commissions). The Selling Securityholders and any broker-dealers that act in
connection with the sale of the Securities might be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act and
any commissions received by them and any profit on the resale of the
Securities as principal might be deemed to be underwriting discounts and
commissions under the Securities Act.
At the time a particular sale of any of the Securities is made, to the
extent required, a Prospectus Supplement will be distributed which will set
forth the amount of Securities being sold and the terms of the sale, including
the name or names of any underwriters, brokers, dealers or agents (whether
such party is acting as a principal or as agent for the Selling
Securityholders), any discounts, commissions, concessions and other items
constituting compensation from the Selling Securityholders and any discounts,
commissions or concessions allowed or re-allowed or paid to dealers.
The Company will pay all expenses incident to the sale of the Securities
other than the fees and expenses of the Selling Securityholders and
underwriting discounts and commissions.
SELLING SECURITYHOLDERS
The Registration Statement of which this Prospectus forms a part has been
filed pursuant to Rule 415 under the Securities Act to afford the holders of
the Securities the opportunity to sell such Securities in a public transaction
rather than pursuant to an exemption from the registration and prospectus
delivery requirements of the Securities Act. In order to avail itself of that
opportunity, a holder must notify the Company in writing of its intention to
sell Securities and request that the Company file a supplement to this
Prospectus or an amendment
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to the Registration Statement, if required, identifying such holder as a
Selling Securityholder and disclosing such other information concerning the
Selling Securityholder and the Securities to be sold as may then be required
by the Securities Act and the rules of the Commission. No offer or sale
pursuant to this Prospectus may be made by any holder until such a request has
been made and until any such supplement has been filed or any such amendment
has become effective.
This Prospectus has been prepared for use by the Initial Purchasers in
connection with offers and sales of the Convertible Notes, the Initial
Warrants, the Convertible Note Shares and the Warrant Shares, in market-making
transactions at negotiated prices related to prevailing market prices at the
time of sale. The Initial Purchasers may act as principal or agent in such
transactions. The Initial Purchasers have advised the Company that they
currently intend to make a market in the Securities but they are not obligated
to do so and may discontinue any such market-making at any time without
notice. Accordingly, no assurance can be given that an active trading market
will develop for or as to the liquidity of the Securities.
LEGAL MATTERS
The validity of the Securities was passed upon for the Company by Skadden,
Arps, Slate, Meagher & Flom (Illinois).
EXPERTS
The consolidated financial statements of the Company as of December 31,
1996, 1995 and 1994 and for the fiscal years then ended included in this
Prospectus have been audited by Deloitte & Touche LLP, independent auditors,
as stated in their reports appearing herein, and have been so included in
reliance upon the reports of such firm given upon their authority as experts
in accounting and auditing.
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GLOSSARY
ACCESS CHARGES--The fees paid by IXCs to LECs for originating and
terminating long distance calls on their local networks.
CAP (Competitive Access Provider)--A company that provides its subscribers
with an alternative to the local telephone company for local transport of
private line, special access and interstate transport of switched access
telecommunications services. CAPs are also referred to in the industry as
alternative local telecommunications service providers (ALTs) and metropolitan
area network providers (MANs) and were formerly referred to as alternative
access vendors (AAVs).
CENTRAL OFFICES--The switching centers or central switching facilities of
the LECs.
CENTREX--Centrex is a service that offers features similar to those of a
Private Branch Exchange (PBX), except the equipment is located at the
carrier's premises and not at the premises of the subscriber. These features
include direct dialing within a given phone system, direct dialing of incoming
calls, and automatic identification of outbound calls. This is a value added
service that carriers can provide to a wide range of subscribers who do not
have the size or the funds to support their own on-site PBX.
CHURN--The effect of a subscriber electing an alternative telecommunications
provider after having been provided with the telecommunications services of
the Company.
CO-CARRIER STATUS--A relationship between competitive local exchange
carriers ("CLECs") that affords the same access to and rights on each other's
networks, and that provides access and services on an equal basis.
COLLOCATION--The ability of a CLEC such as the Company to connect its
network to the LEC's central offices. Physical collocation occurs when a CLEC
places its network connection equipment inside the LEC's central offices.
Virtual collocation is an alternative to physical collocation pursuant to
which the LEC permits a CLEC to connect its network to the LEC's central
offices at competitive prices, even though the CLEC's network connection
equipment is not physically located inside the central offices.
DEDICATED LINES--Telecommunications lines dedicated or reserved for use
exclusively by particular subscribers along predetermined routes (in contrast
to telecommunications lines within the LEC's public switched network).
DEDICATED SERVICES--Special access, switched transport and private line
services generally offered by CLECs, including the Company.
DIVESTITURE--In 1982, the Department of Justice and AT&T entered into the
Modified Final Judgment (the "MFJ") which resulted in the break-up of AT&T's
monopoly over local and long distance services. This judgment established
seven separate regionally based local switched bell operating companies and
essentially laid the ground work for intense competition in the newly defined
long distance segment of the telecommunications market.
FCC--Federal Communications Commission.
FIBER OPTICS--Fiber optic cable is the medium of choice for the
telecommunications and cable industries. Fiber is immune to electrical
interference and environmental factors that affect copper wiring and satellite
transmission. Fiber optic technology involves sending laser light pulses
across glass strands in order to transmit digital information. A strand of
fiber optic cable is as thick as a human hair yet is said to have more
bandwidth capacity than copper cable the size of a telephone pole.
FRAME RELAY--Frame Relay is a high-speed data packet switching service used
to transmit data between computers. Frame Relay supports data units of
variable lengths at access speeds ranging from 56kbs to 1.5 mbs.
91
<PAGE>
This service is ideal for connecting LANS, but is not appropriate for voice
and video applications due to the variable delays that can occur. Frame Relay
was designed to operate at higher speeds on modern fiber optic networks.
INTERCONNECTION DECISIONS--Rulings by the FCC announced in September 1992
and August 1993, which require the RBOCs and most other LECs to provide
interconnection in LEC central offices to any CLEC, long distance carrier or
end user seeking such interconnection for the provision of interstate special
access and switched access transport services.
INTEREXCHANGE CARRIERS OR IXCS--See Long Distance Carrier.
LANS (Local Area Networks)--The interconnection of computers for the purpose
of sharing files, programs and various devices such as work stations, printers
and high-speed modems. LANs may include dedicated computers or file servers
that provide a centralized source of shared files and programs.
LATAS (Local Access and Transport Areas)--The geographically defined areas
in which LECs are authorized by the MFJ to provide local switched services.
LECS (Local Exchange Carriers)--Companies providing local telephone
services.
LOCAL EXCHANGE AREAS--A geographic area determined by the appropriate state
regulatory authority in which local calls generally are transmitted without
toll charges to the calling or called party.
LONG DISTANCE CARRIERS OR 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. Long distance carriers include, among others, AT&T, MCI, Sprint
and WorldCom, as well as resellers of long distance capacity.
POPS (Point 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 private, dedicated telecommunications line connecting
different locations (excluding long distance carrier POPs).
PROVISIONING--The process of initiating a carrier's service to a subscriber.
RBOCS (Regional Bell Operating Companies)--The seven local telephone compa-
nies established by the MFJ. These RBOCs are prohibited from providing inter-
LATA services and from manufacturing telecommunications equipment.
RESELLER--A company which does not own its own transmission facilities and
contracts with facilities-based carriers for the transmission of its
subscribers' long distance calls. In essence, a reseller buys excess capacity
(in minutes) from large facilities-based carriers at volume discounts and
sells services (minutes) to subscribers at reduced cost.
SPECIAL ACCESS SERVICES--The lease of private, dedicated telecommunications
lines or "circuits" along the network of a LEC or a CLEC (such as the
Company), 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 a subscriber to its
long distance carrier POP. Special access services do not require the use of
switches.
SWITCH--A sophisticated computer that accepts instructions from a caller in
the form of a telephone number. Like an address on an envelope, the numbers
tell the switch where to route the call. The switch opens or closes circuits
or selects the paths or circuits to be used for transmission of information.
Switching is a process of
92
<PAGE>
interconnecting circuits to form a transmission path between users. Switches
allow local telecommunications service providers to connect calls directly to
their destination, while providing advanced features and recording connection
information for future billing.
SWITCHED ACCESS SERVICES--The origination or termination of long distance
traffic between a customer premise and an IXC POP via shared local trunks
using a local switch.
SWITCHED TRANSPORT SERVICES--Transportation of switched traffic along
dedicated lines between the LEC central offices and interexchange POPs.
SWITCHED TRAFFIC--Telecommunications traffic along a switched network.
TELECOMMUNICATIONS ACT--The Telecommunications Act of 1996.
93
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INDEPENDENT AUDITORS' REPORT............................................... F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Operations.................................... F-4
Consolidated Statements of Redeemable Preferred Stock.................... F-5
Consolidated Statements of Common Stockholders' Deficit.................. F-6
Consolidated Statements of Cash Flows.................................... F-7
Notes to Consolidated Financial Statements............................... F-8
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
USN Communications, Inc.
Chicago, Illinois
We have audited the accompanying consolidated balance sheets of USN
Communications, Inc. and subsidiaries (the "Company") as of December 31, 1996
and 1995, the related consolidated statements of operations, redeemable
preferred stock, common stockholders' deficit and cash flows for the years
ended December 31, 1996 and 1995 and for the period from April 20, 1994
(Inception) to December 31, 1994. These consolidated 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 audits 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 the
Company as of December 31, 1996 and 1995, and the results of its operations
and its cash flows for the years ended December 31, 1996 and 1995 and for the
period from April 20, 1994 (Inception) to December 31, 1994, in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 20 to the
financial statements, the Company's recurring losses from operations raise
substantial doubt about its ability to continue as a going concern.
Management's plans concerning this matter are also described in Note 20. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
DELOITTE & TOUCHE LLP
March 14, 1997
F-2
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
ASSETS 1996 1995
------ ----------- ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents........................... $60,569,365 $ 13,705,025
Accounts receivable, net of allowances for doubtful
accounts of $223,000 (1996) and $193,000 (1995).... 3,004,408 1,184,453
Interest receivable................................. 249,113 61,015
Prepaid expenses.................................... 187,051 171,111
Notes receivable.................................... 150,000
Other receivables................................... 22,567
Net assets held for sale............................ 1,453,699
----------- ------------
Total current assets.............................. 64,182,504 16,575,303
Property and Equipment--net........................... 3,507,350 1,214,647
Other Assets.......................................... 10,362,438 2,681,255
----------- ------------
Total Assets...................................... $78,052,292 $ 20,471,205
=========== ============
<CAPTION>
LIABILITIES, REDEEMABLE PREFERRED STOCK AND COMMON
STOCKHOLDERS' DEFICIT
--------------------------------------------------
<S> <C> <C>
Current Liabilities:
Accounts payable.................................... $ 7,907,654 $ 2,734,122
Accrued expenses and other liabilities.............. 3,176,762 1,106,010
Current maturities on notes payable................. 386,522 409,348
Capital lease obligations--current.................. 277,844 75,192
----------- ------------
Total current liabilities......................... 11,748,782 4,324,672
Capital Lease Obligations--Noncurrent................. 312,280 81,391
Notes Payable......................................... 49,727 436,825
14% Senior Discount Notes, net of Original Issue
Discount............................................. 31,242,614
9% Convertible Subordinated Discount Notes, net of
Original Issue Discount.............................. 28,259,555
----------- ------------
Total liabilities................................. 71,612,958 4,842,888
Redeemable Preferred Stock:
9% Cumulative Convertible Pay-In-Kind Preferred
Stock.............................................. 10,000
Series A 10% Senior Cumulative Preferred Stock...... 16,200
Series A-2 10% Senior Cumulative Preferred Stock.... 26,235
Accumulated unpaid dividends........................ 225,000 3,810,000
Additional paid-in capital.......................... 9,810,185 40,543,605
----------- ------------
Total redeemable preferred stock.................. 10,045,185 44,396,040
Common Stockholders' Deficit:
Common stock: $.01 par value;
2,500,000 and 500,000 authorized at 1996 and 1995;
718,526 and 315,729 shares issued at 1996 and 1995
................................................... 7,185 3,137
Additional paid-in capital.......................... 54,179,423 282,955
Accumulated deficit................................. (57,791,382) (29,053,815)
Treasury stock, 1,000 shares at 1996................ (1,077)
----------- ------------
Total common stockholders' deficit................ (3,605,851) (28,767,723)
----------- ------------
Total Liabilities, Redeemable Preferred Stock and
Common Stockholders' Deficit..................... $78,052,292 $ 20,471,205
=========== ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
Net service revenue................... $ 9,814,479 $ 7,883,890 $ 1,737,461
Cost of services...................... 9,256,472 9,075,749 1,454,882
------------ ------------ -----------
Gross margin...................... 558,007 (1,191,859) 282,579
------------ ------------ -----------
Expenses:
Sales and marketing................. 12,612,172 5,867,200 2,869,463
General and administrative.......... 20,664,612 10,131,390 4,685,894
------------ ------------ -----------
Operating loss........................ (32,718,777) (18,159,720) (7,272,778)
------------ ------------ -----------
Other income (Expense):
Interest income..................... 1,376,429 586,946 152,099
Interest expense.................... (1,797,112) (733,566) (26,110)
Gain on sale of switch-based
facilities......................... 8,078,901
Other income........................ 13,968 59,314
------------ ------------ -----------
Other income (expense)--net....... 7,672,186 (87,306) 125,989
------------ ------------ -----------
Net loss before minority interest..... (25,046,591) (18,247,026) (7,146,789)
Minority interest share in loss of
USNCN................................ 150,000
------------ ------------ -----------
Net loss.............................. $(25,046,591) $(18,097,026) $(7,146,789)
============ ============ ===========
Accumulated unpaid preferred
dividends............................ $ 225,000 $ 3,810,000 $ 707,000
============ ============ ===========
Net loss per common share............. $ (49.53) $ (72.42) $ (65.63)
============ ============ ===========
Weighted average common and common
equivalent shares outstanding........ $ 510,233 $ 302,520 $ 119,678
============ ============ ===========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
SERIES
9% PIK SERIES A A-2 ACCUMULATED ADDITIONAL
PREFERRED PREFERRED PREFERRED UNPAID PAID-IN-
STOCK STOCK STOCK DIVIDENDS CAPITAL TOTAL
--------- --------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, April 20, 1994.
Issuance of 16,200
shares of Series A
10% Senior Cumulative
preferred stock...... $16,200 $15,212,824 $15,229,024
Costs incurred related
to issuance of stock. (630,474) (630,474)
Accumulated unpaid
preferred dividends.. $ 707,000 707,000
------- ---------- ----------- -----------
Balance, December 31,
1994................... 16,200 707,000 14,582,350 15,305,550
Issuance of 26,235
shares of Series A-2
10% Senior Cumulative
preferred stock...... $26,235 26,208,765 26,235,000
Costs incurred related
to issuance of stock. (247,510) (247,510)
Accumulated unpaid
preferred dividends.. 3,103,000 3,103,000
------- ------- ---------- ----------- -----------
Balance, December 31,
1995................... $16,200 $26,235 $3,810,000 $40,543,605 $44,396,040
======= ======= ========== =========== ===========
Accumulated unpaid
preferred dividends.. 3,465,976 3,465,976
Conversion of Series A
and A-2 Preferred
Stock to Class A
Common Stock......... (16,200) (26,235) (7,275,976) (40,543,605) (47,862,016)
Issuance of 10,000
shares of 9% PIK
preferred stock...... $10,000 9,990,000 10,000,000
Costs incurred related
to issuance of 9% PIK
preferred stock...... 179,815 179,815
Accumulated unpaid
preferred dividends
on 9% PIK preferred
stock................ 225,000 225,000
------- ------- ------- ---------- ----------- -----------
Balance, December 31,
1996................... 10,000 $ 225,000 $ 9,810,185 $10,045,185
======= ======= ======= ========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE
PERIOD FROM APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
ADDITIONAL COMMON
COMMON PAID-IN ACCUMULATED STOCK HELD
STOCK CAPITAL DEFICIT IN TREASURY TOTAL
------ ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Balance, April 20, 1994.
Issuance of 177,840
shares of common
stock................ $1,778 $ 236,661 $ $238,439
Costs incurred related
to issuance of stock. (214,860) (214,860)
Accumulated unpaid
preferred dividends.. $ (707,000) (707,000)
Net loss.............. (7,146,789) (7,146,789)
------ ----------- ------------ ------------
Balance, December 31,
1994................... 1,778 21,801 (7,853,789) (7,830,210)
Issuance of 135,899
shares of common
stock................ 1,359 263,644 265,003
Costs incurred related
to issuance of stock. (2,490) (2,490)
Accumulated unpaid
preferred dividends.. (3,103,000) (3,103,000)
Net loss.............. (18,097,026) (18,097,026)
------ ----------- ------------ ------------
Balance, December 31,
1995................... 3,137 282,955 (29,053,815) (28,767,723)
Conversion of Series A
and A-2 Preferred
Stock to Class A
Common Stock......... 2,676 47,859,340 47,862,016
Issuance of 5,000
shares of common
stock................ 50 5,450 5,500
Compensation grants of
22,000 shares of
common stock......... 220 32,780 33,000
Repricing of common
stock................ 1,102 (1,102)
Repurchase of 1,000
shares of common
stock................ $(1,077) (1,077)
Issuance of stock
warrants............. 6,000,000 6,000,000
Accumulated unpaid
preferred dividends.. (3,690,976) (3,690,976)
Net loss.............. (25,046,591) (25,046,591)
------ ----------- ------------ ------- ------------
Balance, December 31,
1996................... $7,185 $54,179,423 $(57,791,382) $(1,077) $ (3,605,851)
====== =========== ============ ======= ============
</TABLE>
F-6
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss............................ $(25,046,591) $(18,097,026) $(7,146,789)
Adjustments to reconcile net loss to
net cash flows from operating
activities:
Depreciation and amortization..... 558,236 1,288,991 159,685
Amortization of organization costs
and intangibles.................. 1,770,936 969,271 26,376
Interest accreted on debt
obligation....................... 1,654,394
Stock compensation award expense.. 33,000
Gain on disposal of assets........ (8,078,901) (16,274)
Changes in:
Accounts receivable............. (1,819,956) (372,245) (862,208)
Interest receivable............. (188,098) (61,015)
Prepaid expenses................ (38,468) 13,082 (37,624)
Other receivables............... (172,567)
Other assets.................... (14,948)
Account payable................. 4,819,840 1,578,757 953,465
Accrued expenses and other
liabilities.................... 2,424,642 338,412 766,532
------------ ------------ -----------
Net cash flows from operating
activities................... (24,098,481) (14,308,047) (6,140,563)
------------ ------------ -----------
Cash flows from investing activities:
Purchase of property and equipment.. (2,258,969) (1,739,542) (1,728,327)
Proceeds from sale of assets........ 9,532,600
Purchase of subsidiary.............. (892,287)
Organization costs.................. (161,702)
Cash acquired from purchase of
subsidiaries....................... 331,975
Issuance of noncurrent notes
receivable......................... (150,000)
Proceeds from note receivable....... 76,204
------------ ------------ -----------
Net cash flows from investing
activities................... 7,273,631 (2,555,625) (1,708,054)
------------ ------------ -----------
Cash flows from financing activities:
Proceeds from Senior Notes.......... 30,203,375
Proceeds from Convertible Notes..... 27,644,400
Debt acquisition costs.............. (2,920,239)
Issuance of preferred stock......... 10,000,000 26,235,000 14,850,000
Issuance of common stock............ 5,500 265,003 150,000
Costs incurred related to issuance
of stock........................... (179,815) (250,000) (845,334)
Repurchase of common stock.......... (1,077)
Deposits............................ (494,603) (20,855) (555,270)
Proceeds from borrowings............ 180,000
Payments on assumed indebtedness.... (350,412) (1,459,458)
Proceeds from notes payable......... 46,645 73,504
Repayment of notes payable.......... (59,512) (71,588) (8,330)
Repayment of capital lease
obligation......................... (158,427) (155,272) (16,731)
------------ ------------ -----------
Net cash flows from financing
activities................... 63,689,190 24,589,475 13,827,839
------------ ------------ -----------
Net increase in cash.................. 46,864,340 7,725,803 5,979,222
Cash and cash equivalents--Beginning
of year.............................. 13,705,025 5,979,222
------------ ------------ -----------
Cash and cash equivalents--End of
year................................. $ 60,569,365 $ 13,705,025 $ 5,979,222
============ ============ ===========
Supplemental cash flow information--
See Note 3
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
1. ORGANIZATION AND ACQUISITIONS
USN Communications, Inc., formerly United USN, Inc. ("USN") was incorporated
under the laws of the State of Delaware on April 20, 1994 and was initially
funded in 1994 through capital contributions totaling $15 million in cash,
before financing costs. In June 1995 and September 1996, USN received
additional capital contributions of approximately $26 million and $10 million,
respectively. USN holds controlling investments in three companies: US Network
Corporation, USN Communications Northeast, Inc. (formerly United
Telemanagement Services, Inc.), and USN Communications Midwest, Inc. USN and
its subsidiaries operate in a single business segment, primarily as a reseller
of a broad range of telecommunications services in various cities in the
Midwest and the Northeast regions of the U.S.
On April 20, 1994, USN purchased US Network Corporation ("US Network") and
its 100% subsidiary, FoneNet/Ohio, Inc., in exchange for 1,350 shares of
United's preferred stock and 31,500 shares of its common stock. This
transaction was accounted for as a purchase and was valued at US Network's net
book value of approximately $467,000. The consolidated financial statements
include the results of operations of US Network since April 20, 1994.
In July 1994, USN purchased a 50.1% ownership interest in USN Communications
Northeast, Inc. ("USNCN") for approximately $2 million. USNCN provides
telecommunications services to business customers in New York and
Massachusetts. USN has had substantive control of USNCN since its inception.
Therefore, the consolidated financial statements include the results of
operations for USNCN since its commencement of operations in 1994. In December
1995, USN's ownership in USNCN increased to 83.9% as a result of additional
investments approximating $9.4 million. In July 1996, USN's ownership in USNCN
increased to 100% as a result of an additional investment of $150,000.
In June 1995, USNCN (through a newly formed subsidiary, Quest United, Inc.)
purchased specific assets and assumed certain liabilities of an independent
telephone services company Quest America, L.P. ("Quest"), for cash of $950,000
and notes payable to investors of Quest of $842,985 (the "Acquisition"). The
Acquisition has been accounted for as a purchase, and such assets and
liabilities were recorded at their then fair values (which approximated their
historical cost bases) as of the Acquisition date. The excess of the cost of
the Acquisition over the net assets acquired has been ascribed to various
intangible assets (principally customer lists, employment contracts and work
force in place). The consolidated statement of operations for the year ended
December 31, 1996 and 1995 include Quest's revenues and expenses from the
Acquisition date forward.
In January 1995, USN Communications Midwest, Inc. ("USNCM") was incorporated
as a wholly owned subsidiary of USN. USNCM began operations in July 1996 and
provides telecommunication services to business customers in Illinois, Ohio
and Michigan.
2. SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation
of the accompanying consolidated financial statements follows:
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the 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 revenue and expenses during the
reporting period. Actual results could differ from those estimates.
F-8
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Principles of Consolidation--The accompanying consolidated financial
statements include the accounts of USN Communications, Inc. and its
subsidiaries (the "Company"). Significant intercompany balances and
transactions have been eliminated in consolidation.
Revenue Recognition--The Company recognizes revenues in the period in which
telephone services are provided. For the operating unit which the Company has
operated as a commission agent only, revenues are recorded at the net
commissions earned.
Cash and Cash Equivalents--Cash and cash equivalents are defined as cash in
banks, time deposits and highly liquid short-term investments with initial
maturities of three months or less.
Recourse Provisions--Until June 1996, USNCN utilized a third-party billing
and collection agency (the "Agency") to process and factor its accounts
receivable, yet retained the risk of loss on amounts that were deemed to be
uncollectible in the normal course of business. The Agency charged USNCN an
allowance for estimated bad debts on factored accounts receivable, subject to
the recourse provisions, using prior collection experience and industry
statistics. Adjustments were made between actual loss experience and estimated
bad debt expenses on a periodic basis by the Agency. At December 31, 1996,
there were no factored receivables subject to such adjustment. At December 31,
1995, factored receivables of approximately $828,000 were subject to such
adjustment.
Fair Value of Financial Instruments--The carrying values of financial
instruments included in current assets and liabilities approximate fair values
due to the short-term maturities of these instruments. The carrying values of
long-term debt and notes payable are reasonable estimates of their fair values
as the interest rates approximate rates currently available to the Company for
instruments with similar terms and remaining maturities.
Property and Equipment--Purchases of property and equipment are carried at
cost. Depreciation is provided on the straight-line basis. Furniture and
fixtures are depreciated over five years. Computer equipment is depreciated
over three years. Leasehold improvements and assets leased under capital
leases are amortized over the shorter of the related lease term or the
estimated useful life of the asset.
Intangible Assets--Costs incurred in the formation of the Company are being
amortized on a straight-line basis over five years. The intangible assets
associated with the acquisition of Quest are being amortized on a straight-
line basis over two years. Debt acquisition costs are being amortized over the
life of the related debt. The value of the warrants issued with the Senior
Notes are being amortized over the life of those notes.
Stock-based Compensation--During 1996, the Company implemented Statement of
Financial Accounting Standards No. 123 "Accounting for Stock Based
Compensation" ("SFAS No. 123"). SFAS No. 123 allows the Company to recognize
compensation under the "intrinsic value" method prescribed by Accounting
Principles Board Opinion No. 25, and requires the pro forma disclosure of net
income and earnings per share as if the fair value method had been applied.
Reclassifications--Certain prior year amounts have been reclassified to
conform to the current year presentation.
F-9
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- ----------- ----------
<S> <C> <C> <C>
Capital lease obligations incurred
(Notes 5
and 9)................................. $591,967 $33,398,105 $3,137,119
======== =========== ==========
Fair value of Quest America Management
L.P. noncash assets acquired in 1995... $ 414,726
Consideration incurred in connection
with the Acquisition (including
$950,000 in cash advances) (Note 1).... 3,104,588
-----------
Liabilities assumed..................... $ 2,689,862
===========
Note payable incurred to finance
insurance policies (Note 11)........... $ 58,650 $ 72,000
=========== ==========
Fair value of US Network's noncash
assets acquired........................ $ 623,659
Common and preferred stock issued in
connection with the acquisition (Note
1)..................................... 467,463
----------
Liabilities assumed..................... $ 156,196
==========
Note payable to UTS minority
shareholder............................ $ 149,708
Proceeds received upon issuance of note
payable................................ (73,504)
----------
Note receivable from UTS minority
shareholder............................ $ 76,204
==========
</TABLE>
Cash paid for interest in 1996 and 1995 was approximately $32,000 and
$613,000, respectively. No cash was paid in 1994 for interest and in 1996,
1995 and 1994 for income taxes.
4. RELATED PARTY TRANSACTIONS
Notes receivable at December 31, 1996 includes a $75,000 non-interest
bearing note due to the Company from a corporate officer.
F-10
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. NET ASSETS HELD FOR SALE
On December 29, 1995, the Company entered into an agreement to sell its
switch-based facilities in Ohio for $9.5 million in cash plus the assumption
of capital and operating leases. The transaction closed on February 29, 1996
and a gain of approximately $8.1 million was realized and recorded at that
time. The Company will continue to serve its Ohio customer base as a reseller
of telecommunication services.
The net assets held at December 31, 1995 in conjunction with this sale were
as follows:
<TABLE>
<S> <C>
Switching equipment........................................... $6,233,557
Leasehold improvements........................................ 1,781,260
Outside plant and equipment................................... 423,424
Furniture and equipment....................................... 318,355
----------
8,756,596
Less accumulated depreciation................................. (1,181,587)
----------
Net property and equipment.................................... 7,575,009
Deposits...................................................... 100,532
----------
Total assets.................................................. 7,675,541
Less liabilities assumed:
Accrued liabilities......................................... 15,204
Capital lease obligations................................... 6,206,638
----------
Net assets held for sale...................................... $1,453,699
==========
</TABLE>
Additionally, approximately $2.0 million in operating leases were assumed by
the buyer. The Company remains contingently liable on capital and operating
leases assumed by the buyer until expiration.
6. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consist of:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Furniture and equipment........................... $3,940,719 $1,364,479
Leasehold improvements............................ 392,601 117,902
---------- ----------
4,333,320 1,482,381
Less accumulated depreciation..................... (825,970) (267,734)
---------- ----------
Total......................................... $3,507,350 $1,214,647
========== ==========
</TABLE>
F-11
<PAGE>
USN COMMUNICATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. OTHER ASSETS
Other assets at December 31 consist of:
<TABLE>
<CAPTION>
1996 1995
----------- ----------
<S> <C> <C>
Stock warrants (net of accumulated amortization:
1996--$214,286).................................. $ 5,785,714
Debt acquisition costs (net of accumulated
amortization: 1996--$98,064)..................... 2,822,175
Deposits.......................................... 1,044,098 $ 426,902
Goodwill (net of accumulated amortization:
1996--$2,337,015; 1995--$923,850) ............... 588,819 2,001,985
Organization costs (net of accumulated
amortization:
1996--$118,853; 1995--$73,432)................... 108,257 153,677
Other............................................. 13,375 98,691
----------- ----------
Total............................................. $10,362,438 $2,681,255
=========== ==========
</TABLE>
8. ACCRUED EXPENSES
Accrued expenses at December 31 consist of:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Payroll and benefits................................ $1,515,197 $ 548,775
Professional services............................... 814,388 163,540
Excise taxes........................................ 575,790 117,812
Rent................................................ 6,600 4,380
Interest payable.................................... 21,764
Other............................................... 264,787 249,739
---------- ----------
Total............................................... $3,176,762 $1,106,010
========== ==========
</TABLE>
9. CAPITAL LEASE OBLIGATIONS
The Company leases certain furniture and equipment under capital leases at
December 31 as follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Furniture and equipment............................... $841,359 $221,855
Less accumulated amortization......................... (261,905) (73,003)
-------- --------
Total................................................. $579,454 $148,852
======== ========
</TABLE>
Future minimum lease payments at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997.......................... 341,883
1998.......................... 288,865
1999.......................... 54,422
---------
Total minimum lease payments.. 685,170
Less imputed interest......... (95,046)
---------
Present value of minimum lease
payments..................... 590,124
Less current portion.......... (277,844)
---------
Long-term lease obligations... $ 312,280
=========
</TABLE>
F-12
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. OPERATING LEASES
The Company leases certain office space and equipment under operating
leases. Future minimum lease commitments under noncancelable operating leases
as of December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997......................... 2,113,254
1998......................... 2,206,947
1999......................... 1,737,457
2000......................... 1,530,196
Thereafter................... 2,531,822
-----------
Total.................... $10,119,676
===========
</TABLE>
Rent expense for the years ended December 31, 1996 and 1995 and the period
from April 20, 1994 to December 31, 1994 was approximately $1,024,000,
$867,000 and $214,000, respectively.
11. NOTES PAYABLE
The Company issued a note payable of $58,650 in 1995 to finance an insurance
policy. The note was payable in nine monthly installments through August 1996.
Interest was payable at 6.45%. The principal balance was paid in full at
December 31, 1996.
In 1995, the Company issued an additional note payable of $46,353 to finance
improvements to an office space. The note requires monthly principal payments
of $831 through July 2001. Interest is payable at 8%. At December 31, 1996 and
1995, the outstanding principal balances were $37,573 and $44,777,
reepectively.
In connection with the acquisition of Quest, USNCN assumed notes payable to
investors of Quest. The notes bear interest at 8% and the balances outstanding
at December 31, 1996 and 1995 total $398,676 and $749,088, respectively. The
notes require quarterly principal and interest payments in 1996 and 1997 and
in the first quarter of 1998.
Maturities on notes payable are as follows:
<TABLE>
<S> <C>
1997............................ $386,522
1998............................ 27,204
1999............................ 8,474
2000............................ 9,178
2001............................ 4,871
--------
Total....................... $436,249
========
</TABLE>
12. PRIVATE PLACEMENT OFFERING
On September 30, 1996, the Company received approximately $55 million in
cash, net of commissions paid, in exchange for 48,500 units consisting of
$48.5 million aggregate principal amount at maturity of 14% Senior Discount
Notes ("Senior Notes") due 2003 and warrants to purchase 61,550 shares of
Class A Common Stock, and 36,000 units consisting of $36 million aggregate
principal amount at maturity of 9% Convertible Subordinated Notes
("Convertible Notes") due 2004.
The Senior Notes were sold at a unit price, before commissions, of $622.75
per $1,000 face amount. These notes will accrete interest at an annual rate of
14% from September 30, 1996 to March 31, 2000. Thereafter, the notes will bear
interest at an annual rate of 14%, and will be paid semiannually in arrears,
on the aggregate principal amount at maturity of $48.5 million.
F-13
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Convertible Notes were sold at a unit price, before commissions, of
$767.90 per $1,000 face amount. These notes will accrete interest at an annual
rate of 9% from September 30, 1996 to September 30, 1999. Thereafter, the
notes will bear interest at an annual rate of 9%, and will be paid
semiannually in arrears, on the aggregate principal amount at maturity of $36
million.
13. REDEEMABLE PREFERRED STOCK
The Board of Directors authorized 20,000 shares of Series A 10% Senior
Cumulative Preferred Stock ("Series A") and 30,000 shares of Series A-2 10%
Senior Cumulative Preferred Stock ("Series A-2"), with par values of $1 in
1994 and 1995, respectively. On December 31, 1995, 16,200 shares of Series A
and 26,235 shares of Series A-2 were outstanding.
In September 1996, the Board of Directors and the existing shareholders
approved the conversion of all outstanding Series A and Series A-2 Preferred
Stock to shares of Class A Common Stock. The conversion was consummated on
September 30, 1996 and 267,630 shares of Class A Common Stock were issued in
exchange for the outstanding Series A and Series A-2 Preferred Stock,
including dividends accrued through the conversion date.
In September 1996, the Board of Directors authorized the issuance of up to
30,000 shares of $1 par value preferred stock designated as 9% Cumulative
Convertible Pay-in-Kind Preferred Stock ("9% Preferred Stock"). In connection
with the Private Placement Offering (Note 12), the Company issued 10,000
shares of its 9% Preferred Stock to its existing shareholders, for an
aggregate purchase price of $10.0 million.
Dividends--Dividends on the 9% Preferred Stock accrue semiannually at a rate
of 9% per annum, are fully cumulative and are payable through the issuance of
additional shares of 9% Preferred Stock. No dividends have been declared or
paid on the preferred stock.
Liquidation--Upon any liquidation, dissolution or winding up of the Company,
holders of the 9% Preferred Stock will be entitled to receive their full
liquidation preference and stated value of $1,000 per share, together with
accrued and unpaid dividends, prior to the distribution of any assets of the
Company to the holders of Class A Common Stock.
Redemption--Shares of 9% Preferred Stock are not redeemable at the option of
the Company, but are subject to mandatory redemption in 2006 at the stated
value, together with all accrued and unpaid dividends to the redemption date.
Conversion--Each share of 9% Preferred Stock is convertible into 7.0623
shares of Class A Common Stock, at any time, in whole or in part, at the
option of the holders thereof.
14. COMMON STOCK
In 1996, a 1995 transaction in which Class A Common Stock was issued was
repriced, whereby the number of shares issued increased from 135,899 to
246,056 and the purchase price decreased from $1.95 to $1.077 per share.
Dividends--The holders of Class A Common Stock are entitled to receive
dividends as dividends are declared by the Board of Directors of the Company
out of funds legally available therefor, provided that if any shares of
Preferred Stock are at the time outstanding, the payment of dividends on the
Class A Common Stock or other distributions may be subject to the declaration
and payment of full cumulative dividends on outstanding shares of Preferred
Stock.
F-14
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Liquidation--Upon any liquidation, dissolution or winding up of the affairs
of the Company, whether voluntary or involuntary, any assets remaining after
the satisfaction in full of the prior rights of creditors and the aggregate
liquidation preference of any Preferred Stock then outstanding will be
distributed to the holders of Class A Common Stock.
15. STOCK OPTION PLAN
The Company has granted options to acquire shares of common stock to certain
officers and other employees under the 1994 Stock Option Plan. These options
generally become exercisable at a rate of 25% every six months over a period
of two years after the date of grant, although with respect to certain grants
no vesting occurs until twelve months after the grant date.
In connection with the financing described in Note 12 and the issuance of
the 9% Preferred Stock described in Note 13, the Company granted 31,961
options to purchase Class A Common Stock at an exercise price of $1.50 per
share. These options were not issued under the 1994 Stock Option Plan, but
rather were issued pursuant to separate stock option agreements between the
Company and the option holders. 6,637 of these options become exercisable as
the Convertible Notes are converted to Class A Common Stock, and 25,324 of
these options become exercisable as shares of 9% Preferred Stock are converted
to Class A Common Stock.
Stock option transactions are summarized as follows:
<TABLE>
<CAPTION>
PRICE PER PRICE PER PRICE PER
1996 SHARE 1995 SHARE 1994 SHARE
------- ----------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January
1...................... 19,050 $ 1.10 21,300 $1.10
Granted................. 103,324 1.10-96.00 21,300 $1.10
Exercised............... (5,000) 1.10
Cancelled............... (6,475) 1.10 (2,250) 1.10
------- ------ ------
Outstanding at December
31..................... 110,899 1.10-96.00 19,050 1.10 21,300 1.10
======= ====== ======
Options exercisable at
December 31............ 10,662 1.10-1.50 10,024 1.10 --
======= ====== ======
</TABLE>
For pro forma information regarding net loss and loss per common share, the
fair value for the options awarded in 1996 and 1994 was estimated as of the
date of the grant using a Black-Scholes option valuation model with the
following weighted average assumptions for 1996 and 1994, respectively: risk-
free interest rates of 4.95% and 4.97%; dividend yields of 0%; and an expected
life of the option of ten years.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting period. Therefore, in the year
of adoption and subsequently affected years, the effect of applying SFAS 123
for providing pro forma net loss and loss per common share are not likely to
be representative of the effects on reported income in future years. The
effect on the Company's reported net loss, on a pro forma basis, was not
material for 1996, 1995 and 1994.
The Black-Scholes option valuation model used by the Company was developed
for use in estimating the fair value of fully tradable options which have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. It is management's opinion that the Company's
stock options have characteristics significantly different from those of
traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options.
F-15
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. EMPLOYEE BENEFIT PLAN
On January 1, 1995, the Company adopted a qualified 401(k) plan covering all
eligible employees in which the Company contributions are discretionary.
Employees are permitted to make annual contributions through salary deductions
up to 15% of their annual salary. The plan can be amended or terminated at any
time by the Board of Directors. The Company made no contributions to the plan
in 1996 or 1995.
17. INCOME TAXES
The Company incurred net losses of $25,046,591, $18,097,026 and $7,146,789
in 1996, 1995 and 1994, respectively. Accordingly, no provision for current
Federal or state income taxes has been made to the financial statements.
The Company's deferred tax asset components are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
Net operating loss carry-forwards............. $(18,285,000) $(9,121,000)
Accrued liabilities and asset valuation
reserves..................................... (172,000) (195,000)
Amortization of intangibles................... 790,000 (309,000)
------------ -----------
Subtotal.................................. 19,247,000 9,625,000
Valuation allowance........................... (19,247,000) (9,625,000)
------------ -----------
Total..................................... $ -- $ --
============ ===========
</TABLE>
As of December 31, 1996 and 1995 the Company had not recognized deferred
income tax assets related to deductible temporary differences and cumulative
net operating losses. The ability of the Company to fully realize deferred tax
assets in future years is contingent upon its success in generating sufficient
levels of taxable income before the statutory expiration periods for utilizing
such net operating losses lapses. After an assessment of all available
evidence, including historical and projected operating trends, the Company was
unable to conclude that realization of such deferred tax assets in the near
future was more likely than not. Accordingly, a valuation allowance was
recorded to offset the full amount of such assets.
At December 31, 1996, the Company had net operating loss carry-forwards for
income tax purposes of approximately $46,120,000. The expiration periods for
utilizing these operating losses begin in 2009 for Federal tax purposes. Of
the net operating loss carry-forwards available at December 31, 1996,
$12,286,000 can be applied only against future taxable income of USNCN. In
addition, if the Company or the Company's subsidiaries experience an
"ownership change" within the meaning of Section 382 of the Internal Revenue
Code of 1986, as amended (the "Code"), the net operating loss carry-forwards
allocable to such entity will be subject to an annual limitation in an amount
generally equal to the value of the entity immediately before the ownership
change at the long-term tax-exempt rate (the "Section 382 limitation"). Any
unused Section 382 limitation in one year is added to the limitation for the
next year. Generally, an ownership change occurs with respect to an entity if
the aggregate increase in the percentage stock ownership (by value) of such
entity by one or more of its five-percent stockholders exceeds 50 percentage
points within a testing period. The tax laws for determining whether an
ownership change of an entity has occurred are complex and subject to
differing interpretations in certain respects. It is possible that the Company
or the Company's subsidiaries have experienced an ownership change under
Section 382 of the Code and that the Company or the Company's subsidiaries may
experience an ownership change as a result of the Company's future
transactions including, but not limited to, the issuance of the Warrants and
consummation of one or more public offerings of Common Stock. In such event,
the ability of the Company or the Company's subsidiaries to utilize their
operating loss carry-forwards to offset future taxable income would be subject
to limitations as discussed above.
F-16
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. MINORITY INTEREST IN USNCN
In September 1996, all minority shareholders interests' in USNCN were
repurchased, increasing the Company's ownership of USNCN's outstanding common
stock to 100%. Prior to this transaction , no minority interest in USNCN had
been recorded, as losses applicable to the minority interest in USNCN exceeded
the minority interest in the equity capital of USNCN, and there was no
obligation of the minority interest to make good on such losses.
19. COMMITMENTS
In 1995 and 1996 the Company entered into agreements with two independent
telecommunications companies ("TelCos") to allow the Company to resell the
TelCos local telephone service in various regional markets. The agreements
have terms of up to ten years and contain minimum purchase commitments of
local access lines, ranging from zero to 150,000 lines. These commitments are
measured by the number of lines in place on the last day of each 12-month
period. The agreements allow for ramp-up periods before any commitment levels
are required to be met. So long as the Company maintains cumulative net
shortfalls lower than established caps, no payments will be due to the TelCos
other than for normal usage. Even if no lines were sold by the Company, the
earliest required payment for any shortfall amount is in 1999.
In July 1996, the Company entered into an agreement with a third
telecommunications company to allow the Company to resell long distance
telephone service. The agreement is for a term of 33 months and contains an
annual purchase commitment of $12 million, with a minimum monthly commitment
of $600,000 to qualify for the contract rates. The agreement allows for a
ramp-up period before commitment levels are required to be met.
In 1994, USNCN executed an exclusive agreement with an independent
telecommunications company ("TelCo One"), whereby TelCo One allows USNCN to
establish a local private network on its infrastructure in which to provide
service to customers. The majority of USNCN's local service customers are
provided access to this network and, accordingly, a substantial portion of
USNCN's revenue is earned through the use of these access rights. Under this
agreement, TelCo One provides network maintenance and access to telephone
switches. The initial term of the agreement expires in 2004.
20. FUTURE OPERATING PLANS
Although the Company had working capital of approximately $52.4 million and
total redeemable preferred stock and common stockholders' deficit of
approximately $6.4 million, projected cash usage in 1997 combined with an
anticipated net loss in 1997, absent the infusion of additional capital
resources, is anticipated to fully deplete the Company's working capital prior
to December 31, 1997. Such events would raise substantial doubt about the
Company's ability to continue as a going concern. Although the Company's
management believes that the Company will be able to raise sufficient funds,
through capital contributions or additional equity or debt financings, to meet
its operating expenses and other cash requirements, there can be no assurance
that the Company would be able to complete such contributions or financing, or
that any such contributions or financing would be completed on terms
satisfactory to the Company.
21. CONTINGENCIES
Loss Contingency--In April 1995, a derivative action was filed by a minority
interest owner of USNCN against the Company and specific officers and
directors. In July 1996, the Company settled the dispute for $1.7 million.
F-17
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Gain Contingency--In 1995, USNCN submitted a claim of approximately $1.4
million with TelCo One requesting that certain revenues, purportedly not
billed by TelCo One to its customers, be paid to USNCN. During 1996, USNCN has
recorded $867,000 of this claim as revenue. TelCo One is in the process of
reviewing USNCN's remaining claim and has not formally concluded on the amount
or terms of a settlement. While USNCN believes its claim has merit, it is
unable to predict, at this time, whether they will be successful in fully
resolving this matter favorably.
* * * * *
F-18
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED HEREIN OTHER THAN THOSE
CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REP-
RESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER
OR SOLICITATION IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
TO SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE IN-
FORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE
SUCH DATE.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information...................................................... 3
Prospectus Summary......................................................... 5
Risk Factors............................................................... 12
Use of Proceeds............................................................ 22
Dividend Policy............................................................ 22
Capitalization............................................................. 23
Selected Historical Consolidated Financial and Operating Data.............. 24
Management's Discussion and Analysis
of Financial Condition and Results
of Operations............................................................. 25
Industry Overview: The Local Telecommunications Service Industry........... 30
Business................................................................... 32
Management................................................................. 43
Certain Relationships and Related Transactions............................. 51
Stock Ownership............................................................ 52
Description of Securities.................................................. 53
Registration Rights........................................................ 81
Certain Other Indebtedness................................................. 82
Description of Capital Stock............................................... 83
Certain Federal Income Tax Considerations.................................. 86
Plan of Distribution....................................................... 89
Selling Securityholders.................................................... 89
Legal Matters.............................................................. 90
Experts.................................................................... 90
Glossary................................................................... 91
Index to Consolidated Financial Statements................................. F-1
</TABLE>
-----------
UNTIL , 1997 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
---------------
PROSPECTUS
---------------
LOGO
USN COMMUNICATIONS, INC.
9% CONVERTIBLE SUBORDINATED
DISCOUNT NOTES DUE 2004
WARRANTS TO PURCHASE CLASS A
COMMON STOCK
CLASS A COMMON STOCK
, 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the expenses paid or payable in connection
with the offering of the securities being registered hereby:
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee................... $ 8,378
Printing and Engraving Expenses....................................... 100,000
Legal Fees and Expenses............................................... 60,000
Accounting Fees and Expenses.......................................... 44,000
--------
Total............................................................. $212,378
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law ("DGCL") empowers a
corporation, subject to certain limitations, to indemnify its directors and
officers against expenses (including attorneys' fees, judgments, fines and
certain settlements) actually and reasonably incurred by them in connection
with any suit or proceeding to which they are a party so long as they acted in
good faith and in a manner reasonably believed to be in or not opposed to the
best interests of the corporation, and, with respect to a criminal action or
proceeding, so long as they had no reasonable cause to believe their conduct
to have been unlawful. The Registrant's Certificate of Incorporation and By-
laws provide that the Registrant shall indemnify its directors and such
officers, employees and agents as the Board of Directors may determine from
time to time, to the fullest extent permitted by Section 145 of the DGCL. The
Registrant has entered into indemnification agreements with its directors and
certain of its officers, employees and agents, which provide that the
Registrant shall indemnify such parties pursuant to Section 145 of the DGCL.
Section 102 of the DGCL permits a Delaware corporation to include in its
certificate of incorporation a provision eliminating or limiting a director's
liability to a corporation or its stockholders for monetary damages for
breaches of fiduciary duty. The enabling statute provides, however, that
liability for breaches of the duty of loyalty, acts or omissions not in good
faith or involving intentional misconduct, or knowing violation of the law,
and the unlawful purchase or redemption of stock or payment of unlawful
dividends or the receipt of improper personal benefits cannot be eliminated or
limited in this manner. The Registrant's Certificate of Incorporation and By-
laws include a provision which eliminates, to the fullest extent permitted,
director liability for monetary damages for breaches of fiduciary duty.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
(1) On April 20, 1994, Chase Capital Partners and CIBC Wood Gundy Securities
Corp. each purchased from the Registrant 2,475 shares of Series A Preferred
Stock at a price of $1,000 per share and 25,000 shares of Common Stock at a
price of $1.00 per share.
(2) On June 10, 1994, Hancock Venture Capital Associates purchased from the
Registrant 2,475 shares of Series A Preferred Stock at a price of $1,000 per
share and 23,210 shares of Common Stock at a price of $1.077 per share.
(3) On November 2, 1994, Chase Capital Partners, CIBC Wood Gundy Securities
Corp. and Hancock Venture Capital Associates each purchased from the
Registrant 7,425 shares of Series A Preferred Stock and 69,630 shares of
Common Stock for a total purchase price of $7,500,000.
II-1
<PAGE>
(4) On June 22, 1995, Chase Capital Partners, CIBC Wood Gundy Securities
Corp., Hancock Venture Capital Associates, Northwood Capital Partners LLC,
Northwood Ventures and BT Capital Partners, Inc. purchased from the Registrant
23,760 shares of Series A-2 Preferred Stock at a price of $1,000 per share and
123,078 shares of Class A Common Stock at a price of $1.95 per share.
(5) On July 21, 1995, Enterprises & Transcommunications, L.P. purchased from
the Registrant 2,475 shares of Series A-2 Preferred Stock at a price of $1,000
per share and 12,821 shares of Class A Common Stock at a price of $1.95 per
share.
(6) Pursuant to a recapitalization, in March 1996, Chase Capital Partners,
CIBC Wood Gundy Securities Corp., Hancock Venture Capital Associates,
Northwood Capital Partners LLC, Northwood Ventures, BT Capital Partners, Inc.
and Enterprises & Transcommunications, L.P. purchased, in the aggregate,
110,157 shares of Common Stock for no consideration in order to settle a
dispute relating to the price per share paid for previously purchased shares
of Common Stock.
(7) On September 30, 1996, the Registrant caused its outstanding shares of
Series A Preferred Stock and Series A-2 Preferred Stock to be converted into
newly issued shares of Class A Common Stock.
(8) On September 30, 1996, Chase Capital Partners, CIBC Wood Gundy
Securities Corp., Hancock Venture Capital Associates, Northwood Capital
Partners LLC, Northwood Ventures, BT Capital Partners, Inc. and Enterprises &
Transcommunications, L.P. purchased, in the aggregate, 10,000 shares of 9%
Cumulative Convertible Pay-In-Kind Preferred Stock for an aggregate purchase
price of $10 million.
(9) On September 30, 1996, the Registrant sold to Smith Barney Inc., BT
Securities Corporation, Chase Securities Inc. and CIBC Wood Gundy Securities
Corp. (a) 48,000 units, each consisting of a 14% Senior Discount Note due 2003
and a warrant to purchase approximately 1.27 shares of Class A Common Stock
and (b) $36.0 million in aggregate principal amount at stated maturity of 9%
Convertible Subordinated Discount Notes due 2004 for an aggregate purchase
price of $57,847,775. In connection with this sale, Smith Barney Inc. received
approximately $1,316,000 in commissions, and BT Securities Corporation, Chase
Securities Inc. and CIBC Wood Gundy Securities Corp. each received
approximately $188,000, resulting in net proceeds to the Registrant of
$55,967,722. These securities were immediately resold to Merrill Lynch Global
Allocation Fund, Inc. pursuant to Rule 144A of the Securities Act of 1933, as
amended.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1* Amended and Restated Certificate of Incorporation of the Registrant.
3.2+ Certificate of Designations, Powers, Rights and Preferences of 9%
Cumulative Convertible Pay-In-Kind Preferred Stock (the "9% Preferred
Stock") of the Registrant.
3.3+ Bylaws of the Registrant.
4.1+ Indenture, dated as of September 30, 1996, by and between the
Registrant and Harris Trust and Savings Bank, as Trustee, for the
Registrant's 9% Convertible Subordinated Discount Notes due 2004 (the
"Convertible Note Indenture").
4.2+ Registration Rights Agreement dated as of September 30, 1996, by and
among the Registrant and the Initial Purchasers named therein.
4.3+ Warrant Agreement, dated as of September 30, 1996, by and between the
Registrant and Harris Trust and Savings Bank, as Warrant Agent.
5.1** Legal Opinion of Skadden, Arps, Slate, Meagher & Flom (Illinois).
10.1+ Indenture, dated as of September 30, 1996, by and between the
Registrant and Harris Trust and Savings Bank, as Trustee, for the
Registrant's 14% Senior Discount Notes due 2003.
10.2+ Employment Agreement, dated as of July 18, 1996, by and between the
Registrant and J. Thomas Elliott.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.3+ Employment Agreement, dated as of July 18, 1996, by and between the
Registrant and Ronald W. Gavillet.
10.4+ Form of Employment Agreement between the Registrant and certain
officers of the Registrant.
10.5+ 1994 Stock Option Plan of the Registrant.
10.6+ Form of Indemnification Agreement between the Registrant and certain
directors and officers of the Registrant.
10.7+ Consulting Agreement, dated January 24, 1995, by and between the
Registrant and Eugene A. Sekulow.
10.8+ Promissory Note, dated December 15, 1995, between the Registrant and
J. Thomas Elliott.
10.9+ Purchase Agreement, dated as of September 25, 1996, by and among the
Registrant and the purchasers named therein, relating to the 9%
Preferred Stock.
10.10+ Purchase Agreement, dated as of April 20, 1994, by and among the
Registrant, CIBC Wood Gundy Ventures, Inc. ("CIBC") and Chemical
Venture Capital Associates ("Chemical").
10.11+ Stockholders Agreement, dated as of April 20, 1994, by and among the
Registrant, CIBC, Chemical and the stockholders of the Registrant
listed on a schedule attached thereto (the "Stockholders").
10.12+ Registration Rights Agreement, dated as of April 20, 1994, by and
among the Registrant, CIBC and Chemical.
10.13+ First Amendment to Purchase Agreement, dated as of June 10, 1994, by
and among the Registrant, CIBC, Chemical and Hancock Venture Partners
IV--Direct Fund, L.P. ("Hancock," and together with CIBC and Chemical,
the "Initial Investors").
10.14+ First Amendment to Stockholders Agreement, dated as of June 10, 1994,
by and among the Registrant, the Initial Investors and the
Stockholders.
10.15+ First Amendment to Registration Rights Agreement, dated as of June 10,
1994, by and among the Registrant and the Initial Investors.
10.16+ Third Amendment to Purchase Agreement, dated as of November 1, 1994,
by and among the Registrant and the Initial Investors.
10.17+ Asset Purchase Agreement, dated as of June 13, 1995, by and among
United Telemanagement Services, Inc. ("UTS"), Quest United, Inc.
("Quest United"), Quest America Management, Inc. ("QAM"), Edward H.
Lavin, Jr. ("Lavin"), J. Thomas Elliott ("Elliott") and Quest America,
LP ("Quest").
10.18+ Fourth Amendment to Purchase Agreement, dated as of June 22, 1995, by
and among the Registrant and the Initial Investors.
10.19+ Purchase Agreement, dated as of June 22, 1995, by and among the
Registrant, CIBC, Chemical, Hancock, BT Capital Partners, Inc.,
Northwood Capital Partners LLC and Northwood Ventures (collectively,
the "Investors").
10.20+ Amended and Restated Stockholders Agreement, dated as of June 22,
1995, by and among the Registrant and the Investors.
10.21+ Amended and Restated Registration Agreement, dated as of June 22,
1995, by and among the Registrant and the Investors.
10.22+ First Amendment to Purchase Agreement, dated as of July 21, 1995, by
and among the Registrant, the Investors and Enterprises &
Transcommunications, L.P. (collectively, the "Original Purchasers").
10.23+ Amended and Restated Stockholders Agreement, dated as of July 21,
1995, by and among the Registrant, the Original Purchasers and the
Stockholders.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.24+ Amendment No. 1 to Asset Purchase Agreement, dated as of October 27,
1995, by and among UTS, Quest United, QAM, Lavin, Elliott, and Quest.
10.25+ Second Amendment to Purchase Agreement, dated as of March 5, 1996, by
and among the Registrant and the Original Purchasers.
10.26+ Resale Local Exchange Service Agreement, dated July 8, 1996, by and
between New York Telephone Company and UTS.
10.27+ Resale Local Exchange Service Confirmation of Service Order, dated
October 31, 1995, by and between the Registrant and Ameritech
Information Industry Services ("Ameritech") on behalf of Illinois Bell
Telephone Company.
10.28+ Agreement for Resale Services, dated as of April 26, 1996, by and
between the Registrant and Ameritech on behalf of Ameritech Michigan.
10.29+ Local Exchange Telecommunications Services Resale Agreement, dated May
21, 1996, by and between the Registrant and Ameritech on behalf of The
Ohio Bell Telephone Company.
10.30++ Supplemental Indenture, dated as of March 17, 1997, by and between the
Company and the Trustee, to the Senior Note Indenture.
10.31++ Employment Agreement, dated as of November 18, 1996, by and between
the Company and Gerald J. Sweas.
10.32++ Employment Agreement, dated as of October 21, 1996, by and between the
Company and Ryan Mullaney.
11.01++ Computation of Net Loss per Common Share.
12.1++ Computation of Earnings to Fixed Charges.
21.1+ Subsidiaries of the Registrant.
23.1* Consent of Deloitte & Touche LLP.
23.2** Consent of Skadden, Arps, Slate, Meagher & Flom (Illinois) (included
in its opinion filed as Exhibit 5.1).
24.1+ Powers of Attorney.
24.2* Power of Attorney.
25.1** Statement of Eligibility and Qualification on form T-1 under the Trust
Indenture Act of 1939 of Harris Trust and Savings Bank, as Trustee
under the Convertible Note Indenture.
</TABLE>
- --------
+Incorporated by reference to the Registrant's Registration Statement on Form
S-4, file number 333-16265.
++Incorporated by reference to the Registrant's Form 10-K, file number 333-
16265, filed on March 31, 1997.
*Filed herewith.
**Previously filed as an Exhibit to this Registration Statement on Form S-1,
file number 333-16947.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-
effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities
II-4
<PAGE>
offered would not exceed that which was registered) and any deviation from
the low or high and of the estimated maximum offering range may be
reflected in the form of prospectus filed with the Commission pursuant to
Rule 424(b) if, in the aggregate, the changes in volume and price represent
no more than 20 percent change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in the effective
registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of
the offering.
The undersigned Registrant hereby further undertakes:
(4) That, for purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part of
a registration statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497
under the Securities Act shall be deemed to be part of the registration
statement as of the time it was declared effective;
(5) That, for the purposes of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof; and
(6) That insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
II-5
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THE
REGISTRANT HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED, IN THE CITY OF CHICAGO,
STATE OF ILLINOIS ON APRIL 10, 1997.
USN COMMUNICATIONS, INC.
/s/ J. Thomas Elliott
By: _________________________________
J. Thomas Elliott
President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON THE DATES
AND IN THE CAPACITIES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ J. Thomas Elliott President, Chief Executive April 10, 1997
____________________________________ Officer and Director
J. Thomas Elliott (Principal Executive
Officer)
Richard J. Brekka* Chairman of the Board April 10, 1997
____________________________________
Richard J. Brekka
Thomas C. Brandenburg* Director April 10, 1997
____________________________________
Thomas C. Brandenburg
Dean M. Greenwood* Director April 10, 1997
____________________________________
Dean M. Greenwood
Donald J. Hofmann, Jr.* Director April 10, 1997
____________________________________
Donald J. Hofmann, Jr.
William A. Johnston* Director April 10, 1997
____________________________________
William A. Johnston
Paul S. Lattanzio* Director April 10, 1997
____________________________________
Paul S. Lattanzio
Eugene A. Sekulow* Director April 10, 1997
____________________________________
Eugene A. Sekulow
/s/ Gerald J. Sweas Executive Vice President and April 10, 1997
____________________________________ Chief Financial Officer
Gerald J. Sweas (Principal Financial
Officer)
/s/ Letitia D. Bonthron Controller April 10, 1997
____________________________________ (Principal Accounting
Letitia D. Bonthron Officer)
</TABLE>
/s/ J. Thomas Elliott
*By____________________________
Attorney-in-Fact April 10, 1997
II-6
<PAGE>
EXHIBIT 3.1
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
USN COMMUNICATIONS, INC.
ARTICLE ONE
-----------
The name of the corporation is USN Communications, Inc. (the
"Corporation").
ARTICLE TWO
-----------
The address of the Corporation's registered office in the State of Delaware
is 11th floor, Rodney Square North, 11th and Market Streets, County of New
Castle, Wilmington, Delaware 19801. The name of its registered agent at such
address is Corporation Guarantee and Trust Company.
ARTICLE THREE
-------------
The nature of the business or purposes to be conducted or promoted is to
engage in any lawful act or activity for which corporations may be organized
under the General Corporation Law of the State of Delaware.
ARTICLE FOUR
------------
The Total number of shares of stock which the Corporation has authority to
issue is 2,650,000 shares, 2,500,000 of which shall be Class A Common Stock,
with a par value of $.01 per share, with one vote per share, 50,000 of which
shall be Class B Common Stock with a par value of $.01 per share, with no voting
rights except when required by law, and 100,000 of which shall be Preferred
Stock, with a par value of $1.00 per share. Except as to voting rights, the
rights of the Class A Common Stock and the Class B Common Stock, including
without limitation rights regarding payment of dividends, distributions and
liquidations, will be identical in all respects. The holders of the Class A
Common Stock have the right, upon 5 days written notice to the Corporation, to
convert their shares of Class A Common Stock into shares of Class B Common Stock
on a one-for-one conversion basis.
The board of directors of the Corporation (the "Board of Directors") is
expressly authorized, at any time and from time to time, to provide for the
issuance of shares of Preferred Stock in one or more series with such
designations, preferences and relative, participating, optional or other special
rights, and
<PAGE>
such qualifications, limitations or restrictions thereof, as shall be expressed
in the resolution or resolutions providing for the issuance thereof adopted by
the Board of Directors (a "Preferred Stock Designation") and as are not
inconsistent with this Certificate of Incorporation or any amendment thereto,
and as may be permitted by the General Corporation Law of Delaware. Except as
otherwise expressly required by law and except for such voting powers as may be
stated in a Certificate of Designations with respect to any series of Preferred
Stock of the Corporation, the holders of any such series shall have no voting
power whatsoever.
ARTICLE FIVE
------------
The Corporation is to have perpetual existence.
ARTICLE SIX
-----------
The furtherance and not in limitation of the powers conferred by statute,
the Board of Directors is expressly authorized to make, alter or repeal the
By-laws of the Corporation.
ARTICLE SEVEN
-------------
Meetings of stockholders of the Corporation may be held within or without
the State of Delaware, as the By-laws of the Corporation may provide. The books
of the Corporation may be kept outside the State of Delaware at such place or
places as may be designated from time to time by the Board of Directors or in
the By-laws of the Corporation. Election of directors need not be by written
ballot unless the By-laws of the Corporation so provide.
ARTICLE EIGHT
-------------
The Corporation shall indemnify, to the fullest extent permitted by Section
145 of the General Corporation Law of Delaware, as amended from time to time,
all persons whom it may indemnify pursuant thereto. The personal liability of a
director of the Corporation to the Corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director shall be limited to the
fullest extent permitted by the General Corporation Law of the State of
Delaware, as it now exists or may hereafter be amended. Any repeal or
modification of this paragraph by the stockholders of the Corporation shall not
adversely affect any right or protection of a director of the Corporation
existing at the time of such repeal or modification.
ARTICLE NINE
------------
The Corporation expressly elects not to be governed by Section 203 of the
General Corporation Law of the State of Delaware.
2
<PAGE>
ARTICLE TEN
-----------
The Corporation reserves the right to amend, alter, change or repeal any
provision contained in this Certificate of Incorporation in the manner now or
hereafter prescribed herein and by the laws of the State of Delaware, and all
rights conferred upon stockholders herein are granted subject to this
reservation.
3
<PAGE>
Exhibit 23.1
[Letterhead of Deloitte & Touche LLP]
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Post-Effective Amendment No. 1 to Registration
Statement No. 333-16947 of USN Communications, Inc. of our report dated March
14, 1997 which expresses an unqualified opinion and includes an explanatory
paragraph concerning substantial doubt about the entity's ability to continue as
a going concern, appearing in the Prospectus, which is part of this Registration
Statement, and to the reference to us under the heading "Experts" in such
Prospectus.
DELOITTE & TOUCHE LLP
April 9, 1997
Chicago, Illinois
<PAGE>
Exhibit 24.2
UNITED USN, INC.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that I, the undersigned, Dean M.
Greenwood of Austin, Texas, as a director of United USN, Inc., a Delaware
corporation, do hereby nominate, constitute and appoint J. Thomas Elliott and
Ronald W. Gavillet, or either one or both of them, my true and lawful attorneys-
in-fact and agents to do any and all acts and things and execute any and all
instruments which said attorneys-in-fact and agents, or either of them, may deem
necessary or advisable giving and granting unto said attorneys full power and
authority to do and perform such actions as fully as I might have or could do if
personally present and executing any of the said documents to enable United USN,
Inc. to comply with the Securities Act of 1933, as amended, the Securities
Exchange Act of 1934, as amended, and any requirement of the Securities and
Exchange Commission in respect thereof, in connection with the registration
under said Acts of debt securities and/or warrants and/or common stock of said
United USN, Inc. including, specifically, but without limitation thereof, full
power and authority to sign my name as director and/or officer of said United
USN, Inc. to one or more registration statements on Form S-1 covering such debt
securities and/or warrants and/or common stock and to any amendments to said
registration statements, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or either of them, shall do or cause to be done by
virtue hereof.
IN WITNESS WHEREOF, I have hereunto set my hand this 15th day of
March, 1997.
/s/ Dean M. Greenwood
