SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number
December 31, 1996 333-16265
USN Communications, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-3947804
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
10 South Riverside Plaza, Suite 401, Chicago, Illinois 60606
(Address of principal executive offices)
Registrant's telephone number, including area code (312) 906-3600
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. YES _____
NO X
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. X
The number of shares of Registrant's Class A Common Stock, par
value $.01 per share, outstanding as of March 15, 1997: 717,526 shares.
There are no outstanding shares of the Registrant's Class B Common Stock,
par value $.01 per share.
PART I
Item 1. BUSINESS
Introduction
USN Communications, Inc., formerly United USN, Inc. (the
"Company"), a Delaware corporation, was formed and commenced operations in
April 1994. The Company is a rapidly growing provider of integrated local
and long distance telecommunications services in the United States. The
Company resells telecommunications services of certain regional Bell
operating companies ("RBOCs") and certain long distance carriers to provide
an integrated solution of local and long distance services to the
underserved small and medium-sized business segment. The Company primarily
focuses its marketing efforts on businesses with telecommunications usage
of less than $5,000 per month. The Company's approach simplifies the
subscriber's telecommunications procurement and management tasks and
provides for the easy addition of customized services, such as special
local and long distance pricing and enhanced and other value-added calling
and billing features designed to meet specific subscriber needs.
The Company's goal is to be more flexible, innovative and
responsive to the needs of its subscribers than the RBOCs and the large
long distance carriers, which primarily concentrate their sales and
marketing efforts on residential and large commercial subscribers. Market
research combined with the Company's experience indicates that its target
subscribers prefer a single source and single bill for all of their
telecommunications needs. The Company provides local service obtained from
the incumbent RBOCs at wholesale rates, which allows subscribers to switch
to local service provided by the Company without changing their existing
telephone numbers or adding new facilities or equipment. The Company
provides long distance services by purchasing bulk capacity from long
distance carriers and reselling those services to the Company's
subscribers. By providing an integrated, customized package of local, long
distance and enhanced and other value-added services on a single bill
through its proprietary software and responsive subscriber care systems,
the Company believes that it provides a differentiated and competitive
product.
The Company obtains its resold local services pursuant to
comprehensive local exchange resale agreements with Ameritech Corporation
("Ameritech") for the greater metropolitan Chicago area, Ohio and Michigan
(collectively, the "Ameritech Resale Agreements") and with NYNEX
Corporation ("NYNEX") for the states of New York and Massachusetts (the
"NYNEX Resale Agreements"). The Company has also entered into a limited
service offering ("LSO") agreement with NYNEX for the resale of Centrex
services over a private local network which provides access to the majority
of business lines in Manhattan, New York. After a nine month systems test
period with Ameritech, the Company commenced service in Illinois in August
1996, followed by Ohio in October 1996. The Company completed a systems
test period in New York in October 1996 and started offering service in
November 1996. The Company began service in Michigan at the end of 1996 and
commenced service in Massachusetts in March 1997. Additionally, the Company
has contracted with certain long distance carriers, including MCI
Communications Corporation ("MCI") and Sprint Corporation ("Sprint") to
provide capacity for its long distance traffic. The Company continuously
seeks to enter into agreements with additional RBOCs, long distance
carriers and enhanced and other value-added service providers in order to
aggressively build its subscriber base as well as to provide additional
services to its existing subscribers while reducing costs. See "--Vendor
Agreements."
Market Opportunity
The Telecommunications Act of 1996 (the "Telecommunications
Act") is expected to result in a fundamental change in the competitive
structure of the local exchange market, greatly accelerating changes that
have been under way for several years as a result of policy initiatives of
the Federal Communications Commission (the "FCC") and ongoing deregulatory
trends at the state level. Specifically, the Telecommunications Act lifted
regulatory barriers to entry into the local market, required the resale of
local services by the RBOCs and put in place various measures designed to
further the development of a competitive market, all of which benefit the
Company.
Subscribers and Marketing
The Company's subscribers include small and medium-sized
businesses which principally have telecommunications usage of less than
$5,000 per month. The Company believes that the RBOCs and large
interexchange carriers historically have chosen not to concentrate their
sales and marketing efforts on this business segment, which the Company
believes represents a significant portion of the telecommunications service
market. Through radio and newspaper advertising as well as various
marketing programs, the Company has sought to establish itself as a
recognized brand name for its products and services emphasizing responsive
subscriber support systems, competitive product and pricing packages and a
targeted sales and marketing strategy. The Company had approximately 1,700
customers as of December 31, 1996.
The Company's services are currently sold through a direct sales
effort, but the Company plans to expand its sales efforts to a
multi-channel marketing approach, which combines both direct and indirect
sales efforts. The Company believes this marketing approach would increase
market coverage and reduce marketing costs and subscriber acquisition
costs. The Company focuses on the structuring, management and control of
its marketing programs in order to effectively integrate with the billing
and information systems of the RBOCs.
The Company has recruited and continues to recruit a direct
sales force in each of the markets in which it operates. The Company
recruits salespeople with experience in selling competitive
telecommunications services in the markets where they are based. The
Company's sales force is trained in-house with a rigorous
subscriber-focused training program that promotes activity-based selling
with a uniquely designed program for subscriber acquisition. The sales
force makes calls to prospective subscribers from potential subscriber
modules created by acquiring business databases sorted by target
characteristics (e.g., size of business and number of telephone lines).
Salespeople are given an incentive through a commission structure, with a
target of 50% of a salesperson's compensation based on such person's
performance.
Management Information Systems
Introduction
The Company is committed to the continued development and
successful implementation of billing and subscriber care systems that
provide accurate and timely information to both the Company and its
subscribers. The proprietary interfaces of the Company's management infor-
mation systems for the provisioning of services to the Company's customers
have been developed in cooperation with Ameritech and NYNEX, with which the
Company has entered into resale agreements. The Company believes this
method of development is a critical element to successfully providing local
telecommunications services and is an advantage, as the RBOCs have an
economic and strategic incentive to work with resellers that have
sophisticated information systems that can interface efficiently with the
RBOCs' systems. The Company believes its experience in developing these
systems will allow it to offer services quickly in new markets. The
subscriber care systems have been developed and continue to be enhanced in
a client/server environment allowing for flexibility to accommodate an
expanding subscriber base, efficient entry into new markets and rapid
development of additional functionality.
As a result of the Ameritech Resale Agreements and the NYNEX
Resale Agreements, as well as changes in the Company's subscriber base and
product mix, the Company has modified its billing and subscriber care
systems. The new systems were developed to run in a multi-site wide area
network configuration allowing the Company to decentralize certain data
processing and subscriber care activities as desired. Due to the modular
nature of this hardware and software setup, new centers may be added by the
Company to accommodate subscriber growth and entry into additional
territories.
The systems are designed to provide access to a broad range of
information on individual subscribers, including their call volume,
patterns of usage and billing history. This same information is used by the
Company to identify subscriber trends and will allow for proactive support
of the Company's marketing efforts.
The Company expects to continue to pursue a strategy of growth
and expansion, which will place additional demands on the Company's billing
and subscriber care systems. In the past the Company has experienced a
number of billing and provisioning problems under its LSO agreement with
NYNEX. Although the Company believes that the NYNEX-related problem has
been substantially resolved and that its billing and subscriber care
systems have been adequate to date for its business, there can be no
assurance that the problems will not recur or that new billing and
provisioning difficulties will not arise in the course of the Company's
execution of its business strategy. Such difficulties, if they were to
occur, could have a material adverse effect on the Company's business,
operating results and financial condition.
The anticipated high growth in the subscriber base in 1997 and
1998 following the recent significant expansion of the field sales
organization is likely to put substantial stress on the legacy billing and
subscriber care systems. The Company intends to invest a significant
portion of its capital plan for 1997 and 1998 to develop more robust
billing and subscriber care systems.
Billing and Management Systems
The Company currently outsources the rating, printing and
mailing of subscriber bills. Since these functions require a high volume of
processing in a limited time frame, the Company has determined that the
most economical way currently to process bills is to share the hardware
resources with others. The subscriber usage information for billing and the
tables and procedures used in the rating of call records are maintained
separately by the Company to manage the ongoing needs of each subscriber.
Standard management reports are generated for every billing cycle.
Provisioning and Subscriber Information/Subscriber Care
Provisioning of service to subscribers is accomplished through
the Company's proprietary systems. The provisioning gateway systems are
designed to interface with the RBOCs' systems through a variety of delivery
mechanisms, including Internet mail, direct connect, fax and network data
mover. Information regarding new subscribers is electronically requested
from the RBOCs and long-distance carriers, evaluated by the Company in
terms of credit risk and potential revenue and subsequently processed into
the Company's subscriber care system. In addition, the Company's
information systems generate margin analysis reports on existing businesses
of the Company and accounts receivable information.
Vendor Agreements
Introduction
The Company has executed comprehensive local exchange resale
agreements, including the Ameritech Resale Agreements for the greater
metropolitan Chicago area, Ohio and Michigan, and the NYNEX Resale
Agreements for the states of New York and Massachusetts. Additionally,
the Company has entered into an LSO agreement with NYNEX for the resale of
Centrex over a private local network which provides access to a majority of
the business lines in Manhattan, New York. The Company estimates, based on
data compiled by the FCC, that the regions covered by the Ameritech Resale
Agreements and the NYNEX Resale Agreements include access to over 10
million business access lines and over 20 million residential access
lines. The Company continuously evaluates opportunities to enter into
agreements with additional RBOCs, long distance carriers and enhanced and
other value-added service providers in order to aggressively build its
subscriber base as well as to provide additional services to its existing
subscribers while reducing costs.
The Company currently has long distance resale agreements with
MCI and Sprint. Such agreements allow the Company to offer its subscribers
integrated local and long distance telecommunications services. In
addition, such agreements have allowed the Company to enter and establish
itself as a telecommunications provider in strategically targeted markets
prior to establishing a local exchange resale agreement.
Ameritech Resale Agreements
Pursuant to the Ameritech Resale Agreements, the Company
purchases local exchange services at discounted rates based on a ten-year
term. These agreements contain pricing protections designed to maintain the
competitiveness of the Company's discounted rates and position the Company
to purchase capacity at rates at least as favorable as those of competitors
that have or may eventually negotiate a resale agreement. The level of
discounts of the resold services provided under these agreements vary based
on the state and the nature of services resold (i.e., access lines, local
calls, toll calls or features).
Services offered for resale include most of the
telecommunications products and services engineered and provided by
Ameritech, such as local exchange calling and attendant features including
call waiting, call forwarding, caller ID and three-way calling. The rates
for these services are filed with the public utilities commission of each
respective state. The Company also has an agreement with Ameritech for the
resale of certain non-tariffed services to its subscribers, including
inside wire maintenance.
The Ameritech Resale Agreements include a minimum commitment of
resold access lines per region covered. The minimum commitment in Illinois
is 150,000 business access lines and in Ohio and Michigan, 100,000 business
access lines and 10,000 residential lines. The minimum commitment is not a
limitation on the Company's overall ability to sell access lines at
discounted rates. However, if the Company fails to meet its minimum
commitment, the Company is subject to an underutilization charge equal to
the number of unutilized lines multiplied by a fixed average business line
rate. The measurement period of the minimum commitment does not commence,
however, until the completion of a three month trial or "beta period" and
an 18 month "ramp up" period which gives the Company the ability to build
its subscriber base. In addition, the Ameritech Resale Agreements provide a
"carryforward" provision designed to minimize the potential for any
liability resulting from a failure to meet the minimum commitment by
carrying forward underutilization amounts which may be met in the future.
If the Company does not meet its minimum commitment by the end
of the ten-year term, with the benefit of the carryforward provision, the
Company has the option to either pay a penalty based on the aggregate
number of unutilized lines or subscribe on a monthly basis to an equivalent
number of lines during the next three-year period. In the event the Company
terminates any of the Ameritech Resale Agreements prior to their expiration
without cause, the Company is subject to a termination charge.
NYNEX Resale Agreements
On July 9, 1996, the Company executed a resale agreement with
NYNEX to provide for the resale of local exchange services for the state of
New York at discounted rates based on a ten-year term. The New York NYNEX
Resale Agreement contains pricing protections designed to maintain the
competitiveness of discounted rates provided to the Company. Under the New
York NYNEX Resale Agreement, the Company receives the lowest rate and/or
most favorable term provided to any reseller; however, if a lower rate is
provided to a reseller committing to both a longer term and a greater
volume commitment, the Company receives the lower rate but must negotiate
with NYNEX a reasonable transition to similar commitments. If the Company
cannot successfully negotiate such a transition with NYNEX, then the
Company may be unable to maintain the lowest rate. The level of discounts
of resold services varies based on the nature of the services. The New York
NYNEX Resale Agreement contains a minimum commitment of 100,000 business
access lines. In the event the Company does not satisfy the minimum
commitment after a beta period and ramp-up period, the Company is subject
to an underutilization charge. However, the NYNEX Resale Agreement also
contains a carryforward provision designed to minimize the potential of an
underutilization charge. The Company has also executed an interim resale
agreement with NYNEX for Massachusetts. This agreement does not contain a
term and volume commitment, but was designed to allow the Company to begin
reselling services in Massachusetts expeditiously in a manner consistent
with state regulatory developments. It is expected that the Company and
NYNEX will enter into a long-term resale agreement for Massachusetts
similar to the New York NYNEX Resale Agreement.
NYNEX Limited Service Offering
Since 1994, the Company has offered Centrex over a private local
network, which allows the Company to provide integrated local exchange
service and long distance service, on a resale basis to the majority of
business lines of Manhattan, New York. The Company has access to 23 NYNEX
switches over a private local network and dedicated lines at discounted
rates based on volume of traffic. The Company believes the LSO agreement
will complement services provided under the NYNEX Resale Agreement by
allowing the Company to package specifically tailored telecommunications
services. The LSO agreement contains a minimum commitment of 10,000 local
exchange access lines. The Company has not met this minimum commitment due
to NYNEX provisioning delays. The LSO Agreement provides that provisioning
delays allow the Company to postpone its obligation to meet the minimum
commitment.
Long Distance Agreements
The Company primarily uses MCI to provide a wide range of long
distance telecommunications services to its customers. Services offered
for resale from MCI include a variety of inbound, outbound, calling card
and international services. In addition, the Company also resells
teleconferencing, debit cards, branded operator services and private line
services.
The Company's primary long distance carrier agreement is with
MCI, which became effective August 1, 1996 and contains a 33-month term. It
requires the Company to achieve certain monthly dollar targets in order to
qualify for discounted rates on carrier services. After a nine-month
"ramp-up" period, the agreement provides for an annual commitment for each
of the two years following the "ramp-up" period. If the Company does not
meet its annual commitment during any annual period of the term, an
underutilization charge shall apply in an amount equal to 15% of the
difference between the committed amount and the actual usage. However, the
Company may carry forward up to 10% of the initial annual commitment for a
period of up to three months in the following annual period.
Enhanced and Other Value-Added Telecommunications Services
The Company is in the process of negotiating agreements to offer
on a resale basis enhanced and other value-added services such as Internet
access, paging and voicemail. In addition, the Company has entered into an
agreement for the exclusive rights in the United States and Canada to
distribute a Windows-based teleconferencing product which allows the
conference host to conduct a conference call using point and click graphics
directly from a personal computer without having to make teleconference
reservations.
Competition
The Company operates in a highly competitive environment and has
no significant market share in any market in which it operates. The Company
expects that competition will intensify in the future due to regulatory
changes, including the enactment of the Telecommunications Act and the
increase in the size, resources and number of market participants. In each
of its markets, the Company faces competition for local service from
larger, better capitalized incumbent providers, many of whom have greater
financial resources than the Company. Additionally, the long distance
market is already significantly more competitive than the local exchange
market, because the RBOCs have historically had a monopoly position within
the local exchange market. The incumbent local exchange carriers ("LECs")
have long-established relationships with their subscribers and provide
those subscribers with various transmission and switching services that the
Company, in many cases, has only recently begun to offer.
In the local exchange market, the Company also faces competition
or prospective competition from one or more competitive access providers
("CAPs"), which have significantly greater financial resources than the
Company, and from other competitive providers, including
non-facilities-based providers like the Company. For example, AT&T, MCI and
Sprint, among other carriers, have each begun or indicated their intention
to begin offering local telecommunication services in major U.S. markets
using their own facilities or by resale of the LECs' or other providers'
services. In fact, certain competitors, including MCI, Sprint and AT&T,
have entered into interconnection agreements with Ameritech with respect to
the states of Illinois, Michigan and Ohio. These competitors either have
begun or will in the first half of 1997 likely begin offering local
exchange service in those states, subject to the joint marketing
restrictions under the Telecommunications Act described below. In addition,
some of these competitors have entered into interconnection agreements with
NYNEX and either have begun or in the first half of 1997 will likely begin
offering local exchange service in New York and Massachusetts, subject to
such joint marketing restrictions. In addition to these long distance
service providers, entities potentially capable of offering switched
services include CAPs, cable television companies, electric utilities,
other long distance carriers, microwave carriers, wireless telephone system
operators and large subscribers who build private networks. Many
facilities-based CAPs and long distance carriers, for example, have
committed substantial resources to building their networks. By building a
network, a facilities-based provider can enter the local exchange market by
using its own network, or entering into interconnection agreements or
resale agreements with incumbent LECs, including RBOCs. Such additional
alternatives may provide the CAPs with greater flexibility and a lower cost
structure than the Company.
With respect to wireless telephone system operators, the FCC
recently authorized cellular, personal communications service and other
commercial mobile radio service ("CMRS") providers to offer wireless
services to fixed locations, rather than just to mobile subscribers, in
whatever capacity such CMRS providers choose. Previously, cellular
providers could provide service to fixed locations only on an ancillary or
incidental basis. This authority to provide fixed as well as mobile
services will enable CMRS providers to offer wireless local loop service
and other services to fixed locations (e.g., office and apartment
buildings) in direct competition with the Company and other providers of
traditional fixed telephone service. In addition, in August 1996 the FCC
promulgated regulations that classify CMRS providers as telecommunications
carriers, thus giving them the same rights to interconnection and
reciprocal compensation under the Telecommunications Act as other non-LEC
telecommunications carriers, including the Company.
Under the Telecommunications Act and related federal and state
regulatory initiatives, barriers to local exchange competition are being
removed. The availability of broad-based local resale and introduction of
facilities-based local competition are required before the RBOCs may
provide in-region interexchange long distance services. Also, the largest
long distance carriers (AT&T, MCI, Sprint and any other carrier with 5% or
more of the pre-subscribed access lines) are prevented under the
Telecommunications Act from bundling local services resold from an RBOC in
a particular state with their long distance services until the earlier of
(i) February 8, 1999 or (ii) the date on which the RBOC whose services are
being resold obtains in-region long distance authority in that state. The
RBOCs are currently allowed to offer certain in-region "incidental"
long-distance services (such as cellular, audio and visual programming and
certain interactive storage and retrieval functions) and to offer virtually
all out-of-region long distance services.
In January 1997, Ameritech, the RBOC in three states where the
Company operates, filed and subsequently withdrew an application for
in-region long distance authority in Michigan. The Company anticipates that
Ameritech will again file an application with respect to Michigan as well
as most or all of its other states--including Illinois and Ohio. Other
RBOCs, including NYNEX in New York, are expected to file such applications
as early as the first half of 1997. The FCC will have 90 days from the date
such an application is filed to decide whether to grant or deny the
application. Once the RBOCs are allowed to offer widespread in-region long
distance services, both they and the largest interexchange carriers will be
in a position to offer single-source local and long distance services
similar to those offered by the Company. While new business opportunities
will be made available to the Company through the Telecommunications Act
and other federal and state regulatory initiatives, regulators are likely
to provide the incumbent LECs with an increased degree of flexibility with
regard to pricing of their services as competition increases. Although the
Ameritech Resale Agreements and the NYNEX Resale Agreements contain certain
pricing protections, including adjustments in the wholesale rates to be
consistent with any changes in the Ameritech and NYNEX retail rates, if the
incumbent LECs elect to lower their rates and sustain lower rates over
time, this may adversely affect the revenues of the Company and place
downward pressure on the rates the Company can charge. While the Ameritech
and NYNEX Resale Agreements ensure that the Company will receive any lower
rate provided to any other reseller, under the NYNEX Resale Agreement if
such lower rate is provided to a reseller committing to both a longer term
and a greater volume commitment, the Company receives the lower rate, but
must negotiate with NYNEX a reasonable transition to similar commitments.
If the Company cannot successfully renegotiate such a transition with
NYNEX, then the Company may be unable to maintain the lowest rate. The
Company believes the effect of lower rates may be offset by the increased
revenues available by offering new products and services to its target
subscribers, but there can be no assurance that this will occur. In
addition, if future regulatory decisions afford the LECs excessive pricing
flexibility or other regulatory relief, such decisions could have a
material adverse effect on the Company.
Competition for the Company's products and services is based on
price, quality, network reliability, service features and responsiveness to
subscriber needs. While the Company believes that it currently has certain
advantages relating to the timing, ubiquity and cost savings resulting from
its resale agreements, there is no assurance that the Company will be able
to maintain these advantages. A continuing trend toward business
combinations and alliances in the telecommunications industry may create
significant new competitors to the Company. Many of the Company's existing
and potential competitors have financial, technical and other resources
significantly greater than those of the Company.
Government Regulation
The Company is subject to varying degrees of federal, state,
local and international regulation. In the United States, the Company is
most heavily regulated by the states, especially for the provision of local
exchange services. The Company must be separately certified in each state
to offer local exchange services. No state, however, subjects the Company
to price cap or rate-of-return regulation. FCC approval is required for the
resale of international facilities and services. The FCC has determined
that nondominant carriers, such as the Company, are required to file
interstate tariffs on an ongoing basis, setting forth the Company's rates
and operating procedures. Such tariffs can currently be modified on one
day's notice. The FCC recently issued regulations to eliminate this tariff
filing requirement for all nondominant carriers, such as the Company and
all other nondominant interexchange carriers (except possibly the RBOCs in
certain circumstances), effective in late 1997. The FCC has recently ruled,
subject to its consideration of the issue in another pending FCC
proceeding, that RBOCs providing out-of-region long distance service
through separate subsidiaries from their local telephone operations qualify
for nondominant treatment. Out-of-region RBOC services provided through
unseparated entities, however, are subject to full dominant carrier
regulation, including the requirement to submit cost support with tariffs
and to file tariffs on at least 15 to 45 days' notice, depending on various
factors. The FCC has not yet indicated whether RBOC in-region service, when
authorized, will be subject to dominant or nondominant regulatory status.
Legislation. On February 8, 1996, President Clinton signed into
law the Telecommunications Act, comprehensive federal telecommunications
legislation affecting all aspects of the telecommunications industry. The
Telecommunications Act establishes a national policy that promotes local
exchange competition. The Telecommunications Act requires that local and
state barriers to entry into the local exchange market be removed and
establishes broad uniform standards under which the FCC and the state
commissions are to implement local competition and co-carrier arrangements
in the local exchange market. Under certain conditions and subject to
reasonable exceptions, incumbent LECs will be required to make available
for resale to new entrants all services offered by the LEC on a retail
basis. The Telecommunications Act also imposes significant obligations on
the RBOCs and other incumbent LECs, including the obligation to
interconnect their networks with the networks of competitors. Each
incumbent LEC would be required not only to open its network but also to
"unbundle" the network. The FCC issued regulations in August 1996 defining
a minimum set of elements which must actually be unbundled, and each state
may augment this list if it wishes. The pricing of these unbundled network
elements and services will determine whether it is economically attractive
to use these elements.
In addition to the required network unbundling applicable to all
incumbent LECs, the RBOCs have an added incentive to open their local
exchange networks to facilities-based competition because the
Telecommunications Act provides for the removal of the current ban on RBOC
provision of in-region inter-LATA toll service and equipment manufacturing.
This ban will be removed only after the RBOC demonstrates to the FCC, which
must consult with the Department of Justice and the relevant state
commissions, that the RBOC has (1) met the requirements of the
Telecommunications Act's 14-point competitive checklist and (2) entered
into an approved interconnection agreement with at least one unaffiliated,
facilities-based competitor in some portion of the state pursuant to which
such competitor provides both business and residential service (or that by
a date certain no such competitors have "requested" interconnection as
defined in the Telecommunications Act). RBOC in-region services must be
provided through a separate subsidiary for three years, unless extended by
the FCC. In January 1997, Ameritech, the RBOC in three states where the
Company operates, filed and subsequently withdrew an application for
in-region long distance authority in Michigan. The Company anticipates
that Ameritech will again file an application with respect to Michigan as
well as most or all of its other states--including Illinois and Ohio. Other
RBOCs, including NYNEX in New York, are expected to file such applications
as early as the first half of 1997. If the FCC determines that the RBOC's
entry into in-region provision of long distance in that state is in the
public interest and that the RBOC has met the 14-point checklist, it must
authorize the RBOC to provide such services.
Under the 14-point competitive checklist, in order to obtain
in-region long distance authority an RBOC must first demonstrate to the
FCC, among other things, that, within a particular state, it offers
competing LECs the following: interconnection as required under the
Telecommunications Act; non-discriminatory access to unbundled network
elements at just and reasonable rates; non-discriminatory access to its
poles, ducts, conduits and rights-of-way; unbundled local loop
transmission, unbundled local transport and unbundled local switching;
non-discriminatory access to 911 services; directory assistance, operator
call completion services and white pages directory listings for competing
local carriers' subscribers; non-discriminatory access to call routing
databases; number portability (i.e., the ability of a subscriber to keep
the same telephone number when switching local telephone service
providers); dialing parity (i.e., the ability of subscribers of one
telephone service provider to call subscribers of other providers without
dialing access codes); reciprocal compensation arrangements for the
termination of calls between competing local networks; and permitting
resale of its telecommunications services.
While state-by-state regulatory activity has to date brought
resale co-carrier arrangements or initiatives to various degrees of
completion in nearly all states, the Telecommunications Act is intended to
accelerate the process and create a competitive environment in all markets,
eliminating state and local statutory and regulatory barriers to entry.
This preemption of state laws barring local competition and the relaxation
of regulatory restraints should enhance the Company's ability to expand its
service offerings nationwide. In contrast, by removing barriers to entry
into the local exchange market and at the same time enabling multiple
carriers to compete with the Company in the provision of local and long
distance services, ultimately allowing the RBOCs and large interexchange
carriers to offer their own packages of single-source local/long distance
services, the Telecommunications Act will substantially increase the compe-
tition the Company will face.
In addition to providing the Company with a national framework
to achieve local exchange resale carrier status in local exchange markets,
the Telecommunications Act permits the Company, as a telecommunications
carrier with less than 5% of nationwide presubscribed access lines, to
continue to offer single-source combined packages of local and long
distance services. In contrast, AT&T, MCI and Sprint may not bundle in an
RBOC's territory their local services resold from an RBOC and in-region
long distance service until the earlier of (i) February 8, 1999 or (ii) the
date the RBOC is authorized to enter the inter-LATA long distance market in
that state.
The Telecommunications Act also creates a new Federal-State
Joint Board for the purpose of making recommendations to the FCC regarding
the implementation of a largely revised universal service program. All
telecommunications carriers, including the Company, that provide interstate
services are required to contribute, on an equitable and nondiscriminatory
basis, to the preservation and advancement of universal service pursuant to
a specific and predictable universal service mechanism to be established by
the FCC. The Federal-State Joint Board issued recommendations regarding the
scope and funding of universal service in December 1996, but those
recommendations are not binding. The FCC may exempt certain classes of
carriers from having to contribute to the universal service fund. The
Company is unable to predict the final formula for universal service
contribution or its own level of contribution.
Federal Regulation. The Telecommunications Act in some sections
is self-executing, but in most cases the FCC must issue regulations that
identify specific requirements before the Company and its competitors can
proceed to implement the changes the Telecommunications Act prescribes. The
FCC already has commenced several of these rulemaking proceedings.
The Company actively monitors all pertinent FCC proceedings and
has participated in some of these proceedings. The Telecommunications Act
provides that individual state utility commissions can, consistent with FCC
regulations, prohibit resellers from reselling a particular service to
specific categories of subscribers to whom the incumbent LEC does not offer
that service at retail. In August 1996, the FCC issued detailed regulations
providing that many such limitations are presumptively unreasonable and
that states may enact such prohibitions on resale only in certain limited
circumstances. In particular, the FCC concluded that while it would be
permissible to prohibit the resale of certain residential or other
subsidized services to end users that would be ineligible to receive such
services directly from the LEC, all other "cross-class" selling
restrictions, including those on volume discount and flat-rated offerings
to business customers, would be presumed unreasonable. An incumbent LEC may
rebut this presumption, however, by demonstrating that the class
restriction is reasonable and nondiscriminatory. The FCC also rejected
claims by several incumbent LECs to provide for several exceptions to the
general resale obligation. For instance, it refused to create a general
exception for all promotional or discounted offerings, including contract
and customer-specific offerings. The FCC did, however, conclude that
short-term promotional prices (i.e., those offered for 90 days or less) are
not "retail rates" and thus are not subject to the wholesale rate
obligation. Incumbent LECs may not offer consecutive 90-day promotions to
avoid these resale obligations.
The Telecommunications Act also provides that state commissions
shall be given an opportunity to determine the wholesale rates for local
telecommunications services (i.e., the rates charged by incumbent LECs to
resellers such as the Company) on the basis of retail rates less "avoided
costs," i.e., marketing, billing, collection and other administrative costs
avoided by the incumbent LEC when it sells at wholesale. In August 1996 the
FCC issued detailed regulations identifying such avoided costs, and also
included in such category "avoidable" costs. To determine the specific
value of avoided and avoidable costs applicable to each service of a
particular incumbent LEC, the FCC required the state public service
commissions to conduct detailed cost studies consistent with the FCC
regulations governing what constitutes avoided and avoidable costs. Until
such time that these costs studies are completed, the FCC established an
interim default discount of between 17% and 25%. Accordingly, until such
time that a state determines the actual level of avoided and avoidable
costs pursuant to the FCC's regulations, it may require incumbent LECs to
discount their retail offerings by 17% to 25%, provided that actual cost
studies are completed within a reasonable time. The Telecommunications Act
also provides that state commissions shall determine the rates charged for
unbundled elements of the incumbent LEC's network on the basis of cost plus
a reasonable profit. In August 1996, the FCC declined to issue detailed
regulations governing the relationship between these two pricing standards,
leaving the interpretation and implementation of the two standards to the
states. The Company is unable to predict the final form of such state
regulation, or its potential impact on the Company or the local exchange
market in general.
In August 1996, the FCC also issued regulations that, among
other things, set minimum standards governing the terms and prices of
interconnection and access to unbundled incumbent LEC network elements.
These regulations indirectly affect the price at which the Company's new
facilities-based competitors may ultimately provide service. At the same
time, the FCC imposed minimum obligations regarding the duty of incumbent
LECs to negotiate interconnection or resale arrangements in good faith.
A number of RBOCs, state regulatory commissions and other
parties have filed requests for reconsideration by the FCC of various parts
of the rules announced by the FCC in August 1996, including those
provisions (a) limiting competitors' ability to purchase for resale certain
types of service that the RBOC is no longer marketing to new customers
("grandfathered services"), and (b) establishing pricing methodologies and
interim default rates for resold services and unbundled network elements.
The FCC is conducting a proceeding to consider the various petitions for
reconsideration, and a decision is expected in the first half of 1997. In
addition, many of the same parties and certain other parties have filed
court appeals challenging the same FCC rules. All the court appeals have
been consolidated before the Eighth Circuit Federal Court of Appeals, which
has stayed the effect of certain parts of the rules (including the
provisions establishing pricing methodologies and default rates for resold
services and unbundled network elements) pending its decision in the
appeals. The U.S. Supreme Court declined to dissolve the stay, and the
court of appeals' decision is not expected before the middle of 1997. The
Company cannot predict at this time the outcome of the appeals or
reconsideration processes.
In July 1996, the FCC mandated that over the course of the next
year responsibility for administering and assigning local telephone numbers
be transferred from the RBOCs and a few other LECs to a neutral entity. In
August 1996, the FCC issued regulations which address certain of these
issues, but leave others for decision by the states and the still-to-be
selected neutral numbering plan administrator. The new FCC numbering
regulations (a) prohibit states from creating new area codes that could
unfairly hinder LEC competitors (including the Company) by requiring their
customers to use 10 digit dialing while existing incumbent LEC customers
use 7 digit dialing, and (b) prohibit incumbent LECs (which are still
administering central office numbers pending selection of the neutral
administrator) from charging "code opening" fees to competitors (such as
the Company) unless they charge the same fee to all carriers including
themselves. In addition, each carrier is required to contribute to the cost
of numbering administration through a formula based on net
telecommunications revenues. In July 1996, the FCC released rules to permit
both residential and business consumers to retain their telephone numbers
when switching from one local service provider to another (known as "number
portability"). RBOCs are required to implement number portability in the
top 100 markets by October 1, 1997 and to complete it by December 31, 1998.
In smaller markets, RBOCs must implement number portability within six
months of a request therefor commencing December 31, 1998. Other LECs,
including the Company, are required to implement number portability by
October 31, 1997 only in those of the top 100 markets where the feature is
requested by another LEC. Similarly, the Company and other non-RBOC LECs
are only required to implement number portability by December 31, 1998 in
those additional markets where the feature is requested by another LEC. The
Company already offers number portability as it provides local service
obtained from the incumbent RBOCs. This allows subscribers to switch to the
Company's services and still retain their existing telephone numbers.
In addition, the FCC recently authorized cellular and other CMRS
providers to offer wireless services to fixed locations (rather than just
to mobile subscribers), including offering wireless local loop service, in
whatever capacity such provider determines. Previously, many CMRS providers
could provide fixed services on only an ancillary or incidental basis. In
addition, in August 1996 the FCC promulgated regulations that classify CMRS
providers as telecommunications carriers, thus giving them the same rights
to interconnection and reciprocal compensation under the Telecommunications
Act as other non-LEC telecommunications carriers, including the Company.
State Regulation. Historically, certain of the Company's resold
local and long distance services were classified as intrastate and
therefore subject to state regulation. As its local service business and
product lines has expanded, the Company has offered more intrastate service
and become increasingly subject to state regulation. The Telecommunications
Act maintains the authority of individual state utility commissions to
impose their own regulation of local exchange services so long as such
regulation is not inconsistent with the requirements of the
Telecommunications Act. In all states where certification is required, the
Company's operating subsidiaries are certificated as common carriers. In
all states, the Company believes that it operates with the appropriate
state regulatory authorization. The Company currently is authorized to
provide intrastate toll or a combination of local and intrastate toll
service in more than 40 states. These authorizations vary in the scope of
the intrastate services permitted.
The Telecommunications Act provides that the Company's resale
agreements must be submitted to the applicable state utility commission for
approval, and it places strict limitations on the bases on which a state
commission can reject such an agreement. If the state commission does not
act within 90 days after the agreement is submitted for approval, then the
agreement is deemed approved. In addition, if a state commission fails to
act to enforce an agreement, the FCC can (upon request of a party) take
jurisdiction over the matter. A state commission's decisions regarding
implementation and enforcement of an agreement are appealable to the
federal district court in that state.
Employees
As of December 31, 1996, the Company employed approximately 450
people. The Company's employees are not unionized, and the Company believes
its relations with its employees are good. In connection with its marketing
and sales efforts and the conduct of its other business operations, the
Company uses third party contractors, some of whose employees may be
represented by unions or collective bargaining agreements. The Company
believes that its success will depend in part on its ability to attract and
retain highly qualified employees.
Item 2. PROPERTIES
The Company leases twenty-seven facilities, principally sales
facilities, in Boston, Massachusetts, Chicago, Illinois, Detroit, Michigan,
Cleveland and Columbus, Ohio and New York City, as well as in a number of
areas surrounding such cities and in other significant urban areas in
Michigan, New York and Ohio. The Company maintains its corporate
headquarters in Chicago, Illinois. Although the Company's facilities are
adequate at this time, the Company believes that it may have to lease
additional facilities, particularly in new metropolitan areas where the
Company enters RBOC resale agreements.
Item 3. LEGAL PROCEEDINGS
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.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
No matters were submitted to a vote of the Company's
securityholders during the fourth quarter of fiscal 1996.
PART II
Item 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
No established public trading market exists for the Company's
common equity. As of March 15, 1997, there were approximately 32 holders of
record of the Company's Class A Common Stock, par value $.01 per share, and
no holders of record of the Company's Class B Common Stock, par value $.01
per share.
The Company has not declared any dividends on its common equity
in the two most recent fiscal years. Pursuant to the terms of the Company's
Certificate of Designations, Powers, Rights and Preferences of 9.0%
Cumulative Convertible Pay-In-Kind Preferred Stock, the Company may not pay
or declare any dividend or make any distribution upon the Company's common
stock. In addition, under the terms of an indenture governing the Company's
14% Senior Discount Notes due 2003, the Company may not declare any
dividend or make any distribution on any of its capital stock (other than
dividends, distributions or payments made solely in nonredeemable capital
stock of the Company) unless certain financial conditions are satisfied and
no default under such indenture has occurred or shall occur as a
consequence thereof.
Item 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table presents selected historical consolidated
financial data for the period from inception of the Company in April 1994
to December 31, 1994 and for the fiscal years ended December 31, 1995 and
1996. The selected financial data has been derived from consolidated
financial statements of the Company. The selected financial data should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial
statements of the Company and the related notes appearing elsewhere in this
report.
<TABLE>
<CAPTION>
Inception to
December 31, Fiscal Year Ended December 31,
1994 1995 1996
---------------- ------------- --------
(in thousands, except per share information and ratios)
Statement of Operations Data:
<S> <C> <C> <C>
Net service revenue................................ $ 1,737 $ 7,884 $ 9,814
Cost of services................................... 1,455 9,076 9,256
------------ ------------- -------------
Gross margin....................................... 282 (1,192) 558
Sales and marketing expense........................ 2,869 5,867 12,612
General and administrative expense................. 4,686 11,100 20,665
Interest expense................................... 26 734 1,797
Interest and other income(1)....................... 152 646 9,469
Minority interest.................................. -- 150 --
------------ ------------- -------------
Net loss........................................... $ (7,147) $ (18,097) $ (25,047)
============= ============== =============
Accumulated unpaid preferred dividends............. $ 707 $ 3,810 $ 225
Net loss to common shareholders.................... $ (7,854) $ (21,907) $ (25,272)
Net loss per common share.......................... $ (65.63) $ (72.42) $ (49.53)
Weighted average shares outstanding................ 119,678 302,520 510,233
December 31,
------------------------------------------------------------
1994 1995 1996
------------ ------------- --------
Balance Sheet Data:
Cash and cash equivalents.......................... $ 5,979 $ 13,705 $ 60,569
Total assets....................................... 12,747 20,471 78,052
Long-term debt (net of current maturities)......... 3,176 518 59,864
Redeemable preferred stock......................... 15,306 44,396 10,045
Common stockholders' deficit....................... (7,830) (28,768) (3,606)
Inception to
December 31, Fiscal Year Ended December 31,
1994 1995 1996
---------------- ------------- --------
(in thousands, except ratios)
Other Data:
EBITDA(2).......................................... $ (7,087) $ (15,901) $ (30,390)
Cash flows from operating activities............... (6,141) (14,308) (24,098)
Cash flows from investing activities............... (1,708) (2,556) 7,274
Cash flows from financing activities............... 13,828 24,589 63,689
Depreciation and amortization...................... 186 2,258 2,329
Capital expenditures............................... 1,728 1,740 2,259
Ratio of earnings to fixed charges(3).............. -- -- --
</TABLE>
- --------
(1) Interest and other income for the year ended December 31, 1996
includes a gain of $8.1 million realized on the sale of the Company's
switching facilities in Ohio.
(2) EBITDA consists of operating income (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 included
because management believes that certain investors find it to be a
useful tool for measuring the ability of the Company to service its
debt. EBITDA is not necessarily a measure of the Company's ability to
fund its cash needs. See the Consolidated Statements of Cash Flows of
the Company and the related notes to the Consolidated Financial
Statements thereto included herein.
(3) The ratio of earnings to fixed charges is computed by dividing pretax
income (loss) from operations before interest charges by interest
expense. Earnings were insufficient to cover fixed charges for the
periods ended December 31, 1994, 1995 and 1996 by $7.0 million, $16.8
million and $22.6 million, respectively.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The Company commenced operations in April 1994 as a provider of
local and long distance telecommunications services to meet the needs of
small and medium-sized business subscribers, through the purchase of US
Network Corporation ("US Network"). US Network had four months of
operations prior to being acquired by the Company. Operations during this
four month period included limited administrative expenses and no revenues,
and assets consisted primarily of cash and organization costs. In October
1995, the Company, through a newly formed wholly owned acquisition
subsidiary, Quest United, Inc. ("Quest"), acquired certain assets and
assumed certain liabilities of Quest America, LP., a telecommunications
reseller and consulting firm (the "Quest Acquisition").
Initially, the Company entered the local telecommunications
market as a facilities-based CAP with network facilities in Ohio. Due to
the high costs associated with the initial construction, installation and
expansion of each local network facility, including right-of-way costs,
franchise fees, interconnection charges and other operating expenses and in
anticipation of the impact of the passage of the Telecommunications Act of
1996, the Company refocused its operations. The Company sold its existing
facilities in Ohio and certain other assets in February 1996, and
transferred certain liabilities with respect to those facilities, to pursue
a non-facilities-based approach to the local telecommunications market.
The Company negotiated for the first broad based resale
agreement with Ameritech for local services, which was signed in November
1995, and negotiated with NYNEX for a comprehensive local resale agreement
which was signed in July 1996. The Company also consummated various other
agreements in 1996 with certain carriers for the resale of long distance
and enhanced and other value-added services. The Company commenced the
marketing and provisioning of services under those agreements during the
latter half of 1996. Although management believes that its current strategy
will have a positive effect on the Company's results of operations over the
long-term, by continuing to seek other providers of local, long distance
and enhanced and other value-added services in order to increase its
subscriber base and product offerings and reduce expenses, this strategy is
expected to have a negative effect on the Company's results of operations
over the short-term. The Company anticipates losses and negative cash flow
for the foreseeable future, attributable in part to significant investments
in operating, sales, marketing, management information systems and general
and administrative expenses. To date, the Company's growth, including
capital expenditures, has been funded primarily by the capital
contributions of Chase Venture Capital Associates, L P., CIBC Wood Gundy
Ventures, Inc., Hancock Venture Partners IV - Direct Fund, L.P., BT Capital
Partners, Inc., Northwood Capital Partners LLC, Northwood Ventures and
Enterprises & Transcommunications, LP and by the proceeds from the
September 30, 1996 sale to Merrill Lynch Global Allocation Fund, Inc. of
debt securities and warrants to purchase common stock, which are described
in detail under the caption "Liquidity and Capital Resources."
The Company's net service revenue, which is recognized on a
resale basis, primarily consists of sales revenue from telecommunications
services. The Company bills its subscribers for local and long distance
usage based on the type of service utilized, the number, time and duration
of calls, the geographic location of the terminating phone numbers and the
applicable rate plan in effect at the time of the call. Net service revenue
for the Quest operations, which is recognized on an agency basis, primarily
consists of commissions earned from carriers on telecommunications services
provided to their subscribers.
Cost of services includes the cost of local and long distance
services charged by carriers for recurring charges, per minute usage
charges and feature charges, as well as the cost of fixed facilities for
dedicated services and special regional calling plans. In 1995, cost of
services also included fixed and one-time charges associated with the Ohio
switching facilities owned by the Company. These costs were transferred to
a third party subsequent to December 31, 1995, when the obligations with
respect to the switching facilities were effectively transferred.
Sales and marketing expense consists of the costs of providing
sales and other support services for subscribers. General and
administrative expense consists of the costs of the billing and information
systems and personnel required to support the Company's operations and
growth as well as all depreciation and amortization expenses.
The Company has experienced significant growth in the past and,
depending on the extent of its future growth, may experience significant
strain on its management, personnel and information systems. To accommodate
this growth, the Company will continue to implement and improve
operational, financial and management information systems. In an effort to
support its growth, the Company added several senior management positions
and over 250 employees in 1996. Also, the Company is implementing new
information systems that will provide improved recordkeeping for subscriber
information and management of uncollectible accounts and fraud control.
Results of Operations
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net service revenue increased to $9.8 million for the year ended
December 31, 1996 from $7.9 million for the year ended December 31, 1995.
The increase in net service revenue was due primarily to a 36% increase in
the subscriber base in the Company's geographic markets (from approximately
1,250 customers at the end of 1995 to approximately 1,700 customers at the
end of 1996) and the revenues attributable to the Quest Acquisition which
primarily consist of commissions earned from carriers on telecommunications
services provided to their subscribers. Approximately $1.4 million in
increased revenues is attributable to the addition of new customers,
primarily in Ohio, and approximately $0.5 million is attributable to
revenues gained from the Quest Acquisition.
Gross margin of $0.6 million for the year ended December 31,
1996 improved from the negative margin of $1.2 million for the year ended
December 31, 1995 due primarily to the elimination of fixed costs upon the
sale of the switching facilities in Ohio and a $1.4 million sales and
related margin adjustment for 1995 revenue purportedly not billed by NYNEX
to the Company's customers under the billing and collection agreement. In
1996, the Company recovered approximately $0.9 million from NYNEX and is
continuing to pursue additional amounts.
Sales and marketing expenses increased $6.7 million, or 114%,
from $5.9 million for the year ended December 31, 1995 to $12.6 million for
the year ended December 31, 1996. The increase was due primarily to an
increase in the number of sales and marketing employees from approximately
115 at the end of 1995 to over 300 at the end of 1996, which resulted in
increases to salaries and benefits of $3.9 million, travel, training and
entertainment costs of $1.0 million and recruitment costs of $0.8 million.
Additionally, advertising costs increased $0.9 million due to product
launches in the Company's target markets.
General and administrative expenses increased $9.6 million, or
86%, to $20.7 million for the year ended December 31, 1996 versus $11.1
million for the year ended December 31, 1995. The increase was due
primarily to an increase in the number of operations and administrative
employees from approximately 90 at the end of 1995 to approximately 160 at
the end of 1996, which resulted in increases to salaries and benefits of
$2.5 million and facility costs of $1.2 million. Additionally, fees paid to
consultants and other professionals increased over $1.0 million, primarily
relating to the development and expansion of the Company's customer
service, billing and administrative information systems and facilities.
Amortization expense increased $0.8 million due primarily to a full year of
amortization expense related to the Quest Acquisition in 1996 versus eight
months in 1995. Additionally, $1.7 million of expense was incurred relating
to the settlement of a derivative action filed by a minority shareholder.
Interest and other income increased to $9.5 million for the year
ended December 31, 1996 from $646,000 for the year ended December 31, 1995
due primarily to an $8.1 million non-recurring gain on the sale of the
Company's switching facilities in Ohio in February 1996.
Interest expense increased to $1.8 million for the year ended
December 31, 1996 from $734,000 for the year ended December 31, 1995. This
increase was due primarily to interest expense attributable to the Senior
Notes and Convertible Notes issued in September 1996, which are described
in more detail under the caption "Liquidity and Capital Resources."
As a result of the factors described above, the Company's net
loss increased to $25.1 million for the year ended December 31, 1996 from
$18.1 million for the year ended December 31, 1995.
Year Ended December 31, 1995 versus Inception to December 31, 1994
The results for fiscal 1995 are not comparable with the results
for fiscal 1994 as fiscal 1995 represents a full fiscal year and fiscal
1994 represents approximately eight months of operations since the
Company's inception in April 1994.
Net service revenue increased to $7.9 million in fiscal 1995
from $1.7 million in fiscal 1994. This increase was due to a full year of
operations and a 34% increase in the subscriber base (from approximately
930 customers at December 31, 1994 to approximately 1,250 customers at
December 31, 1995).
Cost of services increased to $9.1 million in fiscal 1995 from
$1.5 million in fiscal 1994. The increase was due to the one-time
installation costs and fixed ongoing costs related to the Ohio switching
facilities, as well as increased costs associated with an increase in the
number of subscribers.
Sales and marketing expenses increased $3.0 million, or 103%, to
$5.9 million in fiscal 1995 from $2.9 million in fiscal 1994. Approximately
$1.5 million of the increase is due to the impact of a full year of
operation in 1995 versus approximately eight months in 1994. The inclusion
of expenses related to the operations of Quest in 1995 contributed an
additional $0.8 million to the increase.
General and administrative expenses increased $6.4 million, or
136%, to $11.1 million in fiscal 1995 from $4.7 million in fiscal 1994.
Approximately $2.0 million of the increase is due to the impact of a full
year of operation in 1995 versus approximately eight months in 1994. An
additional $2.0 million was attributable to depreciation and amortization
and other expenses related to the Quest Acquisition. The remaining increase
is a result of increased personnel and expenses required to build the
Company's customer service and administrative information systems and
office facilities.
Interest and other income increased to $646,000 in fiscal 1995
from $152,000 in fiscal 1994, due to significantly higher investable cash
balances in fiscal 1995 resulting from the proceeds of the issuance of
$26.3 million of preferred and common stock, as well as fiscal 1995 being a
full year.
Interest expense increased to $734,000 in fiscal 1995 from
$26,000 in fiscal 1994. This increase was due to interest expense
associated with the capitalized leases for the Ohio switch sites which
began in December 1994.
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. As of December 31, 1996, the Company had
cash and cash equivalents of $60.6 million and working capital of $52.4
million. The Company's operating activities utilized cash of approximately
$24.1 million for the year ended December 31, 1996, $14.3 million for the
year ended December 31, 1995 and $6.1 million for the period ended December
31, 1994.
The Company's investing activities have consisted primarily of
property and equipment purchases of $2.3 million, $1.7 million and $1.7
million for the years ended December 31, 1996, 1995 and 1994, respectively.
In 1996, these expenditures were primarily related to the buildout of new
office space. In 1995 and 1994, these expenditures were primarily for fiber
optic rings, leasehold improvements and furniture in Ohio that were sold in
February 1996. In addition, the Company entered into capital leases of $0.6
million, $3.4 million and $3.1 million in 1996, 1995 and 1994,
respectively, related to furniture and equipment and, in 1995 and 1994, the
Ohio switch sites. The Company remains contingently liable on the 1994 and
1995 Ohio leases, but the Company believes that it has secured adequate
protection from the assignee. In February 1996, the Company received $9.5
million in proceeds from the December 1995 sale of the Ohio facilities.
In 1997 the Company anticipates having approximately $12 million
of capital expenditures. A significant portion of the capital plan has been
allocated to investments in information technology to support the growth of
the subscriber base with more robust billing and subscriber care systems.
The anticipated continued high growth in the subscriber base in 1998 will
require a continued high level of investment in information technology in
1998.
On September 30, 1996, the Company raised $10 million through
the sale to Chase Venture Capital Associates, L.P., CIBC Wood Gundy
Ventures, Inc., Hancock Venture Partners IV - Direct Fund, L.P., Northwood
Capital Partners LLC, Northwood Ventures, BT Capital Partners, Inc. and
Enterprises & Transcommunications, L.P. of 10,000 shares of 9% Cumulative
Convertible Pay-In-Kind Preferred Stock (the "9% Preferred Stock"). Also on
September 30, 1996, the Company raised approximately $55 million, net of
issuance costs, through the sale to Merrill Lynch Global Allocation Fund,
Inc. of (i) 48,500 units (the "Units") consisting of $48.5 million in
aggregate principal amount at maturity of 14% Senior Discount Notes due
2003 (the "Senior Notes") and warrants to purchase 61,550 shares, subject
to adjustment under certain circumstances, of Class A Common Stock, par
value $.01 per share, of the Company, at an initial exercise price of $.01
per share, and (ii) $36.0 million in aggregate principal amount at maturity
of 9% Convertible Subordinated Discount Notes due 2004 (the "Convertible
Notes"). The aggregate purchase price of the Units was $30,203,375, and the
aggregate purchase price of the Convertible Notes was $27,644,400. In 1995
and 1994, the Company's financing activities consisted primarily of raising
capital in the form of Common Stock and Preferred Stock placements with
venture capital organizations. During 1995 and 1994, the Company raised
$26.3 million and $14.2 million, respectively, net of issuance costs. In
1995, the Company also assumed notes payable to investors in the Quest
Acquisition.
Although at December 31, 1996, the Company had working capital
of approximately $52.4 million and total redeemable preferred stock and
common stockholders' equity of approximately $6.4 million, projected cash
usage in 1997 combined with an anticipated net loss in 1997, absent the
infusion of additional capital resources, is anticipated to fully deplete
the Company's working capital prior to December 31, 1997. Such events would
place substantial doubt about the Company's ability to continue as a going
concern. Although the Company's management believes that the Company will
be able to raise sufficient funds, through capital contributions or
additional equity or debt financings, to meet its operating expenses and
other cash requirements, there can be no assurance that the Company would
be able to complete such contributions or financing or that any such
contributions or financing would be completed on terms satisfactory to the
Company.
The Company incurred net losses of $25.1 million, $18.1 million
and $7.1 million in 1996, 1995 and 1994, respectively. Accordingly, no
provision for current federal or state income taxes has been made to the
financial statements. At December 31, 1996, the Company and its
subsidiaries had net operating loss carry-forwards for Federal income tax
purposes of approximately $46.1 million. The ability of the Company or the
Company's subsidiaries, as the case may be, to utilize their net operating
loss carry-forwards to offset future taxable income may be subject to
certain limitations contained in the Internal Revenue Code of 1986, as
amended (the "Code"). These operating losses begin to expire in 2009 for
Federal income tax purposes. Of the net operating loss carry-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.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this statement are set
forth on pages F-1 through F-14.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table provides certain information regarding the
executive officers and directors of the Company.
Name Age Position
Richard J. Brekka ......... 36 Chairman of the Board
J. Thomas Elliott ......... 50 President, Chief Executive Officer and
Director
Ronald W. Gavillet......... 37 Executive Vice President, Strategy &
External Affairs
Gerald J. Sweas............ 49 Executive Vice President and Chief
Financial Officer
Ryan Mullaney ............. 40 Executive Vice President, Sales
Steven J. Parrish ......... 41 Executive Vice President, Operations
Thomas A. Monson .......... 36 Vice President, General Counsel and
Secretary
Thad J. Pellino ........... 35 Vice President, Marketing
Neil A. Bethke ............ 37 Vice President, Information Systems
Thomas C. Brandenburg...... 60 Director
Dean M. Greenwood ....... 53 Director
Donald J. Hofmann, Jr...... 39 Director
William A. Johnston ...... 45 Director
Paul S. Lattanzio ........ 33 Director
Eugene A. Sekulow ....... 65 Director
Each director serves until his successor is duly elected and
qualified. Officers serve at the discretion of the Board of Directors.
Richard J. Brekka, Chairman of the Board, has been a director of
the Company since April 1994. He is a Managing Director of CIBC Wood Gundy
Capital, the merchant banking division of Canadian Imperial Bank of
Commerce, and is a director and the President of CIBC Wood Gundy Ventures,
Inc. ("CIBC"), an indirect wholly owned subsidiary of Canadian Imperial
Bank of Commerce. Mr. Brekka joined CIBC in February 1992. Currently, Mr.
Brekka serves on the board of directors of Orion Network Systems, Inc.,
MultiTechnology Corp., Telesystem International Wireless N.V., and Epoch
Networks, Inc. (formerly HLC-- Internet, Inc.), and on the Board of
Advisors of Telecom Partners L.P. Mr. Brekka received a B.S. in finance
from the University of Southern California and an M.B.A. from the
University of Chicago.
J. Thomas Elliott, President and Chief Executive Officer, has
been the Chief Executive Officer since April 1996. Mr. Elliott joined the
Company in 1995 as a result of the acquisition of certain assets and
assumption of certain liabilities of Quest, a company which he co-founded.
From 1991 to 1993, Mr. Elliott was Senior Vice President of Sales and
Marketing of Wiltel Communications Systems. From 1990 to 1991, Mr. Elliott
was President and Chief Executive Officer of Call Net Inc. (Canada's first
alternative long distance company) and Lightel Inc., its affiliate fiber
optic facility provider. Subsequently, these companies were combined to
form Sprint Canada. Mr. Elliott holds a bachelor's and master's degree in
economics from the University of Windsor.
Ronald W. Gavillet, Executive Vice President, Strategy &
External Affairs, has performed the Company's legal, regulatory and
strategic functions since 1994. Prior to joining the Company, Mr. Gavillet
spent more than four years, from 1985 to 1987 and from 1992 to 1994, with
MCI in a number of senior legal and regulatory positions. While at MCI, Mr.
Gavillet developed and implemented the firm's regulatory policies in
Illinois, Indiana, Michigan, Ohio and Wisconsin and negotiated sales
agreements with national accounts. Mr. Gavillet holds a B.A. and B.S. from
Southern Illinois University, a J.D. from Catholic University of America's
Columbus School of Law and a Master of Management degree from Northwestern
University's Kellogg School of Management and serves on the
Telecommunications Resellers Association Local Services Council.
Gerald J. Sweas, Executive Vice President and Chief Financial
Officer, joined the Company in November 1996. From 1989 to 1996, Mr. Sweas
was Vice President Finance and Administration, Treasurer and Chief
Financial Officer of Norand Corporation, a wireless data communications
networks company. Mr. Sweas holds a B.B.A. from Loyola University in
Chicago, Illinois and an M.B.A. from the University of Wisconsin (Madison)
and is a Certified Public Accountant.
Ryan Mullaney, Executive Vice President, Sales, joined the
Company in October 1996. From 1995 to 1996, Mr. Mullaney served as Vice
President, Sales, USA West for Citizens Telecom, a medium-sized
telecommunications company, where he managed sales in 13 states. From 1993
to 1995, Mr. Mullaney was Director of Member Development for McLeod
Telemanagement Organization, where his duties included management of the
company's field sales and service organization. From 1991 to 1993, Mr.
Mullaney was National Sales Director of Centex Telemanagement, responsible
for developing sales in the national market. Mr. Mullaney has a B.A. from
the University of Nevada, Las Vegas.
Steven J. Parrish, Executive Vice President, Operations, joined
the Company in January 1996 initially as a consultant and assumed a
full-time position. Prior to joining the Company, Mr. Parrish spent more
than 12 years with Illinois Bell in various planning and operations
positions. Mr. Parrish moved to Ameritech in 1991 where he helped start the
Information Industry Services business unit as Vice President of Business
Development and Vice President of Marketing and Sales for Network
Providers. Mr. Parrish holds a bachelor's degree in electrical engineering
from the University of Illinois and an MBA from the Illinois Institute of
Technology.
Thomas A. Monson, Vice President, General Counsel and Secretary,
joined the Company in January 1997. From 1989 to 1996, Mr. Monson was
Associate General Counsel of Envirodyne Industries, Inc., a $650 million
public company, where he performed various corporate law, securities
regulation, litigation and corporate operations support activities. Mr.
Monson holds a B.S. from the University of Illinois and a J.D. from Harvard
Law School.
Thad J. Pellino, Vice President, Marketing, joined the Company
in August 1995. From 1988 through 1995, Mr. Pellino was with MCI where he
held a variety of marketing and business development positions, which
included responsibility for the design of customized telecommunication
packages for mid-size and long distance carriers. Mr. Pellino received his
bachelor's degree in marketing/business administration from the University
of Illinois.
Neil A. Bethke, Vice President, Information Systems, joined the
Company initially as a consultant in 1995 and assumed a full-time position
in May 1996. From 1994 to 1996 Mr. Bethke served as principal for New
Resources Corporation, a medium-sized consulting company specializing in
client/server technology development for large service-oriented companies.
From 1988 to 1994, Mr. Bethke served at Quantum Chemical Corporation and
Sara Lee Corporation as Director of MIS, responsible for the reengineering
of business processes through document routing and wide area network
database management. Mr. Bethke holds a B.S. from the University of
Wisconsin.
Thomas C. Brandenburg, Director, has been a director of the
Company since founding the Company in 1994. Prior to joining the Company,
Mr. Brandenburg was the co-founder and principal of a telecommunications
consulting firm with a service bureau-based enhanced service company. In
1983, Mr. Brandenburg was the co-founder and principal of LiTel Communica-
tions, Inc. (now LCI International). Mr. Brandenburg is a graduate of the
University of Notre Dame.
Dean M. Greenwood, Director, was elected as a director of the
Company in February 1997. Mr. Greenwood is Vice President of Prime
Management Group and has been an officer of that company since 1992. Mr.
Greenwood holds a B.B.A. and a J.D. from the University of Texas at Austin.
Donald J. Hofmann, Jr., Director, has been a director of the
Company since April 1994. Mr. Hofmann has been a General Partner of Chase
Capital Partners (formerly known as Chemical Venture Partners) since 1992.
Chase Capital Partners is the sole general partner of Chase Venture Capital
Associates, L.P. Prior to joining Chase Capital Partners, he was head of MH
Capital Partners, Inc., the equity investment arm of Manufacturers Hanover.
William A. Johnston, Director, was elected a director of the
Company in June 1994. Mr. Johnston has been a Managing Director of HVP
Partners, LLC since January 1997. HVP Partners, LLC was formed to acquire
Hancock Venture Partners, Inc., where Mr. Johnston has served in various
capacities since 1983. Currently, Mr. Johnston serves on the advisory
boards of The Centennial Funds, Austin Ventures, and Highland Capital
Partners, as well as on the board of directors of Centennial Security,
Inc., HLC-Internet, Inc., MultiTechnology Corp., The Marks Group, Inc., and
Masada Security Corporation. Internationally, he serves on the board of
directors of Telesystem International Wireless Corporation and Esprit
Telecom. Mr. Johnston received a bachelor's degree from Colgate University
and a master's degree from Syracuse University School of Management.
Paul S. Lattanzio, Director, was appointed a director of the
Company in August 1995. Currently, Mr. Lattanzio is a Managing Director of
BT Capital Partners, Inc., an affiliate of Bankers Trust New York Corp. Mr.
Lattanzio has been employed by BT Capital Partners, Inc. or an affiliate
since 1984. Mr. Lattanzio received his B.S. in economics from the
University of Pennsylvania's Wharton School of Business.
Eugene A. Sekulow, Director, was elected a director of the
Company in August 1995. Mr. Sekulow served as Executive Vice President of
NYNEX Corporation from December 1991 to 1993. From 1986 to 1991, he served
as President of NYNEX International Company. Since his retirement from
NYNEX in 1993, Mr. Sekulow has founded his own telecommunications
consultancy where he has been retained by European, U.S., Japanese,
Southeast Asian and Canadian companies. Mr. Sekulow attended the University
of Stockholm and the University of Oslo. He earned an M.A. in political
science and economics and a Ph.D. from Johns Hopkins University.
The Board of Directors of the Company consists of eight persons,
including one outside director, one appointed by CIBC Wood Gundy Ventures,
Inc., one appointed by Chase Venture Capital Associates, L.P., one
appointed by Hancock Venture Partners IV Direct Fund, L.P., one appointed
by BT Capital Partners, Inc. and one appointed by Enterprises & Trans-
communications, L.P.
Directors' Compensation
The Company's policy is not to pay compensation to its
directors.
Compensation Committee Interlocks and Insider Participation
The Company's Compensation Committee consists of Messrs. Brekka,
Johnston and Lattanzio, none of whom is currently an employee or officer of
the Company. No executive officer of the Company served during fiscal year
1996 as a member of a compensation committee or as a director of any entity
of which any of the Company's directors serves as an executive officer.
Item 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information concerning
the cash and non-cash compensation during fiscal year 1996 earned by or
awarded to the Chief Executive Officer and to the four other most highly
compensated executive officers of the Company whose combined salary and
bonus exceeded $100,000 during the fiscal year ended December 31, 1996 (the
"Named Executive Officers").
<TABLE>
<CAPTION>
Annual Compensation
All Other
Year Salary Bonus Compensation
<S> <C> <C> <C> <C>
J. Thomas Elliott
President and Chief Executive Officer 1996 $ 182,500 $ 97,500(1) --
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(3) --
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 services to the Company prior to the
Company's acquisition of the business of Quest America, LP.
(3) Represents amounts paid in 1996 with respect to bonuses earned in
prior periods, primarily in 1995.
(4) Mr. Gavillet commenced employment with the Company in November 1994.
(5) Mr. Pellino commenced employment with the Company in August 1995.
(6) Mr. Bethke commenced employment with the Company in June 1996.
(7) Includes amounts reimbursed by the Company for life and disability
insurance premiums and temporary living expenses.
Option Grants
The following table sets forth the aggregate number of stock
options granted to each of the Named Executive Officers during the fiscal
year ended December 31, 1996. Options are exercisable for Class A Common
Stock, par value $.01 per share, of the Company.
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATE OF
PERCENT OF TOTAL STOCK PRICE APPRECIATION
NUMBER OF SECURITIES OPTIONS GRANTED FOR OPTION TERM ($)(1)
UNDERLYING OPTIONS TO EMPLOYEES IN EXERCISE PRICE EXPIRATION ---------------------------
NAME GRANTED (#) FISCAL YEAR ($/SHARE) DATE 5% 10%
---- -------------------- ------------------ ------------- ----------- -- ---
<S> <C> <C> <C> <C> <C> <C> <C>
J. Thomas Elliott 7,500 7.3% $ 1.50 6/28/96 $1,105,725 $ 1,686,450
29,925 29.0% 1.50 9/30/96 4,411,843 6,728,936
Ronald W. Gavillet 6,150 6.0% 1.50 6/28/96 906,695 1,382,889
21,859 21.2% 1.50 9/30/96 3,222,672 4,915,215
Thad J. Pellino 2,000 1.9% 1.50 6/28/96 294,860 449,720
1,494 1.4% 1.50 9/30/96 220,260 335,941
Neil A. Bethke 2,000 1.9% 1.50 6/28/96 294,860 449,720
1,494 1.4% 1.50 9/30/96 220,260 335,941
</TABLE>
(1) The information disclosed assumes, solely for purposes of
demonstrating potential realizable value of the options, that the
per share fair market value of the Class A Common Stock is $96.00
per share as of December 31, 1996 and increases at the rate
indicated, effective as of December 31 of each subsequent year
during the option term. However, there is no established trading
market for the Class A Common Stock, and no representation is made
that the Class A Common Stock actually has such value or that the
rates of increase in value can or will be achieved.
The following table sets forth certain information concerning
the exercise of stock options by the Named Executive Officers during the
fiscal year ended December 31, 1996 and the December 31, 1996 aggregate
value of unexercised options held by each of the Named Executive Officers.
<TABLE>
<CAPTION>
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES (1)
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-
UNEXERCISED OPTIONS AT MONEY OPTIONS AT FISCAL
FISCAL YEAR-END (#) YEAR-END ($) (1)
-------------------------------- ---------------------------
SHARES
ACQUIRED ON VALUE
NAME EXERCISE (#) REALIZED ($) Exercisable/Unexercisable Exercisable/Unexercisable
---- ------------ ------------ ------------------------- -------------------------
<S> <C> <C> <C> <C>
J. Thomas Elliott -- -- 1,875 / 35,550 177,188 / 3,359,475
Ronald W. Gavillet -- -- 5,388 / 26,471 510,706 / 2,501,510
Thad J. Pellino -- -- 500 / 2,994 47,250 / 282,933
Neil A. Bethke -- -- 500 / 2,994 47,250 / 282,933
Robert J. Luth 2,000 189,000 1,850 / 0 175,565 /0
</TABLE>
(1) The information disclosed assumes, solely for purposes of
illustrating the value of in-the-money options, that the per share
fair market value of the Class A Common Stock is $96.00 as of
December 31, 1996. However, there is no established trading market
for the Class A Common Stock, and no representation is made that the
Class A Common Stock actually has such value.
Benefit Plans
1994 Stock Option Plan
In September 1994, the Board of Directors adopted the 1994 Stock
Option Plan (the "1994 Plan"), which was subsequently approved by the
stockholders in September 1994. A total of 100,452 shares of Class A 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 Mr. Sweas, Mr. Mullaney and Mr. Monson in connection with their
employment agreements will be exercisable with respect to 50% of such
options on the one-year anniversary of the date of grant and with respect
to 25% of such options on each of 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 not
previously exercised expire and are forfeited. In addition, the Company has
the option to repurchase all or any part of the shares issued or issuable
upon exercise, if an optionee's employment terminates for any reason
whatsoever.
The 1994 Plan may be amended at any time by the Board of
Directors, although certain amendments require the consent of the
participants of the 1994 Plan. The 1994 Plan will terminate in September
2004, unless earlier terminated by the Board of Directors.
1996 Option Grants Outside of the 1994 Stock Option Plan
In connection with the issuance of the 9% Preferred Stock
(described below) and the consummation of the Private Placement (described
below), Messrs. Elliott, Gavillet, Parrish, Pellino and Bethke were granted
18,234, 11,996, 600, 312 and 312 additional options, respectively, to
purchase a corresponding number of shares of Class A Common Stock at an
exercise price of $1.50 per share. Such options are exercisable only upon
conversion from time to time of the 9% Preferred Stock, in the case of all
such employees, or, as the case may be with respect to Messrs. Elliott and
Gavillet, of the Convertible Notes (described below), into shares of Class
A Common Stock.
401(k) Plan
In January 1995, the Company adopted the Employee 401(k) Profit
Sharing Plan (the "401(k) Plan") covering all of the Company's employees.
Pursuant to the 401(k) Plan, employees may elect to reduce their current
compensation by up to the lesser of 15% of eligible compensation or the
statutorily prescribed annual limit ($9,500 in 1996) and have the amount of
such reduction contributed to the 401(k) Plan. The 401(k) Plan permits, but
does not require, additional contributions to the 401(k) Plan by the
Company on behalf of all participants. The Company has not made any
contributions to date. The 401(k) Plan is intended to qualify under Section
401 of the Code so that contributions by employees or by the Company to the
401(k) Plan, and income earned on plan contributions, are not taxable to
employees until withdrawn, and contributions by the Company, if any, will
be deductible by the Company when made.
Employment Agreements
In July 1996, Messrs. J. Thomas Elliott, President and Chief
Executive Officer, and Ronald W. Gavillet, Executive Vice President,
Strategy & External Affairs, entered into employment agreements with the
Company. In November 1996, Mr. Gerald J. Sweas entered into an agreement
with the Company pursuant to which he became the Company's Executive Vice
President and Chief Financial Officer. The terms of such agreements are for
a period of three years subject to automatic one-year renewals at each
anniversary unless otherwise notified by the Company. The agreements
establish a base salary to be paid each year which may be increased
annually at the discretion of the Board of Directors. The annual base
salaries of Messrs. Elliott, Gavillet and Sweas are $195,000, $185,000 and
$150,000, respectively. In addition, subject to the attainment of certain
performance objectives, each is entitled to an annual bonus. With respect
to Messrs. Elliott and Gavillet, the agreements provide certain preemptive
rights such that, if the Company raises capital by selling shares of any
class of stock, each executive will have a right to purchase a certain
percentage (3.8% for Mr. Elliott and 2.5% for Mr. Gavillet) of such shares
on the same terms and conditions as the shares are being sold to others.
Each of Messrs. Elliott's and Gavillet's agreements also provides that if
the current shareholders sell any of their shares of Company stock to a
third party under certain circumstances, each executive has a right to sell
the same percentage of his shares of Company stock as the percentage of
their shares that the current shareholders are selling, on the same terms
and for the same consideration. With respect to each of Messrs. Elliott and
Gavillet, if their employment is terminated by the Company without "Cause"
or by either executive with "Good Reason" or during a "Window Period" (each
as defined in the respective agreement): (i) all amounts earned, accrued or
owing to the executive shall be paid as soon as practicable, (ii) the
Company must pay a lump sum equal to one year's base salary and, if the
executive complies with the noncompete and nonsolicitation provisions of
the agreement for the two-year period following termination, will pay the
executive an additional one year's base salary in equal installments over
that two-year period, and (iii) the Company must maintain in full force and
effect all employee benefit plans for the benefit of the executive for the
longer of a two-year period or the remaining term of the executive's
agreement. With respect to Mr. Sweas, if his employment is terminated by
the Company without "Cause" or by him with "Good Reason" (each as defined
in his agreement): (i) all amounts earned, accrued or owing to him shall be
paid as soon as practicable; (ii) the Company must pay a lump sum equal to
the sum of (A) any annual bonus paid to Mr. Sweas for a fiscal year
completed prior to the date of termination, plus (B) a pro rata portion of
the annual bonus that would have been payable to Mr. Sweas in the year of
such termination, assuming the achievement of all performance goals, plus
(C) if Mr. Sweas complies with the noncompete and nonsolicitation
provisions of his agreement for the 18-month period following termination,
the greater amount of Mr. Sweas' highest annual base salary during the term
of his agreement or the aggregate amount of base salary payable to Mr.
Sweas through the end of the term of such agreement; and (iii) the Company
must maintain in full force and effect all employee benefit plans for the
benefit of Mr. Sweas for the longer of a one-year period or the remaining
term of his agreement. If the executive's employment is terminated under
any other circumstances, the executive will not receive any of the
above-described severance pay and benefits. With respect to Messrs. Elliott
and Gavillet, upon a Change in Control the executive's options will become
exercisable and the restrictions on Mr. Elliott's restricted shares will
lapse. With respect to Mr. Sweas, upon a Change of Control the Company
shall pay, in exchange for the cancellation of any options and the
surrender of any shares held by him, an amount equal to the fair market
value of the shares held by Mr. Sweas or issuable upon exercise of any such
options (less the applicable exercise price). Upon a Change of Control, the
Company shall pay to each of Messrs. Elliott, Gavillet and Sweas, within
the 10-day period following such Change of Control, an amount equal to the
pro rata portion of the annual bonus that would have been payable to such
executive during such year, assuming the achievement of all performance
goals. Under each employment agreement, a "Change in Control" occurs if (i)
a person or entity becomes the beneficial owner of 35% or more of the
combined voting power of the Company's securities, (ii) the current
directors, or individuals who are approved by two-thirds of the current
directors, cease to constitute a majority of the board of the Company or
(iii) certain mergers or liquidations of the Company occur. Messrs. Elliott
and Gavillet have agreed not to compete with the Company in the network
telecommunications services business or to solicit customers or employees
of the Company for their term of employment with the Company and for an
additional period of two years thereafter and Mr. Sweas has agreed to
similar restrictions for the term of his employment with the Company and
for an additional period of 18 months thereafter.
In January 1997, Mr. Ryan Mullaney entered into an employment
agreement with the Company. Mr. Mullaney's agreement provides for a base
salary of $125,000 and an annual bonus (targeted at $75,000) based upon
certain performance standards established by the Board of Directors of the
Company. The agreement also provides that Mr. Mullaney will be entitled to
receive certain payments in the event that his employment is terminated
other than for cause. Mr. Mullaney has agreed not to compete with the
Company during the term of his employment and for a specified period
thereafter.
Each of the other key employees (including Steven J. Parrish,
Executive Vice President, Operations, Thomas A. Monson, Vice President,
General Counsel and Secretary, Thad J. Pellino, Vice President of Marketing
and Neil A. Bethke, Vice President of Information Systems) have also
entered into employment agreements with the Company as of July 18, 1996
with respect to Messrs. Parrish, Pellino and Bethke, and as of January 6,
1997 with respect to Mr. Monson. The terms of the employment agreements are
for a period of two years subject to automatic one-year renewal upon each
anniversary unless otherwise notified by the Company. Each agreement
specifies the base salary to be received by the executive, and provides for
annual adjustment of base salary by the Board of Directors. The following
annual base salaries were approved effective July 31, 1996: Mr. Parrish -
$140,000, Mr. Bethke - $125,000 and Mr. Pellino - $110,000. The annual base
salary for Mr. Monson, provided in his employment agreement, is $143,000.
Each of these executives is also entitled to annual bonuses in the range of
15% to 30% of base salary, subject to the attainment of certain performance
objectives. If the Company terminates the employment of any such officer
without "Cause" or, if the officer terminates his employment with "Good
Reason" (both as defined in the respective agreements), the officer is
entitled to receive benefits and payments similar to those discussed above
for Messrs. Elliott and Gavillet. No "Window Period" will apply to such
officers. Upon a Change in Control, the executive's options will become
exercisable. Each officer has agreed not to compete with the Company in the
network telecommunications services business or to solicit customers or
employees of the Company during the term of his employment and for a period
of one year following voluntary or involuntary termination.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of February 28, 1997, the
number of shares of Class A Common Stock and the percentage of the
outstanding shares of such class that are beneficially owned by (i) each
person that is the beneficial owner of more than 5% of the outstanding
shares of Class A Common Stock, (ii) each of the directors and the Named
Executive Officers of the Company and (iii) all of the current directors
and executive officers of the Company as a group.
Class A
Common Stock
Number of Percent
Name and Address of Beneficial Owner(1) Shares Owned of Class
Merrill Lynch Global Allocation Fund, Inc.(2)....... 333,505 31.73%
800 Scudders Mill Road
Plainsboro, New Jersey 08536
BT Capital Partners, Inc.(3)........................ 129,043 17.67%
130 Liberty Street
New York, New York 10017-2070
Chase Venture Capital Associates, L.P.(3)........... 174,257 23.72%
380 Madison Ave., 12th Floor
New York, New York 10017-2070
CIBC Wood Gundy Ventures, Inc.(3)................... 174,257 23.72%
425 Lexington Avenue
New York, New York 10017-3903
Hancock Venture Partners IV-Direct Fund L.P.(3)..... 172,248 23.45%
One Financial Center, 44th Floor
New York, New York 10017-3903
Enterprises & Transcommunications, L.P.(3).......... 43,003 5.96%
600 Congress Suite 3000
One American Center
Austin, Texas 78701
Thomas C. Brandenburg(4)(5)......................... 22,216 3.10%
Richard J. Brekka(5)................................ 174,257 23.72%
J. Thomas Elliott................................... 12,875 1.79%
Ronald W. Gavillet(6)............................... 5,388 *
Robert J. Luth...................................... 3,850 *
Dean M. Greenwood(5)................................ 43,003 5.96%
Donald J. Hofmann, Jr.(5)........................... 174,257 23.72%
William A. Johnston(5).............................. 172,248 23.45%
Paul S. Lattanzio(5)................................ 129,043 17.67%
Eugene A. Sekulow................................... 0 0
All directors and executive officers of
the Company as a group (15 persons)................. 737,637 92.76%
- --------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of
the Securities and Exchange Commission and includes voting and
investment power with respect to the shares. As to each stockholder,
the percentage ownership is calculated by dividing (i) the sum of the
number of shares of Class A Common Stock owned by such stockholder
plus the number of shares of Class A Common Stock that such
stockholder would receive upon the exercise of warrants or the
conversion of convertible securities held by such stockholder (the
"Conversion Shares") by (ii) the sum of the total number of
outstanding shares of Class A Common Stock plus the number of
Convertible Shares held by such stockholder.
(2) Represents shares for which warrants are exercisable after March 29,
1996 and shares into which convertible notes are convertible. Also,
Merrill Lynch Global Allocation Fund, Inc. is entitled to receive
additional warrants to purchase common stock under certain
circumstances pursuant to the indentures governing debt securities
purchased from the Company.
(3) BT Capital Partners, Inc., Chase Venture Capital Associates, L.P.,
CIBC Wood Gundy Ventures, Inc., Hancock Venture Partners IV and
Enterprises & Transcommunications, L.P. are affiliates of Bankers
Trust New York Corporation, Chase Manhattan Corporation, Canadian
Imperial Bank of Commerce, Hancock Venture Partners, Inc., and Prime
Cable Income Partners LP, respectively.
(4) Includes 11,108 shares subject to a voting trust for David Montville.
Mr. Brandenburg, as the voting trust agent, disclaims beneficial
ownership with respect to the shares held in trust.
(5) Each director disclaims beneficial ownership of any shares of Common
Stock or Preferred Stock which he does not directly own.
(6) These shares are subject to exercisable options held by Mr. Gavillet.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On September 30, 1996, BT Securities Corporation, Chase
Securities Inc. and CIBC Wood Gundy Securities Corp. purchased securities
from the Company which were immediately resold to Merrill Lynch Global
Allocation Fund, Inc. pursuant to Rule 144A of the Securities Act of 1933,
as amended. 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. BT Securities
Corporation, Chase Securities Inc. and CIBC Wood Gundy Securities Corp.
each received commissions of approximately $188,000.
In September 1996, in connection with the private placement (the
"Private Placement") described above, the Certificate of Incorporation of
the Company was amended to provide for the authorization of two classes of
common stock, Class A Common Stock and Class B Common Stock (collectively,
the "Common Stock"). The rights of such classes are identical, except that
Class A Common Stock is entitled to one vote per share, while Class B
Common Stock is not entitled to any voting rights, except as required by
law. In addition, each outstanding share of Common Stock of the Company
existing on the date of the Private Placement was converted into one share
of Class A Common Stock.
In connection with the Private Placement, by requisite vote, the
Original Purchasers (as defined below) waived certain preemptive rights and
registration rights held by them pursuant to agreements entered into with
respect to earlier investments in the Company. The Original Purchasers also
approved, and the Company took all necessary action to effect prior to the
consummation of the Private Placement, the amendment of the terms of the
Company's Series A Preferred Stock and Series A-2 Preferred Stock to
provide for and effectuate the conversion of the shares of each such series
of Preferred Stock into newly issued shares of Class A Common Stock, which
conversion was consummated on September 30, 1996.
Also in connection with the Private Placement, the Original
Purchasers purchased from the Company shares of its newly created 9%
Cumulative Convertible PIK Preferred Stock, par value $1.00 per share (the
"9% Preferred Stock"), for an aggregate purchase price of $10 million.
In March 1996, the Company effected a recapitalization
(described below) pursuant to which the Company issued an aggregate of
110,157 shares of common stock to CIBC Wood Gundy Ventures, Inc., Chase
Venture Capital Associates, L.P. (formerly Chemical Venture Capital
Associates), Hancock Venture Partners IV - Direct Fund L.P., BT Capital
Partners, Inc., Northwood Capital Partners LLC, Northwood Ventures and
Enterprises & Transcommunications, L.P. (collectively, the "Original
Purchasers") for no consideration in order to settle a dispute relating to
the price per share paid by the Original Purchasers for common stock
purchased in 1995. The dispute stemmed from, in part, the Company's actual
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 Series A-2 Preferred Stock to
be senior to its Series A Preferred Stock with respect to redemption,
dividends and liquidation in further settlement of the dispute referred to
above.
In December 1995, Mr. J. Thomas Elliott, President and Chief
Executive Officer of the Company, executed a promissory note in favor of
the Company in the principal amount of $75,000. Such promissory note was
originally payable by January 2, 1997, but such date has been extended to a
date as yet undetermined.
Item 14. EHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS
ON FORM 8-K
Financial Statements and Schedules
The financial statements which are filed with this Form 10-K are
set forth in the Index to Financial Statements at Page F-1 which
immediately precedes such documents.
Exhibits
The following exhibits are, as indicated below, either filed
herewith or have heretofore been filed with the Securities and Exchange
Commission under the Securities Act, and are referred to and incorporated
herein by reference to such filings.
Exhibit
Number Exhibit
3.1 Amended and Restated Certificate of Incorporation of the
Company. (2)
3.2 Certificate of Designations, Powers, Rights and Preferences of
9% Cumulative Convertible Pay-In-Kind Preferred Stock (the 9%
Preferred Stock") of the Company. (1)
3.3 Bylaws of the Company. (1)
4.1 Indenture, dated as of September 30, 1996, by and among the
Company and Harris Trust and Savings Bank, as Trustee, for the
Company's 9% Convertible Subordinated Discount Notes due 2004.(1)
4.2 Indenture, dated as of September 30, 1996, by and between the
Company and Harris Trust and Savings Bank, as Trustee, for the
Company's 14% Senior Discount Notes due 2003 (the "Senior Note
Indenture"). (1)
4.3 Registration Rights Agreement dated as of September 30, 1996, by
and among the Company and the Initial Purchasers named therein.(1)
4.4 Warrant Agreement, dated as of September 30, 1996, by and
between the Company and Harris Trust and Savings Bank, as
Warrant Agent. (1)
4.5 Supplemental Indenture, dated as of March 17, 1997, by and
between the Company and the Trustee, to the Senior Note
Indenture.(2)
10.1 Employment Agreement, dated as of July 18, 1996, by and between
the Company and J. Thomas Elliott. (1)
10.2 Employment Agreement, dated as of July 18, 1996, by and between
the Company and Ronald W. Gavillet. (1)
10.3 Form of Employment Agreement between the Company and certain
officers of the Company. (1)
10.4 1994 Stock Option Plan of the Company. (1)
10.5 Form of Indemnification Agreement between the Company and
certain directors and officers of the Company. (1)
10.6 Consulting Agreement, dated January 24, 1995, by and between the
Company and Eugene A. Sekulow. (1)
10.7 Promissory Note, dated December 15, 1995, between the Company
and J. Thomas Elliott. (1)
10.8 Purchase Agreement, dated as of September 25, 1996, by and among
the Company and the purchasers named therein, relating to the 9%
Preferred Stock. (1)
10.9 Purchase Agreement, dated as of April 20, 1994, by and among the
Company, CIBC Wood Gundy Ventures, Inc. ("CIMBC") and Chemical
Venture Capital Associates ("Chemical"). (1)
10.10 Purchase Agreement, dated as of April 20, 1994, by and among the
Registrant, CIBC, Chemical and the stockholders of the Company
listed on a schedule attached thereto (the "Stockholders"). (1)
10.11 Registration Rights Agreement, dated as of April 20, 1994, by
and among the Company, CIBC and Chemical. (1)
10.12 First Amendment to Purchase Agreement, dated as of June 10,
1994, by and among the Company, CIBC, Chemical and Hancock
Venture Partners IV - Direct Fund, L.P. ("Hancock," and together
with CIBC and Chemical, the "Initial Investors"). (1)
10.13 First Amendment to Stockholders Agreement, dated as of June 10,
1994, by and among the Company, the Initial Investors and the
Stockholders. (1)
10.14 First Amendment to Registration Rights Agreement, dated as of
June 10, 1994, by and among the Company and the Initial
Investors. (1)
10.15 Third Amendment to Purchase Agreement, dated as of November 1,
1994, by and among the Company and the Initial Investors. (1)
10.16 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"). (1)
10.17 Fourth Amendment to Purchase Agreement, dated as of June 22,
1995, by and among the Company and the Initial Investors. (1)
10.18 Purchase Agreement, dated as of June 22, 1995, by and among the
Company, CIBC, Chemical Hancock, BT Capital Partners, Inc.,
Northwood Capital Partners LLC and Northwood Ventures
(collectively, the "Investors"). (1)
10.19 Amended and Restated Stockholders Agreement, dated as of June
22, 1995, by and among the Company and the Investors. (1)
10.20 Amended and Restated Registration Agreement, dated as of June
22, 1995, by and among the Company and the Investors. (1)
10.21 Amended and Restated Stockholders Agreement, dated as of July
21, 1995, by and among the Company, the Investors and
Enterprises & Transcommunications, L.P. (collectively the
"Original Purchasers"). (1)
10.22 Amended and Restated Stockholders Agreement, dated as of July
21, 1995, by and among the Company, the Original Purchasers and
the Stockholders. (1)
10.23 Amendment No. 1 to Asset Purchase Agreement, dated as of October
27, 1995, by and among UTS, Quest United, QAM, Lavin, Elliott,
and Quest. (1)
10.24 Second Amendment to Purchase Agreement, dated as of March 5,
1996, by and among the Company and the Original Purchasers. (1)
10.25 Resale Local Exchange Service Agreement, dated July 8, 1996, by
and between New York Telephone Company and UTS. (1)
10.26 Resale Local Exchange Service Confirmation of Service Order
dated October 31, 1995, by and between the Company and Ameritech
Information Industry Services ("Ameritech") on behalf of
Illinois Bell Telephone Company. (1)
10.27 Agreement for Resale Services, dated as of April 26, 1996, by
and between the Company and Ameritech on behalf of Ameritech
Michigan. (1)
10.28 Local Exchange Telecommunications Services Resale Agreement,
dated May 21, 1996, by and between the Company and Ameritech on
behalf of The Ohio Bell Telephone Company. (1)
10.29 Employment Agreement, dated as of November 18, 1996, by and
between the Company and Gerald J. Sweas. (2)
10.30 Employment Agreement, dated as of October 21, 1996, by and
between the Company and Ryan Mullaney. (2)
11 Computation of Net Loss per Common Share.(2)
12.1 Computation of Earnings to Fixed Charges. (2)
21.1 Subsidiaries of the Company. (1)
27.1 Financial Data Schedule.(2)
- --------------
(1) Incorporated by reference to United USN. Inc.'s Registration
Statement on Form S-4 (File No. 333-16265).
(2) Filed herewith.
Executive Compensation Plans and Arrangements
Included in the preceding list of exhibits are the following
management contracts or compensatory plans or arrangements:
Exhibit
Number Exhibit
10.1 Employment Agreement, dated as of July 18, 1996, by and between
the Company and J. Thomas Elliott.
10.2 Employment Agreement, dated as of July 18, 1996, by and between
the Company and Ronald W. Gavillet.
10.3 Form of Employment Agreement between the Company and certain
officers of the Company.
10.4 1994 Stock Option Plan of the Company.
10.29 Employment Agreement, dated as of November 18, 1996, by and
between the Company and Gerald J. Sweas.
10.30 Employment Agreement, dated as of October 21, 1996, by and
between the Company and Ryan Mullaney.
Reports on Form 8-K
No forms 8-K were filed by the Company during the fourth quarter
of fiscal 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, USN Communications, Inc. has caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized on the ___ day of March, 1997.
USN COMMUNICATIONS, INC.
By: /s/ J. Thomas Elliott
J. Thomas Elliott
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, as amended, this report has been signed below by the following
persons in the capacities and on the dates indicated.
Signature Title Date
/s/ J. Thomas Elliott President, Chief Executive March , 1997
- -------------------------------- Officer and Director
J. Thomas Elliott (Principal Executive Officer)
/s/ Richard J. Brekka Chairman of the Board March , 1997
- --------------------------------
Richard J. Brekka
/s/ Thomas C. Brandenburg Director March , 1997
- --------------------------------
Thomas C. Brandenburg
/s/ Dean M. Greenwood Director March , 1997
- --------------------------------
Dean M. Greenwood
/s/ Donald J. Hofmann, Jr. Director March , 1997
_________________________________
Donald J. Hofmann, Jr.
/s/ William A. Johnston Director March , 1997
- --------------------------------
William A. Johnston
/s/ Paul S. Lattanzio Director March , 1997
- --------------------------------
Paul S. Lattanzio
/s/ Eugene A. Sekulow Director March , 1997
- --------------------------------
Eugene A. Sekulow
/s/ Gerald J. Sweas Executive Vice President March , 1997
________________________________ and Chief Financial Officer
Gerald J. Sweas (Principal Financial Officer)
/s/ Letitia D. Bonthron Controller March , 1997
- -------------------------------- (Principal
Letitia D. Bonthron Accounting Officer)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
INDEPENDENT AUDITORS' REPORT F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Redeemable Preferred Stock F-5
Consolidated Statements of Common Stockholders' Deficit F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8
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.
March 14, 1997
<TABLE>
<CAPTION>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
- -----------------------------------------------------------------------------------------------------------------------------
LIABILITIES, REDEEMABLE PREFERRED STOCK,
ASSETS 1996 1995 AND COMMON STOCKHOLDERS' DEFICIT 1996 1995
CURRENT ASSETS: CURRENT LIABILITIES:
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $60,569,365 $13,705,025 Accounts payable $ 7,907,654 $ 2,734,122
Accounts receivable, net of Accrued expenses and other
allowances for doubtful liabilities 3,176,762 1,106,010
accounts of $223,000 (1996) Current maturities on notes payable 386,522 409,348
and $193,000 (1995) 3,004,408 1,184,453 Capital lease obligations - current 277,844 75,192
Interest receivable 249,113 61,015
Prepaid expenses 187,051 171,111 ----------- ----------
Notes receivable 150,000 Total current liabilities 11,748,782 4,324,672
Other receivables 22,567
Net assets held for sale 1,453,699 Capital lease obligations -
------------ ----------- noncurrent 312,280 81,391
Notes payable 49,727 436,825
Total current assets 64,182,504 16,575,303 14% Senior Discount Notes,
net of Original Issue Discount 31,242,614
PROPERTY AND EQUIPMENT, NET 3,507,350 1,214,647 9% Convertible Subordinated
Discount Notes, net of Original
OTHER ASSETS 10,362,438 2,681,255 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-2 10% Senior Cumulative
Preferred Stock 26,235
Series A 10% Senior Cumulative
Preferred Stock 16,200
Accumulated unpaid dividends 225,000 3,810,000
Additional paid-in-capital 9,810,185 40,543,605
---------- ----------
Total redeemable preferred stock 10,045,185 44,396,040
COMMON STOCKHOLDERS' DEFICIT:
Common stock, $.01 par value;
2,500,000 and 500,000
authorized at 1996 and 1995;
718,526 and 313,729 shares
issued at 1996 and 1995 7,185 3,137
Additional paid-in capital 54,179,423 282,955
Accumulated deficit (57,791,382) (29,053,815)
Treasury stock, 1,000 shares
at 1996 (1,077)
------------ -----------
------------ ------------ Total common stockholders' deficit (3,605,851) (28,767,723)
----------- -----------
TOTAL LIABILITIES, REDEEMABLE
PREFERRED STOCK AND COMMON
TOTAL ASSETS $78,052,292 $20,471,205 STOCKHOLDERS' DEFICIT $78,052,292 $20,471,205
============ =========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
<TABLE>
<CAPTION>
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
- ---------------------------------------------------------------------------
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 UNPAID PREFERRED
DIVIDENDS $ 225,000 $ 3,810,000 $ 707,000
============ =========== ============
NET LOSS PER COMMON SHARE $ (49.53) $ (72.42) $ (65.63)
============= ============= =============
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES
OUTSTANDING 510,233 302,520 119,678
============= ============ ============
</TABLE>
See notes to consolidated financial statements.
<TABLE>
<CAPTION>
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
- --------------------------------------------------------------------------------------------------------------------------------
9% PIK SERIES A-2 SERIES A ACCUMULATED ADDITIONAL
PREFERRED PREFERRED PREFERRED UNPAID PAID-IN
STOCK STOCK STOCK DIVIDENDS CAPITAL TOTAL
BALANCE, APRIL 20, 1994
<S> <C> <C> <C> <C> <C> <C>
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
-------- -------- ---------- ----------- ----------
26,235 16,200 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 (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 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.
<TABLE>
<CAPTION>
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
- -----------------------------------------------------------------------------------------------------------------------------
ADDITIONAL COMMON
COMMON PAID-IN ACCUMULATED STOCK HELD
STOCK CAPITAL DEFICIT IN TREASURY TOTAL
BALANCE, APRIL 20, 1994
<S> <C> <C> <C> <C> <C>
Issuance of 177,840 shares of common stock $ 1,778 $ 236,661 $ 238,439
Costs incurred related to issuance of stock (214,860) (214,860)
Accumulated unpaid preferred dividends $ (707,000) (707,000)
Net loss _______ ____________ (7,146,789) (7,146,789)
------------ -----------
BALANCE, DECEMBER 31, 1994 1,778 21,801 (7,853,789) (7,830,210)
Issuance of 135,899 shares of common stock 1,359 263,644 265,003
Costs incurred related to issuance of stock (2,490) (2,490)
Accumulated unpaid preferred dividends (3,103,000) (3,103,000)
Net loss _______ ___________ (18,097,026) (18,097,026)
------------ ------------
BALANCE, DECEMBER 31, 1995 3,137 282,955 (29,053,815) (28,767,723)
Conversion of Series A and A-2 Preferred
Stock to Class A Common Stock 2,676 47,859,340 47,862,016
Issuance of 5,000 shares of common stock 50 5,450 5,500
Compensation grants of 22,000 shares of
common stock 220 32,780 33,000
Repricing of common stock 1,102 (1,102)
Repurchase of 1,000 shares of common stock $(1,077) (1,077)
Issuance of stock warrants 6,000,000 6,000,000
Accumulated unpaid preferred dividends (3,690,976) (3,690,976)
Net loss _______ ___________ (25,046,591) _______ (25,046,591)
------------ ------------
BALANCE, DECEMBER 31, 1996 $ 7,185 $54,179,423 $(57,791,382) $(1,077) $ (3,605,851)
======= =========== ============ ======= ============
</TABLE>
<TABLE>
<CAPTION>
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
- --------------------------------------------------------------------------------------------------------------
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
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
Cost 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)
Payments on assumed indebtedness (350,412) (1,459,458)
Repayment of capital lease obligation (158,427) (155,272) (16,731)
Repayment of notes payable (59,512) (71,588) (8,330)
Proceeds from notes payable 46,645 73,504
Proceeds from borrowings 180,000
-------------- -------------- ------------
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
See notes to consolidated financial statements.
</TABLE>
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 telecommunication 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 31,500
shares of its common stock. This transaction was accounted for
as a purchase and was valued at US Network's net book value of
approximately $467,000. The consolidated financial statements
include the results of operations of US Network since April 20,
1994.
In July 1994, USN purchased a 50.1% ownership interest in USN
Communications Northeast, Inc. ("USNCN") for approximately $2
million. USNCN provides telecommunications services to business
customers in New York and Massachusetts. USN has had substantive
control of USNCN since its inception. Therefore, the
consolidated financial statements include the results of
operations for USNCN since its commencement of operations in
1994. In December 1995, USN's ownership in USNCN increased to
83.9% as a result of additional investments approximating $9.4
million. In July 1996, USN's ownership in USNCN increased to
100% as a result of an additional investment of $150,000.
In June 1995, USNCN (through a newly formed subsidiary, Quest
United, Inc.) purchased specific assets and assumed certain
liabilities of an independent telephone services company, Quest
America, L.P. ("Quest"), for cash of $950,000 and notes payable
to investors of Quest of $842,985 (the "Acquisition"). The
Acquisition has been accounted for as a purchase, and such
assets and liabilities were recorded at their then fair values
(which approximated their historical cost bases) as of the
Acquisition date. The excess of the cost of the Acquisition over
the net assets acquired has been ascribed to various intangible
assets (principally customer lists, employment contracts and
work force in place). The consolidated statement of operations
for the year ended December 31, 1996 and 1995 include Quest's
revenues and expenses from the Acquisition date forward.
In January 1995, USN Communications Midwest, Inc. ("USNCM") was
incorporated as a wholly owned subsidiary of USN. USNCM began
operations in July 1996 and provides telecommunication services
to business customers in Illinois, Ohio and Michigan.
2. SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the
preparation of the accompanying consolidated financial
statements follows:
USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenue
and expenses during the reporting period. Actual results could
differ from those estimates.
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 from dates of
acquisition of three months or less.
RECOURSE PROVISION - 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
adjustments. 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. Office furniture and equipment are depreciated over five
years. Computer equipment is depreciated over 3 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.
3. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Capital lease obligations incurred (Notes 5 and 9) $591,967 $33,398,105 $3,137,119
======== =========== ==========
Fair value of Quest America Management L.P.
noncash assets acquired in 1995 $ 414,726
Consideration incurred in connection with the
Acquisition including $950,000 in cash advances)
(Note 1) 3,104,588
----------
Liabilities assumed $2,689,862
==========
Note payable incurred to finance insurance policies
(Note 11) $ 58,650 $ 72,000
========== ===========
Fair value of US Network's noncash assets acquired $ 623,659
Common and preferred stock issued in connection
with the acquisition (Note 1) 467,463
----------
Liabilities assumed $ 156,196
==========
Note payable to UTS minority shareholder $ 149,708
Proceeds received upon issuance of note payable (73,504)
---------
Note receivable from UTS minority shareholder $ 76,204
==========
</TABLE>
Cash paid for interest in 1996 and 1995 was approximately
$32,000 and $613,000, respectively. No cash was paid in 1994 for
interest and in 1996, 1995 and 1994 for income taxes.
4. RELATED PARTY TRANSACTIONS
Notes receivable at December 31, 1996 includes a $75,000
non-interest bearing note due to the Company from a corporate
officer.
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:
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
===========
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:
1996 1995
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>
<CAPTION>
7. OTHER ASSETS
Other assets at December 31 consist of:
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:
1996 1995
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
========== ==========
9. CAPITAL LEASE OBLIGATIONS
The Company leases certain furniture and equipment under capital
leases at December 31, as follows:
1996 1995
Furniture and equipment $ 841,359 $221,855
Less accumulated amortization (261,905) (73,003)
--------- --------
Total $ 579,454 $148,852
========= ========
Future minimum lease payments at December 31, 1996 are as
follows:
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
=========
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:
1997 $ 2,113,254
1998 2,206,947
1999 1,737,457
2000 1,530,196
Thereafter 2,531,822
-----------
Total $10,119,676
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,
respectively.
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:
1997 $386,522
1998 27,204
1999 8,474
2000 9,178
2001 4,871
--------
Total $436,249
12. PRIVATE PLACEMENT OFFERING
On September 30, 1996, the Company received approximately $55
million in cash, net of commissions paid, in exchange for 48,500
units consisting of $48.5 million aggregate principal amount at
maturity of 14% Senior Discount Notes ("Senior Notes") due 2003
and warrants to purchase 61,550 shares of Class A Common Stock,
and 36,000 units consisting of $36 million aggregate principal
amount at maturity of 9% Convertible Subordinated Notes
("Convertible Notes") due 2004.
The Senior Notes were sold at a unit price, before commissions,
of $622.75 per $1,000 face amount. These notes will accrete
interest at an annual rate of 14% from September 30, 1996 to
March 31, 2000. Thereafter, the notes will bear interest at an
annual rate of 14%, and will be paid semiannually in arrears, on
the aggregate principal amount at maturity of $48.5 million.
The Convertible Notes were sold at a unit price, before
commissions, of $767.90 per $1,000 face amount. These notes will
accrete interest at an annual rate of 9% from September 30, 1996
to September 30, 1999. Thereafter, the notes will bear interest
at an annual rate of 9%, and will be paid semiannually in
arrears, on the aggregate principal amount at maturity of $36
million.
13. REDEEMABLE PREFERRED STOCK
The Board of Directors authorized 20,000 shares of Series A 10%
Senior Cumulative Preferred Stock ("Series A"), and 30,000
shares of Series A-2 10% Senior Cumulative Preferred Stock
("Series A-2"), with par values of $1 in 1994 and 1995,
respectively. On December 31, 1995, 16,200 shares of Series A
and 26,235 shares of Series A-2 were outstanding.
In September 1996, the Board of Directors and the existing
shareholders approved the conversion of all outstanding Series A
and Series A-2 Preferred Stock to shares of Class A Common
Stock. The conversion was consummated on September 30, 1996 and
267,630 shares of Class A Common Stock were issued in exchange
for the outstanding Series A and Series A-2 Preferred Stock,
including dividends accrued through the conversion date.
In September 1996, the Board of Directors authorized the
issuance of up to 30,000 shares of $1 par value preferred stock
designated as 9% Cumulative Convertible Pay-in-Kind Preferred
Stock ("9% Preferred Stock"). In connection with the Private
Placement Offering (Note 12), the Company issued 10,000 shares
of its 9% Preferred Stock to its existing shareholders, for an
aggregate purchase price of $10.0 million.
DIVIDENDS - Dividends on the 9% Preferred Stock accrue
semiannually at a rate of 9% per annum, are fully cumulative and
are payable through the issuance of additional shares of 9%
Preferred Stock. No dividends have been declared or paid on the
preferred stock.
LIQUIDATION - Upon any liquidation, dissolution or winding up of
the Company, holders of the 9% Preferred Stock will be entitled
to receive their full liquidation preference and stated value of
$1,000 per share, together with accrued and unpaid dividends,
prior to the distribution of any assets of the Company to the
holders of Class A Common Stock.
REDEMPTION - Shares of 9% Preferred Stock are not redeemable at
the option of the Company, but are subject to mandatory
redemption in 2006 at the stated value, together with all
accrued and unpaid dividends to the redemption date.
CONVERSION - Each share of 9% Preferred Stock is convertible
into 7.0623 shares of Class A Common Stock, at any time, in
whole or in part, at the option of the holders thereof.
14. COMMON STOCK
In 1996, a 1995 transaction in which Class A Common Stock was
issued was repriced, whereby the number of shares issued
increased from 135,899 to 246,056 and the purchase price
decreased from $1.95 to $1.077 per share.
DIVIDENDS - The holders of Class A Common Stock are entitled to
receive dividends as dividends are declared by the Board of
Directors of the Company out of funds legally available
therefor, provided that if any shares of Preferred Stock are at
the time outstanding, the payment of dividends on the Class A
Common Stock or other distributions may be subject to the
declaration and payment of full cumulative dividends on
outstanding shares of Preferred Stock.
LIQUIDATION - Upon any liquidation, dissolution or winding up of
the affairs of the Company, whether voluntary or involuntary,
any assets remaining after the satisfaction in full of the prior
rights of creditors and the aggregate liquidation preference of
any Preferred Stock then outstanding will be distributed to the
holders of Class A Common Stock.
15. STOCK OPTION PLAN
The Company has granted options to acquire shares of common
stock to certain officers and other employees under the 1994
Stock Option Plan. These options generally become exercisable at
a rate of 25% every six months over a period of two years after
the date of grant, although with respect to certain grants no
vesting occurs until twelve months after the grant date.
In connection with the financing described in Note 12 and the
issuance of the 9% Preferred Stock described in Note 13, the
Company granted 31,961 options to purchase Class A Common Stock
at an exercise price of $1.50 per share. These options were not
issued under the 1994 Stock Option Plan, but rather were issued
pursuant to separate stock option agreements between the Company
and the option holders. 6,637 of these options become
exercisable as the Convertible Notes are converted to Class A
Common Stock, and 25,324 of these options become exercisable as
shares of 9% Preferred Stock are converted to Class A Common
Stock.
Stock option transactions are summarized as follows:
<TABLE>
<CAPTION>
PRICE PRICE PRICE
PER PER PER
1996 SHARE 1995 SHARE 1994 SHARE
<S> <C> <C> <C> <C> <C> <C> <C>
Outstanding at January 1 19,050 $ 1.10 21,300 $ 1.10
Granted 103,324 1.10-96.00 21,300 $ 1.10
Exercised (5,000) 1.10
Cancelled (6,475) 1.10 (2,250) 1.10 ______
------- ------
Outstanding at December 31 110,899 1.10-96.00 19,050 1.10 21,300 1.10
======= ====== ======
Options exercisable at December 31 10,662 1.10-1.50 10,024 1.10 -
======== ====== ======
</TABLE>
For pro forma information regarding net loss and loss per common
share, the fair value for the options awarded in 1996 and 1994
was estimated as of the date of the grant using a Black-Scholes
option valuation model with the following weighted average
assumptions for 1996 and 1994, respectively: risk-free interest
rates of 4.95% and 4.97%; dividend yields of 0%; and an expected
life of the option of ten years.
For purposes of pro forma disclosures, the estimated fair value
of the options is amortized over the options' vesting period.
Therefore, in the year of adoption and subsequently affected
years, the effect of applying SFAS 123 for providing pro forma
net loss and loss per common share are not likely to be
representative of the effects on reported income in future
years. The effect on the Company's reported net loss, on a pro
forma basis, was not material for 1996, 1995 and 1994.
The Black-Scholes option valuation model used by the Company was
developed for use in estimating the fair value of fully tradable
options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected
stock price volatility. It is management's opinion that the
Company's stock options have characteristics significantly
different from those of traded options and because changes in
the subjective input assumptions can materially affect the fair
value estimate, the existing models do not necessarily provide a
reliable single measure of the fair value of its stock options.
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:
DECEMBER 31, DECEMBER 31,
1996 1995
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 $ - $ -
========== ==========
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.
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.
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
USNCN 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.
* * * * * *
UNITED USN, INC.
$137,000,000
14% SENIOR DISCOUNT NOTES DUE 2003
-------------------------------
FIRST SUPPLEMENTAL INDENTURE
Dated as of March 17, 1997
-------------------------------
HARRIS TRUST AND SAVINGS BANK,
Trustee
FIRST SUPPLEMENTAL INDENTURE, dated as of March
17, 1997, between UNITED USN, INC., a Delaware
Corporation (the "Company"), having its principal office
at 10 South Riverside Plaza, Suite 401, Chicago, Illinois
60606-3709, and HARRIS TRUST AND SAVINGS BANK, as trustee
hereunder (the "Trustee"), having its Corporate Trust
Office at 311 West Monroe, Chicago, Illinois 60606.
RECITALS
The Company has heretofore executed and
delivered to the Trustee an Indenture for its 14% Senior
Discount Notes due 2003 (the "Senior Notes"), dated as of
September 30, 1996 (the "Indenture"), providing for the
issuance of the Senior Notes.
Section 9.01 of the Indenture provides that the
Company and the Trustee may, at any time, without notice
to or consent of any Holders of Senior Notes, enter into
an indenture supplemental to the Indenture for the
purpose of curing any ambiguity in the Indenture, or
correcting any provision of the Indenture, provided that
such action shall not adversely affect the interests of
the Holders of Senior Notes in any material respect.
NOW, THEREFORE, THIS FIRST SUPPLEMENTAL
INDENTURE WITNESSETH:
For and in consideration of the premises, it is
mutually agreed, for the equal and proportionate benefit
of all Holders of the Senior Notes, as follows:
ARTICLE I
Relation to Indenture; Definitions
Section 1.1 This First Supplemental Indenture
constitutes an integral part of the Indenture.
Section 1.2 Capitalized terms used herein
without definition shall have the meanings specified in
the Indenture.
ARTICLE II
Outside Director
Section 2.1 The covenant set forth in Section
4.22 of the Indenture shall be deleted and replaced with
the following:
SECTION 4.22. Outside Director. The Company
shall, within 120 days following the Closing Date,
nominate and take all reasonable actions to cause to be
elected a disinterested outside Director to the Board of
Directors of the Company who is not a Director on the
Issue Date and who has experience in the
telecommunications industry (an "Additional Outside
Director"). At all times during the period commencing
120 days following the Closing Date and ending on
Maturity, in the event that an Additional Outside
Director (or any successor Additional Outside Director)
is no longer serving as a Director, the Company shall, as
promptly as practicable, nominate and take all reasonable
actions to cause to be elected, a successor Additional
Outside Director.
IN WITNESS WHEREOF, the parties hereto have
caused this First Supplemental Indenture to be duly
executed, and their respective corporate seals to be
hereunto affixed and attested, on the date or dates
indicated in the acknowledgements and as of the day and
year first above written.
UNITED USN, INC.
By /s/ J. Thomas Elliott
_________________________
Name: J. Thomas Elliott
Title: President and Chief
Executive Officer
[Corporate Seal]
Attest:
/s/ Thomas A. Monson
------------------------
HARRIS TRUST AND SAVINGS
BANK,
as Trustee
By /s/ J. Bartolini
________________________
Name: J. Bartolini
Title: Vice President
[Corporate Seal]
Attest:
_______________________
STATE OF ILLINOIS )
) SS.:
COUNTY OF COOK )
On the 17th day of March, 1997, before me personally
came J. Thomas Elliott, to me known, who being by me duly
sworn, did depose and say that he is President and Chief
Executive Officer of United USN, Inc., one of the
corporations described in and which executed the
foregoing instrument; that he knows the seal of said
corporation; that the seal affixed to said instrument is
such corporate seal; that it was so affixed by authority
of the Board of Directors of said corporation, and that
he signed his name thereto by like authority.
/s/ Lisa Ann Solava
_______________________________
Notary Public
State of Illinois
My commission expires
[Corporate Seal]
STATE OF ILLINOIS )
) SS.:
COUNTY OF COOK )
On the 18 day of March, 1997, before me personally
came J. Bartolini, to me known, who being by me
duly sworn, did depose and say that he is Vice President
of Harris Trust and Savings Bank, the Trustee described
in and which executed the foregoing instrument; that he
knows the seal of said corporation; that the seal affixed
to said instrument is such corporate seal; that it was so
affixed by authority of the Board of Directors of said
corporation, and that he signed his name thereto by like
authority.
/s/ Marianne Cody
_______________________________
Notary Public
State of Illinois
My commission expires
[Corporate Seal]
EMPLOYMENT AGREEMENT
AGREEMENT, dated as of November 18, 1996, by
and between Gerald J. Sweas (the "Executive") and United
USN, Inc., a Delaware corporation (the "Company").
WHEREAS, it is deemed by the Company to be in the
best interests of the Company to assure the Executive's
employment; and
WHEREAS, the Company and the Executive have
determined to enter into this Agreement pursuant to which
the Company will employ the Executive on the terms and
conditions set forth herein;
NOW, THEREFORE, in consideration of the premises and
the mutual covenants herein contained, the parties hereto
agree as follows:
1. Employment. The Company hereby agrees to
employ the Executive, and the Executive hereby accepts
such employment, on the terms and conditions hereinafter
set forth.
2. Term. This Agreement shall become
effective on the date hereof (the "Effective Date").
Unless earlier terminated as herein provided, the
Executive's employment with the Company hereunder shall
commence at the Effective Date and shall end on the last
day of the "Term". For purposes of this Agreement, the
"Term" of this Agreement shall mean the full three-year
term of the Agreement, plus any extensions made as
provided in this Section 2. On each anniversary of the
Effective Date, the Term shall automatically be extended
for an additional year unless, not later than ninety (90)
days prior to any such anniversary, the Company or the
Executive shall have given notice not to extend the Term.
For purposes of this Agreement, the "Employment Period"
(which in no event shall extend beyond the Term) shall
mean the period during which Executive has an obligation
to render services hereunder, as described in Section 3
hereof, taking into account any Notice of Termination (as
defined in Section 6(e) hereof) which may be given by
either the Company or the Executive. Nothing in this
Section shall limit the right of the Company or the
Executive to terminate the Executive's employment
hereunder on the terms and conditions set forth in
Section 6 hereof.
3. Position and Duties. On and after the
Effective Date, the Executive shall serve as Executive
Vice President and Chief Financial Officer of the Company
and shall have such additional duties and
responsibilities as may be assigned to him by the Chief
Executive Officer of the Company (or by an executive
reasonably designated by the Chief Executive Officer),
provided that such duties and responsibilities are
consistent with the Executive's position as Executive
Vice President and Chief Financial Officer of the
Company. The Executive shall report to the Chief
Executive Officer of the Company (or to an executive
reasonably designated by the Chief Executive Officer).
The Executive agrees to devote substantially all his full
working time, attention and energies during normal
business hours to the performance of his duties for the
Company, provided that the Executive may serve as a
director on the boards of such companies and
organizations as may be agreed upon in writing by the
Board of Directors of the Company (the "Board") and the
Executive.
4. Place of Performance. The principal place
of employment and office of the Executive shall be in
Chicago, Illinois or such other location as may be agreed
to in writing by the Executive.
5. Compensation and Related Matters.
(a) Base Salary. As compensation for the
performance by the Executive of his duties hereunder,
the Company shall pay the Executive an annual base salary
(effective as of November 18, 1996) of One Hundred Fifty
Thousand Dollars ($150,000)(such amount, as it may be
increased from time to time, is hereinafter referred to
as "Base Salary"). Base Salary shall be payable in
accordance with the Company's normal payroll practices,
shall be reviewed annually and may be increased upon such
review. Base Salary, once increased, shall not be
decreased.
(b) Annual Bonus. Subject to meeting
reasonable performance goals established by the Chief
Executive Officer and subject to the approval of the
Board, the Executive shall be entitled to an annual bonus
(the "Annual Bonus") for each calendar year beginning in
1997 which ends within the Employment Period, including,
without limitation, the year in which this Agreement is
executed. The Executive's target bonus shall initially
be forty percent (40%) of his then-current Base Salary.
The Annual Bonus (if any) for each fiscal year which ends
within the Employment Period shall be paid as soon as
practicable after the end of such fiscal year, and no
later than the thirtieth (30th) day immediately following
the end of such fiscal year. The percentage of Base
Salary which determines the Executive's Annual Bonus
opportunity shall be reviewed by the Board annually.
Within the ten-(10)-day period immediately following any
Change in Control (as defined in Section 9 hereof), the
Company shall pay the Executive a lump sum amount equal
to a pro rata portion of the Annual Bonus for the year in
which the Change in Control occurs, calculated by
multiplying the award that the Executive would have
earned for the entire year, assuming the achievement, at
the target level, of any performance goals established
with respect to such award, by a fraction the numerator
of which shall be the number of days of employment in
such year up to and including the date of the Change in
Control and the denominator of which shall be three-
hundred-sixty-five (365). The Executive shall also be
entitled to a one-time bonus of $20,000, payable the
first pay period within the Employment Period.
(c) Stock Options. The Executive shall
be entitled to participate, at a level appropriate to his
position with the Company, in any stock option plan or
stock-based compensation plan which the Company maintains
from time to time. The initial grants of stock options
("Options") for shares of common stock of the Company
("Shares") to the Executive will be made under the
Company's 1994 Stock Option Plan (the "1994 Plan"). The
Company agrees that it will take such actions as are
necessary (including, without limitation, amendment of
the 1994 Plan and options outstanding thereunder, subject
to any required consents of participants therein) to
assure the following:
(i) All Options held by the Executive shall become
fully vested and exercisable upon a Change in
Control (as defined in Section 9 hereof); and
(ii) Upon the occurrence during the Employment
Period of any event which affects the Shares in such
a way that an adjustment of the Options is
appropriate in order to prevent dilution of the
rights of the Executive under the Options
(including, without limitation, any dividend or
other distribution (whether in cash or in kind),
recapitalization, stock split, reverse split,
reorganization, merger, consolidation, spin-off,
combination, repurchase, or share exchange, or other
similar corporate transaction or event), the Company
shall make appropriate equitable adjustments, which
may include, without limitation, adjustments to any
or all of the number and kind of shares of stock of
the Company (or other securities) which may
thereafter be issued in connection with future
grants of options pursuant to this Section 5(c) and
which may thereafter be issued upon exercise of the
then outstanding Options and adjustments to the
exercise prices of all such Options.
(d) Expenses. The Company shall
reimburse the Executive for all reasonable business
expenses, subject to the applicable and reasonable
policies and procedures of the Company in force from time
to time.
(e) Services Furnished. The Company
shall furnish the Executive with appropriate office space
and such other facilities and services as shall be
suitable to the Executive's position and adequate for the
performance of his duties as set forth in Section 3
hereof, such office space and other facilities and
services to be furnished at the location set forth in
Section 4 hereof.
(f) Other Benefits. The Company shall
provide to the Executive such employee benefit and
compensation plans and arrangements and fringe benefits
as are generally available to senior officers of the
Company. Such arrangements shall include four weeks of
paid vacation annually. To the extent permitted by
applicable law and any third-party insurance or other
contractual terms with respect to any Company plan, any
waiting period for participation in such plan which
otherwise would be applicable to the Executive shall be
waived.
6. Termination. The Executive's employment
hereunder may be terminated as follows:
(a) Death. The Executive's employment
shall terminate upon his death. Upon such a termination,
the Executive's estate or designated beneficiary, as the
case may be, shall become entitled to the payments
provided in Section 7(b) hereof.
(b) Disability. If, as a result of the
Executive's incapacity due to physical or mental illness
(as determined by a medical doctor mutually agreed to by
the Executive or his legal representative and the
Company), the Executive shall have been absent from his
duties hereunder on a full-time basis for either one-
hundred-eighty (180) consecutive days or for an aggregate
two-hundred-ten (210) days within a consecutive two-
hundred-seventy (270) day period and, within thirty (30)
days after Notice of Termination is given, shall not have
returned to the performance of his duties hereunder on a
full-time basis ("Disability"), the Company may terminate
the Executive's employment for Disability. Upon such a
termination, the Executive shall become entitled to the
payments provided in Section 7(b) hereof.
(c) Cause. The Company may terminate the
Executive's employment hereunder for "Cause" (as defined
in this Section 6(c)). Upon such a termination, the
Executive shall become entitled to the payments provided
in Section 7(b) hereof. For purposes of this Agreement,
the Company shall have "Cause" to terminate the
Executive's employment hereunder upon (i) the willful (or
grossly negligent) and continued failure by the Executive
to substantially perform his duties hereunder (other than
any such failure resulting from the Executive's
incapacity due to physical or mental illness or any such
actual or anticipated failure after the issuance of a
"Notice of Termination" by the Executive for "Good
Reason", as defined in Section 6(d)(i) hereof), after
demand for substantial performance is delivered by the
Company that specifically identifies the manner in which
the Company believes the Executive has not substantially
performed his duties, (ii) the willful or grossly
negligent engaging by the Executive in misconduct, (iii)
any breach by the Executive of any of the provisions of
Section 10 hereof, or (iv) the Executive's being
convicted of, or pleading guilty to, a felony. For
purposes of this paragraph, no act, or failure to act, on
the Executive's part shall be considered "willful" unless
done, or omitted to be done, by him not in good faith and
without reasonable belief that his action or omission was
in the best interest of the Company. Further, unless the
Executive has been convicted of, or pleaded guilty to, a
felony, the Executive shall not be deemed to have been
terminated for Cause without (1) reasonable notice to the
Executive setting forth the reasons for the Company's
intention to terminate for Cause, (2) an opportunity for
the Executive, together with his counsel, to be heard
before the Board, and (3) delivery to the Executive of a
Notice of Termination from the Board finding that, in the
good faith opinion of a majority of the Board, the
Executive was guilty of conduct set forth above in clause
(i), (ii) or (iii) of the second sentence of this Section
6(c), and specifying the particulars thereof in
reasonable detail.
(d) Termination by the Executive.
(i) The Executive may terminate his
employment hereunder for "Good Reason", which, for
purposes of this Agreement, shall mean (A) assignment of
duties materially inconsistent with his executive status,
or substantial adverse alteration in responsibilities,
which assignment or alteration is not cured within thirty
(30) days after notice from the Executive; (B) any
failure of the Company to pay any compensation to
Executive within thirty (30) days of the Executive's
notice to Company that payment is overdue; or (C)
Company's breach of a material term or condition of the
Agreement, and failure to correct breach within thirty
(30) days after the Executive's notice thereof
(specifying in reasonable detail the particulars of such
noncompliance). Upon a Good Reason termination, the
Executive shall become entitled to the payments and
benefits provided in Section 7(c) hereof.
(ii) The Executive may terminate his
employment hereunder without Good Reason upon giving
three months notice to the Company. In the event of such
a termination, the Executive shall comply with any
reasonable request of the Company to assist in providing
for an orderly transition of authority, but such
assistance shall not delay the Executive's termination of
employment longer than six months beyond the giving of
the Executive's Notice of Termination. Upon such a
termination, the Executive shall become entitled to the
payments provided in Section 7(b) hereof.
(e) Notice of Termination. Any purported
termination of the Executive's employment (other than
termination pursuant to Section 6(a) hereof) shall be
communicated by written Notice of Termination to the
other party hereto in accordance with Section 14 hereof.
For purposes of this Agreement, a "Notice of Termination"
shall mean a notice that shall indicate the specific
termination provision in this Agreement relied upon and
shall set forth in reasonable detail the facts and
circumstances claimed to provide a basis for termination
of the Executive's employment under the provision so
indicated.
(f) Date of Termination. For purposes of
this Agreement, "Date of Termination" shall mean the
following: (i) if the Executive's employment is
terminated by his death, the date of his death; (ii) if
the Executive's employment is terminated pursuant to
Section 6(b) hereof, thirty (30) days after the Notice of
Termination is given; (iii) if the Executive's employment
is terminated pursuant to Section 6(c) hereof, the date
specified in the Notice of Termination; (iv) if the
Executive's employment is terminated pursuant to Section
6(d)(i) or 6(d)(ii) hereof, thirty (30) days after the
Notice of Termination is given; and (v) if the
Executive's employment is terminated pursuant to Section
6(d)(iii) hereof, the date determined in accordance with
said Section.
(g) Dispute Concerning Termination. If
within fifteen (15) days after any Notice of Termination
is given, or, if later, prior to the Date of Termination
(as determined without regard to this Section 6(g), the
party receiving such Notice of Termination notifies the
other party that a dispute exists concerning the
termination, the Date of Termination shall be extended
until the earlier to occur of (i) the date on which the
Term ends or (ii) the date on which the dispute is
finally resolved, either by mutual written agreement of
the parties or by the final determination of a court of
law, which is not subject to appeal; provided, however,
that the Date of Termination shall be extended by a
notice of dispute given by the Executive only if such
notice is given in good faith and the Executive pursues
the resolution of such dispute with reasonable diligence.
(h) Compensation During Dispute. If the
Date of Termination is extended in accordance with
Section 6(g) hereof, the Company shall continue to pay
the Executive the full compensation in effect when the
notice giving rise to the dispute was given (including,
but not limited to, Base Salary and Annual Bonus) and
continue the Executive as a participant in all
compensation, benefit and insurance plans in which the
Executive was participating when the notice giving rise
to the dispute was given, until the Date of Termination,
as determined in accordance with Section 6(g) hereof.
Amounts paid under this Section 6(h) are in addition to
all other amounts due under this Agreement and shall not
be offset against or reduce any other amounts due under
this Agreement.
7. Compensation During Disability or Upon
Termination.
(a) Disability Period. During any period
during the Term that the Executive fails to perform his
duties hereunder as a result of incapacity due to
physical or mental illness ("Disability Period"), the
Executive shall continue to (i) receive his full Base
Salary, (ii) remain eligible to receive an Annual Bonus
under Section 5(b) hereof, and (iii) participate in the
plans and arrangements described in Section 5(f) hereof
(except to the extent such participation is not permitted
under the terms of such plans and arrangements). Such
payments made to the Executive during the Disability
Period shall be reduced by the sum of the amounts, if
any, payable to the Executive at or prior to the time of
any such payment under disability benefit plans of the
Company or under the Social Security disability insurance
program, and which amounts were not previously applied to
reduce any such payment.
(b) Termination other than by the Company
without Cause or by the Executive with Good Reason. If
the Executive's employment hereunder is terminated other
than by the Company without Cause or by the Executive
with Good Reason, then:
(i) as soon as practicable after
the Date of Termination, the Company shall pay any
amounts earned, accrued or owing the Executive
hereunder for services prior to the Date of
Termination to the Executive (or the Executive's
estate or designated beneficiary, as the case may
be); and
(ii) the Company shall have no
additional obligations to the Executive (or the
Executive's estate or designated beneficiary) under
this Agreement except to the extent provided in
Sections 5(c) and 5(d) hereof or otherwise provided
in the applicable plans and programs of the Company.
(c) Termination by Company without Cause
or by the Executive with Good Reason. If the Executive's
employment hereunder is terminated by the Company without
Cause or by the Executive with Good Reason, then, subject
to the Executive's continuing compliance with Section 10
hereof:
(i) as soon as practicable after the
Date of Termination, the Company shall pay any
amounts earned, accrued or owing the Executive
hereunder for services prior to the Date of
Termination to the Executive;
(ii) notwithstanding any provision
of any Annual Bonus plan to the contrary, the
Company shall pay to the Executive, as soon as
practicable after the Date of Termination, a lump
sum amount, in cash, equal to the sum of (A) any
Annual Bonus which has been allocated or awarded to
the Executive for a completed fiscal year preceding
the Date of Termination under any Annual Bonus plan,
and (B) a pro rata portion to the Date of
Termination of the Annual Bonus for the year in
which the Date of Termination occurs, calculated by
multiplying the award that the Executive would have
earned for the entire year, assuming the
achievement, at the target level, of any performance
goals established with respect to such award, by a
fraction the numerator of which shall be the number
of days of employment in such year up to and
including the Date of Termination and the
denominator of which shall be three-hundred-sixty-
five (365); provided, however, that any amount
otherwise payable pursuant to this clause (B) of
this Section 7(c)(ii) shall be reduced by any pro-
rated Annual Bonus payment already received by the
Executive pursuant to Section 5(b) hereof with
respect to the year in which the Date of Termination
occurs;
(iii) subject to the Executive's
continuing compliance with Section 10 hereof, the
Company shall pay as severance payments to the
Executive (in substantially equal installments and
in the same manner and over the same period of time
as the Executive's salary payments would have been
made) an amount (the "Severance Amount") equal to
the greater of (x) the amount of the Executive's
highest annual Base Salary in effect during the Term
or (y) the aggregate amount of the Executive's Base
Salary through the end of the Term (using, to
calculate such amount, the Executive's highest
annual Base Salary in effect during the Term); such
installment payments shall cease upon any violation
of Section 10 hereof;
(iv) the Company shall maintain in
full force and effect, for the continued benefit of
the Executive until the later of (x) the first
anniversary of the Date of Termination or (y) the
end of the Term, each "employee welfare benefit
plan" (as defined in section 3(1) of the Employee
Retirement Income Security Act of 1974, as amended
("ERISA")), other than any disability plan, in which
the Executive was entitled to participate
immediately prior to the Date of Termination,
provided that the Executive's continued
participation is possible under the general terms
and provisions of such plans. In the event that the
Executive's participation in any such plan is
barred, the Company shall arrange to provide the
Executive with benefits substantially similar to
those which the Executive would otherwise have been
entitled to receive under the plan from which his
continued participation is barred;
(v) if the Date of Termination shall
occur within the two (2) years immediately following
a Change in Control, then, in lieu of Shares
issuable upon exercise of the Executive's Options
(which Options shall be cancelled upon the making of
the payment referred to below), the Company shall
pay the Executive a lump sum amount, in cash, equal
to the product of (1) the excess of (x) the higher
of the "Fair Market Value" (as defined in Section
7(d) hereof) of a Share on the Date of Termination
or the highest price per Share actually paid in
connection with such Change in Control over (y) the
exercise price per Share of each such Option held by
the Executive (whether or not then fully
exercisable), times (2) the number of Shares covered
by such Option;
(vi) if the Date of Termination
shall occur within the two (2) years immediately
following a Change in Control, then, upon surrender
by the Executive of all Shares owned outright by him
and all rights which he may have to any restricted
Shares, in payment for and in lieu of all such
Shares, the Company shall pay the Executive a lump
sum amount, in cash, equal to the product of (1) the
higher of the Fair Market Value of a Share on the
Date of Termination or the highest price per Share
actually paid in connection with such Change in
Control, times (2) the number of all such Shares
(whether or not restricted) of the Executive; and
(vii) the Company shall have no
additional obligations to the Executive under this
Agreement except to the extent provided in Sections
5(c) and 5(d) hereof or otherwise provided in the
applicable plans and programs of the Company.
(d) Fair Market Value. For purposes of
this Agreement, if the Shares are publicly traded on any
date for which the "Fair Market Value" of a Share is
required by this Agreement, the "Fair Market Value" shall
be the closing price of a Share on the date the Fair
Market Value is to be determined, or if no sale is
reported for such date, then on the next preceding date
for which a sale is reported. If the Shares are not
publicly traded on any date for which the Fair Market
Value of a Share is required by this Agreement, the Fair
Market Value shall be determined in accordance with the
following procedure: The Executive and the Company shall
each select a nationally recognized appraiser, which
shall determine a value for a Share of the Company. If
the higher of the two original appraisal values is not
more than ten percent (10%) above the lower appraisal
value, the Fair Market Value shall be the value agreed
upon by the two original appraisers or, in the absence of
such an agreement, the Fair Market Value shall be the
average of the two original appraisal values. If the
higher of the two original appraisal values is more than
ten percent (10%) above the lower appraisal value, the
two appraisers shall select a third nationally recognized
appraiser who shall determine a Fair Market Value which
shall be at least equal to the lower appraisal value and
whose determination of the Fair Market Value shall be
final.
8. No Mitigation. The Executive shall not be
required to mitigate amounts payable pursuant to Section
7 hereof by seeking other employment or otherwise, but
any payments made or benefits provided pursuant to
Section 7(c)(iv) hereof shall be offset by any similar
payments or benefits made available without cost to the
Executive from any subsequent employment during the Term
(determined immediately prior to such termination of
employment).
9. Change in Control.
(a) For purposes of this Agreement, a
"Change in Control" shall be deemed to have occurred if
an event set forth in any one of the following paragraphs
(i)-(iv) shall have occurred:
(i) any Person (as defined in
Section 9(b) hereof) is or becomes the Beneficial
Owner (as defined in Section 9(c) hereof), directly
or indirectly, of securities of the Company
representing thirty-five percent (35%) or more of
the combined voting power of the Company's then
outstanding securities, excluding any Person who
becomes such a Beneficial Owner in connection with a
transaction described in clause (x) of paragraph
(iii) below; or
(ii) prior to any initial public
offering, the following individuals cease for any
reason to constitute a majority of the number of
directors then serving: individuals who, on the date
hereof, constitute the Board and any new director
(other than a director whose initial assumption of
office is in connection with an actual or threatened
election contest, including but not limited to a
consent solicitation, relating to the election of
directors of the Company) whose appointment or
election by the Board or nomination for election by
the Company's stockholders was approved or
recommended by a vote of at least two-thirds (2/3)
of the directors then still in office who either
were directors on the date hereof or whose
appointment, election or nomination for election was
previously so approved or recommended; or
(iii) the stockholders of the Company
approve a merger or consolidation of the Company
with any other corporation or the issuance of voting
securities of the Company in connection with a
merger or consolidation of the Company (or any
direct or indirect subsidiary of the Company)
pursuant to applicable stock exchange requirements,
other than (x) a merger or consolidation which would
result in the voting securities of the Company
outstanding immediately prior to such merger or
consolidation continuing to represent (either by
remaining outstanding or by being converted into
voting securities of the surviving entity or any
parent thereof) at least fifty percent (50%) of the
combined voting power of the securities of the
Company or such surviving entity or any parent
thereof outstanding immediately after such merger or
consolidation, or (y) a merger or consolidation
effected to implement a recapitalization of the
Company (or similar transaction) in which no Person
is or becomes the Beneficial Owner, directly or
indirectly, of securities of the Company
representing thirty-five percent (35%) or more of
the combined voting power of the Company's then
outstanding securities; or
(iv) the stockholders of the Company
approve a plan of complete liquidation or
dissolution of the Company or an agreement for the
sale or disposition by the Company of all or
substantially all of the Company's assets.
Notwithstanding the foregoing, a "Change in Control"
shall not be deemed to have occurred by virtue of the
consummation of any transaction or series of integrated
transactions immediately following which the record
holders of the common stock of the Company immediately
prior to such transaction or series of transactions
continue to have substantially the same proportionate
ownership in an entity which owns all or substantially
all of the assets of the Company immediately following
such transaction or series of transactions.
(b) For purposes of this Agreement,
"Person" shall have the meaning given in Section 3(a)(9)
of the Securities Exchange Act of 1934, as amended from
time to time (the "Exchange Act"), as modified and used
in Sections 13(d) and 14(d) thereof, except that such
term shall not include (i) the Company or any of its
subsidiaries, (ii) a trustee or other fiduciary holding
securities under an employee benefit plan of the Company
or any of its affiliates, (iii) an underwriter
temporarily holding securities pursuant to an offering of
such securities, (iv) a corporation owned, directly or
indirectly, by the stockholders of the Company in
substantially the same proportions as their ownership of
stock of the Company, or (v) any of the following
entities or their affiliates: BT Capital Partners, Inc.,
Chase Capital Partners, CIBC Wood Gundy Ventures, Inc.,
Hancock Venture Partners IV and Enterprises &
Transcommunications, L.P.
(c) For purposes of this Agreement,
"Beneficial Owner" shall have the meaning set forth in
Rule 13d-3 under the Exchange Act.
10. Confidentiality, Noncompetition and
Nonsolicitation.
(a) The Executive will not, during or
after the Term, disclose to any entity or person any
information (including, but not limited to, information
about customers or about the design, manufacture or
marketing of products or services) which is treated as
confidential by the Company and to which the Executive
gains access by reason of his position as an employee of
the Company.
(b) While the Executive continues to be
an employee of the Company and for the eighteen-month
period immediately following his Date of Termination, the
Executive shall not, within any geographic region of the
United States of America in which the Company then
conducts business or in which the Company plans to
conduct business pursuant to a business strategy adopted
by the Board before the Executive's termination of
employment, except as permitted by the Company upon its
prior written consent, (i) enter, directly or indirectly,
into the employ of, or render or engage in, directly or
indirectly, any services to any person, firm or
corporation which directly competes with the Company with
respect to any business then conducted by the Company or
any business which the Company plans to enter pursuant to
a business strategy adopted by the Board before the
Executive's termination of employment (a "Competitor"),
or (ii) become interested, directly or indirectly, in any
such Competitor as an individual, partner, shareholder,
creditor, director, officer, principal, agent, employee,
trustee, consultant, advisor or in any other relationship
or capacity. The ownership of up to one percent (1%) of
any class of the outstanding securities of any publicly
traded corporation, even though such corporation may be a
Competitor, shall not be deemed as constituting an
interest in such Competitor which violates clause (ii) of
the immediately preceding sentence.
(c) While the Executive continues to be
an employee of the Company and for the eighteen-month
period immediately following his Date of Termination, the
Executive shall not, except as permitted by the Company
upon its prior written consent, (i) attempt, directly or
indirectly, to induce any employee employed by or
performing services for the Company (or its affiliates)
to be employed or perform services elsewhere, or (ii)
solicit, directly or indirectly, the customers of the
Company (or its affiliates), the suppliers of the Company
(or its affiliates) or entities or individuals having
other business relationships with the Company (or its
affiliates) for the purpose of encouraging them to
terminate (or reduce or detrimentally alter) their
respective relationships with the Company (or its
affiliates).
(d) Any violation by the Executive of
Section 10(a), 10(b) or 10(c) hereof occurring after the
Date of Termination shall entitle the Company to cease
making any payments and providing any benefits otherwise
required under Section 7(c) hereof. Additionally, the
Company shall have the right and remedy to have the
provisions of this Section 10 specifically enforced,
including by temporary and/or permanent injunction, it
being acknowledged and agreed that any such violation may
cause irreparable injury to the Company and that money
damages will not provide an adequate remedy to the
Company.
11. Independence and Severability of Section
10 Provisions. Each of the rights and remedies
enumerated in Section 10 hereof shall be independent of
the others and shall be severally enforceable and all of
such rights and remedies shall be in addition to, and not
in lieu of, any other rights and remedies available to
the Company under law or in equity. If any of the
covenants contained in Section 10 hereof or if any of the
rights or remedies enumerated in Section 10 hereof, or
any part of any of them, is hereafter construed to be
invalid or unenforceable, the same shall not affect the
remainder of the covenant or covenants or rights or
remedies which shall be given full effect without regard
to the invalid portions. If any of the covenants
contained in Section 10 is held to be unenforceable
because of the duration of such provision or the area
covered thereby, the parties agree that the court making
such determination shall have the authority to reduce the
duration and/or area of such provision, and in its
reduced form said provision shall then be enforceable.
12. Indemnification. The Company shall
indemnify the Executive to the full extent authorized by
law and the Charter and By-Laws of the Company, as
applicable, for all expenses, costs, liabilities and
legal fees which the Executive may incur in the discharge
of his duties hereunder. The Executive shall be insured
under the Company's Directors' and Officers' Liability
Insurance Policy as in effect from time to time. Any
termination of the Executive's employment or of this
Agreement shall have no effect on the continuing
operation of this Section 12.
13. Successors; Binding Agreement.
(a) The Company will require any
purchaser of all or substantially all of the business
and/or assets of the Company, by agreement in form and
substance satisfactory to the Executive, to expressly
assume and agree to perform this Agreement in the same
manner and to the same extent that the Company would be
required to perform it if no such succession had taken
place. As used in this Agreement, "Company" shall mean
the Company as hereinbefore defined and any successor to
its business and/or assets as aforesaid which executes
and delivers the agreement provided for in this Section
13 or which otherwise becomes bound by all the terms and
provisions of this Agreement by operation of law.
(b) This Agreement and all rights of the
Executive hereunder shall inure to the benefit of and be
enforceable by the Executive's personal or legal
representatives, executors, administrators, successors,
heirs, distributees, devisees and legatees. If the
Executive should die while any amounts would still be
payable to him hereunder if he had continued to live, all
such amounts unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to
the Executive's devisee, legatee, or other designee or,
if there be no such designee, to the Executive's estate.
14. Notices. For purposes of this Agreement,
notices and all other communications provided for in the
Agreement shall be in writing and shall be deemed to have
been duly given when delivered or received by facsimile
or three (3) days after mailing by United States
certified mail, return receipt requested, postage
prepaid, addressed, if to the Executive, to the address
inserted below the Executive's signature on the final
page hereof and, if to the Company, to the address set
forth below, or to such other address as either party may
have furnished to the other in writing in accordance
herewith, except that notice of change of address shall
be effective only upon actual receipt:
To the Company:
United USN, Inc.
10 South Riverside Plaza
Chicago, Illinois 60022
Attention: President
15. Miscellaneous. No provision of this
Agreement may be modified, waived or discharged unless
such waiver, modification or discharge is agreed to in
writing and signed by the Executive and such officer as
may be specifically designated by the Board. No waiver
by either party hereto at any time of any breach by the
other party hereto of, or of any lack of compliance with,
any condition or provision of this Agreement to be
performed by such other party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the
same or at any prior or subsequent time. The validity,
interpretation, construction and performance of this
Agreement shall be governed by the laws of the State of
Illinois (without regard to its principles of conflicts
of laws). All references to sections of ERISA shall be
deemed also to refer to any successor provisions to such
sections. Payments provided for hereunder shall be paid
net of any applicable withholding required under federal,
state or local law and any additional withholding to
which the Executive has agreed. The invalidity or
unenforceability of any provision of this Agreement shall
not affect the validity or enforceability of any other
provision of this Agreement, which shall remain in full
force and effect. Captions and Section headings in this
Agreement are provided merely for convenience and shall
not affect the interpretation of any of the provisions
herein. The obligations of the Company and the Executive
under this Agreement which by their nature may require
either partial or total performance after the expiration
of the Term shall survive such expiration.
16. Counterparts. This Agreement may be
executed in one or more counterparts, each of which shall
be deemed to be an original but all of which together
will constitute one and the same instrument.
17. Entire Agreement. This Agreement
supersedes, as of the Effective Date, all prior
agreements, promises, covenants, arrangements,
communications, representations or warranties, whether
oral or written, by the parties hereto in respect of the
subject matter contained herein; and any prior agreement
of the parties hereto in respect of the subject matter
contained herein shall be terminated and cancelled as of
the Effective Date.
IN WITNESS WHEREOF, the parties hereto have
executed this Agreement as of the date set forth above.
UNITED USN, INC.
By: /s/ J. Thomas Elliott
Name:
Title:
/s/ Gerald J. Sweas
Gerald J. Sweas
622 Forest Avenue
Wilmette, Illinois 60091
EMPLOYMENT AGREEMENT
AGREEMENT, dated as of October 21, 1996, by and
between Ryan Mullaney (the "Executive") and United USN,
Inc., a Delaware corporation (the "Company").
WHEREAS, it is deemed by the Company to be in the
best interests of the Company to assure the Executive's
employment; and
WHEREAS, the Company and the Executive have
determined to enter into this Agreement pursuant to which
the Company will employ the Executive on the terms and
conditions set forth herein;
NOW, THEREFORE, in consideration of the premises and
the mutual covenants herein contained, the parties hereto
agree as follows:
1. Employment. The Company hereby agrees to
employ the Executive, and the Executive hereby accepts
such employment, on the terms and conditions hereinafter
set forth.
2. Term. This Agreement shall become
effective on the date hereof (the "Effective Date").
Unless earlier terminated as herein provided, the
Executive's employment with the Company hereunder shall
commence at the Effective Date and shall end on the last
day of the "Term". For purposes of this Agreement, the
"Term" of this Agreement shall mean the full two-year
term of the Agreement, plus any extensions made as
provided in this Section 2. On each anniversary of the
Effective Date, the Term shall automatically be extended
for an additional year unless, not later than ninety (90)
days prior to any such anniversary, the Company or the
Executive shall have given notice not to extend the Term.
For purposes of this Agreement, the "Employment Period"
(which in no event shall extend beyond the Term) shall
mean the period during which Executive has an obligation
to render services hereunder, as described in Section 3
hereof, taking into account any Notice of Termination (as
defined in Section 6(e) hereof) which may be given by
either the Company or the Executive. Nothing in this
Section shall limit the right of the Company or the
Executive to terminate the Executive's employment
hereunder on the terms and conditions set forth in
Section 6 hereof.
3. Position and Duties. On and after the
Effective Date, the Executive shall serve as Executive
Vice President Sales of the Company and shall have such
additional duties and responsibilities as may be assigned
to him by the Chief Executive Officer of the Company (or
by an executive reasonably designated by the Chief
Executive Officer), provided that such duties and
responsibilities are consistent with the Executive's
position as Executive Vice President Sales of the
Company. The Executive shall report to the Chief
Executive Officer of the Company (or to an executive
reasonably designated by the Chief Executive Officer).
The Executive agrees to devote substantially all his full
working time, attention and energies during normal
business hours to the performance of his duties for the
Company, provided that the Executive may serve as a
director on the boards of such companies and
organizations as may be agreed upon in writing by the
Board of Directors of the Company (the "Board") and the
Executive.
4. Place of Performance. The principal place
of employment and office of the Executive shall be in
Chicago, Illinois or such other location as may be agreed
to in writing by the Executive.
5. Compensation and Related Matters.
(a) Base Salary. As compensation for the
performance by the Executive of his duties hereunder,
the Company shall pay the Executive an annual base salary
(effective as of October 21, 1996) of One Hundred Twenty-
five Thousand Dollars ($125,000)(such amount, as it may
be increased from time to time, is hereinafter referred
to as "Base Salary"). Base Salary shall be payable in
accordance with the Company's normal payroll practices,
shall be reviewed annually and may be increased upon such
review. Base Salary, once increased, shall not be
decreased.
(b) Bonus. Subject to meeting reasonable
performance goals established by the Chief Executive
Officer and subject to the approval of the Board, the
Executive shall be entitled to a bonus paid quarterly
(the "Bonus") for each calendar quarter which ends within
the Employment Period. The Executive's target quarterly
Bonus shall be Eighteen Thousand Seven Hundred and Fifty
Dollars ($18,750) during the calendar year 1997. The
Bonus (if any) for each calendar quarter which ends
within the Employment Period shall be paid as soon as
practicable after the thirtieth (30th) day of the month
immediately following the end of each such calendar
quarter. Within the ten-(10)-day period immediately
following any Change in Control (as defined in Section 9
hereof), the Company shall pay the Executive a lump sum
amount equal to a pro rata portion of the Bonus for the
calendar quarter in which the Change in Control occurs,
calculated by multiplying the award that the Executive
would have earned for the entire quarter, assuming the
achievement, at the target level, of any performance
goals established with respect to such award, by a
fraction the numerator of which shall be the number of
days of employment in such calendar quarter up to and
including the date of the Change in Control and the
denominator of which shall be ninety (90).
(c) Stock Options. The Executive shall
be entitled to participate, at a level appropriate to his
position with the Company, in any stock option plan or
stock-based compensation plan which the Company maintains
from time to time. The initial grants of stock options
("Options") for shares of common stock of the Company
("Shares") to the Executive will be made under the
Company's 1994 Stock Option Plan (the "1994 Plan"). The
Company agrees that it will take such actions as are
necessary (including, without limitation, amendment of
the 1994 Plan and options outstanding thereunder, subject
to any required consents of participants therein) to
assure the following:
(i) All Options held by the Executive shall become
fully vested and exercisable upon a Change in
Control (as defined in Section 9 hereof); and
(ii) Upon the occurrence during the Employment
Period of any event which affects the Shares in such
a way that an adjustment of the Options is
appropriate in order to prevent dilution of the
rights of the Executive under the Options
(including, without limitation, any dividend or
other distribution (whether in cash or in kind),
recapitalization, stock split, reverse split,
reorganization, merger, consolidation, spin-off,
combination, repurchase, or share exchange, or other
similar corporate transaction or event), the Company
shall make appropriate equitable adjustments, which
may include, without limitation, adjustments to any
or all of the number and kind of shares of stock of
the Company (or other securities) which may
thereafter be issued in connection with future
grants of options pursuant to this Section 5(c) and
which may thereafter be issued upon exercise of the
then outstanding Options and adjustments to the
exercise prices of all such Options.
(d) Expenses. The Company shall
reimburse the Executive for all reasonable business
expenses, subject to the applicable and reasonable
policies and procedures of the Company in force from time
to time.
(e) Services Furnished. The Company
shall furnish the Executive with appropriate office space
and such other facilities and services as shall be
suitable to the Executive's position and adequate for the
performance of his duties as set forth in Section 3
hereof, such office space and other facilities and
services to be furnished at the location set forth in
Section 4 hereof.
(f) Other Benefits. The Company shall
provide to the Executive such employee benefit and
compensation plans and arrangements and fringe benefits
as are generally available to senior officers of the
Company.
6. Termination. The Executive's employment
hereunder may be terminated as follows:
(a) Death. The Executive's employment
shall terminate upon his death. Upon such a termination,
the Executive's estate or designated beneficiary, as the
case may be, shall become entitled to the payments
provided in Section 7(b) hereof.
(b) Disability. If, as a result of the
Executive's incapacity due to physical or mental illness
(as determined by a medical doctor mutually agreed to by
the Executive or his legal representative and the
Company), the Executive shall have been absent from his
duties hereunder on a full-time basis for either one-
hundred-eighty (180) consecutive days or for an aggregate
two-hundred-ten (210) days within a consecutive two-
hundred-seventy (270) day period and, within thirty (30)
days after Notice of Termination is given, shall not have
returned to the performance of his duties hereunder on a
full-time basis ("Disability"), the Company may terminate
the Executive's employment for Disability. Upon such a
termination, the Executive shall become entitled to the
payments provided in Section 7(b) hereof.
(c) Cause. The Company may terminate the
Executive's employment hereunder for "Cause" (as defined
in this Section 6(c)). Upon such a termination, the
Executive shall become entitled to the payments provided
in Section 7(b) hereof. For purposes of this Agreement,
the Company shall have "Cause" to terminate the
Executive's employment hereunder upon (i) the willful (or
grossly negligent) and continued failure by the Executive
to substantially perform his duties hereunder (other than
any such failure resulting from the Executive's
incapacity due to physical or mental illness or any such
actual or anticipated failure after the issuance of a
"Notice of Termination" by the Executive for "Good
Reason", as defined in Section 6(d)(i) hereof, after
demand for substantial performance is delivered by the
Company that specifically identifies the manner in which
the Company believes the Executive has not substantially
performed his duties, (ii) the willful or grossly
negligent engaging by the Executive in misconduct, (iii)
any breach by the Executive of any of the provisions of
Section 10 hereof, or (iv) the Executive's being
convicted of, or pleading guilty to, a felony. For
purposes of this paragraph, no act, or failure to act, on
the Executive's part shall be considered "willful" unless
done, or omitted to be done, by him not in good faith and
without reasonable belief that his action or omission was
in the best interest of the Company. Further, unless the
Executive has been convicted of, or pleaded guilty to, a
felony, the Executive shall not be deemed to have been
terminated for Cause without (1) reasonable notice to the
Executive setting forth the reasons for the Company's
intention to terminate for Cause, (2) an opportunity for
the Executive, together with his counsel, to be heard
before the Board, and (3) delivery to the Executive of a
Notice of Termination from the Board finding that, in the
good faith opinion of a majority of the Board, the
Executive was guilty of conduct set forth above in clause
(i), (ii) or (iii) of the second sentence of this Section
6(c), and specifying the particulars thereof in
reasonable detail.
(d) Termination by the Executive.
(i) The Executive may terminate his
employment hereunder for "Good Reason", which, for
purposes of this Agreement, shall mean (A) assignment of
duties materially inconsistent with his executive status,
or substantial adverse alteration in responsibilities,
which assignment or alteration is not cured within thirty
(30) days after notice from the Executive; (B) any
failure of the Company to pay any compensation to
Executive within thirty (30) days of the Executive's
notice to Company that payment is overdue; or (C)
Company's breach of a material term or condition of the
Agreement, and failure to correct breach within thirty
(30) days after the Executive's notice thereof
(specifying in reasonable detail the particulars of such
noncompliance). Upon a Good Reason termination, the
Executive shall become entitled to the payments and
benefits provided in Section 7(c) hereof.
(ii) The Executive may terminate his
employment hereunder without Good Reason upon giving
three months notice to the Company. In the event of such
a termination, the Executive shall comply with any
reasonable request of the Company to assist in providing
for an orderly transition of authority, but such
assistance shall not delay the Executive's termination of
employment longer than six months beyond the giving of
the Executive's Notice of Termination. Upon such a
termination, the Executive shall become entitled to the
payments provided in Section 7(b) hereof.
(e) Notice of Termination. Any purported
termination of the Executive's employment (other than
termination pursuant to Section 6(a) hereof) shall be
communicated by written Notice of Termination to the
other party hereto in accordance with Section 14 hereof.
For purposes of this Agreement, a "Notice of Termination"
shall mean a notice that shall indicate the specific
termination provision in this Agreement relied upon and
shall set forth in reasonable detail the facts and
circumstances claimed to provide a basis for termination
of the Executive's employment under the provision so
indicated.
(f) Date of Termination. For purposes of
this Agreement, "Date of Termination" shall mean the
following: (i) if the Executive's employment is
terminated by his death, the date of his death; (ii) if
the Executive's employment is terminated pursuant to
Section 6(b) hereof, thirty (30) days after the Notice of
Termination is given; (iii) if the Executive's employment
is terminated pursuant to Section 6(c) hereof, the date
specified in the Notice of Termination; (iv) if the
Executive's employment is terminated pursuant to Section
6(d)(i) or 6(d)(ii) hereof, thirty (30) days after the
Notice of Termination is given; and (v) if the
Executive's employment is terminated pursuant to Section
6(d)(iii) hereof, the date determined in accordance with
said Section.
(g) Dispute Concerning Termination. If
within fifteen (15) days after any Notice of Termination
is given, or, if later, prior to the Date of Termination
(as determined without regard to this Section 6(g), the
party receiving such Notice of Termination notifies the
other party that a dispute exists concerning the
termination, the Date of Termination shall be extended
until the earlier to occur of (i) the date on which the
Term ends or (ii) the date on which the dispute is
finally resolved, either by mutual written agreement of
the parties or by the final determination of a court of
law, which is not subject to appeal; provided, however,
that the Date of Termination shall be extended by a
notice of dispute given by the Executive only if such
notice is given in good faith and the Executive pursues
the resolution of such dispute with reasonable diligence.
(h) Compensation During Dispute. If the
Date of Termination is extended in accordance with
Section 6(g) hereof, the Company shall continue to pay
the Executive the full compensation in effect when the
notice giving rise to the dispute was given (including,
but not limited to, Base Salary and Annual Bonus) and
continue the Executive as a participant in all
compensation, benefit and insurance plans in which the
Executive was participating when the notice giving rise
to the dispute was given, until the Date of Termination,
as determined in accordance with Section 6(g) hereof.
Amounts paid under this Section 6(h) are in addition to
all other amounts due under this Agreement and shall not
be offset against or reduce any other amounts due under
this Agreement.
7. Compensation During Disability or Upon
Termination.
(a) Disability Period. During any period
during the Term that the Executive fails to perform his
duties hereunder as a result of incapacity due to
physical or mental illness ("Disability Period"), the
Executive shall continue to (i) receive his full Base
Salary, (ii) remain eligible to receive an Annual Bonus
under Section 5(b) hereof, and (iii) participate in the
plans and arrangements described in Section 5(f) hereof
(except to the extent such participation is not permitted
under the terms of such plans and arrangements). Such
payments made to the Executive during the Disability
Period shall be reduced by the sum of the amounts, if
any, payable to the Executive at or prior to the time of
any such payment under disability benefit plans of the
Company or under the Social Security disability insurance
program, and which amounts were not previously applied to
reduce any such payment.
(b) Termination other than by the Company
without Cause or by the Executive with Good Reason. If
the Executive's employment hereunder is terminated other
than by the Company without Cause or by the Executive
with Good Reason, then:
(i) as soon as practicable after
the Date of Termination, the Company shall pay any
amounts earned, accrued or owing the Executive
hereunder for services prior to the Date of
Termination to the Executive (or the Executive's
estate or designated beneficiary, as the case may
be); and
(ii) the Company shall have no
additional obligations to the Executive (or the
Executive's estate or designated beneficiary) under
this Agreement except to the extent provided in
Sections 5(c) and 5(d) hereof or otherwise provided
in the applicable plans and programs of the Company.
(c) Termination by Company without Cause
or by the Executive with Good Reason. If the Executive's
employment hereunder is terminated by the Company without
Cause or by the Executive with Good Reason, then, subject
to the Executive's continuing compliance with Section 10
hereof:
(i) as soon as practicable after the
Date of Termination, the Company shall pay any
amounts earned, accrued or owing the Executive
hereunder for services prior to the Date of
Termination to the Executive;
(ii) notwithstanding any provision
of any Annual Bonus plan to the contrary, the
Company shall pay to the Executive, as soon as
practicable after the Date of Termination, a lump
sum amount, in cash, equal to the sum of (A) any
Annual Bonus which has been allocated or awarded to
the Executive for a completed fiscal year preceding
the Date of Termination under any Annual Bonus plan,
and (B) a pro rata portion to the Date of
Termination of the Annual Bonus for the year in
which the Date of Termination occurs, calculated by
multiplying the award that the Executive would have
earned for the entire year, assuming the
achievement, at the target level, of any performance
goals established with respect to such award, by a
fraction the numerator of which shall be the number
of days of employment in such year up to and
including the Date of Termination and the
denominator of which shall be three-hundred-sixty-
five (365); provided, however, that any amount
otherwise payable pursuant to this clause (B) of
this Section 7(c)(ii) shall be reduced by any pro-
rated Annual Bonus payment already received by the
Executive pursuant to Section 5(b) hereof with
respect to the year in which the Date of Termination
occurs;
(iii) subject to the Executive's
continuing compliance with Section 10 hereof, the
Company shall pay as severance payments to the
Executive (in substantially equal installments and
in the same manner and over the same period of time
as the Executive's salary payments would have been
made) an amount (the "Severance Amount") equal to
the greater of (x) the amount of the Executive's
highest annual Base Salary in effect during the Term
or (y) the aggregate amount of the Executive's Base
Salary through the end of the Term (using, to
calculate such amount, the Executive's highest
annual Base Salary in effect during the Term); such
installment payments shall cease upon any violation
of Section 10 hereof;
(iv) the Company shall maintain in
full force and effect, for the continued benefit of
the Executive until the later of (x) the first
anniversary of the Date of Termination or (y) the
end of the Term, each "employee welfare benefit
plan" (as defined in section 3(1) of the Employee
Retirement Income Security Act of 1974, as amended
("ERISA")), other than any disability plan, in which
the Executive was entitled to participate
immediately prior to the Date of Termination,
provided that the Executive's continued
participation is possible under the general terms
and provisions of such plans. In the event that the
Executive's participation in any such plan is
barred, the Company shall arrange to provide the
Executive with benefits substantially similar to
those which the Executive would otherwise have been
entitled to receive under the plan from which his
continued participation is barred;
(v) if the Date of Termination shall
occur within the two (2) years immediately following
a Change in Control, then, in lieu of Shares
issuable upon exercise of the Executive's Options
(which Options shall be cancelled upon the making of
the payment referred to below), the Company shall
pay the Executive a lump sum amount, in cash, equal
to the product of (1) the excess of (x) the higher
of the "Fair Market Value" (as defined in Section
7(d) hereof) of a Share on the Date of Termination
or the highest price per Share actually paid in
connection with such Change in Control over (y) the
exercise price per Share of each such Option held by
the Executive (whether or not then fully
exercisable), times (2) the number of Shares covered
by such Option;
(vi) if the Date of Termination
shall occur within the two (2) years immediately
following a Change in Control, then, upon surrender
by the Executive of all Shares owned outright by him
and all rights which he may have to any restricted
Shares, in payment for and in lieu of all such
Shares, the Company shall pay the Executive a lump
sum amount, in cash, equal to the product of (1) the
higher of the Fair Market Value of a Share on the
Date of Termination or the highest price per Share
actually paid in connection with such Change in
Control, times (2) the number of all such Shares
(whether or not restricted) of the Executive; and
(vii) the Company shall have no
additional obligations to the Executive under this
Agreement except to the extent provided in Sections
5(c) and 5(d) hereof or otherwise provided in the
applicable plans and programs of the Company.
(d) Fair Market Value. For purposes of
this Agreement, if the Shares are publicly traded on any
date for which the "Fair Market Value" of a Share is
required by this Agreement, the "Fair Market Value" shall
be the closing price of a Share on the date the Fair
Market Value is to be determined, or if no sale is
reported for such date, then on the next preceding date
for which a sale is reported. If the Shares are not
publicly traded on any date for which the Fair Market
Value of a Share is required by this Agreement, the Fair
Market Value shall be determined in accordance with the
following procedure: The Executive and the Company shall
each select a nationally recognized appraiser, which
shall determine a value for a Share of the Company. If
the higher of the two original appraisal values is not
more than ten percent (10%) above the lower appraisal
value, the Fair Market Value shall be the value agreed
upon by the two original appraisers or, in the absence of
such an agreement, the Fair Market Value shall be the
average of the two original appraisal values. If the
higher of the two original appraisal values is more than
ten percent (10%) above the lower appraisal value, the
two appraisers shall select a third nationally recognized
appraiser who shall determine a Fair Market Value which
shall be at least equal to the lower appraisal value and
whose determination of the Fair Market Value shall be
final.
8. No Mitigation. The Executive shall not be
required to mitigate amounts payable pursuant to Section
7 hereof by seeking other employment or otherwise, but
any payments made or benefits provided pursuant to
Section 7(c)(iv) hereof shall be offset by any similar
payments or benefits made available without cost to the
Executive from any subsequent employment during the Term
(determined immediately prior to such termination of
employment).
9. Change in Control.
(a) For purposes of this Agreement, a
"Change in Control" shall be deemed to have occurred if
an event set forth in any one of the following paragraphs
(i)-(iv) shall have occurred:
(i) any Person (as defined in
Section 9(b) hereof) is or becomes the Beneficial
Owner (as defined in Section 9(c) hereof), directly
or indirectly, of securities of the Company
representing thirty-five percent (35%) or more of
the combined voting power of the Company's then
outstanding securities, excluding any Person who
becomes such a Beneficial Owner in connection with a
transaction described in clause (x) of paragraph
(iii) below; or
(ii) prior to any initial public
offering, the following individuals cease for any
reason to constitute a majority of the number of
directors then serving: individuals who, on the date
hereof, constitute the Board and any new director
(other than a director whose initial assumption of
office is in connection with an actual or threatened
election contest, including but not limited to a
consent solicitation, relating to the election of
directors of the Company) whose appointment or
election by the Board or nomination for election by
the Company's stockholders was approved or
recommended by a vote of at least two-thirds (2/3)
of the directors then still in office who either
were directors on the date hereof or whose
appointment, election or nomination for election was
previously so approved or recommended; or
(iii) the stockholders of the Company
approve a merger or consolidation of the Company
with any other corporation or the issuance of voting
securities of the Company in connection with a
merger or consolidation of the Company (or any
direct or indirect subsidiary of the Company)
pursuant to applicable stock exchange requirements,
other than (x) a merger or consolidation which would
result in the voting securities of the Company
outstanding immediately prior to such merger or
consolidation continuing to represent (either by
remaining outstanding or by being converted into
voting securities of the surviving entity or any
parent thereof) at least fifty percent (50%) of the
combined voting power of the securities of the
Company or such surviving entity or any parent
thereof outstanding immediately after such merger or
consolidation, or (y) a merger or consolidation
effected to implement a recapitalization of the
Company (or similar transaction) in which no Person
is or becomes the Beneficial Owner, directly or
indirectly, of securities of the Company
representing thirty-five percent (35%) or more of
the combined voting power of the Company's then
outstanding securities; or
(iv) the stockholders of the Company
approve a plan of complete liquidation or
dissolution of the Company or an agreement for the
sale or disposition by the Company of all or
substantially all of the Company's assets.
Notwithstanding the foregoing, a "Change in Control"
shall not be deemed to have occurred by virtue of the
consummation of any transaction or series of integrated
transactions immediately following which the record
holders of the common stock of the Company immediately
prior to such transaction or series of transactions
continue to have substantially the same proportionate
ownership in an entity which owns all or substantially
all of the assets of the Company immediately following
such transaction or series of transactions.
(b) For purposes of this Agreement,
"Person" shall have the meaning given in Section 3(a)(9)
of the Securities Exchange Act of 1934, as amended from
time to time (the "Exchange Act"), as modified and used
in Sections 13(d) and 14(d) thereof, except that such
term shall not include (i) the Company or any of its
subsidiaries, (ii) a trustee or other fiduciary holding
securities under an employee benefit plan of the Company
or any of its affiliates, (iii) an underwriter
temporarily holding securities pursuant to an offering of
such securities, (iv) a corporation owned, directly or
indirectly, by the stockholders of the Company in
substantially the same proportions as their ownership of
stock of the Company, or (v) any of the following
entities or their affiliates: BT Capital Partners, Inc.,
Chase Capital Partners, CIBC Wood Gundy Ventures, Inc.,
Hancock Venture Partners IV and Enterprises &
Transcommunications, L.P.
(c) For purposes of this Agreement,
"Beneficial Owner" shall have the meaning set forth in
Rule 13d-3 under the Exchange Act.
10. Confidentiality, Noncompetition and
Nonsolicitation.
(a) The Executive will not, during or
after the Term, disclose to any entity or person any
information (including, but not limited to, information
about customers or about the design, manufacture or
marketing of products or services) which is treated as
confidential by the Company and to which the Executive
gains access by reason of his position as an employee of
the Company.
(b) While the Executive continues to be
an employee of the Company and for the eighteen-month
period immediately following his Date of Termination, the
Executive shall not, within any geographic region of the
United States of America in which the Company then
conducts business or in which the Company plans to
conduct business pursuant to a business strategy adopted
by the Board before the Executive's termination of
employment, except as permitted by the Company upon its
prior written consent, (i) enter, directly or indirectly,
into the employ of, or render or engage in, directly or
indirectly, any services to any person, firm or
corporation which directly competes with the Company with
respect to any business then conducted by the Company or
any business which the Company plans to enter pursuant to
a business strategy adopted by the Board before the
Executive's termination of employment (a "Competitor"),
or (ii) become interested, directly or indirectly, in any
such Competitor as an individual, partner, shareholder,
creditor, director, officer, principal, agent, employee,
trustee, consultant, advisor or in any other relationship
or capacity. The ownership of up to one percent (1%) of
any class of the outstanding securities of any publicly
traded corporation, even though such corporation may be a
Competitor, shall not be deemed as constituting an
interest in such Competitor which violates clause (ii) of
the immediately preceding sentence. Notwithstanding the
preceding provisions of this Section 10(b), the Executive
may render legal services to businesses which are
directly competitive with the Company so long as the
Executive, in rendering such legal services, does not
violate any attorney-client privilege or any duties of
confidentiality and non-disclosure owed to the Company
under this Agreement, under any other agreement between
the Executive and the Company, or otherwise.
(c) While the Executive continues to be
an employee of the Company and for the eighteen-month
period immediately following his Date of Termination, the
Executive shall not, except as permitted by the Company
upon its prior written consent, (i) attempt, directly or
indirectly, to induce any employee employed by or
performing services for the Company (or its affiliates)
to be employed or perform services elsewhere, or (ii)
solicit, directly or indirectly, the customers of the
Company (or its affiliates), the suppliers of the Company
(or its affiliates) or entities or individuals having
other business relationships with the Company (or its
affiliates) for the purpose of encouraging them to
terminate (or reduce or detrimentally alter) their
respective relationships with the Company (or its
affiliates).
(d) Any violation by the Executive of
Section 10(a), 10(b) or 10(c) hereof occurring after the
Date of Termination shall entitle the Company to cease
making any payments and providing any benefits otherwise
required under Section 7(c) hereof. Additionally, the
Company shall have the right and remedy to have the
provisions of this Section 10 specifically enforced,
including by temporary and/or permanent injunction, it
being acknowledged and agreed that any such violation may
cause irreparable injury to the Company and that money
damages will not provide an adequate remedy to the
Company.
11. Independence and Severability of Section
10 Provisions. Each of the rights and remedies
enumerated in Section 10 hereof shall be independent of
the others and shall be severally enforceable and all of
such rights and remedies shall be in addition to, and not
in lieu of, any other rights and remedies available to
the Company under law or in equity. If any of the
covenants contained in Section 10 hereof or if any of the
rights or remedies enumerated in Section 10 hereof, or
any part of any of them, is hereafter construed to be
invalid or unenforceable, the same shall not affect the
remainder of the covenant or covenants or rights or
remedies which shall be given full effect without regard
to the invalid portions. If any of the covenants
contained in Section 10 is held to be unenforceable
because of the duration of such provision or the area
covered thereby, the parties agree that the court making
such determination shall have the authority to reduce the
duration and/or area of such provision, and in its
reduced form said provision shall then be enforceable.
12. Indemnification. The Company shall
indemnify the Executive to the full extent authorized by
law and the Charter and By-Laws of the Company, as
applicable, for all expenses, costs, liabilities and
legal fees which the Executive may incur in the discharge
of his duties hereunder. The Executive shall be insured
under the Company's Directors' and Officers' Liability
Insurance Policy as in effect from time to time. Any
termination of the Executive's employment or of this
Agreement shall have no effect on the continuing
operation of this Section 12.
13. Successors; Binding Agreement.
(a) The Company will require any
purchaser of all or substantially all of the business
and/or assets of the Company, by agreement in form and
substance satisfactory to the Executive, to expressly
assume and agree to perform this Agreement in the same
manner and to the same extent that the Company would be
required to perform it if no such succession had taken
place. As used in this Agreement, "Company" shall mean
the Company as hereinbefore defined and any successor to
its business and/or assets as aforesaid which executes
and delivers the agreement provided for in this Section
13 or which otherwise becomes bound by all the terms and
provisions of this Agreement by operation of law.
(b) This Agreement and all rights of the
Executive hereunder shall inure to the benefit of and be
enforceable by the Executive's personal or legal
representatives, executors, administrators, successors,
heirs, distributees, devisees and legatees. If the
Executive should die while any amounts would still be
payable to him hereunder if he had continued to live, all
such amounts unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to
the Executive's devisee, legatee, or other designee or,
if there be no such designee, to the Executive's estate.
14. Notices. For purposes of this Agreement,
notices and all other communications provided for in the
Agreement shall be in writing and shall be deemed to have
been duly given when delivered or received by facsimile
or three (3) days after mailing by United States
certified mail, return receipt requested, postage
prepaid, addressed, if to the Executive, to the address
inserted below the Executive's signature on the final
page hereof and, if to the Company, to the address set
forth below, or to such other address as either party may
have furnished to the other in writing in accordance
herewith, except that notice of change of address shall
be effective only upon actual receipt:
To the Company:
United USN, Inc.
10 South Riverside Plaza
Chicago, Illinois 60022
Attention: President
15. Miscellaneous. No provision of this
Agreement may be modified, waived or discharged unless
such waiver, modification or discharge is agreed to in
writing and signed by the Executive and such officer as
may be specifically designated by the Board. No waiver
by either party hereto at any time of any breach by the
other party hereto of, or of any lack of compliance with,
any condition or provision of this Agreement to be
performed by such other party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the
same or at any prior or subsequent time. The validity,
interpretation, construction and performance of this
Agreement shall be governed by the laws of the State of
Illinois (without regard to its principles of conflicts
of laws). All references to sections of ERISA shall be
deemed also to refer to any successor provisions to such
sections. Payments provided for hereunder shall be paid
net of any applicable withholding required under federal,
state or local law and any additional withholding to
which the Executive has agreed. The invalidity or
unenforceability of any provision of this Agreement shall
not affect the validity or enforceability of any other
provision of this Agreement, which shall remain in full
force and effect. Captions and Section headings in this
Agreement are provided merely for convenience and shall
not affect the interpretation of any of the provisions
herein. The obligations of the Company and the Executive
under this Agreement which by their nature may require
either partial or total performance after the expiration
of the Term shall survive such expiration.
16. Counterparts. This Agreement may be
executed in one or more counterparts, each of which shall
be deemed to be an original but all of which together
will constitute one and the same instrument.
17. Entire Agreement. This Agreement
supersedes, as of the Effective Date, all prior
agreements, promises, covenants, arrangements,
communications, representations or warranties, whether
oral or written, by the parties hereto in respect of the
subject matter contained herein; and any prior agreement
of the parties hereto in respect of the subject matter
contained herein shall be terminated and cancelled as of
the Effective Date.
IN WITNESS WHEREOF, the parties hereto have
executed this Agreement as of the date set forth above.
UNITED USN, INC.
By: /s/ J. Thomas Elliott
Name:
Title:
/s/ Ryan Mullaney
Ryan Mullaney
2100 E. Bengal Blvd.
Salt Lake City, Utah 84121
COMPUTATION OF NET LOSS PER COMMON SHARE
A. Primary: See the Consolidated Statements of Operations on
page F-4.
B. Full Dilution: Net loss was adjusted to exclude the effects
of the dividends on the outstanding preferred stock and the
interest expense on the convertible debt as these items were
considered converted to common stock upon original issuance
in 1996 assuming full dilution. The weighted average number
of common shares outstanding was adjusted for the net effects
of the exercise of stock options and warrants and the
conversion of convertible debt and of preferred stock.
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Net loss $(25,046,591) $(18,097,026) $(7,146,789)
Accumulated unpaid preferred 225,000 3,810,000 707,000
dividends -------------------------------------------
Net loss to common
shareholders per
primary calculation $(25,271,591) $(21,907,026) $(7,853,789)
Add back:
Accumulated unpaid
preferred dividend 225,000
Interest expense on
convertible debt 615,155
-------------------------------------------
Net loss to common
shareholders assuming
full dilution $(24,435,931) $(21,907,026) $(7,853,789)
===========================================
Average common and common
equivalent shares:
Average common shares out-
standing per primary
computation 510,233 302,520 119,678
Assuming conversion of pre-
ferred stock 214,307 -- --
Assuming conversion of con-
vertible debt 67,676 -- --
Assuming exercise of stock
options 44,953 21,300 7,568
Assuming exercise of stock
warrants 15,514 -- --
-----------------------------------------
Average common and anti-
dilutive common equivalent
shares as adjusted 852,683 323,820 127,246
=========================================
Net loss per common share
assuming full dilution $ (28.66) $ (67.65) $ (61.72)
=========================================
</TABLE>
This calculation is submitted in accordance with Regulation S-K
item 601(b)(11) of the Securities Exchange Act, although the
inclusion in the calculation of securities whose conversion or
exercise has the effect of reducing the loss per share amounts is
contrary to paragraph 40 of APB Opinion No. 15 because such
inclusion produces an anti-dilutive result.
<TABLE>
<CAPTION>
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
YEAR ENDED DECEMBER 31,
1994 1995 1996
<S> <C> <C> <C>
Net loss . . . . . . . . . $(7,146,789) $(18,097,026) $(25,046,591)
Income tax expense (benefit) -- -- --
-----------------------------------------
Loss before income taxes . $(7,146,789) $(18,097,026) $(25,046,591)
Fixed charges included in
income:
Interest and related
charges on debt 26,110 733,566 1,797,112
Portion of rentals deemed
to be interest . . . . 142,666 578,214 682,708
-----------------------------------------
Total fixed charges included
in income . . . . . . . . 168,777 1,311,780 2,479,820
-----------------------------------------
Earnings available for
fixed charges . . . . . . $(6,978,012) $(16,785,246) $(22,566,771)
=========================================
Fixed Charges:
Fixed charges included
in income . . . . . . . $ 168,777 $ 1,311,780 $ 2,479,820
Interest capitalized in
the period . . . . . . -- -- --
-----------------------------------------
Total fixed charges . . . . $ 168,777 $ 1,311,780 $ 2,479,820
=========================================
Ratio of earnings to fixed
charges(1). . . . . . . . -- -- --
=========================================
</TABLE>
- --------------------------
(1) Earnings were insufficient to cover fixed charges for the periods
ended December 31, 1994, 1995 and 1996 by $7.0 million, $16.8
million and $22.6 million, respectively.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> The Schedule Contains Summary Financial Informa-
tion Extracted From the USN Communications, Inc.
Consolidated Balance Sheets at December 31, 1996
and the Related Consolidated Statements of Opera-
tions for the Twelve Months then Ended and is
Qualified in its Entirety by Reference to Such
Financial Statements.
<MULTIPLIER> 1,000
<S> <C>
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<PERIOD-TYPE> 12-MOS
<CASH> 60,569
<SECURITIES> 0
<RECEIVABLES> 3,154
<ALLOWANCES> 223
<INVENTORY> 0
<CURRENT-ASSETS> 64,183
<PP&E> 4,333
<DEPRECIATION> 826
<TOTAL-ASSETS> 78,052
<CURRENT-LIABILITIES> 11,749
<BONDS> 59,502
10,045
0
<COMMON> 54,186
<OTHER-SE> (57,792)
<TOTAL-LIABILITY-AND-EQUITY> 78,052
<SALES> 9,814
<TOTAL-REVENUES> 9,814
<CGS> 9,256
<TOTAL-COSTS> 9,256
<OTHER-EXPENSES> 33,277
<LOSS-PROVISION> 861
<INTEREST-EXPENSE> 1,797
<INCOME-PRETAX> (25,047)
<INCOME-TAX> 0
<INCOME-CONTINUING> (25,047)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (25,047)
<EPS-PRIMARY> (49.53)
<EPS-DILUTED> (28.66)
</TABLE>
