<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 28, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
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)
---------------
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)
---------------
THOMAS A. MONSON, ESQ.VICE PRESIDENT COPY TO:
AND GENERAL COUNSEL GARY P. CULLEN, ESQ.
USN COMMUNICATIONS, INC. SKADDEN, ARPS, SLATE, MEAGHER & FLOM
10 SOUTH RIVERSIDE PLAZA, SUITE 401 (ILLINOIS)
CHICAGO, ILLINOIS 60606 333 WEST WACKER DRIVE
(312) 906-3600 CHICAGO, ILLINOIS 60606
(NAME, ADDRESS, INCLUDING ZIP CODE, (312) 407-0700
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 this form is a post-effective amendment filed pursuant to Rule 462(d)
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. [_]
---------------
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED PROPOSED
TITLE OF EACH CLASS OF AMOUNT MAXIMUM MAXIMUM AMOUNT OF
SECURITIES TO BE TO BE OFFERING PRICE AGGREGATE REGISTRATION
REGISTERED REGISTERED PER SECURITY OFFERING PRICE FEE
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<S> <C> <C> <C> <C>
Warrants to Purchase
Class A Common Stock... 1,541,766 -- -- --(1)
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Class A Common Stock, par
value $.01 per Share... 2,199,060 $.01 $21,990.60 $7(2)(3)
</TABLE>
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(1) Pursuant to Rule 457(g) under the Securities Act, no registration fee is
payable with respect to the Warrants.
(2) Represents shares issuable upon exercise of the Warrants at an exercise
price of $0.01 per share.
(3) As described below, pursuant to Rule 429 under the Securities Act of 1933,
as amended (the "Securities Act"), the Prospectus filed as part of this
Registration Statement relates to additional securities of the Registrant,
previously registered under its Registration Statement on Form S-1 (File
No. 333-16947), for which a Registration Fee in the amount of $8,378 was
remitted to the Commission.
---------------
PURSUANT TO RULE 429 UNDER THE SECURITIES ACT, THE PROSPECTUS FILED AS PART
OF THIS REGISTRATION STATEMENT RELATES TO THE SECURITIES REGISTERED HEREBY AND
ALSO RELATES TO $36,000,000 AGGREGATE PRINCIPAL AMOUNT AT MATURITY OF
CONVERTIBLE SUBORDINATED NOTES, 48,500 WARRANTS TO PURCHASE COMMON STOCK, UP
TO 3,449,598 SHARES OF CLASS A COMMON STOCK ISSUABLE UPON CONVERSION OF THE
CONVERTIBLE NOTES AND 790,780 SHARES OF CLASS A COMMON STOCK ISSUABLE UPON
EXERCISE OF THE WARRANTS PREVIOUSLY REGISTERED BY USN COMMUNICATIONS, INC.
UNDER ITS REGISTRATION STATEMENT ON FORM S-1 (FILE NO. 333-16947).
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. THIS +
+OFFERING MEMORANDUM SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION +
+OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY +
+JURISDICTION IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL +
+PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH +
+JURISDICTION. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED NOVEMBER 28, 1997
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) 1,590,266 warrants to purchase an aggregate of
2,989,840 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. (the "Company") at an initial exercise price of $.01 per
share (collectively, the "Warrants") and (iii) up to 6,439,438 shares of Class
A Common Stock which includes (a) up to 3,449,598 shares of Class A Common
Stock issuable upon conversion of the Convertible Notes (the "Convertible Note
Shares") and (b) 2,989,840 shares of Class A Common Stock issuable upon
exercise of the Warrants (collectively, 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 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 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 $10.436 per
share (the "Conversion Price"), subject to adjustment under certain
circumstances described herein. 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, 1997, the Convertible Notes were, in the aggregate,
convertible into 2,892,695 shares of Class A Common Stock. On September 30,
1999, the Convertible Notes will be, in the aggregate, convertible into
3,449,598 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 $201.2 million in aggregate principal
amount at maturity of Senior Notes (as defined). 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 $29.3 million as of September 30, 1997, 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 indebtedness of the Company, such subsidiary will be obligated to
guarantee the Convertible Notes. The Senior Note Indentures (as defined) permit
the Company and its subsidiaries to incur, under certain circumstances,
additional indebtedness. See "Certain Other Indebtedness."
(cover page continued on next page)
-----------
SEE "RISK FACTORS," BEGINNING ON PAGE 15, 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.
-----------
The date of this Prospectus is November , 1997.
<PAGE>
(cover page continued from previous page)
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."
The Convertible Notes and 48,500 warrants to purchase an aggregate of
790,780 shares of Class A Common Stock (the "1996 Initial Warrants") 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 "1996 Initial Purchasers"), who placed the securities with
an institutional investor. In connection with the issuance of the Convertible
Notes and 1996 Initial Warrants, the Company also issued and sold $48.5
million in aggregate principal amount at maturity of 14% Senior Discount Notes
due 2003 (the "14% Senior Notes").
On August 18, 1997, the Company sold 1,527,250 warrants to purchase an
aggregate of 2,053,900 shares of Class A Common Stock (the "1997 Initial
Warrants") to Merrill Lynch, Pierce, Fenner & Smith Incorporated and Donaldson
Lufkin & Jenrette Securities Corporation (collectively, the "1997 Initial
Purchasers" and, together with the 1996 Initial Purchasers, the "Initial
Purchasers"), who placed the 1997 Initial Warrants with certain institutional
investors. The Initial Purchasers received customary compensation in
connection with such private placements. In connection with the issuance of
the 1997 Initial Warrants, the Company also issued and sold $152.7 million in
aggregate principal amount at maturity of 14 5/8% Senior Discount Notes due
2004 (the "14 5/8% Senior Notes," and, together with the 14% Senior Notes, the
"Senior Notes"). See "Certain Relationships and Related Transactions."
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. The Company has been advised by the Initial
Purchasers that they intend to make a market for the respective Securities
that each Initial Purchaser placed; 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."
2
<PAGE>
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 Company is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports and other information with
the Commission. The Registration Statement and the exhibits and schedules
thereto and reports and other information filed by the Company 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, 13th
Floor, New York, New York 10048 and at 500 West Madison Street (Suite 1400),
Chicago, Illinois 60661 at prescribed rates. Copies of such material may also
be obtained from the Public Reference Section of the Commission at Judiciary
Plaza, 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, a warrant agreement, dated as of September 30, 1996 (the "1996
Warrant Agreement"), a warrant agreement, dated as of August 15, 1997 (the
"1997 Warrant Agreement"), and a warrant agreement, dated as of August 25,
1997 (the "Consent Warrant Agreement", and together with the 1996 Warrant
Agreement and the 1997 Warrant Agreement, the "Warrant Agreements"), each 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 Warrants,
as applicable, 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.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act,
including statements containing the words "believes," "anticipates," "expects"
and words of similar import. All statements other than statements of
historical facts included in this Prospectus including, without limitation,
such statements under "Prospectus Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business" and located elsewhere herein, regarding the Company or any of the
transactions described herein, including the timing, financing, strategies and
effects of such transactions, are forward-looking statements. Although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such expectations
will prove to have been correct. Important factors that could cause actual
results to differ materially from expectations are disclosed in this
Prospectus, including, without limitation, in conjunction with the forward-
looking statements in this Prospectus and/or under "Risk Factors." The Company
does not intend to update these forward-looking statements.
3
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and consolidated financial
statements and related notes appearing elsewhere in this Prospectus. Except as
otherwise noted, all share numbers contained in this Prospectus reflect a nine-
for-one stock dividend declared by the Company on September 4, 1997, including
share information contained in the Financial Statements and Notes thereto and
in the historical financial data included elsewhere in this Prospectus. Unless
the context indicates otherwise, all references to the Company or USN 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 is one of the fastest growing competitive local exchange carriers
("CLECs") in the United States. The Company offers a bundled package of
telecommunications products, including local and long distance telephony, voice
mail, paging, teleconferencing, Internet access and other enhanced features,
tailored to meet the needs of its customers. The Company primarily targets
small and medium-sized businesses with telecommunications usage of less than
$5,000 per month. The Company's strategy is to continue to increase its
customer base by being more flexible, innovative and responsive to the needs of
its target customers than the regional Bell operating companies ("RBOCs") and
the first-tier interexchange carriers ("IXCs"), which have historically
concentrated their sales and marketing efforts on residential and large
business customers. The Company primarily differentiates itself with a value-
based marketing strategy by providing an integrated, customized package of
telecommunications services on a single bill and responsive customer care.
The Company is presently providing service to customers in certain states in
the NYNEX Corporation ("NYNEX") region (New York and Massachusetts) and the
Ameritech Corporation ("Ameritech") region (Illinois, Ohio and Michigan) and is
currently in negotiations to expand its bundled services offering throughout
the 14-state Bell Atlantic/NYNEX region and the 5-state Ameritech region.
Management anticipates implementing service in at least six additional states
by the end of 1998. In August 1997, NYNEX merged with Bell Atlantic. The
Company continues to operate in the former NYNEX regions, which are now a part
of the Bell Atlantic territory.
During the first nine months of 1997, the Company increased aggregate local
access lines sold from 10,283 lines to 135,172 lines, a compound growth rate of
more than 33% per month, including the sale of 55,851 lines in the third
quarter alone. As of September 30, 1997, the Company had 116,951 access lines
in service, including 51,449 lines which were provisioned in the third quarter.
Services are primarily marketed through an approximately 325 member direct
salesforce in 27 offices located in five states. As part of its customer-
focused product offering, the Company provides personalized customer service,
24 hours a day, 365 days per year, through its two regional customer care
centers.
COMPETITIVE ADVANTAGES
Providing local exchange services is a highly complex process that requires
overcoming significant barriers to entry. Since inception, the Company has
spent significant time, resources and capital to enter the local market. In the
process, it has gained substantial experience in this complicated market
segment. Consequently, the Company believes it has the following competitive
advantages:
. COMPLEMENTARY RELATIONSHIPS WITH RBOCS. The Company believes that the RBOCs'
networks will continue to be the predominant means for providing local
telecommunications services to the Company's target customers for the
foreseeable future. Accordingly, the Company has positioned itself to take
advantage of the opportunities created by the Telecommunications Act of 1996
(the "Telecommunications Act") by leveraging its complementary relationships
with the RBOCs. The Telecommunications Act requires the RBOCs to
4
<PAGE>
complete a number of "checklist" items in order to qualify for long distance
entry in their local service areas. By moving aggressively to enter into
resale agreements and to develop electronic interfaces with the RBOCs, the
Company believes it has positioned itself to play a key role in enabling the
RBOCs to meet a number of those requirements. The Company was the first to
enter into comprehensive resale agreements with Ameritech and NYNEX, served as
the systems beta customer for Ameritech, NYNEX and Bell Atlantic and is
currently one of the largest CLECs in terms of access lines in service in the
Ameritech and NYNEX markets. Consequently, the Company is often requested by
state and federal regulators to provide information on the Company's
experiences. The Company believes its complementary relationships with the
RBOCs have facilitated the Company's rapid growth in its existing markets and
enabled it to become a valuable and viable resale channel partner. The Company
further believes, based on discussions with RBOC officials and industry
experts, that the RBOCs will continue to develop strong resale channel
partners in an effort to mitigate the potential negative effects of
facilities-based competition.
. UNIQUE RESALE AGREEMENTS. The Company has executed comprehensive local
exchange resale agreements with Ameritech for the greater metropolitan
Chicago area, Ohio and Michigan, and with NYNEX for the State of New York. In
addition to the cost advantages associated with the term and volume
commitment contracts, these contracts provide "most favored nation" and other
pricing protections designed to maintain the competitiveness of rates and
position the Company to purchase capacity at rates at least as favorable as
those of other potential resellers of Ameritech and NYNEX local services. In
addition, the Company has executed interim resale agreements with Ameritech
for the State of Wisconsin and with NYNEX for the State of Massachusetts. The
Company is currently in negotiations to expand its resale agreements
throughout the 14-state combined Bell Atlantic/NYNEX region and the 5-state
Ameritech region. In advance of completing these negotiations, the Company
plans to enter certain additional states by reselling local service pursuant
to state-mandated wholesale discounts. The Company estimates, based on data
compiled by the Federal Communications Commission ("FCC"), that the regions
covered by the current comprehensive Ameritech and NYNEX resale agreements
include access to over 10 million business access lines. Management believes
that upon expansion into the remaining Bell Atlantic/NYNEX region and the
Ameritech region, the Company will have access to approximately 20 million
business access lines. The Company continuously evaluates opportunities to
enter into agreements with additional RBOCs, other local and long distance
service providers and enhanced and other value-added service providers in
order to aggressively build its customer base as well as to provide
additional services to its existing customers while reducing costs.
. PROPRIETARY ELECTRONIC PROVISIONING AND INTERFACE SYSTEMS. By serving as the
systems beta customer for Ameritech, NYNEX and Bell Atlantic, the Company was
among the first CLECs to develop electronic provisioning systems for resale
of RBOC services. Development of provisioning systems is critical for
carriers seeking to grow rapidly in the complex, competitive local
telecommunications market. These systems must address the numerous technical
configurations associated with local service, including correctly coding
customers into data bases for 911, 411, white pages and customer service, as
well as provisioning thousands of local services, known as universal service
ordering codes ("USOCs"). Electronic provisioning between the Company and its
RBOC vendors allows the Company to provision a significantly greater volume
of lines than would be possible if transmitting orders by mail or facsimile.
Moreover, because the proprietary systems developed by the Company lessen
manual input and reduce repetitive data entry, the Company experiences
improved efficiency and accuracy in transmitted orders, thereby reducing
costs and increasing customer satisfaction. The Company believes it has
established an industry leadership position in the deployment of these
systems, and it is committed to their continuous improvement.
. LARGEST DIRECT SALESFORCE AMONG CLECS IN ITS MARKETS. The Company's services
are currently sold through an approximately 325 member direct salesforce,
located in 27 offices in Illinois, Ohio, Michigan, New York and
Massachusetts. Additionally, the Company intends to hire approximately 175
new salespeople over the next 12 months to expand service in the Ameritech
and combined Bell Atlantic/NYNEX regions. The
5
<PAGE>
Company primarily recruits salespeople with experience in selling competitive
telecommunications services to businesses in the markets where they are based.
The Company's salesforce is trained in-house with a rigorous customer-focused
training program that promotes activity-based selling. Salespeople are given
an incentive through a commission structure, with a target of 50% of a
salesperson's compensation based on performance. The Company believes its
large, experienced, face-to-face salesforce has been, and will continue to be,
vitally important to expanding its customer base in today's highly competitive
telecommunications industry environment.
. STRATEGIC FLEXIBILITY. The Company believes that its business strategy
affords it more flexibility to take advantage of regulatory and industry
dynamics than its facilities-based competitors. For example, the FCC's
position on unbundled network elements has evolved to the point where
competitors are now able to purchase on an economic basis unbundled network
elements from the RBOCs and rebundle them into an alternative local service
option. The Company expects to exploit this opportunity by rebundling network
elements, thus expanding its products offering and improving its strategic
position. In addition, the increased construction by facilities-based CLECs
has improved the value of the Company's services by creating alternative
resale partners other than RBOCs. The Company is currently evaluating
proposals from facilities-based CLECs to provision local service.
GROWTH STRATEGY
The Company's objective is to be a leading provider of integrated local and
long distance services and other telecommunications products to small and
medium-sized businesses in its target markets. The Company expects to achieve
this goal through the successful implementation of its growth strategy which
includes the following:
. PROVIDE AN INTEGRATED TELECOMMUNICATIONS SOLUTION. A key element in building
its customer base while minimizing churn has been, and will continue to be,
the implementation of a marketing and operating strategy which emphasizes an
integrated telecommunications solution to its target market. To a large
extent, the Company's target customers have not previously been provided the
opportunity to purchase bundled services. The Company attracts and retains
customers by combining responsive customer care with a pricing package to
provide high-quality service at a cost which is usually afforded to only
large business customers. Specifically, the Company provides a single source
and bill for integrated local and long distance telephony, voicemail, paging,
teleconferencing, Internet access and other enhanced and value-added
telecommunications services, with a single point of contact for customer
service, product inquiries, repairs and billing questions. Based on its
experience, the Company believes that this marketing and customer service
approach has minimized customer acquisition costs and churn.
. FOCUS ON LARGE, UNDERSERVED MARKET. The Company utilizes a direct sales
approach and primarily focuses its marketing efforts on small and medium-
sized businesses with telecommunications usage of less than $5,000 per month.
The Company believes this target market is best served by a direct sales
approach because most of these customers do not employ in-house
telecommunications specialists and in most cases obtain services from various
vendors. The Company's experience indicates that these customers prefer a
single source for all their telecommunications requirements, including
products, billing and service. The Company believes that its gross margins on
services provided to its target market are generally higher than for larger
business customers. Since the RBOCs and the first-tier IXCs primarily
concentrate their sales and marketing efforts on residential and large
business customers, the Company will continue to focus its marketing on this
underserved market to rapidly expand its customer base.
. LEVERAGE UBIQUITOUS NETWORKS. The Company believes that a key factor in its
success has been its ability to provide through the RBOC networks the
complete range of local services currently provided by RBOCs across their
entire service territories. There is currently no competing network with the
product breadth, capacity and geographic reach of the RBOC networks. By
contrast, facilities-based CLECs are currently limited primarily to servicing
customers in areas where they have network facilities.
6
<PAGE>
. RAPID MARKET ENTRY. The Company believes its ability to enter a market early
and provide ubiquitous service will continue to allow it to rapidly build a
customer base across a large geographic area prior to the lifting of
regulatory restrictions on the ability of first-tier IXCs and RBOCs to offer
integrated services. Based on recent public announcements, the Company does
not believe that any RBOC will provide in-region long distance services prior
to 1999. As a non-facilities based provider, the Company believes it is able
to build a customer base quickly and efficiently without incurring
significant costs and the developmental delays inherent in constructing
network and transmission facilities. In addition, the Company's proprietary
software interface systems facilitate its rapid customer acquisition strategy
by allowing it to provision high volumes of access lines.
. EXPAND LOCAL SERVICES. The Company plans to expand its local services
offering, positioning it to offer a full range of local services over a broad
geographic area at a competitive cost, by: (i) entering into term and volume
resale agreements in new territories with RBOCs; (ii) entering into resale
agreements with one or more facilities-based CLECs; (iii) rebundling network
elements from RBOCs; and (iv) reselling local service in new territories
pursuant to state-mandated wholesale discounts prior to entering into resale
agreements with RBOCs and/or facilities-based CLECs in such territories. The
Company believes, based on its experience and industry analysts' reports, as
well as recent regulatory and industry developments, that RBOCs have an
incentive to continue to negotiate wholesale agreements with respect to small
and medium-sized businesses to stabilize this revenue base and deter
migration of such customers to RBOC's facilities-based competitors. The
Company also believes that its demonstrated sales and provisioning expertise
is attractive to facilities-based CLECs which may not be having similar
success.
The Company, a Delaware corporation (formerly United USN, Inc.), 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.
RECENT DEVELOPMENTS
On August 18, 1997, the Company consummated a private placement under Rule
144A of the Securities Act (the "1997 Private Placement") pursuant to which the
Company issued and sold 152,725 units (the "Units") consisting of approximately
$152.7 million in aggregate principal amount at maturity of the 14 5/8% Senior
Discount Notes and the 1997 Initial Warrants. The aggregate purchase price of
the Units was approximately $100 million. The indenture with respect to the 14
5/8% Senior Notes (the "14 5/8% Senior Note Indenture") provides that (i) in
the event that on or prior to September 30, 1998, the Company does not
consummate one or more Public Equity Offerings (as defined), or otherwise issue
in one or more transactions additional equity securities of the Company
resulting in net proceeds to the Company of at least $50 million in the
aggregate, based on an equity valuation of at least $160 million, the Company
will be obligated to issue to the holders of the 14 5/8% Senior Notes warrants
(the "1997 Contingent Warrants") exercisable for Class A Common Stock
representing 5.0% of the common stock of the Company on a fully-diluted basis
after giving effect to such issuance. In connection with the 1997 Private
Placement, the Company also issued and sold to certain of its existing
stockholders and their affiliates, approximately 30,200 shares of the Company's
9.0% Cumulative Convertible Pay-In-Kind Preferred Stock, Series A (the "Series
A Preferred Stock") for an aggregate purchase price of approximately $30.2
million.
In connection with the 1997 Private Placement, Merrill Lynch Global
Allocation Fund, Inc. ("MLGAFI") and Merrill Lynch Equity/Convertible Series
(Global Allocation Portfolio) (collectively, "MLAM"), the current holders of
all of the Company's 14% Senior Discount Notes and the Convertible Notes
consented (the "Consent") to the amendment of an indenture with respect to the
14% Senior Notes (the "14% Senior Note Indenture," and, together with the 14
5/8% Senior Note Indenture, the "Senior Note Indentures") and the Convertible
Note Indenture to allow the Company to consummate the 1997 Private Placement.
In connection with the Consent, among other things, the Company granted to MLAM
an option to purchase convertible notes
7
<PAGE>
of the Company on terms substantially similar to the Convertible Notes (the
"Consent Convertible Notes") for an aggregate purchase price of $10.0 million.
The option was exercised by MLAM on October 24, 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Overview."
On October 21, 1997, the Company filed a registration statement with the
Commission registering the Company's initial public offering (the "Initial
Public Offering") of up to $90.0 million of the Company's common stock.
8
<PAGE>
SUMMARY DESCRIPTION OF THE SECURITIES
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 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, at the option of the holders of
Convertible Notes prior to redemption or final
maturity of the Convertible Notes, at a conversion
price of $10.436 per share, subject to adjustment
as described below and as
9
<PAGE>
described in "Description of 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
Price.................... 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
million (each, a "Reset Event") and at the time of
such sale or sales, the equity valuation of the
Company is less than $122.5 million 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 $122.5
million, 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 Convertible
Notes--Issuance of Contingent Warrants."
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, including
the Consent Convertible Notes. 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 Factors--
Holding Company Structure; Source of Repayment of
Notes; Effective Subordination of Convertible Notes
to Indebtedness of Subsidiaries" and
"--Subordination of Convertible Notes."
10
<PAGE>
Change of Control......... Upon a Change of Control, each holder of the
Convertible Notes will have the right to require
the Company to repurchase all or any part of such
holder's Convertible Notes at a price equal to 101%
of the Accreted Value thereof or, in the case of
any such repurchase on or after September 30, 1999,
101% of the principal amount thereof, plus accrued
and unpaid interest, if any, and Special Interest,
if any, thereon, to the date of repurchase. See
"Description of Convertible Notes--Repurchase at
the Option of Holders upon a Change of Control."
Termination of Trading.... Upon a Termination of Trading (as defined herein),
each holder of a Convertible Note will have the
right to require the Company to repurchase all or
any part of such holder's Convertible Notes at a
price equal to 100% of the Accreted Value or 100%
of the principal amount thereof, as the case may
be, plus accrued and unpaid interest, if any, and
Special Interest, if any, thereon to the date of
repurchase. See "Description of Convertible Notes--
Right to Require Repurchase of Convertible Notes
Upon a Termination of Trading."
Guarantees................ The Convertible Note Indenture provides that any
subsidiary that guarantees Indebtedness of the
Company will guarantee unconditionally on a senior
basis (except with respect to the Senior Notes and
the Senior Note Guarantees), the payment of
principal, premium, if any, interest and Special
Interest, if any, on the Convertible Notes and
amounts payable upon a Change of Control, an Asset
Sale Offer or a Termination of Trading. See
"Description of Convertible Notes--Certain
Covenants--Limitation on Issuances of Guarantees by
Restricted Subsidiaries."
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 Convertible
Notes--Certain Covenants," "--Assets Sales" and "--
Consolidation, Merger, Conveyance, Lease or
Transfer."
For additional information concerning the Convertible Notes, see "Description
of Convertible Notes."
WARRANTS
1996 Initial Warrants..... 48,500 warrants which, when exercised, would
entitle the holders thereof to purchase, in the
aggregate, 790,780 shares of Class A Common Stock
(equal to approximately % of the outstanding
shares of Common Stock, on a fully diluted basis as
of the date of this Prospectus). Each 1996 Initial
Warrant entitles the holder thereof to purchase
approximately 16.30474 shares of Class A Common
Stock (subject to adjustment as described herein)
at an initial exercise price of $.01 per share. The
1996 Warrants may be exercised at any time on or
prior to September 30, 2003. See "Description of
Warrants--Certain Terms."
1997 Initial Warrants..... 1,527,250 warrants which, when exercised, would
entitle the holders thereof to purchase, in the
aggregate, 2,053,900 shares of Class A
11
<PAGE>
Common Stock (equal to approximately % of the
outstanding shares of the Common Stock on a
fully-diluted basis as of the date of this
Prospectus). Each 1997 Initial Warrant entitles
the holder thereof to purchase 1.34484 shares
of Class A Common Stock (subject to adjustment
as described herein) at an initial exercise
price of $.01 per share. The 1997 Initial
Warrants may be exercised at any time beginning
on February 15, 1998 or earlier upon the
occurrence of certain circumstances and on or
prior to August 15, 2004. See "Description of
the Warrants--Certain Terms."
Consent Warrants.......... 14,516 warrants, which, when exercised, would
entitle the holders thereof to purchase, in the
aggregate, 145,160 shares of Class A Common
Stock (equal to approximately % of the
outstanding shares of Common Stock, on a fully-
diluted basis as of the date of this
Prospectus). Each Consent Warrant entitles the
holder thereof to purchase 10 shares of Class A
Common Stock (subject to adjustment as
described herein) at an initial exercise price
of $.01 per share. The Consent Warrants may be
exercised at any time beginning on February 15,
1998 or earlier upon the occurrence of certain
circumstances and on or prior to August 15,
2004. See "Description of the Warrants--Certain
Terms."
Adjustments............... The number of shares of Class A Common Stock
for which a 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. A Warrant does not
entitle the holder thereof to receive any
dividends paid on Class A Common Stock.
For additional information concerning the Warrants, see "Description of the
Warrants."
CLASS A COMMON STOCK
Class A Common Stock...... 6,439,438 shares of Class A Common Stock of the
Company, par value $.01 per share, consisting of
the Convertible Note Shares and the Warrant Shares.
Convertible Note Shares... 3,449,598 shares of Class A Common Stock available
for issuance by the Company upon conversion of the
Convertible Notes by the holders thereof.
Warrant Shares............ 2,989,840 shares of Class A Common Stock available
for issuance by the Company upon exercise of the
Warrants by the holders thereof.
Voting Rights............. Holders 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
12
<PAGE>
Note Indentures include 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."
For additional information concerning the Class A Common Stock, see
"Description of Capital Stock."
REGISTRATION RIGHTS
Under the terms of a registration rights agreement dated as of September 30,
1996 between the Company and the 1996 Initial Purchasers (the "1996
Registration Rights Agreement") and a registration rights agreement dated as of
August 15, 1997 between the Company and the 1997 Initial Purchasers (the "1997
Registration Rights Agreement" and, together with the 1996 Registration Rights
Agreement, the "Registration Rights Agreements"), the Company is required to
keep the Registration Statement of which this Prospectus forms a part effective
for a specified period. The Company has also granted to MLAM registration
rights comparable to the registration rights contained in the 1997 Registration
Rights Agreement with respect to the Consent Warrants and the shares of Class A
Common Stock issuable upon the exercise of the Consent Warrants. See
"Registration Rights."
RISK FACTORS
Prospective investors in the Securities should carefully consider the
information set forth in this Prospectus, and in particular, should evaluate
the factors set forth under "Risk Factors" beginning on page 15.
13
<PAGE>
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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. The summary financial data as of and for the nine-month
periods ended September 30, 1996 and 1997, respectively, are derived from, and
should be read in conjunction with, the unaudited financial statements of the
Company and the related notes thereto included elsewhere in this Prospectus. In
the opinion of management, such interim financial statements reflect all
adjustments (consisting solely of normal recurring adjustments) necessary to
fairly present the information presented for such periods. Results of
operations for the nine months ended September 30, 1997 are not necessarily
indicative of results of operations for a full year or indicative of future
periods.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
INCEPTION TO -------------------- --------------------
DECEMBER 31, UNAUDITED
1994 1995 1996 1996 1997
------------ --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net service revenue... $ 1,737 $ 7,884 $ 9,814 $ 7,599 $ 26,998
Cost of services...... 1,455 9,076 9,256 6,587 23,983
--------- --------- --------- --------- ---------
Gross margin.......... 282 (1,192) 558 1,012 3,015
Sales and marketing
expense.............. 2,869 5,867 12,612 5,837 43,087
General and
administrative
expense.............. 4,686 11,100 20,665 10,920 26,882
Interest expense...... 26 734 1,797 46 8,573
Interest and other
income (1)........... 152 646 9,469 8,572 1,889
Minority interest..... -- 150 -- -- --
--------- --------- --------- --------- ---------
Net loss.............. $ (7,147) $ (18,097) $ (25,047) $ (7,219) $ (73,638)
========= ========= ========= ========= =========
Accumulated preferred
dividends............ $ 707 $ 3,103 $ 3,691 $ 3,466 $ 1,012
Net loss to common
shareholder.......... $ (7,854) $ (21,200) $ (28,738) $ (10,685) $ (74,650)
Net loss per common
share................ $ (6.56) $ (7.01) $ (5.63) $ (2.44) $ (10.35)
Weighted average
shares outstanding... 1,196,780 3,025,200 5,102,330 4,384,993 7,212,511
OTHER DATA:
EBITDA (2)............ $ (7,087) $ (15,901) $ (30,390) $ (14,386) $ (64,429)
Cash flows from
operating activities. (6,141) (14,308) (24,098) (14,092) (57,822)
Cash flows from
investing activities. (1,708) (2,556) 7,274 7,647 (10,071)
Cash flows from
financing activities. 13,828 24,589 63,689 64,157 125,018
Depreciation and
amortization......... 186 2,258 2,329 1,360 2,525
Capital expenditures.. 1,728 1,740 2,259 285 10,071
Ratio of earnings to
fixed charges (3).... -- -- -- -- --
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
--------------------------------- --------------------
UNAUDITED
1994 1995 1996 1996 1997
------------ --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents.......... $ 5,979 $ 13,705 $ 60,569 $ 71,390 $ 117,944
Total assets.......... 12,747 20,471 78,052 88,083 179,157
Long-term debt (net of
current maturities).. 3,176 518 59,864 58,352 167,287
Redeemable preferred
stock................ 15,306 44,396 10,045 9,853 41,049
Common stockholders'
equity (deficit)..... (7,830) (28,768) (3,606) 14,022 (58,428)
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF AS OF AS OF AS OF
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1996 1996 1997 1997 1997
------------- ------------ --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Local access line
sold............ 4,630 10,283 35,397 79,321 135,172
Local access
lines in
service......... 4,356 8,364 18,557 65,142 116,591
Total employees.. 225 464 641 766 868
Direct
salesforce...... 81 206 252 325 325
</TABLE>
- -------
(1) Interest and other income for the year ended December 31, 1996 and the nine
months ended September 30, 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 (loss) 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 a measure commonly used in the
telecommunications industry and is presented to assist in understanding the
Company's operating results and as a 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 $7.1 million, $17.4 million and $23.2
million, respectively, and for the nine-month period ended September 30,
1996 and 1997 by $7.2 million and $65.1 million, respectively.
14
<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 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 period from April 20, 1994 to December 31, 1994 and the fiscal year ended
December 31, 1995, the Company's operating losses were $7.3 million and $18.2
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
year ended December 31, 1996. The Company lost $15.3 million (excluding the
$8.1 million non-recurring gain) and $73.6 million for the first nine months
of 1996 and 1997, respectively. The Company expects to realize additional
operating losses on a consolidated basis while it continues to expand and
develop its service offerings and its customer base. There can be no assurance
that the Company will be able to develop or expand its customer 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 offered hereby. 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. See "Business--Growth Strategy."
SUBSTANTIAL LEVERAGE
The Company has and will continue to have consolidated indebtedness that is
substantial in relation to its stockholders' deficit. As of September 30,
1997, the Company had $167.3 million principal amount of long-term debt and a
total common stockholders' deficit of $58.4 million. See "Capitalization."
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. 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 at maturity. See "Description of the
Convertible Notes." In addition, cash interest will commence accruing on the
14 5/8% Senior Notes on August 15, 2000 and the 14% Senior Notes on March 30,
2000. See "--Future Cash Obligations." The Senior Note Indentures permit the
Company and its subsidiaries to incur additional Indebtedness under certain
circumstances, including up to $45 million under a Credit Facility (as defined
in the Senior Note Indenture), $30 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 debt financing. There can be no assurance
that any of these strategies could be effected on satisfactory terms, if at
all.
The degree to which the Company is leveraged could have important
consequences to the holders of the Securities, including the following: (i)
the Company will have significant and increasing cash interest expense and
significant principal repayment obligations with respect to outstanding
indebtedness, including the Senior Notes, the Convertible Notes and the
Consent Convertible Notes; (ii) the Company's degree of leverage and
15
<PAGE>
related debt service obligations may make it more vulnerable than some of its
competitors to the effects of an economic downturn or other adverse
developments; and (iii) the Company's ability to obtain additional financing
could be impaired. In addition, pursuant to the terms of the Senior Note
Indentures and the Convertible Note Indenture, the ability of the Company to
sell assets is restricted. See "Description of Convertible Notes" and "Certain
Other Indebtedness."
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, proceeds from the sale of the 14%
Senior Notes, the Convertible Notes and the 1996 Initial Warrants (together,
the "1996 Private Placement") and the 1997 Private Placement. Commencing
August 15, 2000, cash interest on the 14 5/8% Notes will accrue semiannually
at the rate of 14 5/8% per annum (approximately $22.3 million per year).
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), and commencing March 30, 2000, cash interest on the 14% Senior
Notes will accrue semiannually at the rate of 14% per annum (approximately
$6.8 million per year). The fully accreted principal amount of the 14 5/8%
Senior Notes, 14% Senior Notes and Convertible Notes of $152.7 million, $48.5
million and $36.0 million, respectively, will become due on August 15, 2004,
September 30, 2003 and September 30, 2004, respectively. Pursuant to the
Consent, holders of the 14% Senior Notes may exchange 14% Senior Notes for
Additional Notes which have a higher rate of interest and would therefore
increase the Company's cash obligations. The Consent Convertible Notes will
accrete in value in the same manner as the Convertible Notes and will become
due on September 30, 2004. 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.
ADDITIONAL CAPITAL REQUIREMENTS
The Company anticipates that it may require substantial additional capital
in future periods in order to meet planned capital expenditures and
anticipated negative operating cash flow. Sources of funding for the Company's
future financing requirements may include public offerings or private
placements of equity and/or debt securities, bank loans and additional capital
contributions from new or existing stockholders. There can be no assurance
that the additional financing will be available to the Company or, if
available, that it can be obtained on a timely basis and on terms acceptable
to the Company and within the limitations contained in the Senior Note
Indentures. Failure to obtain such financing could result in the delay or
abandonment of the Company's development and expansion plans.
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
dividends and distributions from its subsidiaries. In order to pay cash
interest on the Convertible Notes, when cash interest is payable thereon, 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 Senior Note 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
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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 Indentures permit the Company to enter into a Credit Facility under which
the Company may incur up to $45 million of Indebtedness (as defined), $30
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 in the future, 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,
including trade payables. As of September 30, 1997, 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 $29.3 million. 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 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 Indentures 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 Indentures, 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 Convertible Notes--Events of Default."
DEPENDENCE ON BILLING SERVICES AND IMPLEMENTATION
The accurate and prompt billing of the Company's customers is essential to
the Company's operations and future profitability. Historically, the Company
has relied on two third-party vendors to provide billing services and is
currently in the process of transitioning to a single vendor. No assurances
can be made that the transition to a single vendor will not adversely affect
the Company's financial condition and results of operations. Presently, the
Company relies, to a significant extent, on its billing vendor to rate, print
and mail its customers' bills, and the Company is not in a position to control
the management of or the provisioning of billing services
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by such vendor. In addition, such vendor has limited financial resources and
personnel, and the Company's expected growth may strain such vendor's
available resources. The Company is currently exploring a number of
alternatives with respect to its billing services, but there can be no
assurance that any such alternatives will be successfully implemented. The
failure of any third-party vendor to provision all of the billing services
required by the Company or the failure by the Company to implement other
alternatives could have a material adverse effect on the results of operations
of the Company.
In addition, the Company is dependent upon the prompt collection of payment
of its customers' bills and, in turn, upon the creditworthiness of its
customers and the continued implementation of adequate revenue assurance
programs. The failure of its customers to pay their bills in a timely manner
or the Company's failure to continue to implement adequate revenue assurance
programs could have a material adverse effect on the Company's financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Overview."
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 customer 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 on a
ubiquitous basis. 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 financial condition and results of
operations. In addition, the accurate and prompt billing of the Company's
customers 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, and such
carriers' failure to do so could have a material adverse effect on the
Company's financial condition and results of operations. For example, there
have been a number of provisioning and billing difficulties related to the
local and long distance services provided to business customers in Manhattan,
New York pursuant to an agreement with NYNEX. The problems included failure to
provision customers, lost customer traffic information and receipt by
customers of 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 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,
the Company or its billing vendor may cause interruption in service and/or
reduced capacity for the Company's customers. In the event that the Company's
long distance carriers are unable to handle the growth in customer 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 local exchange carriers ("LECs") are unable to handle the
provisioning or growth in customer 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 continue to intensify in the future due
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to regulatory changes, including continued implementation 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.
Additionally, the long distance market is already significantly more
competitive than the local exchange market because the incumbent local
exchange carriers ("ILECs"), including the RBOCs, have historically had a
monopoly position within the local exchange market.
In the local exchange market, the Company also faces competition or
prospective competition from one or more CLECs, many of which have
significantly greater financial resources than the Company, and from other
competitive providers, including some non-facilities-based providers like the
Company. For example, AT&T Corp. ("AT&T"), MCI Communications Corporation
("MCI") and Sprint Corporation ("Sprint"), among other carriers, have each
begun to offer local telecommunications services in major U.S. markets using
their own facilities or by resale of the ILECs' or other providers' services.
In fact, certain competitors, including AT&T, MCI and Sprint, have entered
into interconnection agreements with Ameritech with respect to the States of
Illinois, Michigan and Ohio. These competitors either have begun or in the
near future likely will 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 near
future likely will 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 that currently offer or are
potentially capable of offering switched services include CLECs, cable
television companies, electric utilities, other long distance carriers,
microwave carriers, wireless telephone system operators and large customers
who build private networks. Many facilities-based CLECs and long distance
carriers, for example, have committed substantial resources to building their
networks or to purchasing CLECs or IXCs with complementary facilities. By
building or purchasing a network or entering into interconnection agreements
or resale agreements with ILECs, including RBOCs, a facilities-based provider
can offer single source local and long distance services similar to those
offered by the Company. Such additional alternatives may provide such
competitors with greater flexibility and a lower cost structure than the
Company. In addition, some of these CLECs and other facilities-based providers
of local exchange service are acquiring or being acquired by IXCs that are not
subject to joint marketing restrictions. These combined entities may provide a
bundled package of telecommunications products, including local and long
distance telephony, that is in direct competition with the products offered by
the Company.
With respect to wireless telephone system operators, the FCC has authorized
cellular, personal communications service ("PCS") and other commercial mobile
radio service ("CMRS") providers to offer wireless services to fixed
locations, rather than just to mobile customers, 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.
The Company will also face competition from other fixed wireless services,
including Multichannel Multipoint Distribution Service ("MMDS"), 28 GHz Local
Multipoint Distribution Service ("LMDS") and 38 GHz wireless communications
systems, 2.8 GHz Wireless Communications Service ("WCS"), FCC Part 15
unlicensed wireless radio devices, and other services that use existing point-
to-point wireless channels on other frequencies. The FCC has announced plans
to hold an auction for LMDS licenses in all markets for the provision of high
capacity, wide-area fixed wireless point-to-multipoint systems. In addition,
the FCC has adopted rules to auction geographical area wide licenses for the
operation of fixed wireless point-to-multipoint communications services in the
38 GHz band, although many 38 GHz licenses have already been issued
nationwide. The LMDS auction is scheduled to begin in February 1998 and the 38
GHz auction is expected to occur later in 1998. The
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MMDS service, also known as "wireless cable," also currently competes for
metropolitan wireless broadband services. At present, wireless cable licenses
are used primarily for the distribution of video programming and have only a
limited capability to provide two-way communications needed for wireless
broadband telecommunications services, but there can be no assurance that this
will continue to be the case. The FCC has initiated a proceeding to determine
whether to provide wireless cable operators with greater technical flexibility
to offer two-way services. Cellular, PCS, CMRS providers may also offer fixed
services over their licensed frequencies. Finally, the FCC has allocated a
number of spectrum blocks for use by wireless devices that do not require site
or network licensing. A number of vendors have developed such devices that may
provide competition to the Company, in particular for certain low data-rate
transmission services.
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 August 1997, the FCC denied the application of Ameritech, the RBOC in
three states where the Company operates, for in-region long distance authority
in Michigan. The Company anticipates that a number of RBOCs, including
Ameritech and Bell Atlantic, will file additional applications for in-region
long distance authority in 1998. However, based on recent public
announcements, the Company does not believe that any RBOC will provide in-
region long distance services prior to 1999. The FCC will have 90 days from
the date an application is filed for in-region long distance authority 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
IXCs 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 ILECs 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 ILECs 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 Bell Atlantic a reasonable
transition to similar commitments. If the Company cannot successfully
negotiate such a transition with Bell Atlantic, 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 customers, 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 customer
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.
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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). The long
distance resale agreements typically require certain annual commitments from
the Company. The inability of the Company to meet its minimum annual
commitments or designated 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
long-distance 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 customer base, any underutilization
charges or rate increases could have a material adverse effect on the
financial condition and results of operations of the Company.
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, including cellular phone service, in the future. 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 cellular 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, if at all, or that prices and
demand in new markets will be at a level sufficient to provide profitable
operations. See "Industry Overview" and "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
issued regulations eliminating this tariffing requirement for all interstate
nondominant carriers, except for, under certain circumstances, the RBOCs.
Those regulations have been stayed on appeal by third parties, and the Company
is currently required to file tariffs with the FCC.
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 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
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which additional competition in local exchange services develops will depend
on a number of factors, including the extent to which each ILEC 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 ILEC 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 ILEC. An
ILEC 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 arbitrate
their negotiations with various RBOCs and GTE Corporation ("GTE") because they
have been unable to reach agreement with those RBOCs and GTE for access and
interconnection to provide competitive local exchange services. In addition,
all negotiated resale and long distance agreements must be submitted to and
approved by the relevant state public service commission. The speed with which
additional 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. If competition in local exchange services develops
slowly, the ability of the Company to compete may be adversely affected.
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 ILECs. In August 1996, the FCC
issued regulations that, among other things, established pricing methodologies
and interim default rates for resold ILEC services and unbundled LEC network
elements. In July 1997, the U.S. Court of Appeals for the Eighth Circuit
struck down certain of the rules (including the provisions establishing
pricing methodologies and default rates for resold services and unbundled
network elements). The appeals court concluded that the Telecommunications Act
granted the states the authority to set the rates for interconnection,
unbundled network elements and resold services and that the FCC therefore
lacked jurisdiction to issue the pricing rules or to preempt state pricing
rules. Although many state commissions followed the FCC's pricing rules prior
to the Eighth Circuit decision and are not likely to repudiate these actions,
carriers seeking entry into the competitive local exchange market have
expressed concern about the lack of uniformity in pricing that may result from
the court's rejection of national pricing rules. The Company cannot predict
the impact of the Eighth Circuit's decision on the Company's operations. In
October 1997, the same court issued an order clarifying that the RBOCs were
not required to rebundle unbundled network elements that competing carriers
had purchased separately. If upheld, this ruling would make it more difficult
for competitors, including the large IXCs, to use rebundled unbundled network
elements or the "UNE Platform" to enter the local exchange market. The FCC,
numerous IXCs and various other parties filed petitions for certiorari with
the U.S. Supreme Court on November 19, 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 or the court appeals
proceedings, 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. 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, federal and state regulation of the
telecommunications industry, competition, and the ability of LECs, including
the RBOCs, to provision the Company's additional customers. Not all of the
foregoing factors are within the control of the Company. In particular, there
can be no assurance that the RBOCs with which the Company has resale
agreements will be able to provision new customers in a timely manner. The
Company's ability to manage growth successfully will
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require the Company to continue to enhance its operational, managerial,
financial and information systems and controls. The Company has modified and
will continue to modify its billing and customer 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 financial
condition and results of operations 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 management, particularly
members of its senior management team. 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 identify, 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 identify, hire and retain such personnel
could have a material adverse effect on the Company's financial condition and
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 financial condition
and results of operations.
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 of the Internal Revenue Code of
1986, as amended (the "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."
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
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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 for the respective the Securities
each Initial Purchaser placed. 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 to seek approval for quotation
through any automated quotation system.
ABSENCE OF DIVIDENDS
The Company has never paid a cash dividend on its Common Stock and does not
anticipate paying any such dividend in the forseeable 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
Indentures include significant limitations on the Company's ability to pay
dividends to the holders of Common Stock. In addition, the terms of the
Company's 9.0% Cumulative Convertible Pay-In-Kind Preferred Stock (the "9%
Preferred Stock"), the Series A Preferred Stock and the Purchase Agreements
(each as defined) entered into in connection with the sale of Common Stock and
Preferred Stock to the Original Purchasers (as defined) 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 Warrants that are outstanding as of October 17, 1997 are
converted or exercised, as the case may be, the Company will have outstanding
13,107,341 shares of Class A Common Stock. All of the shares of Class A Common
Stock issuable upon the conversion of the Convertible Notes (2,892,695 as of
September 30, 1997 and accreting to 3,449,598 from and after September 30,
1999) and the 2,989,840 shares of Class A Common Stock issuable upon exercise
of the 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 7,222,511 shares of Class A Common Stock outstanding as of the date of
this Prospectus are "restricted shares" under the Securities Act and may be
sold only if they are registered or qualify for an exemption from registration
under the Securities Act. In addition, as of the date of this Prospectus, the
Company has outstanding 10,920 shares of 9% Preferred Stock and 30,209 shares
of Series A Preferred Stock, which are convertible into shares and
shares of Class A Common Stock, respectively, at the current conversion ratio,
and options to purchase shares of Class A Common Stock. Pursuant to a
registration rights agreement dated April 20, 1994, as amended and restated on
June 22, 1995, the Company has granted certain registration rights to the
Original Purchasers. See "Certain Relationships and Related Transactions" and
"Registration Rights."
In addition, the Company is obligated, under certain circumstances, to issue
to holders of the Convertible Notes and the 14% Senior Notes contingent
warrants exercisable for Class A Common Stock representing in the aggregate
5.5% of the outstanding Class A Common Stock on a fully diluted basis after
giving effect to the issuance of such warrants. The Company is also obligated
under certain circumstances to issue to holders of the 14 5/8% Senior Notes,
contingent warrants exercisable for Class A Common Stock representing in the
aggregate 5% of the outstanding Class A Common Stock on a fully-diluted basis
after giving effect to the issuance of such warrants. See "Description of
Convertible Notes" and "Certain Other Indebtedness." Pursuant to the terms of
the indentures under which the Company may become obligated to issue the
foregoing contingent warrants, the Company must register such securities for
resale. In connection with the Consent, the Company granted MLAM an option to
purchase Consent Convertible Notes for an aggregate purchase price of $10.0
million. The option was exercised by MLAM on October 24, 1997.
24
<PAGE>
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., Harbourvest Partners
LLC., Northwood Capital Partners LLC, Northwood Ventures LLC, BT Capital
Partners, Inc. and Prime New Ventures (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, MLAM holds
Convertible Notes which were convertible into 2,892,695 shares of Class A
Common Stock as of September 30, 1997 (representing approximately 14% of the
outstanding Common Stock (on a fully diluted basis) as of such date) and will
be convertible into 3,449,598 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 % of the
outstanding Common Stock (on a fully diluted basis) as of the date of this
Prospectus). In addition, MLAM holds the 1996 Initial Warrants and the Consent
Warrants which are currently exercisable for an aggregate of 935,940 shares of
Class A Common Stock, and, in certain circumstances, including the Company's
failure to consummate an initial public offering by a specified date, may be
issued additional warrants to purchase Class A Common Stock. MLAM has also
exercised its option to purchase the Consent Convertible Notes, which will be
convertible into shares of Class A Common Stock.
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 thereof, or, in the case of any such repurchase on or after September
30, 1999, 101% of principal amount at maturity thereof, plus any accrued and
unpaid interest thereon, and Special Interest, if any, to the date of
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 Convertible Notes."
25
<PAGE>
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 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 may 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 Indentures include 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 Series A 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."
26
<PAGE>
CAPITALIZATION
The following table sets forth the total cash and cash equivalents and
capitalization of the Company as of September 30, 1997 and does not give
effect to (i) the sale of Series A Preferred Stock on October 17, 1997, for an
aggregate purchase price of $15.0 million or, (ii) the exercise by MLAM of its
option to purchase Consent Convertible Notes. This table should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and
related notes thereto included elsewhere in this Prospectus. See "Description
of Securities."
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30,
1997
-------------
<S> <C>
Cash and cash equivalents........................................ $ 117,944
=========
Long term liabilities
14 5/8% Senior Discount Notes due 2004.......................... 101,830
14% Senior Discount Notes due 2003.............................. 34,580
9% Convertible Subordinated Discount Notes due 2004............. 30,188
Notes payable and capital lease obligations..................... 689
---------
Total long term debt......................................... 167,287
Redeemable Preferred Stock
9% Preferred Stock, par value $1.00 per share, 30,000 shares
authorized; 10,920 shares issued and outstanding; liquidation
value $1,000 per share......................................... 11
9% Preferred Stock, Series A, par value $1.00 per share, 150,000
shares authorized, 30,209 shares issued and outstanding;
liquidation value $1,000 per share............................. 30
Accumulated unpaid dividends.................................... 317
Additional paid-in capital...................................... 40,691
---------
Total Preferred Stock........................................ 41,049
Common stockholders' deficit:
Class A Common Stock, $.01 par value, 30,000,000 shares
authorized, 7,222,511 shares issued and outstanding(/1/)....... 72
Class A Common Stock held in treasury........................... (1)
Additional paid-in capital...................................... 73,942
Accumulated deficit............................................. (132,441)
---------
Total common stockholders' deficit........................... (58,428)
---------
Total capitalization....................................... $ 149,908
=========
</TABLE>
- --------
(1) Excludes (i) 3,421,160 shares reserved for issuance upon exercise of
options; (ii) 2,989,840 shares reserved for issuance upon exercise of
outstanding warrants; (iii) 738,010 shares reserved for issuance upon
conversion of the 9% Preferred Stock; (iv) 3,432,350 shares reserved for
issuance upon conversion of the Series A Preferred Stock; and (v)
2,892,695 shares reserved for issuance upon conversion of the Convertible
Notes, respectively. No shares have been reserved for issuance upon
conversion of the Consent Convertible Notes.
27
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 for the
periods ending December 31, 1994, 1995 and 1996 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 selected financial data as of and for the nine-month periods
ending September 30, 1996 and 1997, respectively, are derived from, and should
be read in conjunction with, the unaudited financial statements of the Company
and the related notes thereto included elsewhere in this Prospectus. In the
opinion of management, such interim financial statements reflect all
adjustments (consisting solely of normal recurring adjustments) necessary to
fairly present the information presented for such periods. 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. Results of operations for the nine months ended September 30, 1997
are not necessarily indicative of results of operations for a full year or
indicative of future periods.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
INCEPTION TO ---------------------- ------------------------
DECEMBER 31, UNAUDITED
1994 1995 1996 1996 1997
------------- ------------ --------- --------- -------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net service revenue.... $ 1,737 $ 7,884 $ 9,814 $ 7,599 $ 26,998
Cost of services....... 1,455 9,076 9,256 6,587 23,983
--------- --------- --------- --------- ---------
Gross margin........... 282 (1,192) 558 1,012 3,015
Sales and marketing
expense............... 2,869 5,867 12,612 5,837 43,087
General and
administrative
expense............... 4,686 11,100 20,665 10,920 26,882
Interest expense....... 26 734 1,797 46 8,573
Interest and other
income (1)............ 152 646 9,469 8,572 1,889
Minority interest...... -- 150 -- -- --
--------- --------- --------- --------- ---------
Net loss............... $ (7,147) $ (18,097) $ (25,047) $ (7,219) $ (73,638)
========= ========= ========= ========= =========
Accumulated preferred
dividends............. $ 707 $ 3,103 $ 3,691 $ 3,466 $ 1,012
Net loss to common
shareholders.......... $ (7,854) $ (21,200) $ (28,738) $ (10,685) $ (74,650)
Net loss per common
share................. $ (6.56) $ (7.01) $ (5.63) $ (2.44) $ (10.35)
Weighted average shares
outstanding........... 1,196,780 3,025,200 5,102,330 4,384,993 7,212,511
OTHER DATA:
EBITDA (2)............. $ (7,087) $ (15,901) $ (30,390) $ (14,386) $ (64,429)
Cash flows from
operating activities.. (6,141) (14,308) (24,098) (14,092) (57,822)
Cash flows from
investing activities.. (1,708) (2,556) 7,274 7,647 (10,071)
Cash flows from
financing activities.. 13,828 24,589 63,689 64,157 125,018
Depreciation and
amortization.......... 186 2,258 2,329 1,360 2,525
Capital expenditures... 1,728 1,740 2,259 285 10,071
Ratio of earnings to
fixed charges (3)..... -- -- -- -- --
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------------------ ------------------------
UNAUDITED
1994 1995 1996 1996 1997
------------- ------------ --------- --------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents........... $ 5,979 $ 13,705 $ 60,569 $ 71,390 $ 117,944
Total assets........... 12,747 20,471 78,052 88,083 179,157
Long-term debt (net of
current maturities)... 3,176 518 59,864 58,352 167,287
Redeemable preferred
stock................. 15,306 44,396 10,045 9,853 41,049
Common stockholders'
equity (deficit)...... (7,830) (28,768) (3,606) 14,022 (58,428)
<CAPTION>
AS OF AS OF AS OF AS OF AS OF
SEPTEMBER 30, DECEMBER 31, MARCH 31 JUNE 30, SEPTEMBER 30,
1996 1996 1997 1997 1997
------------- ------------ --------- --------- -------------
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Local access line sold. 4,630 10,283 35,397 79,321 135,172
Local access lines in
service............... 4,356 8,364 18,557 65,142 116,591
Total employees........ 225 464 641 766 868
Direct salesforce...... 81 206 252 325 325
</TABLE>
- --------
(1) Interest and other income for the year ended December 31, 1996 and the nine
months ended September 30, 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 (loss) 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 a measure commonly used in the
telecommunications industry and is presented to assist in understanding the
Company's operating results and as a 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 $7.1 million, $17.4 million and $23.2
million, respectively and for the nine-month period ended September 30,
1996 and 1997 by $7.2 million and $65.1 million, respectively.
28
<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
Initially, the Company entered the local telecommunications market as a
facilities-based CLEC 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. As part of the Company's strategy to refocus
its operations, 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").
The Company negotiated for the first total service resale agreement with
Ameritech for local services, which was signed in November 1995, and
negotiated with NYNEX for a similar comprehensive local resale agreement which
was signed in July 1996. The Company also executed various other agreements in
1996 and 1997 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,
through an increase in its customer base and product offerings, 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 capital contributions, sales of
preferred stock and by the proceeds from private placements of its debt
securities.
In connection with the 1997 Private Placement, MLAM, the current beneficial
holders of all of the 14% Senior Notes and Convertible Notes consented to the
amendment of the 14% Senior Note Indenture and the Convertible Note Indenture
to allow the Company to consummate the 1997 Private Placement. In connection
with the Consent, the Company paid a consent fee to MLAM consisting of
warrants to purchase 145,160 shares of Common Stock, at an exercise price of
$.01 per share. The Company also granted to MLAM an option to purchase the
Consent Convertible Notes, which have terms substantially similar to the
Convertible Notes, for an aggregate purchase price of $10.0 million. The
option was exercised by MLAM on October 24, 1997. Additionally, the Company
granted to holders of the 14% Senior Notes an option, for a specified period
of time, to exchange all, but not less than all, of the 14% Senior Notes for
14 5/8% Senior Notes having an accreted value equal to the accreted value of
such 14% Senior Notes at the time of such exchange.
The Company's net service revenue consists primarily of sales revenue from
telecommunications resale services net of certain adjustments, including
unbillable call records. The Company bills its customers for local and long
distance usage based on the type of local 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.
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 and special regional calling plans.
29
<PAGE>
Sales and marketing expense consists of the costs of providing sales and
other support services for customers including salaries of salesforce
personnel. 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 bad debts, customer allowances and
all amortization expenses. Depreciation is allocated throughout sales,
marketing, general and administrative expense based on asset ownership.
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 added over 250 employees
in 1996 and over 385 employees in the first nine months of 1997. Also, the
Company is implementing new information systems that will provide improved
recordkeeping for customer information and management of uncollectible
accounts and fraud control.
The Company has to date outsourced certain billing services to two outside
vendors. The significant growth experienced by the Company over the past year
has strained the capabilities of the Company's internal billing systems and
those of the billing vendor supporting the sales pursuant to the Ameritech
resale agreements. As a result, the Company has experienced delays in
accurately billing its customers in a timely manner and instances of toll
fraud. Therefore, the Company's revenue assurance and margin utilization
systems and operating controls are being strengthened. Gross margins will be
lower than originally anticipated for 1997 and estimated bad debt provisions
and customer allowances will be higher than expected as a percent of revenue,
since some billings from carriers may not be billed to customers.
As a result of evaluating the capabilities of the Company's two billing
vendors to support the anticipated growth of the Company, a decision was made
to transition to a single vendor that has the strongest current capabilities
and the best potential to support the expansion and related increased number
of customers and access lines of the Company. The Company selected the billing
vendor that has supported its sales pursuant to the NYNEX resale agreement for
the past two years. The transition to a single vendor is expected to be
completed during the fourth quarter of 1997.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September
30, 1996
Net service revenue increased 255% to $27.0 million for the nine months
ended September 30, 1997 from $7.6 million for the nine months ended September
30, 1996. The number of local access lines sold in the third quarter of 1997
was 55,851 and cumulative access lines sold at September 30, 1997 were
135,172. The number of local access lines provisioned in the third quarter of
1997 was 51,449 and cumulative access lines provisioned as of September 30,
1997 were 116,591. The substantial increases in net service revenue and local
access lines were due primarily to the significant change in the Company's
business strategy and the corresponding deployment of a large direct sales
organization. This business strategy change has resulted in an almost nine-
fold increase in the subscriber base in the Company's geographic markets (from
approximately 1,400 customers at September 30, 1996 to approximately 12,000
customers at September 30, 1997).
Gross profit for the nine months ended September 30, 1997 increased 198% to
$3.0 million compared to $1.0 million for the nine months ended September 30,
1996. Due to the significant change in the Company's business strategy and the
corresponding change in cost structure from the original facilities-based
business, the year to year gross margins are not comparable. As noted above,
consolidated gross margins are expected to continue to improve each quarter
primarily as revenue assurance and margin utilization systems and operating
controls are being strengthened, as described above, and as the mix of
revenues from higher margin products increases and the mix of revenue from the
lower margin legacy products decreases. In addition, the Company has continued
to negotiate price reductions with its carriers, the full impact of which is
not yet fully reflected in the results of operations.
30
<PAGE>
Sales and marketing expenses increased $37.3 million from $5.8 million for
the nine months ended September 30, 1996 to $43.1 million for the nine months
ended September 30, 1997. The increase was due primarily to the substantial
increase in the number of sales and marketing employees from approximately 130
at September 30, 1996 to approximately 530 at September 30, 1997. The higher
headcount resulted in increases to salaries and benefits of approximately
$22.6 million, recruitment, training and travel costs of approximately $5.7
million, and facility and office related expenses of approximately $3.3
million. Additionally, advertising and promotional costs increased
approximately $4.3 million due to product launches in the Company's target
markets.
General and administrative expenses increased $16.0 million to $26.9 million
for the nine months ended September 30, 1997 versus $10.9 million for the nine
months ended September 30, 1996. The increase was due primarily to the
substantial increase in the number of operations and administrative employees
from approximately 90 at September 30, 1996 to over 320 at September 30, 1997.
The higher headcount resulted in increases to salaries and benefits of
approximately $7.3 million, facility and office costs of approximately $1.4
million, and recruitment, training and travel costs of approximately $1.6
million. Professional fees increased approximately $1.2 million, primarily
relating to the development and expansion of the Company's customer service,
billing and administrative information systems and facilities. Billing costs
increased approximately $1.6 million in correlation with increased revenue.
Additionally, as noted above, the Company recorded a charge of $2.8 million in
the third quarter of 1997 for estimated additional provisions for bad debts
and customer allowances to cover instances of toll fraud and other matters.
Interest and other income decreased to $1.9 million for the nine months
ended September 30, 1997 from $8.6 million for the nine months ended September
30, 1996 due primarily to an $8.1 million non-recurring gain on the sale of
the Company's switching facilities in Ohio in February 1996, which was
somewhat offset by the additional interest income earned on the higher average
cash balance.
Interest expense increased to $8.6 million for the nine months ended
September 30, 1997 from $46,000 for the nine months ended September 30, 1996.
This increase was due primarily to interest expense attributable to the 14%
Senior Notes and 9% Convertible Notes issued in September 1996 and 14 5/8%
Senior Notes issued in August 1997.
As a result of the factors described above, the Company had a net loss of
$73.6 million for the nine months ended September 30, 1997 compared to a net
loss of $7.2 million for the nine months ended September 30, 1996.
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 customer
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 consisted
of commissions earned from carriers on telecommunications services provided to
their customers. Approximately $1.4 million in increased revenues was
attributable to the addition of new customers, primarily in Ohio, and
approximately $0.5 million was 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.
31
<PAGE>
Sales and marketing expense 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 expense 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 information systems
and facilities. Amortization expense increased $0.8 million due primarily to a
full year of amortization expense related to the Quest Acquisition in 1996
versus approximately 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 $0.6 million 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.
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 Compared to 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 customer 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 customers.
Sales and marketing expense 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 was 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 expense 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 was 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
information systems and office facilities.
Interest and other income increased to $0.6 million in fiscal 1995 from $0.2
million 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.
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Interest expense increased to $0.7 million 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.
As a result of the factors described above, the Company's net loss increased
to $18.1 million for fiscal 1995 from $7.1 million for fiscal 1994.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has funded its operations primarily through
cash from its investors and private placements of debt securities. As of
September 30, 1997, the Company had cash and cash equivalents of $118.0
million and working capital of $104.8 million. The Company's operating
activities utilized cash of approximately $57.8 million for the nine month
period ended September 30, 1997, versus $14.1 million for the nine month
period ended September 30, 1996.
The Company's investing activities in 1997 have consisted primarily of
property and equipment purchases of $10.1 million for the nine month period
ended September 30, 1997, primarily related to sales office expansion in
several of the Company's target markets. In the fourth quarter of 1997, the
Company anticipates spending approximately $5.0 million for capital
expenditures, a substantial portion of which has been allocated to investments
in information technology to support the growth of the customer base with more
robust provisioning, billing and customer care systems. The anticipated
continued high growth in the customer base in 1998 will require a similar
level of investment in information technology. In 1996, the Company's
investing activities consisted of $9.5 million in proceeds received in
February 1996 from the December 1995 sale of facilities in Ohio, partially
offset by a $1.6 million purchase of the remaining minority interest of a
subsidiary in the third quarter 1996 and capital expenditures of $0.3 million
for the nine month period ended September 30, 1996.
The Company's financing activities generated $125.0 million for the nine
months ended September 30, 1996. On August 18, 1997, the Company raised $30.2
million through the sale of its Series A Preferred Stock. Also on August 18,
1997, the Company raised $96.5 million of net proceeds through the 1997
Private Placement. Additionally, on October 17, 1997, the Company issued and
sold Series A Preferred Stock for an aggregate purchase price of $15.0 million
pursuant to agreements contemplated by a letter of intent dated August 6,
1997.
The Company's financing activities generated $64.2 million for the nine
months ended September 30, 1996. On September 30, 1996, the Company raised
$10.0 million through the sale to the Original Purchasers of its 9% Preferred
Stock. Also on September 30, 1996, the Company raised approximately $55.0
million, net of issuance costs, through the sale to MLGAFI of (i) 48,500 Units
consisting of $48.5 million in aggregate principal amount at maturity of 14%
Senior Notes and the 1996 Warrants and (ii) $36.0 million in aggregate
principal amount at maturity of Convertible Notes. The aggregate purchase
price of the Units was $30.2 million, and the aggregate purchase price of the
Convertible Notes was $27.6 million. In 1995 and 1994, the Company's financing
activities consisted primarily of raising capital in the form of equity
investments from 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.
The Company anticipates that it may require additional capital in future
periods in order to meet planned capital expenditures and anticipated negative
operating cash flow. Sources of funding for the Company's future financing
requirements may include public offerings or private placements of equity
and/or debt securities and additional capital contributions from new or
existing stockholders. An additional source may include bank financing,
although the Company currently does not have available a credit facility.
There can be no assurance that additional financing will be available to the
Company, or, if available, that it can be obtained on a timely basis and on
terms acceptable to the Company and within limitations contained in the Senior
Note Indentures. Failure to obtain such financing could result in the delay or
abandonment of the Company's development and expansion plans.
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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-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.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share", which
simplifies the method for computing earnings per share. Under the new
requirements, primary earnings per share will be replaced with basic earnings
per share. The statement, which will not impact the results of operations,
financial position or cash flows of the Company and does not have a material
effect on the earnings per share previously presented, is effective for
financial statements issued for periods ending after December 15, 1997 and
will be adopted by the Company in the fourth quarter of 1997.
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INDUSTRY OVERVIEW
Prior to 1984, AT&T dominated both the local exchange and long distance
marketplace by owning the operating entities that provided both local exchange
and long distance services to most of the U.S. population. While long distance
competition began to emerge in the late 1970s, the critical event triggering
the growth of long distance competition was the breakup of AT&T and the
separation of its local and long distance businesses as mandated by the
Modified Final Judgment relating to the breakup of AT&T (the "MFJ"). To foster
competition in the long distance market, the MFJ prohibited AT&T's divested
local exchange businesses, the RBOCs, from acting as a single source provider
of telecommunications services.
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 affects 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
ILEC 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
(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 such as the Company, provide expanded
service offerings and increased levels of customer service.
Industry sources estimate that in 1996 the total revenues from local and
long distance telecommunications services were approximately $185 billion, of
which approximately $107 billion were derived from local exchange services and
approximately $78 billion from inter-LATA long distance services. According to
FCC information, aggregate revenues for local and long distance services grew
at a compounded annual rate of approximately 5.5% between 1991 and 1996.
Although the MFJ established the preconditions for competition in the market
for long distance services in 1984, the market for local exchange services has
until recently been virtually closed to competition and has largely been
dominated by regulated monopolies. Efforts to open the local exchange market
began in the late 1980s on a state-by-state basis when competitive access
providers ("CAPs") began offering dedicated private line transmission and
access services. These types of services together currently account for
approximately 12% of the total local exchange revenues. CAPs were restricted,
often by state laws, from providing the other, more frequently used services
such as basic and switched services, which today account for approximately 88%
of local exchange revenues.
The Telecommunications Act further increases the opportunities available to
competitive local providers by requiring the RBOCs and other ILECs to offer
various network elements such as switching, transport and loops (i.e., the
facilities connecting a customer'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
competitive local carriers who develop 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 customer in the United States.
The Company believes that carriers such as the Company providing competitive
local exchange services have the opportunity to gain market share in the local
exchange market just as long distance competitors gained market share from
AT&T in the long distance market. In addition, competitors, including the
Company and major IXCs, will be able to take advantage of the unbundling and
resale requirements imposed on the RBOCs and other ILECs under the
Telecommunications Act, thereby accelerating entry of competitors that
previously have not invested in local distribution facilities.
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BUSINESS
INTRODUCTION
USN is one of the fastest growing CLECs in the United States. The Company
offers a bundled package of telecommunications products, including local and
long distance telephony, voice mail, paging, teleconferencing, Internet access
and other enhanced features, tailored to meet the needs of its customers. The
Company primarily targets small and medium-sized businesses with
telecommunications usage of less than $5,000 per month. The Company's strategy
is to continue to increase its customer base by being more flexible,
innovative and responsive to the needs of its target customers than the RBOCs
and the first-tier IXCs, which have historically concentrated their sales and
marketing efforts on residential and large business customers. The Company
primarily differentiates itself with a value-based marketing strategy by
providing an integrated, customized package of telecommunications services on
a single bill and responsive customer care.
The Company is presently providing service to customers in certain states in
the NYNEX region (New York and Massachusetts) and the Ameritech region
(Illinois, Ohio and Michigan) and is currently in negotiations to expand its
bundled services offering throughout the 14-state Bell Atlantic/NYNEX region
and the 5-state Ameritech region. Management anticipates implementing service
in at least six additional states by the end of 1998. In August 1997, NYNEX
merged with Bell Atlantic. The Company continues to operate in the former
NYNEX regions, which are now a part of the Bell Atlantic territory.
During the first nine months of 1997, the Company increased aggregate local
access lines sold from 10,283 lines to 135,172 lines, a compound growth rate
of more than 33% per month, including the sale of 55,851 lines in the third
quarter alone. As of September 30, 1997, the Company had 116,591 access lines
in service, including 51,449 lines which were provisioned in the third
quarter. Services are primarily marketed through an approximately 325 member
direct salesforce in 27 offices located in five states. As part of its
customer-focused product offering, the Company provides personalized customer
service, 24 hours a day, 365 days per year, through its two regional customer
care centers.
COMPETITIVE ADVANTAGES
Providing local exchange services is a highly complex process that requires
overcoming significant barriers to entry. Since inception, the Company has
spent significant time, resources and capital to enter the local market. In
the process, it has gained substantial experience in this complicated market
segment. Consequently, the Company believes it has the following competitive
advantages:
. COMPLEMENTARY RELATIONSHIPS WITH RBOCS. The Company believes that the RBOCs'
networks will continue to be the predominant means for providing local
telecommunications services to the Company's target customers for the
foreseeable future. Accordingly, the Company has positioned itself to take
advantage of the opportunities created by the Telecommunications Act by
leveraging its complementary relationships with the RBOCs. The
Telecommunications Act requires the RBOCs to complete a number of
"checklist" items in order to qualify for long distance entry in their local
service areas. By moving aggressively to enter into resale agreements and to
develop electronic interfaces with the RBOCs, the Company believes it has
positioned itself to play a key role in enabling the RBOCs to meet a number
of those requirements. The Company was the first to enter into comprehensive
resale agreements with Ameritech and NYNEX, served as the systems beta
customer for Ameritech, NYNEX and Bell Atlantic and is currently one of the
largest CLECs in terms of access lines in service in the Ameritech and NYNEX
markets. Consequently, the Company is often requested by state and federal
regulators to provide information on the Company's experiences. The Company
believes its complementary relationships with the RBOCs have facilitated the
Company's rapid growth in its existing markets and enabled it to become a
valuable and viable resale channel partner. The Company further believes,
based on discussions with RBOC officials and industry experts, that the
RBOCs will continue to develop strong resale channel partners in an effort
to mitigate the potential negative effects of facilities-based competition.
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. UNIQUE RESALE AGREEMENTS. The Company has executed comprehensive local
exchange resale agreements with Ameritech for the greater metropolitan
Chicago area, Ohio and Michigan, and with NYNEX for the State of New York.
In addition to the cost advantages associated with the term and volume
commitment contracts, these contracts provide "most favored nation" and
other pricing protections designed to maintain the
competitiveness of rates and position the Company to purchase capacity at
rates at least as favorable as those of other potential resellers of
Ameritech and NYNEX local services. In addition, the Company has executed
interim resale agreements with Ameritech for the State of Wisconsin and with
NYNEX for the State of Massachusetts. The Company is currently in
negotiations to expand its resale agreements throughout the 14-state combined
Bell Atlantic/NYNEX region and the 5-state Ameritech region. In advance of
completing these negotiations, the Company plans to enter certain additional
states by reselling local services pursuant to state-mandated wholesale
discounts. The Company estimates, based on data compiled by the FCC, that the
regions covered by the current comprehensive Ameritech and NYNEX resale
agreements include access to over 10 million business access lines.
Management believes that upon expansion into the remaining Bell
Atlantic/NYNEX region and the Ameritech region, the Company will have access
to approximately 20 million business access lines. The Company continuously
evaluates opportunities to enter into agreements with additional RBOCs and
other local and long distance providers and enhanced and other value-added
service providers in order to aggressively build its customer base as well as
to provide additional services to its existing customers while reducing
costs.
. PROPRIETARY ELECTRONIC PROVISIONING AND INTERFACE SYSTEMS. By serving as the
systems beta customer for Ameritech, NYNEX and Bell Atlantic, the Company
was among the first CLECs to develop electronic provisioning systems for
resale of RBOC services. Development of provisioning systems is critical for
carriers seeking to grow rapidly in the complex, competitive local
telecommunications market. These systems must address the numerous technical
configurations associated with local service, including correctly coding
customers into data bases for 911, 411, white pages and customer service, as
well as provisioning thousands of local services, known as universal service
ordering codes ("USOCs"). Electronic provisioning between the Company and
its RBOC vendors allows the Company to provision a significantly greater
volume of lines than would be possible if transmitting orders by mail or
facsimile. Moreover, because the proprietary systems developed by the
Company lessen manual input and reduce repetitive data entry, the Company
experiences improved efficiency and accuracy in transmitted orders, thereby
reducing costs and increasing customer satisfaction. The Company believes it
has established an industry leadership position in the deployment of these
systems, and it is committed to their continuous improvement.
. LARGEST DIRECT SALESFORCE AMONG CLECS IN ITS MARKETS. The Company's services
are currently sold through an approximately 325 member direct salesforce,
located in 27 offices in Illinois, Ohio, Michigan, New York and
Massachusetts. Additionally, the Company intends to hire approximately 175
new sales people over the next 12 months to expand service in the Ameritech
and combined Bell Atlantic/NYNEX regions. The Company primarily recruits
salespeople with experience in selling competitive telecommunications
services to businesses in the markets where they are based. The Company's
salesforce is trained in-house with a rigorous customer-focused training
program that promotes activity-based selling. Salespeople are given an
incentive through a commission structure, with a target of 50% of a
salesperson's compensation based on performance. The Company believes its
large, experienced, face-to-face salesforce has been, and will continue to
be, vitally important to expanding its customer base in today's highly
competitive telecommunications industry environment.
. STRATEGIC FLEXIBILITY. The Company believes that its business strategy
affords it more flexibility to take advantage of regulatory and industry
dynamics than its facilities-based competitors. For example, the FCC's
position on unbundled network elements has evolved to the point where
competitors are now able to purchase on an economic basis unbundled network
elements from the RBOCs and rebundle them into an alternative local service
option. The Company expects to exploit this opportunity by rebundling
network elements, thus expanding its products offering and improving its
strategic position. In addition, the increased construction by facilities-
based CLECs has improved the value of the Company's services by creating
alternative resale partners other than RBOCs. The Company is currently
evaluating proposals from facilities-based CLECs to provision local service.
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GROWTH STRATEGY
The Company's objective is to be a leading provider of integrated local and
long distance services and other telecommunications products to small and
medium-sized businesses in its target markets. The Company expects to achieve
this goal through the successful implementation of its growth strategy which
includes the following:
. PROVIDE AN INTEGRATED TELECOMMUNICATIONS SOLUTION. A key element in building
its customer base while minimizing churn has been, and will continue to be,
the implementation of a marketing and operating strategy which emphasizes an
integrated telecommunications solution to its target market. To a large
extent, the Company's target customers have not previously been provided the
opportunity to purchase bundled services. The Company attracts and retains
customers by combining responsive customer care with a pricing package to
provide high-quality service at a cost which is usually afforded to only
large business customers. Specifically, the Company provides a single source
and bill for integrated local and long distance telephony, voicemail, paging,
teleconferencing, Internet access and other enhanced and value-added
telecommunications services, with a single point of contact for customer
service, product inquiries, repairs and billing questions. Based on its
experience, the Company believes that this marketing and customer service
approach has minimized customer acquisition costs and churn.
. FOCUS ON LARGE, UNDERSERVED MARKET. The Company utilizes a direct sales
approach and primarily focuses its marketing efforts on small and medium-
sized businesses with telecommunications usage of less than $5,000 per month.
The Company believes this target market is best served by a direct sales
approach because most of these customers do not employ in-house
telecommunications specialists and in most cases obtain services from various
vendors. The Company's experience indicates that these customers prefer a
single source for all their telecommunications requirements, including
products, billing and service. The Company believes that its gross margins on
services provided to its target market are generally higher than for larger
business customers. Since the RBOCs and the first-tier IXCs primarily
concentrate their sales and marketing efforts on residential and large
business customers, the Company will continue to focus its marketing on this
underserved market to rapidly expand its customer base.
. LEVERAGE UBIQUITOUS NETWORKS. The Company believes that a key factor in its
success has been its ability to provide through the RBOC networks the
complete range of local services currently provided by RBOCs across their
entire service territories. There is currently no competing network with the
product breadth, capacity and geographic reach of the RBOC networks. By
contrast, facilities-based CLECs are currently limited primarily to servicing
customers in areas where they have network facilities.
. RAPID MARKET ENTRY. The Company believes its ability to enter a market early
and provide ubiquitous service will continue to allow it to rapidly build a
customer base across a large geographic area prior to the lifting of
regulatory restrictions on the ability of first-tier IXCs and RBOCs to offer
integrated services. Based on recent public announcements, the Company does
not believe that any RBOC will provide in-region long distance services prior
to 1999. As a non-facilities based provider, the Company believes it is able
to build a customer base quickly and efficiently without incurring
significant costs and the developmental delays inherent in constructing
network and transmission facilities. In addition, the Company's proprietary
software interface systems facilitate its rapid customer acquisition strategy
by allowing it to provision high volumes of access lines.
. EXPAND LOCAL SERVICES. The Company plans to expand its local services
offering, positioning it to offer a full range of local services over a broad
geographic area at a competitive cost, by: (i) entering into term and volume
resale agreements in new territories with RBOCs; (ii) entering into resale
agreements with one or more facilities-based CLECs; (iii) rebundling network
elements from RBOCs; and (iv) reselling local service in new territories
pursuant to state-mandated wholesale discounts prior to entering into resale
agreements with RBOCs and/or facilities-based CLECs in such territories. The
Company believes, based on its experience and industry analysts' reports, as
well as recent regulatory and industry developments, that RBOCs have an
incentive to continue to negotiate wholesale agreements with respect to small
and medium-sized businesses to stabilize this revenue base and deter
migration of such customers to RBOCs' facilities-based competitors. The
Company also believes that its demonstrated sales and provisioning expertise
is attractive to facilities-based CLECs which may not be having similar
success.
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SALES AND MARKETING
The Company's customers 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 IXCs 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 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
customer support, competitive product and pricing packages and a targeted
sales and marketing strategy. The Company had in excess of 12,000 customers as
of September 30, 1997.
The Company's services are currently sold through an approximately 325
member direct salesforce, located in 27 offices in Illinois, Ohio, Michigan,
New York and Massachusetts. The sales personnel make direct calls to
prospective and existing customers to outline the range of services offered
and discuss the benefits of the Company's integrated service offerings,
enhanced customer care and potential savings. The Company is planning to
supplement its direct sales organization with outbound telemarketing and
indirect sales efforts. The Company believes this marketing approach will
increase market coverage and reduce marketing and customer acquisition costs.
The Company has recruited and continues to recruit a direct salesforce in
each of the markets in which it operates. The Company primarily recruits
salespeople with experience in selling competitive telecommunications services
to businesses in the markets where they are based. The Company's salesforce is
trained in-house with a rigorous customer-focused training program that
promotes activity-based selling. The salesforce makes calls to prospective
customers from potential customer 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.
CUSTOMER CARE
The Company maintains an emphasis on customer care to differentiate itself
from its competitors and reduce churn. By providing each customer with an
account representative, the Company is able to provide ongoing personalized
contact to address the clients' needs. In addition, the Company has
established a 24-hours-per-day, 365-days-per-year, customer care center to
facilitate customer care and customer service requests. At the Company's
customer care centers, customers' calls are answered by experienced customer
care representatives, many of whom are cross-trained in the provisioning
process. The Company believes that the superior customer service, face-to-face
sales process and integrated service offering provide the Company with a
competitive advantage over the existing local service providers.
MANAGEMENT INFORMATION SYSTEMS
The Company is committed to the continued development and successful
implementation of billing and customer care systems that provide accurate and
timely information to both the Company and its customers. The proprietary
electronic 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. Provisioning of service to customers is
accomplished through the Company's proprietary systems, which are designed to
interface with the RBOCs' systems through a variety of delivery mechanisms.
The Company believes this method of development has been, and will continue to
be a critical element to successfully providing local telecommunications
services and provides the Company with a competitive advantage, as the RBOCs
have an economic and strategic incentive to work with resellers that have
sophisticated information systems that can electronically interface with the
RBOCs' systems. The Company's experience in developing these systems allows it
to offer services quickly in new markets. The customer care systems have been
developed and continue to be enhanced in a client/server environment allowing
for flexibility to accommodate an expanding customer base, efficient entry
into new markets and rapid development of additional functionality.
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The Company's billing systems are designed to provide access to a broad range
of information on individual customers, including their call volume, patterns
of usage and billing history. This same information is used by the Company to
identify customer trends and will allow for proactive support of the Company's
marketing efforts.
The Company currently outsources the rating, printing and mailing of customer
bills. Since these functions require a high volume of processing in a limited
time frame, the Company has determined that currently the most economical way
to process bills is to outsource this function. The customer 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
customer. Standard management reports are generated for every billing cycle.
VENDOR AGREEMENTS
Introduction
The Company has executed comprehensive local exchange resale agreements with
Ameritech for the greater metropolitan Chicago area, Ohio and Michigan, and
with NYNEX for the State of New York. In addition, the Company has executed
interim resale agreements with Ameritech for the State of Wisconsin and with
NYNEX for the State of Massachusetts. The Company estimates, based on data
compiled by the FCC, that the regions covered by the current comprehensive
Ameritech and NYNEX resale agreements include access to over 10 million
business access lines. Management believes that upon expansion in the remaining
Bell Atlantic/NYNEX region and the Ameritech region, the Company will have
access to approximately 20 million business 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 customer base as well as to
provide additional services to its existing customers while reducing costs.
The Company currently has a long distance resale agreement with MCI. Such
agreement allows the Company to offer its customers integrated local and long
distance telecommunications services. In addition, such agreement has 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 may eventually negotiate
a resale agreement. The level 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
customers, 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 an 18 month
"ramp up" period which gives the Company
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the ability to build its customer 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, the Company is subject
to a termination charge.
NYNEX Resale Agreement
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 trial period and ramp-up period, the
Company is subject to an underutilization charge. However, the New York 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. Although there can be no assurance, 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.
Long Distance Agreements
The Company has an agreement with MCI pursuant to which MCI provides a wide
range of long distance telecommunications services to the Company's 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 long distance carrier agreement 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. The agreement provides for an annual commitment for
each of the remaining two years of the contract term. 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 has agreements to offer on a resale basis enhanced and other
value-added services such as Internet access and paging. 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.
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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 continue to intensify in the future due to
regulatory changes, including the continued implementation 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.
Additionally, the long distance market is already significantly more
competitive than the local exchange market, because the ILECs, including the
RBOCs, have historically had a monopoly position within the local exchange
market.
In the local exchange market, the Company also faces competition or
prospective competition from one or more CLECs, many of which have
significantly greater financial resources than the Company, and from other
competitive providers, including some non-facilities-based providers like the
Company. For example, AT&T, MCI and Sprint, among other carriers, have each
begun to offer local telecommunications services in major U.S. markets using
their own facilities or by resale of the ILECs' or other providers' services.
In fact, certain competitors, including AT&T, MCI and Sprint, have entered
into interconnection agreements with Ameritech with respect to the States of
Illinois, Michigan and Ohio. These competitors either have begun or in the
near future likely will 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 near
future likely will begin offering local exchange service in those states,
subject to such joint marketing restrictions. In addition to these long
distance service providers, entities that currently offer or are potentially
capable of offering switched services include CLECs, cable television
companies, electric utilities, other long distance carriers, microwave
carriers, wireless telephone system operators and large customers who build
private networks. Many facilities-based CLECs and long distance carriers, for
example, have committed substantial resources to building their networks or to
purchasing CLECs or IXCs with complementary facilities. By building or
purchasing a network or entering into interconnection agreements or resale
agreements with ILECs, including RBOCs, a facilities-based provider can offer
single source local and long distance services similar to those offered by the
Company. Such additional alternatives may provide such competitors with
greater flexibility and a lower cost structure than the Company. In addition,
some of these CLECs and other facilities-based providers of local exchange
service are acquiring or being acquired by IXCs that are not subject to joint
marketing restrictions. These combined entities may provide a bundled package
of telecommunications products, including local and long distance telephony,
that is in direct competition with the products offered by the Company.
With respect to wireless telephone system operators, the FCC has authorized
cellular, personal communications service, and other CMRS providers to offer
wireless services to fixed locations, rather than just to mobile customers, 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.
The Company will also face competition from other fixed wireless services,
including MMDS, LMDS and 38 GHz wireless communications systems, WCS, FCC Part
15 unlicensed wireless radio devices, and other services that use existing
point-to-point wireless channels on other frequencies. The FCC has announced
plans to hold an auction for LMDS licenses in all markets for the provision of
high capacity, wide-area fixed wireless point-to-multipoint systems. In
addition, the FCC has adopted rules to auction geographical area wide licenses
for the operation of fixed wireless point-to-multipoint communications
services in the 38 GHz band, although many 38 GHz licenses have already been
issued nationwide. The LMDS auction is scheduled to begin in February 1998 and
the 38 GHz auction is expected to occur later in 1998. The MMDS service, also
known as
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"wireless cable," also currently competes for metropolitan wireless broadband
services. At present, wireless cable licenses are used primarily for the
distribution of video programming and have only a limited capability to
provide two-way communications needed for wireless broadband
telecommunications services, but there can be no assurance that this will
continue to be the case. The FCC has initiated a proceeding to determine
whether to provide wireless cable operators with greater technical flexibility
to offer two-way services. Cellular, PCS and other mobile service providers
may also offer fixed services over their licensed frequencies. Finally, the
FCC has allocated a number of spectrum blocks for use by wireless devices that
do not require site or network licensing. A number of vendors have developed
such devices that may provide competition to the Company, in particular for
certain low data-rate transmission services.
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 August 1997, the FCC denied the application of Ameritech, the RBOC in
three states where the Company operates, for in-region long distance authority
in Michigan. The Company anticipates that a number of RBOCs, including
Ameritech, will file additional applications in 1998. However, based on recent
public announcements, the Company does not believe any RBOCs will provide in-
region long distance services prior to 1999. 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 ILECs
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 ILECs 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 customers, 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 customer
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.
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GOVERNMENT REGULATION
The Company is subject to varying degrees of federal, state, local and
international regulation. In the United States, the Company's provision of
local exchange services is regulated by the states. 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. Various carriers have
filed suit to overturn the FCC regulations, and the U.S. Court of Appeals for
the D.C. Circuit has stayed the regulations pending its decision in that
appeal, which is not expected until the end of 1997. The FCC has recently
ruled 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 indicated that RBOC in-region service, when authorized,
will be subject to 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, ILECs
are now 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 ILECs, including the obligation
to interconnect their networks with the networks of competitors. Each ILEC is
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.
States have begun and, in a number of cases, completed regulatory proceedings
to determine the pricing of these unbundled network elements and services, and
the results of these proceedings will determine whether it is economically
attractive to use these elements.
The RBOCs have an added incentive to open their local exchange networks to
facilities-based competition because Section 271 of 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 one
or more unaffiliated, facilities-based competitors in some portion of the
state pursuant to which such competitors provide 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 August 1997, the FCC denied the application of
Ameritech, the RBOC in three states where the Company operates for in-region
long distance authority in Michigan. The Company anticipates that a number of
RBOCs, including Ameritech, will file additional applications in 1998.
However, based on recent public announcements, the Company does not believe
any RBOC will provide in-region long distance services prior to 1999. 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. SBC
Communications Inc., the parent of RBOCs in Oklahoma and other southwestern
states, filed a lawsuit in June 1997 challenging the constitutionality of
Section 271 and seeking to have it declared void. The Company cannot predict
the outcome of this litigation.
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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' customers; non-discriminatory
access to call routing databases; number portability (i.e., the ability of a
customer to keep the same telephone number when switching local telephone
service providers); dialing parity (i.e., the ability of customers of one
telephone service provider to call customers 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.
The Telecommunications Act is intended to eliminate state and local
statutory and regulatory barriers to entry, thus accelerating the process of
creating a competitive environment in all markets. 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. At the same time, the Telecommunications Act will also
substantially increase the competition the Company will face in its various
markets.
The Telecommunications Act permits the Company, as a telecommunications
carrier with less than 5% of nationwide presubscribed access lines, 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.
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 Company
actively monitors all pertinent FCC proceedings and has participated in some
of these proceedings. The FCC already has completed most of these rulemaking
proceedings. The outcome of these various ongoing FCC rulemaking proceedings
or judicial appeals or such proceedings could materially affect the Company's
operations.
In May 1997, the FCC issued new regulations regarding the implementation of
the universal service program and the assessment of access charges on carriers
retaining access to local exchange networks. 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 universal funding service
mechanism established by the FCC. Both the access charge and universal service
regimes were substantially revised. As a result of these changes, the costs of
business and multiple residential telephone lines are expected to increase. In
addition, the new regulations require a reseller, such as the Company, to
begin contributing to the universal service programs for low-income consumers
and high-cost, rural and insular areas on the basis of the reseller's
interstate and international revenues. Several parties have appealed various
parts of the new FCC rules, including the revenue basis on which contributions
are determined. The Company is unable to predict the final formula for
universal service contribution or its own level of contribution.
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 customers to whom the
ILEC 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 ILEC may rebut this presumption,
however, by demonstrating that the class restriction is reasonable and
nondiscriminatory. The FCC also rejected claims by several ILECs 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
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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.
ILECs 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 ILECs 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
ILEC when it sells at wholesale. In August 1996 the FCC issued detailed
regulations establishing an interim default discount of 17% to 25%. Although
this portion of the FCC's rules has been overturned on appeal (see below), in
practice state commissions have generally adopted discount percentages that
fall within the 17-25% default range.
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 ILEC network elements. These regulations indirectly affect
the price at which the Company's new facilities-based competitors may
ultimately provide service. The Telecommunications Act provides that state
commissions shall determine the rates charged for such unbundled elements on
the basis of cost plus a reasonable profit. 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. At the same time, the FCC imposed minimum obligations
regarding the duty of ILECs to negotiate interconnection or resale
arrangements in good faith.
A number of RBOCs, state regulatory commissions and other parties 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 1997. In addition, many of the same parties
and certain other parties have filed court appeals challenging the same FCC
rules. In July 1997, the Eighth Circuit Federal Court of Appeals struck down
certain parts of the rules (including the provisions establishing pricing
methodologies and default rates for resold services and unbundled network
elements). In October 1997, the same court issued an order clarifying that the
RBOCs were not required to rebundle unbundled network elements that competing
carriers had purchased separately. If upheld, this ruling would make it more
difficult for competitors, including the large IXCs, to use rebundled
unbundled network elements or the "UNE Platform" to enter the local exchange
markets. The FCC, numerous IXCs and various other parties filed petitions for
certiorari with the U.S. Supreme Court on November 19, 1997. The Company
cannot predict at this time the outcome of the appeals or reconsideration
processes.
In August 1997, the FCC issued rules transferring responsibility for
administering and assigning local telephone numbers from the RBOCs and a few
other LECs to a neutral entity in each geographic region in the United States.
In August 1996, the FCC issued new numbering regulations that (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 ILEC customers use 7 digit dialing, and (b) prohibit ILECs
(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 therefore
commencing December 31, 1998. Other LECs 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. Non-RBOC LECs are not required to
implement number
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<PAGE>
portability in any additional markets until December 31, 1998 and then only in
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 customers to switch to the Company's services and
still retain their existing telephone numbers.
In addition, the FCC authorized cellular and other CMRS to provide for other
wireless services to fixed locations (rather than to mobile customers),
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 have been 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 27 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 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 will be required to lease additional facilities, particularly
in new metropolitan areas where the Company enters RBOC resale agreements.
EMPLOYEES
As of September 30, 1997, the Company employed 868 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>
J. Thomas Elliott....... 50 Chairman of the Board, President, Chief Executive Officer and Director
Dennis B. Dundon........ 52 Chief Operating Officer
Ronald W. Gavillet...... 38 Executive Vice President, Strategy & External Affairs
Gerald J. Sweas......... 50 Executive Vice President and Chief Financial Officer
Ryan Mullaney........... 41 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
Ellen C. Craig.......... 59 Vice President, Regulatory Affairs
Lane Foster............. 53 Vice President, Human Resources and Organizational Development
Thomas C. Brandenburg... 61 Director
Richard J. Brekka....... 36 Director
Dean M. Greenwood....... 54 Director
Donald J. Hofmann, Jr... 39 Director
William A. Johnston..... 45 Director
Ian Kidson.............. 39 Director
Paul S. Lattanzio....... 34 Director
Eugene A. Sekulow....... 66 Director
</TABLE>
Each director serves until his successor is duly elected and qualified.
Officers serve at the discretion of the Board of Directors.
J. Thomas Elliott, Chairman of the Board, President and Chief Executive
Officer, has been the Chief Executive Officer since April 1996 and Chairman of
the Board since October 1997. Mr. Elliott joined the Company in 1995 as a
result of the Company's acquisition 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 B.A. and M.A. degrees in economics from the
University of Windsor.
Dennis B. Dundon, Chief Operating Officer, joined the Company in April 1997.
From 1991 to 1996, Mr. Dundon served as President and Chief Executive Officer
of EMI Communications Corp. ("EMI"), a regional telecommunications company,
until EMI was acquired by Intermedia Communications, Inc. From June 1996 to
March 1997, Mr. Dundon served as Senior Vice President of Intermedia, a CLEC.
From 1988 to 1991, Mr. Dundon was President and owner of DBD Associates, Inc.,
a consulting firm providing services to the telecommunications sector. Mr.
Dundon is a past Chairman and Director of the Competitive Telecommunications
Association. Mr. Dundon holds a B.S. degree from Clarkson University and an
M.B.A. degree from the University of Rochester.
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. Between these periods at MCI, Mr. Gavillet was in
private law practice representing competitive carriers such as Teleport
Communications Group, Inc., Centex Telemanagement Inc., Centel Corp., Sprint
Corp. and Telesphere Communications Inc. Mr. Gavillet holds B.A. and B.S.
degrees from Southern Illinois University,
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a J.D. degree 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 Financial Officer of
Norand Corporation, a wireless data communications networks company. Mr. Sweas
holds a B.B.A. degree from Loyola University in Chicago, Illinois and an
M.B.A. degree 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. degree 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 later 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 M.B.A. degree 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. degree from
the University of Illinois and a J.D. degree 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. degree from the University of Wisconsin.
Ellen C. Craig, Vice President, Regulatory Affairs, joined the Company in
April 1997. From 1994 to 1997, Ms. Craig served as a consultant to investment
banking and telecommunications companies on domestic and international
utilities and telecommunications issues. From 1989 to 1994, Ms. Craig served
as Chairman and Commissioner of the Illinois Commerce Commission. She holds a
B.A. degree from Cardinal Cushing College and a J.D. degree from The John
Marshall Law School.
Lane Foster, Vice President, Human Resources and Organizational Development,
joined the Company in May 1997. From 1991 to 1996, Mr. Foster served as
Director of Human Resources and Corporate Real Estate for Nextel
Communications, a telecommunications company. From 1980 to 1991, Mr. Foster
served as Director of Human Resources for MCI Telecommunications. Mr. Foster
attended the University of North Dakota and
49
<PAGE>
graduated from the University of Southern California--Center for
Telecommunications Senior Leadership Program.
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 holds a B.A. degree from the University of Notre Dame.
Richard J. Brekka, Director, has been a director of the Company since April
1994. Mr. Brekka served as Chairman of the Board of the Company from December
1996 until October 1997. Mr. Brekka is a Managing Partner of MW&I Partners, a
merchant banking fund, and has formed Dolphin Communications, L.L.C. to make
communications investments in the United States. From 1992 to 1996, he was a
Managing Director of CIBC Wood Gundy Capital ("CIBC"), the merchant banking
division of Canadian Imperial Bank of Commerce, and a director and the
President of CIBC Wood Gundy Ventures, Inc., 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., Telesystem International Wireless, Inc., and Epoch
Networks, Inc. Mr. Brekka received a B.S. degree in finance from the University
of Southern California, and an M.B.A. degree from the University of Chicago.
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 is also a
Managing Director of Prime New Ventures. Mr. Greenwood holds a B.B.A. degree
and a J.D. degree 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. Mr. Hofmann holds a
B.B.A. degree from Hofstra University and an M.B.A. degree from Harvard
Business School.
William A. Johnston, Director, was elected a director of the Company in June
1994. Mr. Johnston has been a Managing Director of HarbourVest Partners, LLC
since January 1997. HarbourVest Partners, LLC was formed by the management team
of Hancock Venture Partners, Inc. where Mr. Johnston had 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 Holdings, Inc., Epoch
Networks, Inc., Golden Sky Systems, Inc., The Marks Group, Inc., and
MultiTechnology Corp. Internationally, he serves on the board of directors of
Esprit Telecom Group, plc. Mr. Johnston received a B.A. degree from Colgate
University and an M.A. degree from Syracuse University School of Management.
Ian M. Kidson, Director, has served as a director of the Company since April
1997. Mr. Kidson is a Managing Director of CIBC Wood Gundy Capital, the
merchant banking division of the Canadian Imperial Bank of Commerce. He joined
CIBC in 1984. Currently, Mr. Kidson serves on the board of directors of
Centennial Security Holdings, Inc. and JBK Arena Co. Mr. Kidson received a
B.S.C. degree and an M.B.A. degree from McMaster University.
Paul S. Lattanzio, Director, was appointed a director of the Company in
August 1995. Mr. Lattanzio served as a Managing Director of BT Capital
Partners, Inc., an affiliate of Bankers Trust New York Corp. until September
1997. He continues to provide consulting services to BT Capital Partners, Inc.
and acts as its representative with respect to its investment in USN. Mr.
Lattanzio was employed by BT Capital Partners, Inc. or an affiliate from 1984.
Currently, Mr. Lattanzio serves on the board of directors of Administaff, Inc.,
an employee leasing company and of Genesis Teleserve, a teleservices company.
Mr. Lattanzio received his B.S. degree in economics from the University of
Pennsylvania's Wharton School of Business.
50
<PAGE>
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.
Currently, Mr. Sekulow serves on the board of directors of RSL Communications,
Inc. Mr. Sekulow attended the University of Stockholm and the University of
Oslo. He earned an M.A. degree in political science and economics and a Ph.D.
degree from Johns Hopkins University.
Currently, certain non-employee directors are designated by the Original
Purchasers pursuant to existing agreements. See "Certain Relationships and
Related Transactions."
The Company is required by the terms of the 14% Senior Note Indenture to
elect a disinterested director with experience in the telecommunications
industry by each of December 31, 1997 and March 31, 1998. The identity of the
independent directors has not yet been determined.
COMMITTEES OF THE BOARD OF DIRECTORS
The Company has established an Audit Committee, a Finance Committee and a
Compensation Committee. Each of these committees is responsible to the full
Board of Directors, and their activities are therefore subject to approval of
the Board of Directors. The functions performed by these committees are
summarized below.
The Audit Committee consists of Messrs. Hofmann, Greenwood and Sekulow. The
Audit Committee is responsible for reviewing the internal accounting controls
of the Company, meeting and conferring with the Company's certified public
accountants and reviewing the results of the accountants' auditing engagement.
The Finance Committee consists of Messrs. Brekka, Elliott, Hofmann, Johnston
and Lattanzio. The Finance Committee is responsible for evaluating the
Company's capital requirements and overseeing the Company's efforts at meeting
its financial needs through capital markets transactions.
The Compensation Committee consists of Messrs. Brekka, Johnston and
Lattanzio. The Compensation Committee establishes compensation and benefits
for the Company's senior executives. The Committee also determines the number
and terms of stock options granted to employees, directors and consultants of
the Company under the Company's stock option plans.
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.
DIRECTORS' COMPENSATION
The Company's directors currently do not receive any cash compensation for
service on the Board of Directors or any committees thereof, but non-employee
directors are reimbursed for certain expenses in connection with attendance
for Board and committee meetings.
51
<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, the former Chief Executive Officer and the five 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 $75,000
included as other compensation represents the amount Mr. Elliott received
for consulting service to the Company prior to the Company's acquisition
of the business of Quest America, LP.
(3) Represents amounts paid in 1996 with respect to bonuses earned in prior
periods, primarily in 1995.
(4) Mr. Gavillet commenced employment with the Company in November 1994.
(5) Mr. Pellino commenced employment with the Company in August 1995.
(6) Mr. Bethke commenced employment with the Company in May 1996.
(7) Includes amounts reimbursed by the Company for life and disability
insurance premiums and temporary living expenses.
52
<PAGE>
OPTION GRANTS
The following table sets forth the aggregate number of stock options granted
to each of the Named Executive Officers during the fiscal year ended December
31, 1996. Options are exercisable for Class A Common Stock of the Company.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
PERCENT OF ANNUAL RATE OF STOCK
NUMBER OF TOTAL OPTIONS PRICE
SECURITIES GRANTED TO APPRECIATION FOR
UNDERLYING EMPLOYEES IN EXERCISE OPTION TERM ($)(1)
OPTIONS FISCAL PRICE EXPIRATION ---------------------
NAME GRANTED(#) YEAR(%) ($/SHARE) DATE 5% 10%
---- ---------- ------------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
J. Thomas Elliot........ 75,000 7.2 0.15 6/28/06 988,500 1,473,750
299,250 28.7 0.15 9/30/06 3,944,115 5,880,263
Ronald W. Gavillet...... 61,500 5.9 0.15 6/28/06 810,570 1,208,475
218,590 20.9 0.15 9/30/06 2,881,016 4,295,294
Thad J. Pellino......... 20,000 1.9 0.15 6/28/06 263,600 393,000
14,940 1.4 0.15 9/30/06 196,909 293,571
Neil A. Bethke.......... 20,000 1.9 0.15 6/28/06 263,600 393,000
14,940 1.4 0.15 9/30/06 196,909 293,571
</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 $8.80 per share as of August 31, 1997
and increases at the rate indicated, effective as of December 31 of each
subsequent full calendar year during the option term. However, there is no
established trading market for the Class A Common Stock, and no
representation is made that the Class A Common Stock actually has such
value or that the rates of increase in value can or will be achieved.
The following table sets forth certain information concerning the exercise
of stock options by the Named Executive Officers during the fiscal year ended
December 31, 1996 and the December 31, 1996 aggregate value of unexercised
options held by each of the Named Executive Officers.
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES(1)
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY OPTIONS
UNEXERCISED OPTIONS AT AT FISCAL
SHARES FISCAL YEAR-END (#) YEAR-END ($)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ----------- ----------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
J. Thomas Elliot........ -- -- 18,750/355,500 177,188/3,359,475
Ronald W. Gavillet...... -- -- 53,880/264,715 510,706/2,501,510
Thad J. Pellino......... -- -- 5,000/ 29,940 47,250/ 282,933
Neil A. Bethke.......... -- -- 5,000/ 29,940 47,250/ 282,933
Robert J. Luth.......... 20,000 189,000 18,500/ 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 $9.60 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.
53
<PAGE>
BENEFIT PLANS
1994 Amended and Restated Stock Option Plan
In September 1996, the Board of Directors adopted, and the stockholders
subsequently approved, the Amended and Restated 1994 Stock Option Plan (the
"1994 Plan"), which was originally adopted by the Board of Directors and
subsequently approved by the stockholders in September 1994. A total of
1,004,520 shares of Class A 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. Options are
subject to adjustment under certain circumstances.
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 1996 Private Placement, Messrs. Elliott, Gavillet,
Parrish, Pellino and Bethke were granted 182,340, 119,960, 6,000, 3,120 and
3,120 additional options, respectively, and certain other employees were
granted a total of 11,110 additional options, to purchase a corresponding
number of shares of Class A Common Stock at an exercise price of $.15 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.
Omnibus Securities Plan
In August 1997, the Board of Directors adopted and the stockholders
approved, the Omnibus Securities Plan of USN Communications, Inc. (the
"Omnibus Securities Plan"). A total of 2,750,000 shares have been reserved for
issuance under the Omnibus Securities Plan. The purpose of the Omnibus
Securities Plan is to benefit the Company's stockholders by encouraging high
levels of performance by individuals whose performance is a key element in
achieving the Company's continued success, and to enable the Company to
recruit, reward, retain and motivate employees for the benefit of the Company
and its stockholders. Under the Omnibus Securities Plan, the Company may grant
incentive or non-qualified stock options, stock appreciation rights,
restricted stock awards, performance awards and other stock based awards.
Employees of the Company and its subsidiaries and non-employee directors of
the Company are eligible to participate in the Omnibus Securities Plan. The
Omnibus Securities Plan is administered by the Compensation Committee, which
determines among other things, the terms
54
<PAGE>
and recipients of the awards. The Omnibus Securities Plan may be amended by
the Board of Directors, although certain amendments require the consent of the
participants. The Omnibus Securities Plan will terminate in 2007 unless
earlier terminated by the Board of Directors.
In September 1997, the Compensation Committee authorized the grant of stock
options to substantially all non-executive officer employees of the Company or
its subsidiaries. These options have an exercise price of $8.80 per share,
with one-third of the options vesting on the earlier of the completion of a
qualified public offering of the Company's Class A Common Stock or the first
anniversary of the date of grant, and with an additional one-third of the
options vesting on each of the two anniversaries following the initial vesting
date. These options cover a total of 958,500 shares. In addition, in September
1997, the Compensation Committee authorized the grant of options for a total
of 1,137,000 shares of Class A Common Stock to the Company's 11 executive
officers and a grant of options for a total of 75,000 shares of Class A Common
Stock to the Company's then Chairman. These options also have an exercise
price of $8.80 per share.
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 Internal Revenue Code of
1986, as amended, 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
All of the Company's executive officers have entered into employment
agreements with the Company. Each agreement provides for an initial term of
two or three years and automatic one-year renewals, and sets forth a base
salary and target annual bonus. The annual base salaries for Messrs. Elliott,
Dundon, Gavillet, Sweas, Mullaney and Parrish are $195,000, $185,000,
$185,000, $150,000, $125,000 and $140,000, respectively. Each agreement
provides that the executive shall receive certain payments in the event his or
her employment is terminated other than for cause, including but not limited
to all amounts earned, accrued and owing to the executive and certain
severance payments. In addition, each agreement contains noncompetition and
nonsolicitation provisions.
The employment agreements also provide that, in the event of a Change of
Control, the options held by the executive shall become exercisable and any
restrictions on such options shall lapse. 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 on 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.
Mr. Elliott's and Mr. Gavillet's agreements provide for certain anti-
dilution rights with respect to their ownership of common stock, including the
right, in the event the Company sells shares of any class of stock, 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 being sold. In
addition, their agreements provide that if the current stockholders sell any
of their shares of capital stock of the Company to a third party under certain
circumstances, each of Messrs. Elliott and Gavillet has the right to sell the
same percentage of his shares of capital stock as the percentage of shares
that the current stockholders are selling, on the same terms and for the same
consideration.
55
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On August 18, 1997, in connection with the 1997 Private Placement, the
Company sold 30,209 shares of Series A Preferred Stock, for an aggregate
purchase price of $30.2 million. The new equity was purchased by existing
Company stockholders and affiliates of certain stockholders.
On September 30, 1996, BT Securities Corporation, Chase Securities Inc. and
CIBC Wood Gundy Securities Corp. purchased securities from the Company
pursuant to the 1996 Private Placement. All of the securities offered in the
1996 Private Placement, consisting of the 14% Senior Notes, the 1996 Initial
Warrants and the Convertible Notes, were immediately resold to MLGAFI, an
affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, one of the
1997 Initial Purchasers. 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. each received commissions of approximately $188,000 of the $1.9 million
paid to the 1996 Initial Purchasers.
In September 1996, in connection with the 1996 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 the 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. Each outstanding share of Common Stock of the
Company existing on the date of the 1996 Private Placement was converted into
one share of Class A Common Stock. See "Description of Capital Stock--Common
Stock."
In connection with the 1996 Private Placement and the 1997 Private
Placement, by requisite vote, the Original Purchasers waived Preemptive Rights
and Registration Rights held by them pursuant to agreements entered into with
respect to earlier investments in the Company. In connection with the 1996
Private Placement the Original Purchasers also approved, and the Company took
all necessary action to effect prior to the consummation of the 1996 Private
Placement, the amendment of the terms of the Company's Series A 10% Senior
Cumulative Preferred Stock (the "10% Series A Preferred Stock") and Series A-2
10% Cumulative Preferred Stock (the "10% 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 1996 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 1,101,570 shares of Common Stock (which was
converted to Class A Common Stock in September 1996) to the Original
Purchasers for no cash 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 its then- existing 10% Series A-2
Preferred Stock to be senior to the 10% 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 an interest-free 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.
56
<PAGE>
STOCK OWNERSHIP
The following table sets forth as of October 17, 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)........... 3,841,230 34.75%
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Harbourvest Partners, LLC ............................... 3,442,373 37.82
One Financial Center, 44th Floor
New York, New York 10017-3903
Chase Venture Capital Associates, L.P. (3)............... 2,309,717 29.05
380 Madison Ave., 12th Floor
New York, New York 10017-2070
CIBC Wood Gundy Ventures, Inc. (3)....................... 2,309,717 29.05
425 Lexington Avenue
New York, New York 10017-3903
BT Capital Partners, Inc. (3)............................ 1,710,566 22.04
130 Liberty Street
New York, New York 10017-2070
Prime New Ventures....................................... 596,680 8.07
600 Congress Suite 3000
One American Center
Austin, Texas 78701
J. Thomas Elliott (4) ................................... 205,955 2.82
Ronald W. Gavillet (4)................................... 118,565 1.62
Thomas C. Brandenburg ................................... 109,082 1.51
Richard J. Brekka ....................................... 75,000 1.03
Dean M. Greenwood (5).................................... 596,680 8.07
Donald J. Hofmann, Jr. (5)............................... 2,309,717 29.05
William A. Johnston (5).................................. 3,442,373 37.82
Ian M. Kidson ........................................... 2,309,717 29.05
Paul S. Lattanzio ....................................... -- *
Robert J. Luth........................................... 38,500 *
Eugene A. Sekulow........................................ -- *
All directors and executive officers of the Company as a
group (19 persons)...................................... 19,296,034 83.19
</TABLE>
- --------
*Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
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 currently exercisable
options and 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 total number
of such stockholder's Conversion Shares. See also "Risk Factors--Control
by Existing Stockholders; Certain Antitakeover Matters" for a description
of certain circumstances under which MLGAFI may receive additional equity
and equity related securities of the Company.
(2) Represents Conversion Shares but does not represent shares that may be
issued upon conversion of the Consent Convertible Notes. Also, MLGAFI is
entitled to receive additional warrants to purchase common stock under
certain circumstances pursuant to the 14% Senior Note Indenture and the
Convertible Note Indenture.
(3) Chase Venture Capital Associates, L.P., CIBC Wood Gundy Ventures, Inc. and
BT Capital Partners, Inc. are affiliates of Chase Manhattan Corporation,
Canadian Imperial Bank of Commerce, and Bankers Trust New York
Corporation, respectively.
(4) These shares include exercisable options.
(5) Each director disclaims beneficial ownership of any shares of Class A
Common Stock or Preferred Stock which he does not directly own.
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<PAGE>
DESCRIPTION OF CONVERTIBLE NOTES
For purposes of this description of the Convertible Notes, 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.
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 unsecured indebtedness
including the Consent Convertible Notes of the Company. The Convertible Notes
are effectively subordinated to any secured indebtedness of the Company to the
extent of the assets securing that indebtedness (including up to $30 million
of indebtedness under a Credit Facility permitted by the Senior Note
Indentures). 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
September 30, 1997, 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 $0.7 million. As of September 30, 1997, 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 $29.3 million. Of that amount, approximately $0.7 million in
indebtedness was secured by Liens on the assets of the borrowing Subsidiaries.
The operations of the Company are conducted in large part 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 Convertible Note Indenture
permits under certain 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," "--Future Cash Obligations" 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
On September 30, 1996, the Company issued $36 million aggregate principal
amount at maturity of Convertible Notes at a discount to their aggregate
principal amount to generate gross proceeds to the Company of approximately
$28 million. The Convertible Notes will mature on September 30, 2004. The
Convertible Notes will accrete interest at the rate of 9% per annum,
compounded semiannually, to an aggregate principal amount of $36 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.
If the Company does not comply with certain deadlines set forth in the
Registration Rights Agreement with respect to registration of the Convertible
Notes for resale under a shelf registration statement, holders of the
Convertible Notes will be entitled to Special Interest.
Principal of, premium, if any, and interest and Special Interest, if any, on
the Convertible Notes will be 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, at a conversion price
of $10.436 per share, subject to adjustment (the "Conversion Price") as
described below. 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
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to any class of Capital 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 (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 Indentures (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
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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 (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.
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 "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 September 30, 1999, 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 September 30, 1999 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
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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 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) irrevocably 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
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
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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 owing 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 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 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 Senior Notes on any Asset
Sale Payment Date occurring on or after September 30, 1999, plus accrued and
unpaid interest, if any, and Special
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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.
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
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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 Indentures, 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 provides 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 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 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.
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Restricted and Unrestricted Subsidiaries
The Convertible Note Indenture provides 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 Indentures have 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 Indentures which
place a limitation on indebtedness and (ii) such designation is at the time
permitted under the provision in the Senior Note Indentures 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 Indentures.
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
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) and (ii) of the immediately preceding
sentence) after giving effect to the issuance of such warrants. Any such
warrants will be issued pursuant to the 1996 Warrant Agreement with the same
rights thereunder as the 1996 Initial Warrants, and holders will have the
benefit of the 1996 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 Convertible Notes, as their names
and addresses appear in the applicable Security Register, without cost to such
holders or Persons, and (ii) file with the Trustee, copies of the annual
reports, quarterly reports and other documents (without exhibits) which the
Company has filed or would have filed with 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,
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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 Convertible Note
Indenture;
(ii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or
in respect of such transaction or series of transactions), no Default or
Event of Default under the Convertible Note Indenture 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 when the same becomes due and payable, and the
continuance of such default for a period of 30 days;
(b) default in the payment of the principal of (or premium, if any, on)
any Convertible Note 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" or "--Right to
Require Repurchase of Convertible Notes upon a Termination of Trading;"
(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
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$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 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 Indentures 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
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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 Indentures, and, in the case of clause (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 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 Convertible Note
Indenture; provided, that such actions shall not adversely affect the
interests of the holders in any material respect; (vii) to secure the
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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.
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 contingent warrants as described above
under "--Issuance of Contingent 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
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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 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
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(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>
ACCRETED
SEMI-ANNUAL ACCRUAL 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>
(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
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(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.
"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 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).
"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.
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"Capital Lease Obligation" of any Person means the obligation to pay rent or
other payment amounts under a lease of (or other Indebtedness arrangement
conveying the right to use) real or personal property of such Person which is
required to be classified and accounted for as a capital lease or a liability
on the face of a balance sheet of such Person 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 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 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 Indentures, 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
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the 14 5/8% 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.
"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 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.
"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).
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"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 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 Indentures; 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.
"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
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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 as a result of such
transaction; provided that, in the event that any consideration for a
transaction (which would
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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 (currently known as Harbourvest
Partners, LLC), BT, the Northwood Entities, Enterprise (currently known as
Prime New Ventures) 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).
"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.
"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."
"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
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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 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.
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"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.
"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.
DESCRIPTION OF WARRANTS
For purposes of this description of the Warrants, 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.
GENERAL
The 1996 Initial Warrants were issued on September 30, 1996 pursuant to the
1996 Warrant Agreement. The 1997 Initial Warrants were issued on August 18,
1997 and the Consent Warrants were issued on August 25, 1997 pursuant to the
1997 Warrant Agreement and the Consent Warrant Agreement, respectively. The
Warrants are subject to all terms in the applicable Warrant Agreement and
holders of Warrants are referred to the applicable Warrant Agreement, copies
of which are 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 Warrants are summaries and do not purport to be complete.
Each 1996 Initial Warrant, 1997 Initial Warrant and Consent Warrant entitle
the holder thereof to purchase 16.30474 shares, 1.34484 shares and 10 shares
of Class A Common Stock, respectively, from the Company, subject to adjustment
under certain circumstances, at a price of $.01 per share. Subject to certain
limitations, the 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 applicable Issue Date (the "Expiration
Date"). Warrants that are not exercised by the applicable Expiration Date will
expire. The Company will give notice of expiration not less than 90 nor more
than 120 days prior to the applicable Expiration Date to registered holders of
the then outstanding Warrants.
CERTAIN TERMS
Exercise
In order to exercise all or any of the 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 a Warrant is being exercised.
Payment for securities upon exercise of a 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 Warrant in accordance with the
applicable Warrant Agreement, the Warrant Agent shall instruct the Company to
transfer promptly to, or upon the written order of, the holder of such 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,
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including, without limitation, any cash payable to adjust for fractional
interests in Warrant Shares issuable upon such exercise. If less than all of
the Warrants evidenced by a Warrant Certificate are to be exercised, a new
Warrant Certificate will be issued for the remaining number of Warrants. All
Warrant Shares or other securities issuable by the Company upon the exercise
of the Warrants shall be validly issued, fully paid and nonassessable.
No fractional Warrant Shares will be issued upon exercise of the Warrants.
If any fraction of a Warrant Share would, except for the foregoing provision,
be issuable upon the exercise of any Warrants (or specified portion thereof),
the Company will pay an amount in cash equal to the Current Market Price (as
defined in the applicable Warrant Agreement) per share of Class A Common
Stock, as determined on the trading day immediately preceding the date the
Warrant is presented for exercise, multiplied by such fraction, computed to
the nearest whole cent.
Certificates for 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 Warrants will be able to exercise their 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, the Exercise Price and the number of Warrant
Shares issuable upon exercise of the 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 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
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
Warrants, as if the Warrants had been exercised immediately prior to such
event, less the Exercise Price. Upon receipt of such payment, if any, the
Warrants will expire and the rights of the holders thereof will cease.
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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 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 Warrants.
No Rights as Stockholders
The holders of unexercised 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
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 Warrants, may amend or supplement the applicable 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 Warrants issued thereunder shall require the written consent of the
holders of a majority of such outstanding Warrants. The consent of each holder
of the 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 Warrants would be decreased (other than pursuant
to adjustments provided in the applicable Warrant Agreement).
REGISTRATION RIGHTS
With respect to the Convertible Notes, the 1996 Initial Warrants, the
Warrant Shares issuable upon exercise of the 1996 Initial Warrants and the
Convertible Note Shares, the Company has entered into the 1996 Registration
Rights Agreement, for the benefit of the holders of the Convertible Notes and
the 1996 Initial Warrants. With respect to the 1997 Initial Warrants and the
Warrant Shares issuable upon exercise of the 1997 Initial Warrants, the
Company has entered into the 1997 Registration Rights Agreement for the
benefit of the holders of the 1997 Initial Warrants. The Company has also
agreed to grant the holders of the Consent Warrants registration rights
comparable to those set forth in the 1997 Registration Rights Agreement.
Pursuant to the Registration Rights Agreements, 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
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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 1996 Registration
Rights Agreement and the 1997 Registration Rights Agreement, copies of which
can be obtained from the Company upon request, for further information with
respect to the provisions of such agreements. In addition, the Company has
entered into an 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."
CERTAIN OTHER INDEBTEDNESS
The Company issued $48.5 million in aggregate principal amount at maturity
of 14% Senior Notes on September 30, 1996 and $152.7 million in aggregate
principal amount at maturity of 14 5/8% Senior Notes on August 18, 1997. 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 14% Senior
Notes were issued with original issue discount and, until March 30, 2000,
accrete interest at a rate of 14% per annum, compounded semiannually, to an
aggregate principal amount of $48.5 million. The 14 5/8% Senior Notes were
also issued with original issue discount and, until August 15, 2000, will
accrete interest at a rate of 14 5/8% per annum, compounded semiannually, to
an aggregate principal amount of $152.7 million. After March 30, 2000 or
August 15, 2000, as applicable, cash interest will accrue on the Senior Notes
and will be payable on March 30 and September 30 of each year, commencing
September 30, 2000, with respect to the 14% Senior Notes, and February 15 and
August 15 of each year, commencing February 15, 2001, with respect to the 14
5/8% Senior Notes.
The Senior Note Indentures contain certain covenants which, among other
things, restrict the ability of the Company and certain subsidiaries to incur
additional indebtedness, pay dividends or make distributions in respect of the
Company's capital stock or make certain other restricted payments, make
investments, create restrictions on the ability of certain subsidiaries to
make distributions on their capital stock or to issue capital stock, create
liens, enter into transactions with affiliates or related persons, sell assets
or consolidate, merge or sell all or substantially all of their assets and
engage in businesses other than the telecommunications business.
From September 30, 2001 to September 30, 2003, the 14% Senior Notes will be
redeemable at the Company's option, in whole or in part, at the prices set
forth in the 14% Senior Note Indenture plus accrued and unpaid interest, if
any, to the redemption date. The 14 5/8% Senior Notes will be redeemable at
the Company's option, in whole or in part, on or after August 15, 2002 at the
redemption prices set forth in the 14 5/8% Senior Note Indenture plus accrued
and unpaid interest, if any, to the redemption date. The Company may also
redeem the 14% Senior Notes or the 14 5/8% Senior Notes on or prior to
September 30, 1999 or August 15, 2000, respectively, out of the proceeds of
any Public Equity Offering (as defined in the Senior Note Indentures). In the
event that the Company elects to redeem the 14 5/8% Senior Notes out of the
proceeds of any Public Equity Offering on or prior to September 30, 1999, the
holders of the 14% Senior Notes shall have the right, but not the obligation,
to cause the Company to offer to repurchase the 14% Senior Notes on a pro rata
basis together with the 14 5/8% Senior Notes and to receive the same
redemption premium as the holders of the 14 5/8% Senior Notes.
In connection with the Consent, the Company has granted the holders of the
14% Senior Notes the option to exchange all, but not less than all, of the 14%
Senior Notes for 14 5/8% Senior Notes having an aggregate principal amount at
maturity equal to the 14% Senior Notes. The Company has also granted and MLAM
has exercised an option to purchase the Consent Convertible Notes for an
aggregate purchase price of $10.0 million with terms substantially similar to
the Convertible Notes.
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DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 30,300,000 shares of
capital stock, consisting of 30,050,000 shares of Common Stock, par value $.01
per share, of which 30,000,000 shares are designated as Class A Common Stock
and 50,000 shares are designated as Class B Common Stock, and 250,000 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.
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
Currently, the Company has 180,000 shares of Preferred Stock designated for
issuance, of which 30,000 have been designated as 9% Preferred Stock and
150,000 of which have been designated as Series A Preferred Stock. There are
currently 10,920 and 30,209 shares outstanding of 9% Preferred Stock and
Series A Preferred Stock, respectively.
The 9% Preferred Stock and the Series A Preferred Stock each has a
liquidation preference and stated value of $1,000 per share. Dividends accrue
semiannually and are fully cumulative. Dividends are payable in additional
shares of 9% Preferred Stock or Series A Preferred Stock, as applicable. In
the event of any liquidation, dissolution or winding up of the Company,
holders of the 9% Preferred Stock and the Series A Preferred Stock each 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.
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Shares of 9% Preferred Stock and Series A 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 and the Series A Preferred Stock each 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.
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 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
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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.
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
Warrants held as capital assets by United States Holders (as defined) 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.
Prospective purchasers should recognize that the present U.S. federal income
tax treatment of an investment in the Securities may be modified by
legislative, judicial or administrative action at any time, and that such
action may affect investments previously made. In addition, the recently
enacted Taxpayer Relief Act of 1997 could affect an investment in Securities
in that, among other things, it reduces the rate of federal income tax imposed
on capital gains of individual taxpayers for capital assets held more than
eighteen months (and reduces such rate even further for capital assets
acquired after the year 2000 and held more than five years). Prospective
purchasers should consult their own tax advisors concerning the effect on them
of such new legislation.
UNITED STATES HOLDERS
As used herein, "United States Holder" means a beneficial owner of a
Security who or which is (i) a citizen or resident of the United States, (ii)
a corporation organized in or under the laws of the United States or any state
thereof or the District of Columbia, or (iii) a person otherwise subject to
United States federal income taxation on a net income basis in respect of a
Security.
86
<PAGE>
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 decreased by the amount
of payments made on the Convertible Notes) 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. All payments on a
Convertible Note generally will be viewed first as a payment of previously
accrued OID (to the extent thereof), with payments considered made from the
earliest accrual period, and then as a payment of principal.
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 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.
87
<PAGE>
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 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.
88
<PAGE>
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 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.
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.
89
<PAGE>
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.
This Prospectus has been prepared for use by the 1996 Initial Purchasers in
connection with offers and sales of the Convertible Notes, the 1996 Initial
Warrants (and the Warrant Shares issuable upon the exercise thereof) and the
Convertible Note Shares and the 1997 Initial Purchasers in connection with
offers and sales of the 1997 Initial Warrants (and the Warrant Shares issuable
upon the exercise thereof), 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. Each of the
Initial Purchasers has advised the Company that it intends to make a market
for the respective Securities each Initial Purchaser placed. 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 to seek
approval for quotation through any automated quotation system.
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 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.
LEGAL MATTERS
The validity of the Securities was passed upon for the Company by Skadden,
Arps, Slate, Meagher & Flom (Illinois).
90
<PAGE>
EXPERTS
The consolidated financial statements of the Company as of December 31,
1996, 1995 and 1994 and for each of 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 (which reports express
an unqualified opinion and include an explanatory paragraph concerning
substantial doubt about the entity's ability to continue as a going concern),
and have been so included in reliance upon the reports of such firm given upon
their authority as experts in accounting and auditing.
91
<PAGE>
GLOSSARY
ACCESS CHARGES--The fees paid by IXCs to LECs for originating and
terminating long distance calls on their local networks.
CLEC (Competitive Local Exchange Carrier)--A company that provides its
customers with an alternative to the local telephone company for local
transport of private line, special access and interstate transport of switched
access telecommunications services.
CENTRAL OFFICES--The switching centers or central switching facilities of
the LECs.
CENTREX--Centrex is a service that offers features similar to those of what
is known as private branch exchange (PBX), except the equipment is located at
the carrier's premises and not at the premises of the customer. 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.
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 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 customers 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.
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. 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.
ILECS (Incumbent Local Exchange Carriers)--Companies providing local
telephone services.
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.
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.
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.
92
<PAGE>
POP (Point of Presence)--Location 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 customer.
SPECIAL ACCESS SERVICES--The lease of private, dedicated telecommunications
lines or "circuits" along the network of a LEC or a CLEC, 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 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.
USOC (UNIVERSAL SERVICE ORDERING CODE)--Identifies a particular service or
equipment under tariff (not necessarily universal any longer).
93
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE NINE MONTH
PERIODS ENDING SEPTEMBER 30, 1996 AND AS OF DECEMBER 31, 1996
AND SEPTEMBER 30, 1997................................................... F-2
INDEPENDENT AUDITORS' REPORT.............................................. F-8
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets............................................. F-9
Consolidated Statements of Operations................................... F-10
Consolidated Statements of Redeemable Preferred Stock................... F-11
Consolidated Statements of Common Stockholders' Deficit................. F-12
Consolidated Statements of Cash Flows................................... F-13
Notes to Consolidated Financial Statements.............................. F-14
</TABLE>
F-1
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER
30, DECEMBER
ASSETS 1997 31, 1996
------ ------------ -----------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents......................... $117,943,711 $60,818,478
Accounts receivable, net.......................... 15,445,860 3,004,408
Prepaid expenses.................................. 271,430 187,051
Other receivables................................. 338,502 172,567
------------ -----------
Total current assets............................ 133,999,503 64,182,504
Property and Equipment--Net......................... 12,604,307 3,507,350
Other Assets........................................ 32,553,221 10,362,438
------------ -----------
Total Assets.................................... $179,157,031 $78,052,292
============ ===========
<CAPTION>
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND COMMON STOCKHOLDERS' DEFICIT
----------------------------------------
<S> <C> <C>
Current Liabilities:
Accounts payable.................................. $ 17,268,085 $ 7,907,654
Accrued expenses and other liabilities............ 11,315,296 3,176,762
Capital lease obligations--current................ 544,213 277,844
Current maturities on notes payable............... 121,874 386,522
------------ -----------
Total current liabilities....................... 29,249,468 11,748,782
14 5/8% Senior Discount Notes, net of Original Issue
Discount........................................... 101,830,062 --
14% Senior Discount Notes, net of Original Issue
Discount........................................... 34,579,844 31,242,614
9% Convertible Subordinated Discount Notes, net of
Original Issue Discount............................ 30,188,376 28,259,555
Capital Lease Obligations--Noncurrent............... 664,421 312,280
Notes Payable....................................... 24,547 49,727
------------ -----------
Total liabilities............................... 196,536,718 71,612,958
Redeemable Preferred Stock:
9% Cumulative Convertible Pay-In-Kind Preferred
stock: par value, $1; 30,000 shares authorized;
10,920 and 10,000 shares outstanding at 1997 and
1996............................................. 10,920 10,000
9% Cumulative Convertible Pay-In-Kind Preferred
stock, Series A: par value, $1; 150,000 shares
authorized; 30,209 shares outstanding at 1997.... 30,209 --
Accumulated unpaid dividends...................... 317,195 225,000
Additional paid-in capital........................ 40,690,299 9,810,185
------------ -----------
Total redeemable preferred stock................ 41,048,623 10,045,185
Common Stockholders' Deficit:
Common stock: par value, $.01; 30,000,000 shares
authorized; 7,222,511 and 7,185,260 shares issued
at 1997 and 1996................................. 72,226 71,853
Additional paid-in capital........................ 73,941,796 54,114,755
Accumulated deficit............................... (132,441,255) (57,791,382)
Common stock held in Treasury: 1997 and 1996--
10,000 shares.................................... (1,077) (1,077)
------------ -----------
Total common stockholders' deficit.............. (58,428,310) (3,605,851)
------------ -----------
Total Liabilities, Redeemable Preferred Stock, and
Common Stockholders' Deficit....................... $179,157,031 $78,052,292
============ ===========
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-2
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1997 1996
------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Net service revenue................................ $ 26,998,315 $ 7,598,705
Cost of services................................... 23,983,125 6,587,126
------------ ------------
Gross margin................................... 3,015,190 1,011,579
Expenses:
Sales and marketing.............................. 43,087,112 5,837,437
General and administrative....................... 26,881,801 10,919,589
------------ ------------
Operating loss..................................... (66,953,723) (15,745,447)
Other income (expense):
Interest income.................................. 1,883,861 472,667
Interest expense................................. (8,572,952) (45,957)
Other income..................................... 5,386 8,099,593
------------ ------------
Other income (expense)--net.................... (6,683,705) 8,526,303
------------ ------------
Net loss........................................... $(73,637,428) $ (7,219,144)
============ ============
Accumulated preferred dividends.................... $ 1,012,445 $ 3,465,976
============ ============
Net loss to common shareholders.................... $(74,649,873) $(10,685,120)
============ ============
Net loss per common share.......................... $ (10.35) $ (2.44)
============ ============
Weighted average common and common equivalent
shares outstanding................................ 7,212,511 4,384,993
============ ============
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-3
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
SERIES A
9% PIK 9% PIK SERIES A-2 SERIES A ACCUMULATED ADDITIONAL
PREFERRED PREFERRED PREFERRED PREFERRED UNPAID PAID-IN
STOCK STOCK STOCK STOCK DIVIDENDS CAPITAL TOTAL
--------- --------- ---------- --------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1,
1996................... $26,235 $16,200 $ 3,810,000 $ 40,543,605 $ 44,396,040
Accumulated dividends
on Series A and A-2
Preferred Stock....... 3,465,976 3,465,976
Conversion of Series A
and
A-2 Preferred Stock to
Class A Common Stock.. (26,235) (16,200) (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 dividends
on 9% PIK preferred
stock................. 225,000 225,000
------- ------- ------- ------- ----------- ------------ ------------
BALANCE, DECEMBER 31,
1996................... 10,000 225,000 9,810,185 10,045,185
Issuance of 30,209
shares of Series A 9%
PIK preferred stock... $30,209 30,178,863 30,209,072
Costs incurred related
to issuance of Series
A 9% PIK preferred
stock................. (218,079) (218,079)
Accumulated dividends
on 9% PIK preferred
stock................. 695,250 695,250
Accumulated dividends
on Series A 9% PIK
preferred stock....... 317,195 317,195
Payment of dividends on
9% PIK preferred
stock................. 920 (920,250) 919,330
------- ------- ------- ------- ----------- ------------ ------------
BALANCE, SEPTEMBER 30,
1997 (UNAUDITED)....... $10,920 $30,209 $ -- $ -- $ 317,195 $ 40,690,299 $ 41,048,623
======= ======= ======= ======= =========== ============ ============
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-4
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
COMMON
ADDITIONAL STOCK
COMMON PAID-IN ACCUMULATED HELD IN
STOCK CAPITAL DEFICIT TREASURY TOTAL
------- ----------- ------------- -------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1,
1996................... $31,374 $ 254,718 $ (29,053,815) $(28,767,723)
Conversion of Series A
and A-2 Preferred
Stock to Class A
Common Stock......... 26,763 47,835,253 47,862,016
Issuance of 50,000
shares of common
stock................ 500 5,000 5,500
Compensation grants of
220,000 shares of
common stock......... 2,200 30,800 33,000
Repricing of common
stock................ 11,016 (11,016)
Repurchase of 10,000
shares of common
stock................ $(1,077) (1,077)
Issuance of stock
warrants............. 6,000,000 6,000,000
Accumulated dividends
on 9% PIK preferred
stock................ (3,690,976) (3,690,976)
Net loss.............. (25,046,591) (25,046,591)
------- ----------- ------------- ------- ------------
BALANCE, DECEMBER 31,
1996................... 71,853 54,114,755 (57,791,382) (1,077) (3,605,851)
Issuance of 37,251
shares of common
stock................ 373 3,723 4,096
Issuance of stock
warrants............. 19,351,727 19,351,727
Compensation expense
on stock options..... 471,591 471,591
Accumulated dividends
on 9% PIK preferred
stock................ (695,250) (695,250)
Accumulated dividends
on Series A 9% PIK
preferred stock...... (317,195) (317,195)
Net loss.............. (73,637,428) (73,637,428)
------- ----------- ------------- ------- ------------
BALANCE, SEPTEMBER 30,
1997 (UNAUDITED)....... $72,226 $73,941,796 $(132,441,255) $(1,077) $(58,428,310)
======= =========== ============= ======= ============
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-5
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1997 1996
------------ -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................... $(73,637,428) $(7,219,144)
Adjustments to reconcile net loss to net cash
flows from operating activities:
Depreciation and amortization................... 1,902,049 254,049
Amortization of organization costs and
intangibles.................................... 622,884 1,105,748
Non-cash interest on debt obligation............ 8,456,677 --
Stock compensation award expense................ 471,591 33,000
Gain on disposal of assets...................... -- (8,078,901)
Changes in:
Accounts receivable, net...................... (12,441,452) (1,469,127)
Prepaid expenses.............................. (84,379) 109,434
Other receivables............................. (165,935) (229,940)
Other assets.................................. (444,960) (18,205)
Accounts payable.............................. 9,360,431 1,440,563
Accrued expenses and other liabilities........ 8,138,534 (19,641)
------------ -----------
Net cash flows from operating activities.... (57,821,988) (14,092,164)
Cash flows from investing activities:
Purchase of property and equipment................ (10,071,051) (284,774)
Proceeds from sale of assets...................... -- 9,532,600
Purchase of Minority Interest..................... -- (1,601,207)
------------ -----------
Net cash flows from investing activities.... (10,071,051) 7,646,619
Cash flows from financing activities:
Issuance of common stock.......................... 4,096 3,300
Issuance of preferred stock....................... 30,209,072 10,000,000
Financing costs................................... (218,079) (147,389)
Repurchase of common stock........................ -- (1,077)
Proceeds from Senior Notes........................ 100,001,276 30,203,375
Proceeds from Convertible Notes................... -- 27,644,400
Debt acquisition costs............................ (4,436,579) (2,732,664)
Deposits.......................................... 57,758 (393,884)
Repayment of notes payable........................ (289,828) (335,442)
Repayment of capital lease obligations............ (309,445) (83,774)
------------ -----------
Net cash flows from financing activities.... 125,018,271 64,156,845
------------ -----------
Net increase in cash................................ 57,125,232 57,711,300
Cash and cash equivalents--Beginning of period...... 60,818,479 13,766,040
------------ -----------
Cash and cash equivalents--End of period............ $117,943,711 $71,477,340
============ ===========
Supplemental cash flow information:
Dividends Paid in Kind............................ $ 920,250 --
============ ===========
Dividends Declared................................ $ 1,012,445 $ 3,465,976
============ ===========
Issuance of Stock Warrants........................ $ 19,351,727 $ 6,000,000
============ ===========
Conversion of Series A and Series A-2 Preferred
Stock to Class A Common Stock.................... -- $47,862,016
============ ===========
Capital Lease Obligations Incurred................ $ 927,955 $ 537,478
============ ===========
Cash Paid for Interest............................ $ 91,993 $ 68,000
============ ===========
Cash Paid for Income Taxes........................ -- --
============ ===========
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-6
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE PERIOD ENDING JUNE 30, 1997
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The unaudited, condensed consolidated financial statements of USN
Communications, Inc. (the "Company") included herein have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission. The interim financial statements reflect all adjustments which
are, in the opinion of management, necessary for a fair presentation of the
results for the interim periods presented. The condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's latest annual
report on Form 10-K. The results of operations for the interim periods should
not be considered indicative of results to be expected for the full year.
2. PRIVATE PLACEMENT OFFERING
On August 18, 1997, the Company received approximately $96.5 million in
cash, net of commissions paid, in exchange for the issuance of 152,725 units
consisting of $152.7 million aggregate principal amount at maturity of 14 5/8%
Senior Discount Notes due 2004 ("14 5/8% Senior Notes") and warrants to
purchase 2,053,900 shares of Class A Common Stock. In connection with this
offering, the Company paid a consent fee to the holders of the outstanding 14%
Senior Discount Notes due 2003 ("14% Senior Notes") and 9% Convertible
Subordinated Notes due 2004 ("9% Convertible Notes") consisting of warrants to
purchase 145,160 shares of Class A Common Stock. The Company also granted
those holders an option, which was exercised on October 24, 1997, to purchase
up to $10.0 million in aggregate proceeds to the Company of convertible notes
of the Company on terms substantially similar to the existing 9% Convertible
Notes. Additionally, the Company granted to holders of the 14% Senior Notes an
option, for a specified period of time, to exchange all of the 14% Senior
Notes for 14 5/8% Senior Notes having an accreted value equal to the accreted
value of such 14% Senior Notes at the time of such exchange.
The Senior Notes were sold at a unit price, before commissions, of $654.78
per $1,000 face amount. These notes will accrete interest at an annual rate of
14 5/8% from August 18, 1997 to August 15, 2000. Thereafter, the notes will
bear interest at an annual rate of 14 5/8% payable semiannually in arrears in
cash.
3. CHANGES IN EQUITY
In August 1997, the Board of Directors authorized the issuance of up to
150,000 shares of a series of $1 par value preferred stock designated as 9%
Cumulative Convertible Pay-in-Kind Preferred Stock, Series A ("Series A
Preferred Stock"). In connection with the private placement offering described
in Note 2, the Company issued 30,209 shares of its Series A Preferred Stock to
certain of its existing stockholders and their affiliates for an aggregate
purchase price of $30.2 million.
In September 1997, the Board of Directors approved a nine-for-one stock
dividend on the Class A Common Stock. Share and per share data have been
retroactively adjusted to reflect this stock dividend.
4. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
F-7
<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
Chicago, Illinois
March 14, 1997 (September 4, 1997 as to Note 22)
F-8
<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;
25,000,000 and 5,000,000 authorized at 1996 and
1995;
7,185,260 and 3,137,290 shares issued at 1996 and
1995 .............................................. 71,853 31,374
Additional paid-in capital.......................... 54,114,755 254,718
Accumulated deficit................................. (57,791,382) (29,053,815)
Treasury stock, 10,000 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-9
<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 11,100,661 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 preferred dividends....... $ 3,690,976 $ 3,103,000 $ 707,000
============ ============ ===========
Net loss per common share............. $ (5.63) $ (7.01) $ (6.56)
============ ============ ===========
Weighted average common and common
equivalent shares outstanding........ 5,102,330 3,025,200 1,196,780
============ ============ ===========
</TABLE>
See notes to consolidated financial statements.
F-10
<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-11
<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 1,778,400
shares of common
stock................ $17,784 $ 220,655 $ 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................... 17,784 5,795 (7,853,789) (7,830,210)
Issuance of 1,358,990
shares of common
stock................ 13,590 251,413 265,003
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................... 31,374 254,718 (29,053,815) (28,767,723)
Conversion of Series A
and A-2 Preferred
Stock to Class A
Common Stock......... 26,763 47,835,253 47,862,016
Issuance of 50,000
shares of common
stock................ 500 5,000 5,500
Compensation grants of
220,000 shares of
common stock......... 2,200 30,800 33,000
Repricing of common
stock................ 11,016 (11,016)
Repurchase of 10,000
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................... $71,853 $54,114,755 $(57,791,382) $(1,077) $ (3,605,851)
======= =========== ============ ======= ============
</TABLE>
F-12
<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) (322,245) (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-13
<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 USN's
preferred stock and 315,000 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-14
<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-15
<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 $3,398,105 $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-16
<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-17
<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-18
<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 615,500 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-19
<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 2,676,300 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 1,358,990 to
2,460,560 and the purchase price decreased from $0.195 to $0.1077 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-20
<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 319,610
options to purchase Class A Common Stock at an exercise price of $0.15 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. 66,370 of these options become exercisable as
the Convertible Notes are converted to Class A Common Stock, and 253,240 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...................... 190,500 $ 0.11 213,000 $0.11
Granted................. 1,033,240 0.11-9.60 213,000 $0.11
Exercised............... (50,000) 0.11
Cancelled............... (64,750) 0.11 (22,500) 0.11
--------- ------- -------
Outstanding at December
31..................... 1,108,990 0.11-9.60 190,500 0.11 213,000 0.11
========= ======= =======
Options exercisable at
December 31............ 106,620 0.11-0.15 100,240 0.11 --
========= ======= =======
</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%; volatility 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-21
<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-22
<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-23
<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.
22. SUBSEQUENT EVENT
On September 4, 1997, the Board of Directors approved a nine-for-one stock
dividend on the Class A Common Stock. Average shares outstanding and all per
share amounts included in the accompanying financial statements and notes are
based on the increased number of shares giving retroactive effect to the stock
dividend.
* * * * *
F-24
<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
Disclosure Regarding Forward-Looking Statements............................ 3
Prospectus Summary......................................................... 4
Risk Factors............................................................... 15
Use of Proceeds............................................................ 26
Dividend Policy............................................................ 26
Capitalization............................................................. 27
Selected Historical Consolidated Financial and Operating Data.............. 28
Management's Discussion and Analysis
of Financial Condition and Results
of Operations............................................................. 29
Industry Overview: The Local Telecommunications Service Industry........... 35
Business................................................................... 36
Management................................................................. 48
Certain Relationships and Related Transactions............................. 56
Stock Ownership............................................................ 57
Description of Convertible Notes........................................... 58
Registration Rights........................................................ 82
Certain Other Indebtedness................................................. 83
Description of Capital Stock............................................... 84
Certain Federal Income Tax Considerations.................................. 86
Plan of Distribution....................................................... 90
Selling Securityholders.................................................... 90
Legal Matters.............................................................. 90
Experts.................................................................... 91
Glossary................................................................... 92
Index to Consolidated Financial Statements................................. F-1
</TABLE>
-----------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
---------------
PROSPECTUS
---------------
LOGO
USN COMMUNICATIONS, INC.
9% CONVERTIBLE SUBORDINATED
DISCOUNT NOTES DUE 2004
WARRANTS TO PURCHASE CLASS A
COMMON STOCK
CLASS A COMMON STOCK
NOVEMBER , 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..................... $8,386
Printing and Engraving Expenses......................................... *
Legal Fees and Expenses................................................. *
Accounting Fees and Expenses............................................ *
------
Total............................................................... $ *
======
</TABLE>
*To be provided by amendment.
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 November 2, 1994, Chase Capital Partners (now known as Chase Venture
Capital Associates, L.P.), CIBC Wood Gundy Securities Corp. (now known as CIBC
Wood Gundy Ventures, Inc.) and Hancock Venture Capital Associates (now known
as HarbourVest Partners LLC) each purchased from the Registrant 7,425 shares
of Series A 10% Senior Cumulative Preferred Stock ("10% Series A Preferred
Stock") and 69,630 shares of Class A Common Stock for a total purchase price
of $7,500,000. The shares of 10% Series A Preferred Stock were not registered
under the Securities Act of 1933, as amended (the "Securities Act") on the
basis that it was a transaction by an issuer not involving any public offering
in accordance with Section 4(2) under the Securities Act.
(2) On June 22, 1995, Chase Capital Partners (now known as Chase Venture
Capital Associates, L.P.), CIBC Wood Gundy Securities Corp. (now known as CIBC
Wood Gundy Ventures, Inc.), Hancock Venture Capital Associates (now known as
HarbourVest Partners LLC), Northwood Capital Partners LLC, Northwood Ventures
and BT Capital Partners, Inc. purchased from the Registrant 23,760 shares of
Series A 10% Cumulative
II-1
<PAGE>
Preferred Stock, par value $1.00 ("Series A-2 Preferred Stock") at a price of
$1,000 per share for a total purchase price of $23,760,000 and 123,078 shares
of Class A Common Stock at a price of $1.95 per share for a total purchase
price of $240,000. The shares of Series A-2 Preferred Stock were not
registered under the Securities Act on the basis that it was a transaction by
an issuer not involving any public offering in accordance with Section 4(2)
under the Securities Act.
(3) 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 for a total purchase price of $2,475,000 and 12,821 shares of Class
A Common Stock at a price of $1.95 per share for a total purchase price of
$25,000. The shares of Series A-2 Preferred Stock were not registered under
the Securities Act on the basis that it was a transaction by an issuer not
involving any public offering in accordance with Section 4(2) under the
Securities Act.
(4) Pursuant to a recapitalization, in March 1996, Chase Capital Partners
(now known as Chase Venture Capital Associates, L.P.), CIBC Wood Gundy
Securities Corp. (now known as CIBC Wood Gundy Ventures, Inc.), Hancock
Venture Capital Associates (now known as HarbourVest Partners LLC), 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 cash consideration in order to settle a dispute
relating to the price per share paid for previously purchased shares of Common
Stock. The shares of Common Stock were not registered under the Securities Act
on the basis that it was a transaction by an issuer not involving any public
offering in accordance with Section 4(2) under the Securities Act.
(5) On September 30, 1996, the Registrant caused its outstanding shares of
10% Series A Preferred Stock and Series A-2 Preferred Stock to be converted
into newly issued shares of Class A Common Stock for no cash consideration.
The shares of Common Stock were not registered under the Securities Act on the
basis that it was a transaction by an issuer not involving any public offering
in accordance with Section 4(2) under the Securities Act.
(6) On September 30, 1996, Chase Capital Partners (now known as Chase
Venture Capital Associates, L.P.), CIBC Wood Gundy Securities Corp. (now known
as CIBC Wood Gundy Ventures, Inc.), Hancock Venture Capital Associates (now
known as HarbourVest Partners LLC), Northwood Capital Partners LLC, Northwood
Ventures, BT Capital Partners, Inc. and Enterprises & Transcommunications,
L.P. purchased, in the aggregate, 10,000 shares of 9.0% Cumulative Convertible
Pay-In-Kind Preferred Stock ("9% Preferred Stock") for an aggregate purchase
price of $10.0 million. The shares of 9% Preferred Stock were not registered
under the Securities Act on the basis that it was a transaction by an issuer
not involving any public offering in accordance with Section 4(2) under the
Securities Act.
(7) 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 $1,000 principal amount at maturity
a 14% Senior Discount Notes due 2003 (the "14% Senior Notes") and warrants to
purchase approximately 1.27 shares of Class A Common Stock (on a pre-split
basis), subject to adjustment under certain circumstances, at an exercise
price of $.01 per share and (b) $36.0 million in aggregate principal amount at
stated maturity of 9% Convertible Subordinated Discount Notes due 2004 (the
"Convertible Notes") 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 $55,967,775. These securities were
immediately resold to Merrill Lynch Global Allocation Fund, Inc. pursuant to
Rule 144A of the Securities Act.
(8) On August 18, 1997, the Registrant sold to Merrill Lynch, Pierce, Fenner
& Smith Incorporated and Donaldson Lufkin & Jenrette Securities Corporation
152,725 units (the "1997 Private Placement"), each consisting of $1,000
aggregate principal amount at maturity of 14 5/8% Senior Discount Notes due
2004 and ten warrants, each warrant entitling the holder to purchase .134484
shares of Class A Common Stock (on a pre-split basis), subject to adjustment
under certain circumstances for an aggregate purchase price of $100 million.
In
II-2
<PAGE>
connection with this sale, Merrill Lynch, Pierce, Fenner & Smith Incorporated
received $2,275,046 in commissions and Donaldson, Lufkin & Jenrette Securities
Corporation received $1,224,998 in commissions. These securities were
immediately resold to certain institutional investors pursuant to Rule 144A of
the Securities Act.
(9) On August 18, 1997, Chase Venture Capital Associates, L.P., CIBC Wood
Gundy Ventures, Inc., Northwood Capital Partners LLC, Northwood Ventures, BT
Capital Partners, Inc., Hancock Venture Partners V-Direct Fund L.P. and Prime
VIII, L.P. purchased, in the aggregate, 30,209 shares of 9.0% Cumulative
Convertible Pay-In-Kind Preferred Stock, Series A (the "9% Series A Preferred
Stock"), for an aggregate purchase price of $30.2 million. The shares of Series
A Preferred Stock were not registered under the Securities Act on the basis
that it was a transaction by an issuer not involving any public offering, in
accordance with Section 4(2) under the Securities Act.
(10) On August 25, 1997, the Registrant issued to Merrill Lynch Global
Association Fund, Inc. and Merrill Lynch Equity/Convertible Series
(collectively, "MLAM"), warrants to purchase an aggregate of 145,160 shares of
Class A Common Stock at an exercise price of $.01 per share for no cash
consideration. The warrants were issued in exchange for MLAM's consent, as the
holder of all of the 14% Senior Notes and the Convertible Notes, to allow the
Company to consummate the 1997 Private Placement. The shares of Common Stock
were not registered under the Securities Act on the basis that it was a
transaction not involving any public offering, in accordance with Section 4(2)
under the Securities Act.
(11) On October 17, 1997, Fidelity Communications International, Inc. and
Fidelity Investors Limited Partnership purchased, in the aggregate, 15,000
shares of 9% Series A Preferred Stock, for an aggregate purchase price of $15
million. The shares of 9% Series A Preferred Stock were not registered under
the Securities Act on the basis that it was a transaction by an issuer not
involving any public offering, in accordance with Section 4(2) under the
Securities Act.
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+++ Amended 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.
3.4+++ Certificate of Designations, Powers, Rights and Preferences of 9%
Cumulative Convertible Pay-In-Kind Preferred Stock, Series A 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 and
Amendment 1 thereto.
4.4+++ Consent Warrant Agreement dated as of August 25, 1997, by and between
the Registrant and Harris Trust and Savings Bank, as Warrant Agent.
4.5+++ Warrant Agreement, dated as of August 15, 1997, by and between the
Registrant and Harris Trust and Savings Bank, as Warrant Agent.
4.6+++ Registration Rights Agreement dated as of August 15, 1997, by and
among the Registrant and the Initial Purchasers named therein.
4.7+++ Supplemental Indenture No. 1, dated as of August 12, 1997, by and
between the Company and the Trustee, to the Convertible Note
Indenture.
5.1* Legal Opinion of Skadden, Arps, Slate, Meagher & Flom (Illinois).
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.1+ Employment Agreement, dated as of July 18, 1996, by and between the
Registrant and J. Thomas Elliott.
10.2+ Employment Agreement, dated as of July 18, 1996, by and between the
Registrant and Ronald W. Gavillet.
10.3++ Employment Agreement, dated as of November 18, 1996, by and between
the Company and Gerald J. Sweas.
10.4++ Employment Agreement, dated as of October 21, 1996, by and between
the Company and Ryan Mullaney.
10.5+ Form of Employment Agreement between the Registrant and certain
officers of the Registrant.
10.6+++ Amended and Restated 1994 Stock Option Plan of the Registrant.
10.7+++ 1997 Omnibus Securities Plan.
10.8+ Consulting Agreement, dated January 24, 1995, by and between the
Registrant and Eugene A. Sekulow.
10.9+ Form of Indemnification Agreement between the Registrant and certain
directors and officers of the Registrant.
10.10+ Promissory Note, dated December 15, 1995, between the Registrant and
J. Thomas Elliott.
10.11+ 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").
10.12+ 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").
10.13+++ Second Amendment to Purchase Agreement, dated as of April 20, 1994,
by and among the Registrant and the Initial Investors.
10.14+ Third Amendment to Purchase Agreement, dated as of November 1, 1994,
by and among the Registrant and the Initial Investors.
10.15+ Fourth Amendment to Purchase Agreement, dated as of June 22, 1995, by
and among the Registrant and the Initial Investors.
10.16+ 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").
10.17+ First Amendment to Stockholders Agreement, dated as of June 10, 1994,
by and among the Registrant, the Initial Investors and the
Stockholders.
10.18+ Registration Rights Agreement, dated as of April 20, 1994, by and
among the Registrant, CIBC and Chemical.
10.19+ First Amendment to Registration Rights Agreement, dated as of June
10, 1994, by and among the Registrant and the Initial Investors.
10.20+ Amended and Restated Registration Agreement, dated as of June 22,
1995, by and among the Registrant and the Investors.
10.21+++ First Amendment to Amended and Restated Registration Agreement, dated
as of October 17, 1997, by and among the Registrant and the
Investors.
10.22+ 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").
10.23+ 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").
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.24+ Second Amendment to Purchase Agreement, dated as of March 5, 1996, by
and among the Registrant and the Original Purchasers.
10.25+++ Third Amendment to Purchase Agreement, dated as of October 17, 1997,
by and among the Registrant, and the Original Purchasers.
10.26+ Amended and Restated Stockholders Agreement, dated as of June 22,
1995, by and among the Registrant and the Investors.
10.27+ Amended and Restated Stockholders Agreement, dated as of July 21,
1995, by and among the Registrant, the Original Purchasers and the
Stockholders.
10.28+++ Purchase Agreement, dated as of October 17, 1997, by and among the
Registrant, Fidelity International, Inc. and Fidelity Investors
Limited Partners.
10.29+ Purchase Agreement, dated as of September 25, 1996, by and among the
Registrant and the purchasers named therein, relating to the 9%
Preferred Stock.
10.30+ 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").
10.31+ Amendment No. 1 to Asset Purchase Agreement, dated as of October 27,
1995, by and among UTS, Quest United, QAM, Lavin, Elliott, and Quest.
10.32+ 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 (the "14% Senior Note
Indenture").
10.33++ Supplemental Indenture, dated as of March 17, 1997, by and between
the Company and the Trustee, to the 14% Senior Note Indenture.
10.34+++ Supplemental Indenture No. 2, dated as of August 18, 1997, by and
between the Company and the Trustee, to the 14% Senior Note
Indenture.
10.35+ Resale Local Exchange Service Agreement, dated July 8, 1996, by and
between New York Telephone Company and UTS.
10.36+ 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.
10.37+++ Indenture, dated as of August 15, 1997, by and between the Registrant
and Harris Trust and Savings Bank, as Trustee, for the Registrant's
14 5/8% Senior Discount Notes due 2004 (the "14 5/8% Senior Note
Indenture").
10.38+ Agreement for Resale Services, dated as of April 26, 1996, by and
between the Registrant and Ameritech on behalf of Ameritech Michigan.
10.39+ 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.
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).
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.
+++Incorporated by reference to the Registrant's Registration Statement on
Form S-4, file number 333-37621.
++++Incorporated by reference to the Registrant's Registration Statement on
Form S-1, file number 333-16947.
*To be filed by amendment.
II-5
<PAGE>
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 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-6
<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 NOVEMBER , 1997.
USN COMMUNICATIONS, INC.
/s/ J. Thomas Elliott
By: _________________________________
J. Thomas Elliott
President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS
BELOW CONSTITUTES AND APPOINTS J. THOMAS ELLIOTT, GERALD J. SWEAS AND THOMAS
A. MONSON WITH FULL POWER TO ACT ALONE, HIS TRUE AND LAWFUL ATTORNEYS-IN-FACT,
WITH THE POWER OF SUBSTITUTION, FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN
ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS (INCLUDING POST-
EFFECTIVE AMENDMENTS) TO THIS REGISTRATION STATEMENT, AND TO SIGN ANY
REGISTRATION STATEMENT FOR THE SAME OFFERING COVERED BY THIS REGISTRATION
STATEMENT THAT IS TO BE EFFECTIVE UPON FILING PURSUANT TO RULE 462(B)
PROMULGATED UNDER THE SECURITIES ACT OF 1933, AND ALL POST-EFFECTIVE
AMENDMENTS THERETO, AND TO FILE THE SAME, WITH ALL EXHIBITS THERETO, AND OTHER
DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE
COMMISSION, GRANTING UNTO SAID ATTORNEYS-IN-FACT FULL POWER AND AUTHORITY TO
DO AND PERFORM EACH AND EVERY ACT AND THING REQUISITE AND NECESSARY TO BE DONE
AS FULLY TO ALL INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON, HEREBY
RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT MAY LAWFULLY DO OR
CAUSE TO BE DONE BY VIRTUE HEREOF.
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>
President, Chief Executive November , 1997
____________________________________ Officer and Chairman of
J. Thomas Elliott the Board (Principal
Executive Officer)
/s/ Richard J. Brekka Director November , 1997
____________________________________
Richard J. Brekka
/s/ Donald J. Hofmann, Jr. Director November , 1997
____________________________________
Donald J. Hofmann, Jr.
/s/ Paul S. Lattanzio Director November , 1997
____________________________________
Paul S. Lattanzio
/s/ Thomas C. Brandenburg Director November , 1997
____________________________________
Thomas C. Brandenburg
</TABLE>
II-7
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ William A. Johnston Director November , 1997
____________________________________
William A. Johnston
/s/ Eugene A. Sekulow Director November , 1997
____________________________________
Eugene A. Sekulow
/s/ Dean M. Greenwood Director November , 1997
____________________________________
Dean M. Greenwood
/s/ Ian Kidson Director November , 1997
____________________________________
Ian Kidson
Executive Vice President and November , 1997
____________________________________ Chief Financial Officer
Gerald J. Sweas (Principal Financial
Officer)
</TABLE>
II-8
<PAGE>
EXHIBIT 3.1
CERTIFICATE OF AMENDMENT
TO THE
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF USN COMMUNICATIONS, INC.
------------------------------------------
Pursuant to Section 242 of the General
Corporation Law of the State of Delaware
------------------------------------------
USN COMMUNICATIONS, INC., a Delaware corporation (hereinafter called
the "Corporation"), does hereby certify as follows:
FIRST: The first sentence of ARTICLE FOUR of the Corporation's
Amended and Restated Certificate of Incorporation is hereby amended to read in
its entirety as set forth below:
"The total number of shares of stock which the Corporation has
authority to issue is 30,300,000 shares, 30,000,000 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 valued of
$.01 per share, with no voting rights except when required by law, and
250,000 of which shall be Preferred Stock, with a par value of $1.00 per
share."
SECOND: The foregoing amendment was duly adopted in accordance with
Section 242 of the General Corporation Law of the State of Delaware.
IN WITNESS WHEREOF, USN COMMUNICATIONS, INC. has caused this
Certificate to be duly executed in its corporate name this 11th day of
September, 1997.
USN COMMUNICATIONS, INC.
By: /s/ J. Thomas Elliott
--------------------------------------------
Name: J. Thomas Elliott
Title: President and Chief Executive Officer
<PAGE>
CERTIFICATE OF AMENDMENT
TO THE
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
USN COMMUNICATIONS, INC.
----------------------------------------
Pursuant to Section 242 of the General
Corporation Law of the State of Delaware
----------------------------------------
USN COMMUNICATIONS, INC., a Delaware corporation (hereinafter called
the "Corporation"), does hereby certify as follows:
FIRST: The first sentence of ARTICLE FOUR of the Corporation's
Amended and Restated Certificate of Incorporation is hereby amended to read in
its entirety as set forth below:
"The total number of shares of stock which the Corporation has
authority to issue is 5,300,000 shares, 5,000,000 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 250,000 of
which shall be Preferred Stock, with a par value of $1.00 per share."
SECOND: The foregoing amendment was duly adopted in accordance with
Section 242 of the General Corporation Law of the State of Delaware.
STATE OF DELAWARE
SECRETARY OF STATE
DIVISION OF CORPORATIONS
FILED 04:15 PM 08/13/1997
971271641 - 2392470
<PAGE>
EXHIBIT A
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
UNITED USN, INC.
ARTICLE ONE
-----------
The name of the corporation is United USN, Inc. (the "Corporation").
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 shall 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 hereto, 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
-----------
In 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 Bylaws 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
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of USN Communications, Inc.
on Form S-1 of our report dated March 14, 1997 (September 4, 1997 as to Note
22), 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 a part of this
Registration Statement, and to the reference to us under the headings "Selected
Historical Consolidated Financial and Operating Data" and "Experts" in the
Prospectus.
/s/ Deloitte & Touche LLP
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DELOITTE & TOUCHE LLP
Chicago, Illinois
November 26, 1997
