<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 10, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
USN COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 4813 36-3947804
(STATE OR OTHER
JURISDICTION OF
INCORPORATION OR
ORGANIZATION)
(PRIMARY STANDARD INDUSTRIAL CLASSIFICATION CODE NUMBER)
(I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
---------------
10 SOUTH RIVERSIDE PLAZA,
SUITE 401
CHICAGO, ILLINOIS 60606
(312) 906-3600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICE)
---------------
THOMAS A. MONSON, ESQ.
VICE PRESIDENT AND GENERAL COUNSEL
USN COMMUNICATIONS, INC.
10 SOUTH RIVERSIDE PLAZA, SUITE 401
CHICAGO, ILLINOIS 60606
(312) 906-3600
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
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COPY TO:
GARY P. CULLEN, ESQ.
SKADDEN, ARPS, SLATE, MEAGHER & FLOM (ILLINOIS)
333 WEST WACKER DRIVE
CHICAGO, ILLINOIS 60606
(312) 407-0700
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF SECURITIES TO PUBLIC:
As soon as practicable after the effective date of this Registration
Statement.
---------------
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance
with General Instruction G, check the following box. [_]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT MAXIMUM AGGREGATE AMOUNT OF
SECURITIES TO BE TO BE OFFERING PRICE OFFERING PRICE REGISTRATION
REGISTERED REGISTERED PER NOTE (1) FEE
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<S> <C> <C> <C> <C>
14 5/8% Series B Senior
Discount Notes due 2004 152,725 $654.78 $100,001,276 $30,303
</TABLE>
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(1) The Proposed Maximum Offering Price per Note is based on the actual
Offering Price Per Note of $654.78.
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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<PAGE>
SUBJECT TO COMPLETION, DATED OCTOBER 10, 1997
PROSPECTUS
USN COMMUNICATIONS, INC.
OFFER TO EXCHANGE ITS LOGO
14 5/8% SERIES B SENIOR DISCOUNT NOTES DUE 2004
FOR ANY AND ALL OF ITS OUTSTANDING
14 5/8% SENIOR DISCOUNT NOTES DUE 2004
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON
, 1998, UNLESS EXTENDED.
USN Communications, Inc. (the "Company") hereby offers, upon the terms and
subject to the conditions set forth in this Prospectus and the accompanying
Letter of Transmittal (which together constitute the "Exchange Offer"), to
exchange $1,000 principal amount at maturity of 14 5/8% Series B Senior
Discount Notes due 2004 (the "New Notes") of the Company for each $1,000
principal amount at maturity of the issued and outstanding 14 5/8% Senior
Discount Notes due 2004 (the "Old Notes" and, together with the New Notes, the
"Notes") of the Company from the holders (the "Holders") thereof. As of the
date of this Prospectus, there was $152,725,000 aggregate principal amount at
maturity of the Old Notes outstanding. The terms of the New Notes are identical
in all material respects to the Old Notes, except that the New Notes have been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
and, therefore, will not bear legends restricting their transfer and will not
contain certain terms providing for an increase in the interest rate on the Old
Notes under certain circumstances relating to the timing of the Exchange Offer.
The New Notes will be senior unsecured obligations of the Company and will
rank pari passu in right of payment with all existing and future senior
unsecured and unsubordinated indebtedness of the Company, and senior in right
of payment to all existing and future subordinated indebtedness of the Company.
The New Notes will be effectively subordinated to all secured indebtedness of
the Company to the extent of the value of the assets securing such indebtedness
and to indebtedness of subsidiaries of the Company. As of August 31, 1997,
there was approximately $0.7 million of secured long-term indebtedness
outstanding to which holders of Old Notes were effectively subordinated in
right of payment and approximately $21.1 million of subsidiary indebtedness to
which holders of Old Notes were structurally subordinated. The Indenture (as
defined) will permit the Company and its subsidiaries to incur additional
indebtedness under certain circumstances. See "Description of the Notes."
The New Notes are being offered hereunder in order to satisfy certain
obligations of the Company contained in the Registration Rights Agreement (as
defined). Based on interpretations by the staff of the Securities and Exchange
Commission (the "Commission") set forth in no-action letters issued to third
parties, the Company believes that the New Notes issued pursuant to the
Exchange Offer in exchange for Old Notes may be offered
(cover page continued on next page)
------------
SEE "RISK FACTORS," BEGINNING ON PAGE 14, FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY HOLDERS PRIOR TO TENDERING THEIR OLD NOTES IN THE
EXCHANGE OFFER.
------------
THE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
, 1997
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
<PAGE>
(cover page continued from previous page)
for resale, resold and otherwise transferred by any Holder thereof (other than
any such Holder which is an "affiliate" of the Company within the meaning of
Rule 405 under the Securities Act), without compliance with the registration
and prospectus delivery provisions of the Securities Act, provided that such
New Notes are acquired in the ordinary course of such Holder's business and
such Holder has no arrangement with any person to participate in the
distribution of such New Notes. Notwithstanding the foregoing, each broker-
dealer that receives New Notes for its own account pursuant to the Exchange
Offer must acknowledge that (i) Old Notes tendered by it in the Exchange Offer
were acquired in the ordinary course of its business as a result of market-
making or other trading activities and (ii) it will deliver a prospectus in
connection with any resale of New Notes received in the Exchange Offer. The
Letter of Transmittal states that by so acknowledging and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. This Prospectus, as it
may be amended or supplemented from time to time, may be used by a broker-
dealer in connection with any resale of the New Notes received in exchange for
Old Notes where such Old Notes were acquired by such broker-dealer as a result
of market-making or other trading activities (other than Old Notes acquired
directly from the Company). The Company has agreed that, for a period of 180
days after the Expiration Date (as defined), it will make this Prospectus
available to any broker-dealer for use in connection with any such resale. See
"Plan of Distribution." Any holder who tenders in the Exchange Offer for the
purpose of participating in a distribution of the New Notes cannot rely on the
Morgan Stanley Letter (as defined) or similar letters and must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with a secondary resale transaction.
Tenders of Old Notes pursuant to the Exchange Offer may be withdrawn at any
time prior to the Expiration Date. The Exchange Offer is subject to certain
customary conditions. In the event the Company terminates the Exchange Offer
and does not accept for exchange any Old Notes, the Company will promptly
return the Old Notes to the Holders thereof. The Company will give oral or
written notice of any extension, amendment, non-acceptance or termination of
the Exchange Offer to the Holders of the Old Notes as promptly as practicable,
such notice in the case of any extension to be issued by means of a press
release or other public announcement no later than 9:00 a.m., New York City
time, on the next business day after the previously scheduled Expiration Date.
The Company can, in its sole discretion, extend the Exchange Offer
indefinitely, subject to the Company's obligation to pay Special Interest (as
defined) if the Exchange Offer is not consummated by February 14, 1998 and,
under certain circumstances, file a shelf registration statement with respect
to the Old Notes. The Company has agreed to pay the expenses of the Exchange
Offer. The Company will not receive any proceeds from the Exchange Offer. See
"Use of Proceeds."
Prior to the date of this Prospectus, there has been no public market for
the Notes. The Company does not currently intend to list the New Notes on any
securities exchange or to seek approval for quotation through any automated
quotation system. Accordingly, there can be no assurance as to the development
or liquidity of any public market for the New Notes.
The Old Notes were sold by the Company on August 18, 1997 in transactions
which were not registered under the Securities Act, in reliance upon the
exemption provided by Section 4(2) of the Securities Act.
2
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (the "Exchange Offer Registration Statement") under the Securities Act
with respect to the New Notes being offered by this Prospectus. This
Prospectus does not contain all of the information set forth in the Exchange
Offer Registration Statement and the exhibits and schedules thereto, certain
portions of which have been omitted pursuant to the rules and regulations of
the Commission. Statements made in this Prospectus as to the contents of any
contract, agreement or other document are not necessarily complete. With
respect to each such contract, agreement or other document filed or
incorporated by reference as an exhibit to the Exchange Offer Registration
Statement, reference is made to such exhibit for a more complete description
of the matter involved, and each such statement is qualified in its entirety
to such reference.
The Company is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and in accordance therewith files reports, proxy statements and other
information with the Commission. The Exchange Offer Registration Statement and
reports, proxy statements and other information filed by the Company can be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549; Suite
1400, 500 West Madison Street, Chicago, Illinois 60661; and Seven World Trade
Center, 13th Floor, New York, New York 10048. Copies of such material can be
obtained by mail from the Public Reference Section of the Commission, 450
Fifth Street, N.W., Washington, D.C. 20549, at prescribed fees. The Commission
also maintains a website that contains reports, proxy and information
statements and other information. The website address is http://www.sec.gov.
Under the terms of the Indenture pursuant to which the Old Notes were, and the
New Notes will be, issued, the Company will be required to file with the
Commission, and to furnish holders of the Notes with, the information,
documents and other reports specified in Sections 13 and 15(d) of the Exchange
Act, including reports on Forms 10-K, 10-Q and 8-K.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act,
including statements containing the words "believes," "anticipates," "expects"
and words of similar import. All statements other than statements of
historical facts included in this Prospectus including, without limitation,
such statements under "Prospectus Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business" and located elsewhere herein, regarding the Company or any of the
transactions described herein, including the timing, financing, strategies and
effects of such transactions, are forward-looking statements. Although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such expectations
will prove to have been correct. Important factors that could cause actual
results to differ materially from expectations are disclosed in this
Prospectus, including, without limitation, in conjunction with the forward-
looking statements in this Prospectus and/or under "Risk Factors." The Company
does not intend to update these forward-looking statements.
3
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and consolidated financial statements and related notes appearing
elsewhere in this Prospectus. All share numbers contained in this Prospectus
reflect a nine-for-one stock dividend declared by the Company on September 4,
1997, except for share information included in the Financial Statements and
Notes thereto and in the historical financial data included elsewhere in this
Prospectus. Unless the context indicates otherwise, all references to the
Company or USN refer to USN Communications, Inc. and its subsidiaries. Please
refer to the Glossary for the definitions of certain capitalized terms used
herein and elsewhere in this Prospectus without definition.
THE COMPANY
USN is one of the fastest growing competitive local exchange carriers
("CLECs") in the United States. The Company offers a bundled package of
telecommunications products, including local and long distance telephony, voice
mail, paging, teleconferencing, Internet access and other enhanced features,
tailored to meet the needs of its customers. The Company primarily targets
small and medium-sized businesses with telecommunications usage of less than
$5,000 per month. The Company's strategy is to continue to increase its
customer base by being more flexible, innovative and responsive to the needs of
its target customers than the regional Bell operating companies ("RBOCs") and
the first-tier interexchange carriers ("IXCs"), which have historically
concentrated their sales and marketing efforts on residential and large
business customers. The Company primarily differentiates itself with a value-
based marketing strategy by providing an integrated, customized package of
telecommunications services on a single bill and responsive customer care.
The Company is presently providing service to customers in certain states in
the NYNEX Corporation ("NYNEX") region (New York and Massachusetts) and the
Ameritech Corporation ("Ameritech") region (Illinois, Ohio and Michigan) and is
currently in negotiations to expand its unique local services resale agreements
throughout the 14-state Bell Atlantic/NYNEX region and the 5-state Ameritech
region. Management anticipates implementing service in at least six additional
states within these regions in 1998. In August 1997, NYNEX merged with Bell
Atlantic. The Company continues to operate in the former NYNEX regions, now a
part of the Bell Atlantic territory. Throughout this Prospectus, references to
NYNEX refer to the portion of the Bell Atlantic territory previously serviced
by NYNEX.
During the first six months of 1997, the Company increased aggregate local
access lines sold from 10,283 lines to 79,321 lines, a compound growth rate of
more than 40% per month. As of June 30, 1997, the Company had 65,142 access
lines in service. Services are primarily marketed through an approximately 325
member direct salesforce in 27 offices located in five states. As part of its
customer-focused product offering, the Company provides personalized customer
service, 24 hours a day, 365 days per year, through its customer care center.
COMPETITIVE ADVANTAGES
Providing local exchange services is a highly complex process that requires
overcoming significant barriers to entry. Since inception, the Company has
spent significant time, resources and capital to enter the local market. In the
process, it has gained substantial experience in this complicated market
segment. Consequently, the Company believes it has the following competitive
advantages:
. Complementary Relationships with RBOCs. The Company believes that the RBOCs'
networks will continue to be the predominant means for providing local
telecommunications services to the Company's target customers for the
foreseeable future. Accordingly, the Company has positioned itself to take
advantage of the opportunities created by the Telecommunications Act of 1996
(the "Telecommunications Act") by leveraging its complementary relationships
with the RBOCs. The Telecommunications Act requires the RBOCs to complete a
number of "checklist" items in order to qualify for long distance entry in
their local service areas. By moving aggressively to enter into resale
agreements and to develop electronic interfaces with the RBOCs, the Company
believes it has positioned itself to play a key role in enabling the RBOCs to
meet a number of those requirements. The Company was the first to enter into
comprehensive resale agreements with Ameritech and NYNEX and served as the
systems beta customer for Ameritech, NYNEX and Bell Atlantic. Currently, the
Company is one of the largest competitors in the Ameritech and NYNEX markets.
Consequently, the
4
<PAGE>
Company is often requested by state and federal regulators to provide
information on the Company's experiences. The Company believes its
complementary relationships with the RBOCs have facilitated the Company's
rapid growth in its existing markets and enabled it to become a valuable and
viable resale channel partner. The Company further believes, based on
discussions with RBOC officials and industry experts, that the RBOCs will
continue to develop strong resale channel partners in an effort to mitigate
the potential negative effects of facilities-based competition.
. Unique Resale Agreements. The Company has executed comprehensive local
exchange resale agreements with Ameritech for the greater metropolitan
Chicago area, Ohio and Michigan, and with NYNEX for the State of New York. In
addition to the cost advantages associated with the term and volume
commitment contracts, these contracts provide "most favored nation" and other
pricing protections designed to maintain the competitiveness of rates and
position the Company to purchase capacity at rates at least as favorable as
those of other potential resellers of Ameritech and NYNEX local services. In
addition, the Company has executed interim resale agreements with Ameritech
for the State of Wisconsin and with NYNEX for the State of Massachusetts. The
Company is currently in negotiations to expand its resale agreements
throughout the 14-state combined Bell Atlantic/NYNEX region and the 5-state
Ameritech region. The Company estimates, based on data compiled by the
Federal Communications Commission ("FCC"), that the regions covered by the
current comprehensive Ameritech and NYNEX resale agreements include access to
over 10 million business access lines. Management believes that if
negotiations are completed for total service resale agreements in the
combined Bell Atlantic/NYNEX region and the Ameritech region, the Company
will have access to approximately 20 million business access lines. The
Company continuously evaluates opportunities to enter into agreements with
additional IXCs and enhanced and other value-added service providers in order
to aggressively build its customer base as well as to provide additional
services to its existing customers while reducing costs.
. Proprietary Electronic Provisioning and Interface Systems. By serving as the
systems beta customer for Ameritech, NYNEX and Bell Atlantic, the Company was
among the first CLECs to develop electronic provisioning systems for resale
of RBOC services. Development of these provisioning systems is critical for
carriers seeking to grow rapidly in the complex, competitive local
telecommunications market. These systems must address the numerous technical
configurations associated with local service, including correctly coding
customers into data bases for 911, 411, white pages and customer service, as
well as provisioning thousands of local services, known as universal service
ordering codes ("USOCs"). Electronic provisioning between the Company and its
RBOC vendors allows the Company to provision a significantly greater volume
of lines than would be possible if transmitting orders by mail or facsimile.
Moreover, because the proprietary systems developed by the Company lessen
manual input and reduce repetitive data entry, the Company experiences
improved efficiency and accuracy in transmitted orders, thereby reducing
costs and increasing customer satisfaction. The Company believes it has
established an industry leadership position in the deployment of these
systems, and it is committed to the continuous improvement of its systems.
. Largest Direct Salesforce Among CLECs in Its Markets. The Company's services
are currently sold through an approximately 325 member direct salesforce,
located in 27 offices in Illinois, Ohio, Michigan, New York and
Massachusetts. Additionally, the Company intends to hire approximately 175
new salespeople over the next 18 months to implement service in the Ameritech
and combined Bell Atlantic/NYNEX regions. The Company primarily recruits
salespeople with experience in selling competitive telecommunications
services to businesses in the markets where they are based. The Company's
salesforce is trained in-house with a rigorous customer-focused training
program that promotes activity-based selling. Salespeople are given an
incentive through a commission structure, with a target of 50% of a
salesperson's compensation based on performance. The Company believes its
large, experienced, face-to-face salesforce has been, and will continue to
be, vitally important in today's highly competitive telecommunications
industry environment.
5
<PAGE>
GROWTH STRATEGY
The Company's objective is to be a leading provider of integrated local and
long distance services and other telecommunications products to small and
medium-sized businesses. The Company expects to achieve this goal through the
successful implementation of its growth strategy which includes the following:
. Provide an Integrated Telecommunications Solution. A key element in building
its customer base while minimizing churn has been, and will continue to be,
the implementation of a marketing and operating strategy which emphasizes an
integrated telecommunications solution to its target market. To a large
extent, the Company's target customers have not previously been provided the
opportunity to purchase bundled services. The Company attracts and retains
customers by combining responsive customer care with a pricing package to
provide high-quality service at a cost which is usually afforded to only
large business customers. Specifically, the Company provides a single source
and bill for integrated local and long distance telephony, voicemail, paging,
teleconferencing, Internet access and other enhanced and value-added
telecommunications services, with a single point of contact for customer
service, product inquiries, repairs and billing questions. Based on its
experience, the Company believes that this marketing and customer service
approach has minimized customer acquisition costs and churn.
. Focus on Large, Underserved Market. The Company utilizes a direct sales
approach and primarily focuses its marketing efforts on small and medium-
sized businesses with telecommunications usage of less than $5,000 per month.
The Company believes this target market is best served by a direct sales
approach because most of these customers do not employ in-house
telecommunications specialists and in most cases obtain services from various
vendors. The Company's experience indicates that these customers prefer a
single source for all their telecommunications requirements, including
products, billing and service. The Company believes that the gross margins on
services provided to its target market are generally higher than for larger
business customers. Since the RBOCs and the first-tier IXCs primarily
concentrate their sales and marketing efforts on residential and large
business customers, the Company will continue to focus its marketing on this
underserved market to rapidly expand its customer base.
. Leverage Ubiquitous Networks. The Company believes that a key factor in its
success has been its ability to provide through the RBOC networks the
complete range of local services currently provided by RBOCs across their
entire service territories. There is currently no competing network with the
product breadth, capacity and geographic reach of the RBOC networks. By
contrast, facilities-based CLECs are currently limited primarily to servicing
customers in areas where they have network facilities. In addition, in light
of the significant investments by NYNEX and Ameritech to continuously upgrade
their networks, the Company believes these networks are substantially more
comprehensive than those being built by facilities-based CLECs.
. Rapid Market Entry. The Company believes its ability to enter a market early
and provide ubiquitous service will continue to allow it to rapidly build a
customer base across a large geographic area prior to the lifting of
regulatory restrictions on the ability of first-tier IXCs and RBOCs to offer
integrated services. As a non-facilities based provider, the Company believes
it is able to build a customer base quickly and efficiently without incurring
significant costs and the developmental delays inherent in constructing
network and transmission facilities. In addition, the Company's proprietary
software interface systems facilitate its rapid customer acquisition strategy
by allowing it to provision high volumes of access lines.
. Negotiate Additional Agreements with RBOCs. The Company seeks to enter into
additional local exchange resale agreements with RBOCs which position it to
offer a full range of local service over a broad geographic area at a
competitive cost to its targeted businesses. The Ameritech resale agreements
provide pricing protections designed to maintain the competitiveness of rates
and position the Company to purchase capacity at rates at least as favorable
as those of other potential resellers of Ameritech local services. The NYNEX
resale agreement contains similar pricing protections. The Company intends to
negotiate similar pricing protections in all future RBOC resale agreements.
The Company believes, based on its experience and industry analysts' reports,
that the RBOCs have an incentive to continue to negotiate wholesale
agreements with respect to small and medium-sized businesses to stabilize
this revenue base and deter migration of the current RBOCs'
6
<PAGE>
customers to facilities-based CLECs and other new entrant local exchange
carriers ("LECs"). The Company further believes, based on its experience with
Ameritech and NYNEX, that it is well positioned to negotiate these types of
agreements in other regions.
The Company, a Delaware corporation (formerly United USN, Inc.), was formed
and commenced operations in April 1994. The Company's principal executive
office is located at 10 S. Riverside Plaza, Suite 401, Chicago, Illinois 60606,
and its telephone number is (312) 906-3600.
RECENT DEVELOPMENTS
On August 18, 1997, the Company consummated a private placement (the
"Offering") under Rule 144A of the Securities Act, pursuant to which the
Company issued and sold 1,527,250 units (the "Units") consisting of $152.7
million aggregate principal amount at maturity of Old Notes and warrants to
purchase 2,053,900 shares of Class A Common Stock (the "Initial Warrants"). The
aggregate purchase price of the Units was $100 million. The Old Notes were
issued pursuant to the terms of an Indenture (the "Indenture"), dated as of
August 15, 1997, by and between the Company and Harris Trust and Savings Bank,
as trustee. The Indenture provides that (i) in the event that, on or prior to
September 30, 1998, the Company does not consummate one or more Public Equity
Offerings (as defined), or otherwise issue in one or more transactions
additional equity securities of the Company, resulting in aggregate net
proceeds to the Company of $50 million, based on an equity valuation of the
Company of at least $160 million, the Company will be obligated to issue to the
holders of the Notes warrants (the "Contingent Warrants," and, together with
the Initial Warrants, the "Warrants") exercisable for Class A Common Stock
representing 5% of the Common Stock of the Company on a fully-diluted basis
after giving effect to such issuance. In connection with the Offering, the
Company also issued and sold to certain of its existing stockholders
approximately $30.2 million of the Company's 9.0% Cumulative Convertible Pay-
In-Kind Preferred Stock, Series A (the "Series A Preferred Stock").
In connection with the Offering, Merrill Lynch Global Allocation Fund, Inc.
("MLGAFI") and Merrill Lynch Equity/Convertible Series (Global Allocation
Portfolio) (collectively, "MLAM"), the current holders of all of the Company's
14% Senior Discount Notes due 2003 (the "14% Senior Notes") and 9% Convertible
Subordinated Discount Notes due 2004 (the "Convertible Notes") issued by the
Company in the 1996 Private Placement (as defined), consented (the "Consent")
to the amendment of the 14% Senior Note Indenture and the Convertible Note
Indenture (each as defined) to allow the Company to, among other things, issue
the Notes on a pari passu basis with the 14% Senior Notes and senior in right
of payment to the Convertible Notes. In connection with the Consent, the
Company paid a consent fee to MLAM consisting of warrants to purchase 145,160
shares of Class A Common Stock at an exercise price of $.01 per share (the
"Consent Warrants"). The Company also granted to MLAM an option, expiring
November 17, 1997, to purchase up to $10 million of a newly created series of
convertible notes of the Company on terms substantially similar to the
Convertible Notes (the "Consent Convertible Notes"). Additionally, the Company
granted to holders of the 14% Senior Notes an option (the "Consent Exchange
Option") to exchange in whole, but not in part, all of the 14% Senior Notes for
New Notes with an accreted value equal to the accreted value of such 14% Senior
Notes at the time of such exchange (the "Additional Notes"). This option is
exercisable for 180 days following the Exchange Offer.
7
<PAGE>
THE EXCHANGE OFFER
The Exchange Offer........ New Notes are being offered in exchange for a like
face amount of Old Notes. As of the date hereof,
$152,725,000 aggregate principal amount at maturity
of Old Notes is outstanding. The Company will issue
the New Notes to Holders promptly following the
Expiration Date. See "Risk Factors--Consequences of
Failure to Exchange." Holders of the Old Notes do
not have appraisal or dissenter's rights in
connection with the Exchange Offer under the
Delaware General Corporation Law, the governing law
of the state of incorporation of the Company.
Minimum Condition......... The Exchange Offer is not conditioned upon any
minimum aggregate principal amount of Old Notes
being tendered or accepted for exchange.
Expiration Date........... 5:00 p.m., New York City time, on , 1998,
unless the Exchange Offer is extended, in which
case the term "Expiration Date" means the latest
date and time to which the Exchange Offer is
extended.
Registration Rights The Old Notes were sold by the Company on August
Agreement................ 18, 1997 to Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") and Donaldson,
Lufkin & Jenrette Securities Corporation (together,
the "Initial Purchasers"), who placed the Old Notes
with institutional investors. In connection
therewith, the Company executed and delivered for
the benefit of the holders of the Old Notes a
registration rights agreement (the "Registration
Rights Agreement") providing, among other things,
for the Exchange Offer.
Conditions to the The Exchange Offer is subject to certain customary
Exchange Offer........... conditions, which may be waived by the Company. See
"The Exchange Offer--Conditions." The Company
reserves the right to terminate or amend the
Exchange Offer at any time prior to the Expiration
Date upon the occurrence of any such condition. NO
VOTE OF THE COMPANY'S SECURITY HOLDERS IS REQUIRED
TO EFFECT THE EXCHANGE OFFER AND NO SUCH VOTE (OR
PROXY THEREFOR) IS BEING SOUGHT HEREBY.
Procedures for Tendering
OldNotes.................
Each Holder of Old Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein
and therein, and mail or otherwise deliver such
Letter of Transmittal, or such facsimile, together
with the Old Notes and any other required
documentation to the exchange agent (the "Exchange
Agent") at the address set forth
herein. By executing the Letter of Transmittal,
each Holder will represent to the Company, among
other things, that (i) the New Notes acquired
pursuant to the Exchange Offer by the Holder and
any beneficial owners of Old Notes are being
obtained in the ordinary course of business of the
person receiving such New Notes, (ii) neither the
Holder nor such beneficial owner is participating
in, intends to participate in or has an arrangement
or understanding with any person
8
<PAGE>
to participate in the distribution of such New
Notes and (iii) neither the Holder nor such
beneficial owner is an "affiliate," as defined
under Rule 405 of the Securities Act, of the
Company. Each broker-dealer that receives New Notes
for its own account in exchange for Old Notes,
where such Old Notes were acquired by such broker
or dealer as a result of market-making activities
or other trading activities (other than
Old Notes acquired directly from the Company), may
participate in the Exchange Offer but may be deemed
an "underwriter" under the Securities Act and,
therefore, must acknowledge in the Letter of
Transmittal that it will deliver a prospectus in
connection with any resale of such New Notes. The
Letter of Transmittal states that by so
acknowledging and by delivering a prospectus, a
broker or dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the
Securities Act. See "The Exchange Offer--Procedures
for Tendering" and "Plan of Distribution."
Special Procedures for
Beneficial Owners........
Any beneficial owner whose Old Notes are registered
in the name of a broker, dealer, commercial bank,
trust company or other nominee and who wishes to
tender should contact such registered Holder
promptly and instruct such registered Holder to
tender on such beneficial owner's behalf. If such
beneficial owner wishes to tender on such owner's
own behalf, such owner must, prior to completing
and executing the Letter of Transmittal and
delivering his Old Notes, either make appropriate
arrangements to register ownership of the Old Notes
in such owner's name or obtain a properly completed
bond power from the registered Holder. The transfer
of registered ownership may take considerable time.
See "The Exchange Offer--Procedures for Tendering."
Guaranteed Delivery Holders of Old Notes who wish to tender their Old
Procedures............... Notes and whose Old Notes are not immediately
available or who cannot deliver their Old Notes,
the Letter of Transmittal or any other documents
required by the Letter of Transmittal to the
Exchange Agent prior to the Expiration Date must
tender their Old Notes according to the guaranteed
delivery procedures set forth in "The Exchange
Offer--Guaranteed Delivery Procedures."
Withdrawal Rights......... Tenders may be withdrawn at any time prior to 5:00
p.m., New York City time, on the Expiration Date.
See "The Exchange Offer--Withdrawal of Tenders."
Acceptance of Old Notes
and Delivery of New
Notes.................... The Company will accept for exchange any and all
Old Notes which are properly tendered in the
Exchange Offer prior to 5:00 p.m., New York City
time, on the Expiration Date. The New Notes issued
pursuant to the Exchange Offer will be delivered
promptly following the Expiration Date. See "The
Exchange Offer--Terms of the Exchange Offer."
Federal Income Tax The exchange of Old Notes for New Notes by
Consequences............. tendering holders should not be a taxable exchange
for federal income tax purposes, and such holders
should not recognize any taxable gain or loss or
any interest income for federal income tax purposes
as a result of such exchange (assuming no Special
Interest becomes due).
9
<PAGE>
Use of Proceeds........... There will be no proceeds to the Company from the
exchange pursuant to the Exchange Offer.
Effect on Holders of Old As a result of the making of this Exchange Offer,
Notes.................... and upon acceptance for exchange of all validly
tendered Old Notes pursuant to the terms of this
Exchange Offer, the Company will have fulfilled a
covenant contained in the terms of the Old Notes
and the Registration Rights Agreement and,
accordingly, the holders of the Old Notes will have
no further registration or other rights under the
Registration Rights Agreement, except under certain
limited circumstances. Holders of the Old Notes who
do not tender their Old Notes in the Exchange Offer
will continue to hold such Old Notes and will be
entitled to all the rights and limitations
applicable thereto under the Indenture. All
untendered, and tendered but unaccepted, Old Notes
will continue to be subject to the restrictions on
transfer provided for in the Old Notes and the
Indenture. To the extent that Old Notes are
tendered and accepted in the Exchange Offer, the
trading market, if any, for the Old Notes not so
tendered could be adversely affected. See "Risk
Factors--Consequences of Failure to Exchange Old
Notes."
Exchange Agent............ Harris Trust Company of New York is serving as
Exchange Agent in connection with the Exchange
Offer. See "The Exchange Offer--Exchange Agent."
10
<PAGE>
SUMMARY DESCRIPTION OF THE NEW NOTES
The Exchange Offer applies to $152,725,000 aggregate principal amount at
maturity of Old Notes. The terms of the New Notes are identical in all material
respects to the Old Notes, except that the New Notes have been registered under
the Securities Act and, therefore, will not bear legends restricting their
transfer and will not contain certain terms providing for an increase in the
interest rate on the Old Notes under certain circumstances relating to the
timing of the Exchange Offer, which rights will terminate when the Exchange
Offer is consummated. The New Notes will evidence the same debt as the Old
Notes and will be entitled to the benefits of the Indenture, under which both
the Old Notes were, and the New Notes will be, issued. See "Description of the
Notes."
The New Notes............. $152,725,000 aggregate principal amount at
Stated Maturity of 14 5/8% Series B Senior
Discount Notes due 2004.
Maturity.................. August 15, 2004.
Interest Payment Dates.... February 15 and August 15, commencing February
15, 2001.
Yield..................... 14 5/8% per annum (computed on a semi-annual
bond equivalent basis) and calculated from
August 18, 1997.
Interest.................. The New Notes will accrete interest at a rate
of 14 5/8% compounded semiannually, to an
aggregate principal amount of $152,725,000 by
August 15, 2000. Thereafter, the New Notes will
bear interest at the rate of 14 5/8% per annum
which will be payable in cash semiannually on
February 15 and August 15 of each year
commencing February 15, 2001. See "Description
of the Notes--Principal, Maturity and
Interest."
Original Issue Discount... For federal income tax purposes, the New Notes
will be treated as having been issued with
"original issue discount" generally equal to
the difference between the issue price of the
New Notes and the sum of all payments (whether
designated as principal or interest) to be made
thereon. Each holder of a New Note must include
in gross income for federal income tax purposes
a portion of such original issue discount for
each day during each taxable year in which a
New Note is held. See "Certain Federal Income
Tax Considerations."
Ranking................... The New Notes will be senior unsecured
obligations of the Company and will rank pari
passu in right of payment with all existing and
future senior unsecured and unsubordinated
indebtedness of the Company, including the 14%
Senior Notes, and senior in right of payment to
all existing and future subordinated
indebtedness of the Company, including the
Convertible Notes and, if issued, the Consent
Convertible Notes. The New Notes will be
effectively subordinated to all secured
indebtedness of the Company to the extent of
the value of the assets securing such
indebtedness and to indebtedness of
subsidiaries of the Company. As of August 31,
1997, there was approximately $0.7 million of
secured long-term indebtedness outstanding to
which holders of Old Notes were effectively
subordinated in right of payment and
approximately $21.1 million of subsidiary
indebtedness to which holders of Old Notes were
structurally subordinated. See "Description of
the Notes--General."
11
<PAGE>
Sinking Fund.............. None.
Optional Redemption....... The New Notes will be redeemable at the option
of the Company, in whole or in part, at any
time on or after August 15, 2002, at the
redemption prices set forth herein, plus
accrued and unpaid interest, if any, to the
date of redemption. In addition, in the event
that after the Issue Date and prior to August
15, 2000, the Company consummates one or more
Public Equity Offerings, the Company may redeem
up to 35% of the aggregate principal amount at
Stated Maturity of Notes with the net proceeds
thereof at a price of 114.63% of the Accreted
Value thereof, together with accrued and unpaid
interest, if any, to the date of redemption;
provided, that immediately after giving effect
to such redemption, not less than 65% of the
aggregate principal amount at Stated Maturity
of the Notes originally issued remains
outstanding. See "Description of the Notes--
Optional Redemption."
Change of Control......... Following the occurrence of a Change of
Control, the Company will be required to make
an offer to purchase the New Notes at a
purchase price equal to 101% of the Accreted
Value thereof, or in the case of any such
repurchase after August 15, 2000, 101% of the
principal amount at maturity thereof plus
accrued and unpaid interest, if any, to the
date of purchase. The Company may not have
available sufficient funds or the financial
resources necessary to satisfy its obligations
to repurchase the New Notes and other debt that
may become repayable upon a Change of Control,
including the 14% Senior Notes, the Convertible
Notes and, if issued, the Consent Convertible
Notes. See "Description of the Notes--
Repurchase at the Option of Holders upon a
Change of Control."
Certain Covenants......... The Indenture contains certain covenants,
including, among others, covenants with respect
to the following matters: (i) limitation on
asset sales and the disposition of proceeds
thereof; (ii) limitation on indebtedness; (iii)
limitation on issuances of guarantees by
restricted subsidiaries; (iv) limitation on
liens; (v) limitation on sale and leaseback
transactions; (vi) limitation on dividends or
distributions in respect of the Company's
capital stock or making of certain other
restricted payments, including investments;
(vii) limitations on dividends and other
payment restrictions affecting subsidiaries;
(viii) limitation on issuance and sale of
capital stock of restricted subsidiaries; (ix)
limitation on transactions with affiliates; (x)
limitation on designations of unrestricted
subsidiaries; (xi) limitation on engaging in
unrelated lines of business; and (xii)
limitation on consolidation, merger,
conveyance, lease or transfer. These covenants
are subject to important exceptions and
qualifications. See "Description of the Notes--
Certain Covenants."
For additional information concerning the New Notes, see "Description of the
Notes."
RISK FACTORS
Holders of the Old Notes should consider carefully the information set forth
in this Prospectus, and in particular, should evaluate the factors set forth
under "Risk Factors" beginning on page 14.
12
<PAGE>
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS)
The following summary historical consolidated financial data for the periods
from inception of the Company in April 1994 to December 31, 1994 and for the
fiscal years ended December 31, 1995 and December 31, 1996 was derived from,
and should be read in conjunction with, the consolidated audited financial
statements of the Company and the related notes thereto included elsewhere in
this Prospectus. The selected financial data as of and for the six-month
periods ended June 30, 1996 and 1997, respectively, are derived from, and
should be read in conjunction with, the unaudited financial statements of the
Company and the related notes thereto included elsewhere in this Prospectus. In
the opinion of management, such interim financial statements reflect all
adjustments (consisting solely of normal recurring adjustments) necessary to
fairly present the information presented for such periods. Results of
operations for the six months ended June 30, 1997 are not necessarily
indicative of results of operations for a full year or indicative of future
periods.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
INCEPTION TO ------------------ ------------------
DECEMBER 31, UNAUDITED
1994 1995 1996 1996 1997
------------ -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net service revenue..... $ 1,737 $ 7,884 $ 9,814 $ 4,804 $ 11,721
Cost of services........ 1,455 9,076 9,256 4,078 10,520
-------- -------- -------- -------- --------
Gross margin............ 282 (1,192) 558 726 1,201
Sales and marketing
expense................ 2,869 5,867 12,612 3,546 27,335
General and
administrative expense. 4,686 11,100 20,665 6,336 15,013
Interest expense........ 26 734 1,797 20 4,129
Interest and other
income (1)............. 152 646 9,469 8,449 1,013
Minority interest....... -- 150 -- -- --
-------- -------- -------- -------- --------
Net loss................ $ (7,147) $(18,097) $(25,047) $ (727) $(44,263)
======== ======== ======== ======== ========
Accumulated unpaid
preferred dividends.... $ 707 $ 3,810 $ 225 $ 6,145 $ 235
Net loss to common
shareholder............ $ (7,854) $(21,907) $(25,272) $ (6,872) $(44,498)
Net loss per common
share.................. $ (65.63) $ (72.42) $ (49.53) $ (16.12) $ (61.70)
Weighted average shares
outstanding............ 119,678 302,520 510,233 426,378 721,251
OTHER DATA:
EBITDA (2).............. $ (7,087) $(15,901) $(30,390) $ (8,996) $(40,105)
Cash flows from
operating activities... (6,141) (14,308) (24,098) (9,178) (37,505)
Cash flows from
investing activities... (1,708) (2,556) 7,274 9,188 (7,171)
Cash flows from
financing activities... 13,828 24,589 63,689 (549) (422)
Depreciation and
amortization........... 186 2,258 2,329 160 1,042
Capital expenditures.... 1,728 1,740 2,259 345 7,171
Ratio of earnings to
fixed charges (3)...... -- -- -- -- --
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------------- ------------------
UNAUDITED
1994 1995 1996 1996 1997
------------ -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents............ $ 5,979 $ 13,705 $ 60,569 $ 13,227 $ 15,720
Total assets............ 12,747 20,471 78,052 19,898 44,146
Long-term debt (net of
current maturities).... 3,176 518 59,864 350 63,466
Redeemable preferred
stock.................. 15,306 44,396 10,045 46,532 10,505
Common stockholders'
deficit................ (7,830) (28,768) (3,606) (31,596) (48,026)
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF AS OF AS OF AS OF AS OF
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1996 1996 1996 1997 1997
OPERATING DATA: --------- -------- ------------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C>
Local access line
sold................. 4,178 3,995 4,630 10,283 35,397 79,321
Local access lines in
service.............. 4,178 3,995 4,356 8,364 18,557 65,142
Total employees....... 188 180 225 464 641 766
Direct salesforce..... 63 50 81 206 252 325
</TABLE>
- -------
(1) Interest and other income for the year ended December 31, 1996 and the six
months ended June 30, 1996 includes a gain of $8.1 million realized on the
sale of the Company's switching facilities in Ohio.
(2) EBITDA consists of operating income (loss) before depreciation and
amortization. While EBITDA should not be construed as a substitute for
operating income or a better indicator of liquidity than cash flow from
operating activities, which are determined in accordance with generally
accepted accounting principles, EBITDA is 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 $7.1 million, $17.4 million and $23.3
million, respectively, and for the six-month period ended June 30, 1996 and
1997 by $0.7 million and $40.1 million, respectively.
13
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, before tendering
their Old Notes for the New Notes offered hereby, holders of Old Notes should
consider carefully the following factors, which may be generally applicable to
the Old Notes as well as to the New Notes.
CONSEQUENCES OF FAILURE TO EXCHANGE
Holders of Old Notes who do not exchange their Old Notes for New Notes
pursuant to the Exchange Offer will continue to be subject to the restrictions
on transfer of such Old Notes, as set forth in the legend thereon, as a
consequence of the issuance of the Old Notes pursuant to exemptions from, or
in transactions not subject to, the registration requirements of the
Securities Act and applicable state securities laws. The Company does not
currently anticipate that it will register the Old Notes under the Securities
Act. Based on interpretations by the staff of the Commission set forth in no-
action letters issued to third parties, including Exxon Capital Holdings
Corporation, SEC No-Action Letter (available April 13, 1988) (the "Exxon
Capital Letter"), Morgan Stanley & Co. Incorporated, SEC No-Action Letter
(available June 5, 1991) (the "Morgan Stanley Letter"), and similar letters,
the Company believes that the New Notes issued pursuant to the Exchange Offer
may be offered for resale, resold or otherwise transferred by any Holder
thereof (other than any such Holder which is an "affiliate" of the Company
within the meaning of Rule 405 under the Securities Act) without compliance
with the registration and prospectus delivery provisions of the Securities Act
provided that such New Notes are acquired in the ordinary course of such
Holder's business and such Holder has no arrangement with any person to
participate in the distribution of such New Notes. Notwithstanding the
foregoing, each broker-dealer that receives New Notes for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such New Notes. The Letter of
Transmittal states that by so acknowledging and by delivering a prospectus, a
broker-dealer will not be deemed to admit that it is an "underwriter" within
the meaning of the Securities Act. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with any resale of New Notes received in exchange for Old Notes where such Old
Notes were acquired by such broker-dealer as a result of market-making
activities or other trading activities (other than Old Notes acquired directly
from the Company). The Company has agreed that, for a period of 180 days from
the Expiration Date, it will make this Prospectus available to any broker-
dealer for use in connection with any such resale. See "Plan of Distribution."
Any holder who tenders in the Exchange Offer for the purpose of participating
in a distribution of the New Notes cannot rely on the Morgan Stanley Letter or
similar letters and must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a secondary resale
transaction. To the extent that Old Notes are tendered and accepted in the
Exchange Offer, the trading market, if any, for the Old Notes not so tendered
could be adversely affected. See "The Exchange Offer."
FAILURE TO COMPLY WITH EXCHANGE OFFER PROCEDURES
Issuance of the New Notes in exchange for the Old Notes pursuant to the
Exchange Offer will be made only after timely receipt by the Exchange Agent of
such Old Notes, a properly completed and duly executed Letter of Transmittal
and all other required documents. Therefore, holders of the Old Notes desiring
to tender such Old Notes in exchange for New Notes should allow sufficient
time to ensure timely delivery. The Company is under no duty to give
notification of defects or irregularities with respect to tenders of Old Notes
for exchange. Holders of Old Notes who do not exchange their Old Notes for New
Notes pursuant to the Exchange Offer will continue to be subject to the
restrictions on transfer of such Old Notes as set forth in the legend thereon.
See "The Exchange Offer."
NEGATIVE CASH FLOW AND OPERATING LOSSES; LIMITED OPERATING HISTORY
The Company has experienced operating losses from its inception in April
1994 through the date of this Prospectus, excluding the effect of a one-time
non-recurring gain, and has, to date, not generated positive cash
14
<PAGE>
flow. For the period from April 1994 to December 31, 1994 and the fiscal year
ended December 31, 1995, the Company's operating losses were $7.3 million and
$18.2 million, respectively. These operating losses were primarily the result
of the one-time installation costs and fixed ongoing costs related to
switching facilities of the Company which were sold in February 1996, and the
sales and marketing and general and administrative expenses required to build
the Company's sales, customer, management information and marketing
infrastructure. Excluding an $8.1 million non-recurring gain on the sale of
such switching facilities, the Company would have lost $33.1 million for the
year ended December 31, 1996. The Company lost $8.8 million (excluding the
$8.1 million non-recurring gain) and $44.3 million for the first six months of
1996 and 1997, respectively. The Company expects to realize additional
operating losses on a consolidated basis while it continues to expand and
develop its service offerings and its customer base. There can be no assurance
that the Company will be able to develop or expand its customer base or that
it will achieve profitability in future years.
The Company has a limited operating history. Prospective investors,
therefore, have limited historical financial information about the Company
upon which to base an evaluation of its performance and an investment in the
New Notes offered hereby. Given the Company's limited operating history, there
can be no assurance that the Company will be able to achieve or sustain
positive cash flow from operating activities or to implement its growth
strategy.
SUBSTANTIAL LEVERAGE
The Company has and will continue to have consolidated indebtedness that is
substantial in relation to its stockholders' deficit. As of August 31, 1997,
the Company had $164.9 million principal amount of long-term debt and a total
common stockholders' deficit of $45.1 million. See "Capitalization."
The Company's ability to make cash payments with respect to the Notes, to
repay its obligations on the Notes at maturity and to satisfy its other debt
obligations will depend on its future operating performance, which will be
affected by prevailing economic conditions and financial, business and other
factors, certain of which are beyond the Company's control. Because the
Company currently has a consolidated cash flow deficit, there can be no
assurance that the Company will be able to make cash interest payments on the
Notes commencing February 15, 2001, or to repay its obligations on the Notes.
In addition, cash interest will commence accruing on the 14% Senior Notes on
March 30, 2000 and on the Convertible Notes on September 30, 1999. See "--
Future Cash Obligations." The Indenture permits the Company and its
subsidiaries to incur additional indebtedness under certain circumstances
including up to $45 million under a Credit Facility (as defined), $30 million
of which may be secured. If the Company is unable to service its indebtedness,
it will be forced to examine alternative strategies that may include actions
such as reducing or delaying capital expenditures, restructuring or
refinancing its indebtedness, the sale of assets or of the Company's ownership
interest in its subsidiaries or seeking additional equity and/or debt
financing. There can be no assurance that any of these strategies could be
effected on satisfactory terms, if at all.
The degree to which the Company is leveraged could have important
consequences to the holders of the Notes, including the following: (i) the
Company will have significant and increasing cash interest expense and
significant principal repayment obligations with respect to outstanding
indebtedness, including the Notes, the 14% Senior Notes, the Convertible Notes
and, if issued, the Consent Convertible Notes; (ii) the Company's degree of
leverage and related debt service obligations may make it more vulnerable than
some of its competitors to the effects of an economic downturn or other
adverse developments; and (iii) the Company's ability to obtain additional
financing could be impaired. In addition, pursuant to the terms of the
Indenture, the ability of the Company to sell assets is restricted. See
"Description of the Notes."
FUTURE CASH OBLIGATIONS
Since inception, the Company's consolidated cash flow from operations has
been negative. As a result, the Company has financed fixed charges (including
interest on existing indebtedness) and operating expenses with
15
<PAGE>
the proceeds from private sales of its equity securities, the proceeds from
the September 30, 1996 sale (the "1996 Private Placement") to MLGAFI of the
14% Senior Notes and related warrants to purchase Class A Common Stock and the
Convertible Notes and the proceeds from the Offering. Commencing August 15,
2000, cash interest on the Notes will accrue semiannually at the rate of 14
5/8% per annum (approximately $22.3 million per year). Commencing September
30, 1999, cash interest on the Convertible Notes will accrue semiannually at
the rate of 9% per annum (approximately $3.2 million per year), and commencing
March 30, 2000, cash interest on the 14% Senior Notes will accrue semiannually
at the rate of 14% per annum (approximately $6.8 million per year). The fully
accreted principal amounts of the 14% Senior Notes and the Convertible Notes
of $48.5 million and $36.0 million, respectively, will become due on September
30, 2003 and September 30, 2004, respectively. Pursuant to the Consent,
holders of the 14% Senior Notes may exchange 14% Senior Notes for Additional
Notes, which have a higher interest rate and would therefore increase the
Company's cash obligations commencing March 30, 2000. The Consent Convertible
Notes, if issued, will accrete in value in a manner similar to the Convertible
Notes and will become due on September 30, 2004. Many factors, certain of
which are beyond the Company's control, will affect its performance and,
therefore, its ability to meet its ongoing obligations to repay all such notes
and other debt.
ADDITIONAL CAPITAL REQUIREMENTS
The Company anticipates that it will require substantial additional capital
by the third quarter of 1998 in order to meet planned capital expenditures and
anticipated negative operating cash flow. Sources of funding for the Company's
further financing requirements may include public offerings or private
placements of equity and/or debt securities, bank loans and additional capital
contributions from new or existing stockholders. There can be no assurance
that additional financing will be available to the Company, or, if available,
that it can be obtained on a timely basis and on terms acceptable to the
Company and within the limitations contained in the Indenture and the 14%
Senior Note Indenture. Failure to obtain such financing could result in the
delay or abandonment of the Company's development and expansion plans.
HOLDING COMPANY STRUCTURE; SOURCE OF REPAYMENT OF NOTES; EFFECTIVE
SUBORDINATION OF NOTES TO INDEBTEDNESS OF SUBSIDIARIES
As a holding company that conducts virtually all of its business through
subsidiaries, the Company has no source of operating cash flow other than
dividends and distributions from its subsidiaries. In order to pay cash
interest on the Notes, the 14% Senior Notes, the Convertible Notes and, if
issued, the Consent Convertible Notes when cash interest is payable thereon,
and to repay the principal amount of the Notes, the 14% Senior Notes, the
Convertible Notes and, if issued, the Consent Convertible Notes at their
respective maturities or to redeem or repurchase the Notes, the 14% Senior
Notes, the Convertible Notes or, if issued, the Consent Convertible Notes, the
Company will be required to obtain dividends or distributions from its
subsidiaries, refinance its indebtedness or raise funds in a public or private
equity or debt offering. However, the Indenture and the 14% Senior Note
Indenture limit the Company's ability to incur additional indebtedness.
If the Company is required to conduct an offering of its capital stock or to
refinance the Notes, its ability to do so on acceptable terms, if at all, will
be affected by several factors, including financial market conditions and the
value and performance of the Company at the time of such offering or
refinancing, which in turn may be affected by many factors, including economic
and industry cycles. There can be no assurance that an offering of the
Company's capital stock or a refinancing of the Notes can or will be completed
on satisfactory terms, that such offering or refinancing would be sufficient
to enable the Company to make any payments with respect to the Notes if
required or that such offering or refinancing would be permitted by the terms
of the debt instruments of the Company and its subsidiaries then in effect.
The Old Notes are and the New Notes will be unsecured senior obligations of
the Company and will rank pari passu in right of payment with all existing and
future senior unsecured and unsubordinated indebtedness of
16
<PAGE>
the Company, including the 14% Senior Notes. The Indenture permits the Company
to enter into a Credit Facility under which the Company may incur up to $45
million of Indebtedness (as defined), $30 million of which may be secured. If
such Indebtedness is secured, the Notes will be effectively subordinated to
such Indebtedness to the extent of the value of the assets securing such
Indebtedness. The Company's subsidiaries have no obligation to pay amounts due
on the Notes and have not guaranteed the Notes as of the date hereof; however,
if a subsidiary guarantees any Indebtedness of the Company in the future, such
subsidiary will be obligated to guarantee the Notes. See "Description of the
Notes--Certain Covenants--Limitation on Issuances of Guarantees by Restricted
Subsidiaries." Therefore, the Notes, if not guaranteed in the future, will be
effectively subordinated to all existing liabilities of the Company's
subsidiaries, including trade payables. As of August 31, 1997, total
liabilities of the Company's subsidiaries (after the elimination of loans and
advances by the Company to its subsidiaries) on a combined consolidated basis
were approximately $21.1 million. Any rights of the Company and its creditors,
including the holders of the Notes, to participate in the assets of any of the
Company's subsidiaries upon any liquidation or reorganization of any such
subsidiary will be subject to the prior claims of that subsidiary's creditors,
including trade creditors.
DEPENDENCE ON THIRD-PARTY SUPPLIERS FOR BILLING SERVICES
The accurate and prompt billing of the Company's customers is essential to
the Company's operations and future profitability. Presently, the Company
relies, to a significant extent, on a single third-party supplier to rate,
print and mail its customers' bills and as such, the Company is not in a
position to control the management of or, to a lesser extent, the provisioning
of billing services by such supplier. In addition, such supplier has limited
financial resources and personnel, and the Company's expected growth may
strain such supplier's available resources. The Company is currently exploring
a number of alternatives with respect to its billing services, but there can
be no assurance that any such alternatives will be successfully implemented.
The failure of any third-party supplier to provision all of the billing
services required by the Company or the failure by the Company to implement
other alternatives could have a material adverse effect on the results of
operations of the Company.
DEPENDENCE ON RELATIONSHIPS WITH THIRD-PARTY FACILITIES-BASED PROVIDERS
The Company does not own any part of a local exchange network or a long
distance network. As a result, the Company depends entirely on facilities-
based carriers for the transmission of customer phone calls. For each local
exchange market in which the Company operates, there currently is a single
provider from whom the Company can purchase local exchange services. Under the
Telecommunications Act, the Company is entitled to access to local exchange
services in such markets. Although the Company believes that its relations
with its underlying carriers are good, the termination of any of the Company's
contracts with its carriers or a reduction in the quality or increase in cost
of such carriers' services could have a material adverse effect on the
Company's results of operations. In addition, the accurate and prompt billing
of the Company's customers is dependent upon the timeliness and accuracy of
call detail records provided by the carriers whose service the Company
resells. There can be no assurance that the current carriers will continue to
provide, or that new carriers will provide, accurate information on a timely
basis, the failure of which could have a material adverse effect on the
Company's results of operations. For example, there were a number of
provisioning and billing difficulties related to the local and long distance
services provided to business customers in Manhattan, New York pursuant to the
NYNEX LSO agreement. The problems included failure to provision customers,
lost customer traffic information and receipt by customers of multiple
billings for the same service. Much of the difficulty was due to the nature of
the private local network with dedicated facilities designed for resale
purposes. NYNEX required the services of a third-party billing vendor to help
implement the billing portion of the arrangement. The Company has now
contracted directly with that vendor for billing and systems support in order
to avoid problems associated with such provisioning. However, because other
RBOCs with which the Company may enter into agreements do not have significant
experience handling large volumes of resold local exchange traffic, there can
be no assurance as to the quality of the service that the Company will receive
or that similar problems will not occur.
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In addition, physical damage, power loss and software defects of the RBOCs
may cause interruption in service and/or reduced capacity for the Company's
customers. In the event that the Company's long distance carriers are unable
to handle the growth in customer usage, the Company could transfer such
traffic to a carrier that had sufficient capacity, but there can be no
assurance that additional capacity will be available. If any of the LECs are
unable to handle the provisioning or growth in customer usage, then the
Company would be required to use another local carrier, which could be
difficult in light of the limited development of facilities-based competitive
local exchange networks. In the event the Company otherwise elects to use
other carriers, the charges for such services may exceed those under the
existing contracts, which could have a material adverse effect on the
Company's financial condition and results of operations. See "Business--Vendor
Agreements."
COMPETITION
The Company operates in a highly competitive environment and has no
significant market share in any market in which it operates. The Company
expects that competition will continue to intensify in the future due 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. Additionally, the long distance market
is already significantly more competitive than the local exchange market,
because the incumbent local exchange carriers ("ILECs"), including the RBOCs,
have historically had a monopoly position within the local exchange market.
In the local exchange market, the Company also faces competition or
prospective competition from one or more CLECs, which have significantly
greater financial resources than the Company, and from other competitive
providers, including some non-facilities-based providers like the Company. For
example, AT&T Corp. ("AT&T"), MCI Communications Corporation ("MCI") and
Sprint Corporation ("Sprint"), among other carriers, have each begun to offer
local telecommunications services in major U.S. markets using their own
facilities or by resale of the ILECs' or other providers' services. In fact,
certain competitors, including AT&T, MCI and Sprint, have entered into
interconnection agreements with Ameritech with respect to the States of
Illinois, Michigan and Ohio. These competitors either have begun or in the
near future likely will begin offering local exchange service in those states,
subject to the joint marketing restrictions under the Telecommunications Act
described below. In addition, some of these competitors have entered into
interconnection agreements with NYNEX and either have begun or in the near
future likely will begin offering local exchange service in New York and
Massachusetts, subject to such joint marketing restrictions. In addition to
these long distance service providers, entities that currently offer or are
potentially capable of offering switched services include CLECs, cable
television companies, electric utilities, other long distance carriers,
microwave carriers, wireless telephone system operators and large subscribers
who build private networks. Many facilities-based CLECs 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 ILECs, including RBOCs.
Such additional alternatives may provide the CLECs with greater flexibility
and a lower cost structure than the Company. In addition, some of these CLECs
and other facilities-based providers of local exchange service are acquiring
or being acquired by IXCs that are not subject to joint marketing
restrictions. These combined entities may provide a bundled package of
telecommunications products, including local and long distance telephony that
is in direct competition with the products offered by the Company.
With respect to wireless telephone system operators, the FCC in 1996
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 customers, in whatever capacity such
CMRS providers choose. Previously, cellular providers could provide service to
fixed locations only on an ancillary or incidental basis. This authority to
provide fixed as well as mobile services will enable CMRS providers to offer
wireless local loop service and other services to fixed locations (e.g.,
office and apartment buildings) in direct competition with the Company and
other providers of traditional fixed telephone service. In addition, in August
1996 the FCC promulgated regulations that classify CMRS providers as
telecommunications carriers, thus giving them the same rights to
interconnection and reciprocal compensation under the Telecommunications Act
as other non-
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LEC telecommunications carriers, including the Company. Further competition
from other wireless carriers is likely to develop in the future, since the FCC
recently announced an auction of spectrum to be used for Local Multi-point
Distribution Systems, which will compete with CMRS and other wireless and land
line services.
Under the Telecommunications Act and related federal and state regulatory
initiatives, barriers to local exchange competition are being removed. The
availability of broad-based local resale and the introduction of facilities-
based local competition are required before the RBOCs may provide in-region
interexchange long distance services. Also, the largest long distance carriers
(AT&T, MCI, Sprint and any other carrier with 5% or more of the pre-subscribed
access lines) are prevented under the Telecommunications Act from bundling
local services resold from an RBOC in a particular state with their long
distance services until the earlier of (i) February 8, 1999 or (ii) the date on
which the RBOC whose services are being resold obtains in-region long distance
authority in that state. The RBOCs are currently allowed to offer certain in-
region "incidental" long distance services (such as cellular, audio and visual
programming and certain interactive storage and retrieval functions) and to
offer virtually all out-of-region long distance services.
In August 1997, the FCC denied the application of Ameritech, the RBOC in
three states where the Company operates, for in-region long distance authority
in Michigan. The Company anticipates that Ameritech will file another
application for Michigan in late 1997 and applications for most or all of its
other states--including Illinois and Ohio--in 1998. Other RBOCs, including
NYNEX in New York, are expected to file such applications in 1998. 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 IXCs will be in a
position to offer single-source local and long distance services similar to
those offered by the Company. While new business opportunities will be made
available to the Company through the Telecommunications Act and other federal
and state regulatory initiatives, regulators are likely to provide the ILECs
with an increased degree of flexibility with regard to pricing of their
services as competition increases. Although the Ameritech resale agreements and
the NYNEX resale agreement contain certain pricing protections, including
adjustments in the wholesale rates to be consistent with any changes in the
Ameritech and NYNEX retail rates, if the ILECs elect to lower their rates and
sustain lower rates over time, this may adversely affect the revenues of the
Company and place downward pressure on the rates the Company can charge. While
the Ameritech and NYNEX resale agreements ensure that the Company will receive
any lower rate provided to any other reseller, under the NYNEX resale agreement
if such lower rate is provided to a reseller committing to both a longer term
and a greater volume commitment, the Company receives the lower rate, but must
negotiate with NYNEX a reasonable transition to similar commitments. If the
Company cannot successfully negotiate such a transition with NYNEX, then the
Company may be unable to maintain the lowest rate. The Company believes the
effect of lower rates may be offset by the increased revenues available by
offering new products and services to its target customers, but there can be no
assurance that this will occur. In addition, if future regulatory decisions
afford the LECs excessive pricing flexibility or other regulatory relief, such
decisions could have a material adverse effect on the Company.
Competition for the Company's products and services is based on price,
quality, network reliability, service features and responsiveness to customer
needs. While the Company believes that it currently has certain advantages
relating to the timing, ubiquity and cost savings resulting from its resale
agreements, there is no assurance that the Company will be able to maintain
these advantages. A continuing trend toward business combinations and alliances
in the telecommunications industry may create significant new competitors to
the Company. Many of the Company's existing and potential competitors have
financial, technical and other resources significantly greater than those of
the Company.
ABILITY TO MEET MINIMUM COMMITMENTS; TERMINATION OF AGREEMENTS
Substantially all of the resale agreements between the Company and local
exchange carriers or long distance carriers contain term and volume
commitments. The local exchange resale agreements typically provide a minimum
usage which requires the Company to have a minimum number of lines in place at
the end of the applicable measurement period (typically one year) (each, a
"Minimum Commitment"). The long distance
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resale agreements typically require the Company to meet a minimum dollar
threshold of usage in order to be eligible for discounted rates. The inability
of the Company to meet its Minimum Commitments or thresholds may result in
substantial underutilization charges, and, in the case of the long distance
agreements, a significant increase in the rates charged to the Company. The
majority of the resale agreements also contain carryover provisions which
permit the Company to carryforward volume shortfalls and may serve to delay,
or possibly eliminate, the payment of a significant portion of any shortfall
the Company may experience. While these "carryover pools" may provide the
Company with some additional time to build its customer base, any
underutilization charges or rate increases could have a material adverse
effect on the financial condition and results of operations of the Company.
Each of the resale agreements contains termination provisions which, among
other things, require the Company to pay termination charges if the Company
terminates an agreement prior to the end of term. The incurrence of any
termination charges could have a material adverse effect on the Company's
financial condition and results of operations.
LACK OF EXPERIENCE OFFERING ADDITIONAL PRODUCTS AND SERVICES
The Company's strategy includes offering additional telecommunications
products and services, including cellular phone service. Entry into new
markets entails risks associated with the state of development of the markets,
intense competition from companies already operating in those markets,
potential competition from companies that may have greater financial resources
and experience than the Company and increased selling and marketing expenses.
The Company has not provided any cellular products or services to date. There
can be no assurance that the Company's products or services will receive
market acceptance in a timely manner, if at all, or that prices and demand in
new markets will be at a level sufficient to provide profitable operations.
See "Industry Overview" and "Business--Growth Strategy" and "--Competition."
REGULATION AND RISKS OF THE TELECOMMUNICATIONS ACT
The Company is currently subject to federal and state government regulation
of its telecommunications services. The Company is regulated at the federal
level by the FCC. It is required to obtain and maintain an FCC certificate in
connection with its international services, and to file and maintain both
domestic and international tariffs containing the currently effective rates,
terms and conditions of service for its resale long distance services. The FCC
issued regulations eliminating this tariffing requirement for all interstate
nondominant carriers, except for, under certain circumstances, the RBOCs.
Those regulations have been stayed on appeal by third parties, and the Company
is currently required to file tariffs with the FCC.
The intrastate long distance telecommunications operations of the Company
are also subject to various state laws and regulations. The Company must
obtain and maintain certificates of public convenience and necessity from
regulatory authorities in most states in which it offers service. In most
states, the Company must also file and obtain prior regulatory approval of
tariffs for intrastate services. In addition, the Company must update or amend
the tariffs and, in some cases, the certificates of public convenience and
necessity, when rates are adjusted or new products are added to the local and
long distance services offered by the Company. Challenges by third parties to
the Company's tariffs filed with the FCC or the state regulatory commissions
could cause the Company to incur substantial legal and administrative
expenses.
The Telecommunications Act has already resulted in comprehensive changes in
the regulatory environment for the telecommunications industry as a whole, and
will have a material impact on the local exchange industry and the competitive
environment in which the Company operates. The Company believes that the speed
with which competition in local exchange services develops will depend on a
number of factors, including the extent to which each ILEC actively attempts
to maintain its local exchange market share or to enter new lines of business,
particularly, in the case of RBOCs, the in-region long distance business.
While each ILEC now has the
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duty to negotiate on a good-faith basis access and interconnection agreements
with facilities-based competitors and resale agreements with competitors such
as the Company, the timing and terms of such agreements are at least in part
within the control of the ILEC. An ILEC that places the highest priority on
maintaining its market share in local exchange service may have less incentive
to negotiate such agreements swiftly or on terms favorable to potential
competitors. Indeed, numerous potential competitors, including AT&T, have
requested, under the provisions of the Telecommunications Act, that various
state regulatory authorities arbitrate their negotiations with various RBOCs
and GTE Corporation ("GTE") because they have been unable to reach agreement
with those RBOCs and GTE for access and interconnection to provide competitive
local exchange services. In addition, all negotiated resale and long distance
agreements must be submitted to and approved by the relevant state public
service commission. The speed with which competition in local exchange
services develops will also depend on the effect of the rules and policies
recently adopted by the FCC and individual states in implementing the relevant
provisions of the Telecommunications Act. If competition in local exchange
services develops slowly, the ability of the Company to compete may be
adversely affected.
The concept of resale of local exchange services is a new development in the
telecommunications industry, and the Company cannot predict how the relevant
provisions of the Telecommunications Act will be interpreted and implemented
by the FCC, state regulators, courts and the ILECs. In August 1996, the FCC
issued regulations that, among other things, established pricing methodologies
and interim default rates for resold ILEC services and for unbundled LEC
network elements. In July 1997, the U.S. Court of Appeals for the Eighth
Circuit struck down certain of the rules (including the provisions
establishing pricing methodologies and default rates for resold services and
unbundled network elements). The appeals court concluded that the
Telecommunications Act granted the states the authority to set the rates for
interconnection, unbundled network elements and resold services and that the
FCC therefore lacked jurisdiction to issue the pricing rules or to preempt
state pricing rules. Although many state commissions followed the FCC's
pricing rules prior to the Eighth Circuit decision and are not likely to
repudiate these actions, carriers seeking entry into the competitive local
exchange market have expressed concern about the lack of uniformity in pricing
that may result from the court's rejection of national pricing rules. The
Company cannot predict the impact of the Eighth Circuit's decision on the
Company's operations. The FCC is expected to appeal the Eighth Circuit's
decision to the U.S. Supreme Court. Some of the same parties and certain other
parties also have asked the FCC and the Eighth Circuit to reconsider these and
other regulations implementing the Telecommunications Act. The Company cannot
predict the outcome of the FCC's reconsideration or the court of appeals
proceedings, either of which could have a material adverse impact on the
Company. In addition, no assurance can be given that changes in current
federal or state legislation or regulations would not materially adversely
affect the Company. See "Business--Government Regulation" and "--Competition."
ABILITY TO MANAGE GROWTH; RAPID EXPANSION OF OPERATIONS
The Company's officers have had limited experience in managing companies as
large and as rapidly growing as the Company. The Company's strategy of
continuing its growth and expansion will place additional demands upon the
Company's current management and other resources and will require additional
working capital, information systems and management, operational and other
financial resources. The continued growth of the Company will depend on
various factors, including, among others, federal and state regulation of the
telecommunications industry, competition, and on the ability of LECs,
including the RBOCs, to provision the Company's additional customers. Not all
of the foregoing factors are within the control of the Company. In particular,
there can be no assurance that the RBOCs with which the Company has resale
agreements will be able to provision new customers in a timely manner. The
Company's ability to manage growth successfully will require the Company to
continue to enhance its operational, managerial, financial and information
systems and controls. The Company has modified its billing and customer care
systems to address the resale of local services under the Ameritech and NYNEX
agreements. However, there can be no assurance that such systems will be
adequate to manage the Company's anticipated expansion. No assurance can be
given that the Company will be able to manage its expanding operations and, if
the Company's management is unable to manage growth
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effectively, the Company's business, operating results and financial condition
could be materially adversely affected. Furthermore, there can be no assurance
that the growth experienced by the Company in the past will continue. See
"Business--Growth Strategy."
DEPENDENCE ON KEY PERSONNEL
The Company believes that its continued success will depend to a significant
extent upon the abilities and continued efforts of its senior management,
particularly members of its senior management team. The Company has employment
agreements with many senior management employees but does not maintain key man
life insurance on any of its employees except Mr. J. Thomas Elliott, President
and Chief Executive Officer of the Company. The beneficiaries of such policy
are certain of the Original Purchasers (as defined). Many of the Company's
executive officers and other key employees have only recently joined the
Company. The loss of the services of any of such individuals could have a
material adverse effect on the Company's results of operations. The success of
the Company will also depend, in part, upon the Company's ability to identify,
hire and retain additional key management personnel, including senior
management, who are also being sought by other businesses. Competition for
qualified personnel in the telecommunications industry is intense. The
inability to identify, hire and retain such personnel could have a material
adverse effect on the Company's results of operations. See "Management--
Executive Officers and Directors."
IMPACT OF TECHNOLOGICAL CHANGE
The telecommunications industry has been characterized by rapid
technological change, frequent new service introductions and evolving industry
standards. For example, increases in technological capabilities or
efficiencies could create an incentive for more entities to enter the
facilities-based local exchange business. Similarly, such changes could result
in lower retail rates for telecommunications services, which could have a
material adverse effect on the Company's ability to price its services
competitively. Although the effect of technological change on the future
business of the Company cannot be predicted, it could have a material adverse
effect on the Company's business, results of operations and financial
condition.
ORIGINAL ISSUE DISCOUNT; POSSIBLE TAX AND OTHER LEGAL CONSEQUENCES FOR HOLDERS
OF NOTES AND THE COMPANY
The Old Notes were issued at a substantial discount from their principal
amount at maturity. Since the New Notes are treated as a continuation of the
Old Notes for federal income tax purposes, the New Notes will also be
considered to have been issued at a substantial discount. Cash payments of
interest on the Notes will not be paid prior to 2000. However, original issue
discount (i.e., the difference between the "stated redemption price at
maturity" of the Notes and the "issue price" of the Notes) has accrued from
the issue date of the Old Notes and will continue to accrue with respect to
the New Notes from the Issue Date of the Old Notes. Such original issue
discount will be includable as interest income periodically in a holder's
gross income for federal income tax purposes in advance of receipt of the cash
payments to which the income is attributable. See "Certain Federal Income Tax
Considerations--Taxation of the Notes--Original Issue Discount." Similar
results may apply under state tax laws. Furthermore, the Notes are subject to
the applicable high-yield discount obligation rules. Accordingly, the Company
will not be able to deduct the original issue discount attributable to the
Notes until paid in cash or property or, in certain circumstances, at all. In
addition, to the extent the Notes constitute corporate acquisition
indebtedness under Section 279 of the Internal Revenue Code of 1986, as
amended (the "Code"), the maximum amount of interest or original issue
discount the Company can deduct with respect thereto may be limited. See
"Certain Federal Income Tax Considerations--Taxation of the Notes--Certain
Potential Federal Income Tax Consequences to the Company and to Corporate
Holders." To the extent the rules applicable to high-yield discount
obligations or corporate acquisition indebtedness apply, the Company's after-
tax cash flow may be less than if such original issue discount were deductible
when accrued or the Notes did not constitute corporate acquisition
indebtedness.
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If a bankruptcy case were commenced by or against the Company under the
United States Bankruptcy Code after the issuance of the Notes, the claim of a
holder of the Notes with respect to the principal amount thereof may be
limited to an amount equal to the sum of (i) the initial offering price and
(ii) that portion of the original issue discount that is not deemed to
constitute "unmatured interest" for purposes of the United States Bankruptcy
Code. Any original issue discount that had not amortized as of the date of any
such bankruptcy filing would constitute "unmatured interest."
ABSENCE OF PUBLIC MARKET; EXCHANGE OFFER; VOLATILITY OF NOTE PRICE
The Old Notes are eligible for trading in the Private Offerings, Resale and
Trading through Automated Linkages ("PORTAL") market. The New Notes will be
securities for which there currently is no market. There can be no assurance
as to the liquidity of any markets that may develop for the New Notes, the
ability of the holders of the New Notes to sell their New Notes or the price
at which holders would be able to sell their New Notes. Future trading prices
of the New Notes will depend on many factors, including, among other things,
prevailing interest rates, the Company's operating results and the market for
similar securities. Each of the Initial Purchasers has advised the Company
that it currently intends to make a market in the New Notes. However, the
Initial Purchasers are not obligated to do so and any market making may be
discontinued at any time without notice. Therefore, there can be no assurance
that any active market for the New Notes will develop. The Company does not
intend to apply for listing of the New Notes on any securities exchange or to
seek approval for quotation through any automated quotation system.
Holders of Old Notes will be able to sell or transfer such securities only
if a registration statement relating to such securities is then in effect, or
the sale or transfer of such securities is exempt from qualification under the
applicable securities laws of the states in which the various holders thereof
reside. See "Registration Rights."
CONTROL BY EXISTING STOCKHOLDERS; CERTAIN ANTITAKEOVER MATTERS
As of the date of this Prospectus, over 90% of the outstanding Class A
Common Stock is owned by the management of the Company and Chase Venture
Capital Associates, L.P., CIBC Wood Gundy Ventures, Inc., Harbourvest
Partners, LLC, Northwood Capital Partners LLC, Northwood Ventures, BT Capital
Partners, Inc. and Prime New Ventures (collectively, the "Original
Purchasers"). Five of the Original Purchasers have stock holdings that exceed
five percent ownership of the Class A Common Stock of the Company. Each of
these stockholders has exercised its right to appoint one director to the
Board of Directors of the Company. See "Stock Ownership." Consequently,
management and the Original Purchasers have the ability to control the
election of all the members of the Company's Board of Directors and the
outcome of all corporate actions requiring stockholder approval. In addition,
the Original Purchasers have certain contractual preemptive rights upon
issuance of any shares of capital stock of the Company. Further, MLAM holds
Convertible Notes which were convertible into 2,892,695 shares of Class A
Common Stock as of September 30, 1997 (representing approximately 14% of the
outstanding Common Stock (on a fully diluted basis) as of such date) and will
be convertible into 3,449,598 shares of Class A Common Stock as of September,
30, 1999, assuming no prior conversion of Convertible Notes and subject to
adjustment as described herein (representing approximately % of the
outstanding Common Stock (on a fully diluted basis) as of the date of this
Prospectus). In addition, MLAM holds warrants which are currently exercisable
for 935,940 shares of Class A Common Stock, and, in certain circumstances,
including the Company's failure to consummate an initial public offering by a
specified date, may be issued additional warrants to purchase Class A Common
Stock. In connection with the Consent, MLAM was granted an option to purchase
Consent Convertible Notes which would be convertible into shares of Class A
Common Stock.
Section 203 ("Section 203") of the Delaware General Corporation Law (the
"DGCL") restricts certain business combinations with any "interested
stockholder," as defined by such statute. The Company has expressly decided
not to be governed by Section 203 but may in the future change such election.
In addition, the Company may adopt certain procedural and other requirements
and/or amend its Certificate of Incorporation
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and/or By-laws that could further have the effect of delaying, deterring or
preventing a change in control of the Company and/or make it more difficult
for stockholders to effect certain corporate actions, including the ability to
replace incumbent directors and to accomplish transactions opposed by the
incumbent Board of Directors. See "Description of Capital Stock."
CHANGE OF CONTROL
In the event of a Change of Control, the Company will be required to offer
to repurchase all of the outstanding Notes at 101% of the Accreted Value
thereof, or, in the case of any such repurchase on or after August 15, 2000,
101% of the principal amount at maturity thereof, plus any accrued and unpaid
interest thereon to the date of repurchase. Under the indenture governing the
14% Senior Notes (the "14% Senior Note Indenture") and the Convertible Note
Indenture, the Company has, and, if Consent Convertible Notes are issued,
under the indenture governing the Consent Convertible Notes (the "Consent
Convertible Note Indenture"), the Company will have, a similar requirement to
repurchase the 14% Senior Notes, the Convertible Notes and the Consent
Convertible Notes upon a Change of Control. The exercise by the holders of the
Notes of their rights to require the Company to offer to purchase the Notes
upon a Change of Control could also cause a default under other indebtedness
of the Company, even if the Change of Control itself does not, because of the
financial effect of such repurchase on the Company. The Company's ability to
pay cash to any of the holders of Notes, 14% Senior Notes, Convertible Notes
and, if issued, Consent Convertible Notes upon a repurchase may be limited by
the Company's then existing capital resources. There can be no assurance that
in the event of a Change of Control, the Company will have, or will have
access to, sufficient funds or will be contractually permitted under the terms
of outstanding indebtedness to pay the required purchase price for any Notes.
See "Description of the Notes."
USE OF PROCEEDS
The Exchange Offer is intended to satisfy certain of the Company's
obligations under the Registration Rights Agreement. The Company will not
receive any proceeds from the issuance of the New Notes in the Exchange Offer.
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THE EXCHANGE OFFER
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
The Old Notes were sold by the Company on August 18, 1997 to the Initial
Purchasers, who placed the Old Notes with institutional investors. In
connection therewith, the Company and the Initial Purchasers entered into a
registration rights agreement (the "Registration Rights Agreement"), pursuant
to which the Company agreed, for the benefit of the holders of the Old Notes,
that the Company would, at its sole cost, (i) within 60 days following the
original issuance of the Old Notes, file with the Commission the Exchange
Offer Registration Statement (of which this Prospectus is a part) under the
Securities Act with respect to an issue of a series of new notes of the
Company identical in all material respects to the series of Old Notes and (ii)
use its best efforts to cause such Exchange Offer Registration Statement to
become effective under the Securities Act within 120 days following the
original issuance of the Old Notes. Upon the effectiveness of the Exchange
Offer Registration Statement (of which this Prospectus is a part), the Company
will offer to the holders of the Old Notes the opportunity to exchange their
Old Notes for a like principal amount of New Notes, to be issued without a
restrictive legend and which might be reoffered and resold by the holder
without restrictions or limitations under the Securities Act. The term
"Holder" with respect to the Exchange Offer means any person in whose name Old
Notes are registered on the books of the Company or any other person who has
obtained a properly completed bond power from the registered holder.
Based on interpretations by the staff of the Commission set forth in no-
action letters issued to third parties, including the Exxon Capital Letter,
the Morgan Stanley Letter and similar letters, the Company believes that New
Notes issued pursuant to the Exchange Offer in exchange for Old Notes may be
offered for resale, resold and otherwise transferred by any holder of such New
Notes (other than any such holder which is an "affiliate" of the Company
within the meaning of Rule 405 under the Securities Act) without compliance
with the registration and prospectus delivery provisions of the Securities
Act, provided that such New Notes are acquired in the ordinary course of such
holder's business and such holder has no arrangement or understanding with any
person to participate in the distribution of such New Notes. Any Holder who
tenders in the Exchange Offer for the purpose of participating in a
distribution of the New Notes cannot rely on the Morgan Stanley Letter or
similar letters and must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a secondary resale
transaction.
Each Holder of the Old Notes (other than certain specified holders) who
wishes to exchange Old Notes for New Notes in the Exchange Offer will be
required to represent that (i) it is not an affiliate of the Company, (ii) any
New Notes to be received by it were acquired in the ordinary course of its
business and (iii) at the time of commencement of the Exchange Offer, it has
no arrangement with any person to participate in a distribution (within the
meaning of the Securities Act) of the New Notes. In addition, in connection
with any resales of New Notes, any broker-dealer (an "Exchanging Dealer") who
acquired the Old Notes for its own account as a result of market-making
activities or other trading activities (other than Old Notes acquired directly
from the Company) must deliver a prospectus meeting the requirements of the
Securities Act. Under the Registration Rights Agreement, the Company has
agreed that for a period of 180 days after the Expiration Date it will make
this Prospectus available to Exchanging Dealers and other persons, if any,
subject to similar prospectus delivery requirements in connection with the
resale of such New Notes. See "Plan of Distribution."
In the event that any changes in law or applicable interpretations of the
staff of the Commission do not permit the Company to effect the Exchange
Offer, or if for any reason the Exchange Offer Registration Statement is not
declared effective within 120 days following the date of original issuance of
the Old Notes, or upon the request of Merrill Lynch under certain
circumstances, the Company will, in lieu of or in addition to effecting the
registration of the New Notes pursuant to the Exchange Offer Registration
Statement and at its expense, (i) as promptly as practicable, file with the
Commission a shelf registration statement (the "Shelf Registration Statement")
covering resales of the Notes, (ii) cause the Shelf Registration Statement to
be declared effective under the Securities Act by the 180th day after the
original issuance of the Old Notes (or promptly in the event
25
<PAGE>
of a request by an Initial Purchaser) and (iii) keep effective the Shelf
Registration Statement until two years after its effective date. The Company
will, in the event of the filing of a Shelf Registration Statement, provide to
each holder of Old Notes covered by the Shelf Registration Statement copies of
the prospectus which is a part of the Shelf Registration Statement, notify
each such holder when the Shelf Registration Statement has become effective
and take certain other actions as are required to permit unrestricted resales
of the Old Notes. A holder of Old Notes that sells such Old Notes pursuant to
the Shelf Registration Statement generally will be required to be named as a
selling security holder in the related prospectus and to deliver a prospectus
to the purchaser, will be subject to certain of the civil liability provisions
under the Securities Act in connection with such sales and will be bound by
the provisions of the Registration Rights Agreement which are applicable to
such holder (including certain indemnification obligations). In addition, each
holder of Old Notes will be required to deliver information to be used in
connection with the Shelf Registration Statement in order to have its Old
Notes included in the Shelf Registration Statement and to benefit from the
provisions regarding Special Interest described in the following paragraph.
If either (i) the Exchange Offer Registration Statement or the Shelf
Registration Statement (either, a "Registration Statement") required to be
filed is not filed with the Commission on or prior to the date specified for
such filing in the Registration Rights Agreement, (ii) any such Registration
Statement has not been declared effective by the Commission on or prior to the
date specified for such effectiveness in the Registration Rights Agreement,
(iii) the Exchange Offer has not been consummated on or prior to the date
specified in the Registration Rights Agreement, or (iv) any Registration
Statement required by the Registration Rights Agreement is filed and declared
effective but shall thereafter cease to be effective or fail to be usable for
its intended purpose without being succeeded immediately by a post-effective
amendment to such Registration Statement that cures such failure and that is
itself declared effective for a period of more than 30 consecutive days (each
such event referred to in clauses (i) through (iv), a "Registration Default"),
then commencing on the day following the date on which such Registration
Default occurs, the Company agrees to pay to each holder of Old Notes during
the first 90-day period immediately following the occurrence of such
Registration Default additional interest at a rate of 0.5% per annum ("Special
Interest"). The amount of Special Interest payable to each holder shall
increase by an additional 0.5% per annum for each subsequent 90-day period up
to a maximum rate of 1.5% per annum. A Registration Default shall cease, and
Special Interest shall cease to be payable with respect to such Registration
Default (1) upon the filing of the applicable Registration Statement in the
case of clause (i) above, (2) upon the effectiveness of the Registration
Statement in the case of clause (ii) above, (3) upon the consummation of the
Exchange Offer in the case of clause (iii) above, and (4) when the
Registration Statement becomes effective or usable in the case of clause (iv)
above. Notwithstanding anything to the contrary, (i) the amount of Special
Interest payable shall not increase because more than one Registration Default
has occurred and is pending, (ii) a holder of Old Notes who is not entitled to
the benefits of the Shelf Registration Statement (i.e., such holder has not
elected to include information) shall not be entitled to Special Interest with
respect to a Registration Default that pertains to the Shelf Registration
Statement and (iii) a holder of Old Notes constituting an unsold allotment
from the original sale of the Old Notes or who otherwise is not entitled to
participate in the Exchange Offer shall not be entitled to Special Interest by
reason of a Registration Default that pertains to the Exchange Offer.
All accrued Special Interest shall be paid to record holders in the same
manner in which payments of interest are made pursuant to the Indenture. See
"Description of the Notes--Principal, Maturity and Interest."
Payment of Special Interest is the sole remedy available to holders of Old
Notes in the event the Company does not comply with the deadlines set forth in
the Registration Rights Agreement with respect to the conduct of an exchange
offer for the Old Notes or the registration of the Old Notes for resale under
a shelf registration statement.
26
<PAGE>
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Old
Notes validly tendered and not withdrawn prior to 5:00 p.m., New York City
time, on the Expiration Date. The Company will issue $1,000 principal amount
at maturity of New Notes in exchange for each $1,000 principal amount at
maturity of outstanding Old Notes accepted in the Exchange Offer. Holders may
tender some or all of their Old Notes pursuant to the Exchange Offer. However,
Old Notes may be tendered only in integral multiples of $1,000.
The form and terms of the New Notes will be identical in all material
respects to the form and terms of the Old Notes, except that (i) the New Notes
will have been registered under the Securities Act and hence will not bear
legends restricting the transfer thereof and (ii) the holders of the New Notes
will not be entitled to certain rights under the Registration Rights
Agreement, including the terms providing for an increase in the interest rate
on the Old Notes under certain circumstances relating to the timing of the
Exchange Offer, all of which rights will terminate when the Exchange Offer is
consummated. The New Notes will evidence the same debt as the Old Notes and
will be entitled to the benefits of the Indenture under which the Old Notes
were, and the New Notes will be, issued.
As of the date of this Prospectus, $152,725,000 aggregate principal amount
at maturity of the Old Notes was outstanding. The Company has fixed the close
of business on , 1997 as the record date for the Exchange Offer for
purposes of determining the persons to whom this Prospectus, together with the
Letter of Transmittal, will initially be sent. As of such date, there were
registered Holders of the Old Notes.
Holders of Old Notes do not have any appraisal or dissenters' rights under
the DGCL or the Indenture in connection with the Exchange Offer. The Company
intends to conduct the Exchange Offer in accordance with the applicable
requirements of the Exchange Act and the rules and regulations of the
Commission thereunder.
The Company shall be deemed to have accepted validly tendered Old Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering Holders
for the purpose of receiving the New Notes from the Company.
If any tendered Old Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, certificates for any such unaccepted Old Notes will be returned,
without expense, to the tendering Holder thereof as promptly as practicable
after the Expiration Date.
Holders who tender Old Notes in the Exchange Offer will not be required to
pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Old
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than certain applicable taxes, in connection with the Exchange
Offer. See "--Fees and Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 5:00 p.m., New York City time, on
, 1998, unless the Company, in its sole discretion, extends the
Exchange Offer, in which case the term "Expiration Date" shall mean the latest
date and time to which the Exchange Offer is extended.
In order to extend the Exchange Offer, the Company will notify the Exchange
Agent of any extension by oral or written notice and will make a public
announcement thereof prior to 9:00 a.m., New York City time, on the next
business day after each previously scheduled expiration date.
The Company reserves the right, in its sole discretion, (i) to delay
accepting any Old Notes, to extend the Exchange Offer or, if any of the
conditions set forth below under the caption "Conditions" shall not have been
satisfied, to terminate the Exchange Offer, by giving oral or written notice
of such delay, extension or termination to the Exchange Agent, or (ii) to
amend the terms of the Exchange Offer in any manner. Any such delay in
27
<PAGE>
acceptance, extension, termination or amendment will be followed as promptly
as practicable by a public announcement thereof. If the Exchange Offer is
amended in a manner determined by the Company to constitute a material change,
the Company will promptly disclose such amendment by means of a prospectus
supplement that will be distributed to the registered holders, and the Company
will extend the Exchange Offer for a period of five to ten business days,
depending upon the significance of the amendment and the manner of disclosure
to the registered Holders, if the Exchange Offer would otherwise expire during
such five to ten business day period.
Without limiting the manner in which the Company may choose to make a public
announcement of any delay, extension, termination or amendment of the Exchange
Offer, the Company shall have no obligation to publish, advertise, or
otherwise communicate any such public announcement, other than by making a
timely release to the Dow Jones News Service.
INTEREST ON THE NEW NOTES
The New Notes offered hereby will accrete interest at a rate of 14 5/8% per
annum from the Issue Date until August 15, 2000. Thereafter, the New Notes
will bear interest at the rate of 14 5/8% per annum which will be payable in
cash semiannually on February 15 and August 15 of each year, commencing
February 15, 2001. Interest on the Old Notes accepted for exchange will cease
to accrete upon issuance of the New Notes.
PROCEDURES FOR TENDERING
Only a Holder of Old Notes may tender such Old Notes in the Exchange Offer.
A Holder who wishes to tender Old Notes for exchange pursuant to the Exchange
Offer must transmit a properly completed and duly executed Letter of
Transmittal, or a facsimile thereof, including any other required documents,
to the Exchange Agent prior to 5:00 p.m., New York City time, on the
Expiration Date. In addition, either (i) certificates for such Old Notes must
be received by the Exchange Agent along with the Letter of Transmittal or (ii)
the Holder must comply with the guaranteed delivery procedures described
below. To be tendered effectively, the Old Notes, the Letter of Transmittal
and other required documents must be received by the Exchange Agent at the
address set forth below under "Exchange Agent" prior to 5:00 p.m., New York
City time, on the Expiration Date.
The tender by a Holder will constitute an agreement between such Holder and
the Company in accordance with the terms and subject to the conditions set
forth herein and in the Letter of Transmittal.
The method of delivery of the Old Notes and the Letter of Transmittal and
all other required documents to the Exchange Agent is at the election and risk
of the Holder. Instead of delivery by mail, it is recommended that Holders use
an overnight or hand delivery service. In all cases, sufficient time should be
allowed to assure delivery to the Exchange Agent before the Expiration Date.
No Letter of Transmittal or Old Notes should be sent to the Company. Holders
may request their respective brokers, dealers, commercial banks, trust
companies or nominees to effect the above transactions for such Holders.
Any beneficial owner whose Old Notes are registered in the name of a broker,
dealer, commercial bank, trust company or other nominee and who wishes to
tender should contact the registered Holder promptly and instruct such
registered Holder to tender on such beneficial owner's behalf. If such
beneficial owner wishes to tender on such owner's own behalf, such owner must,
prior to completing and executing the Letter of Transmittal and delivering
such owner's Old Notes, either make appropriate arrangements to register
ownership of the Old Notes in such owner's name or obtain a properly completed
bond power from the registered Holder. The transfer of registered ownership
may take considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by an Eligible Institution (as defined) unless the
Old Notes tendered pursuant thereto are tendered (i) by a registered Holder
who has not completed the box entitled "Special Registration Instructions" or
"Special Delivery Instructions" on the Letter of Transmittal or (ii) for the
account of an Eligible Institution. In the event that signatures on a Letter
of Transmittal or a notice of withdrawal, as the case may be, are required to
be guaranteed,
28
<PAGE>
such guarantee must be by a member firm of a registered national securities
exchange or of the National Association of Securities Dealers, Inc., a
commercial bank or trust company having an office or correspondent in the
United States or an "eligible guarantor institution" within the meaning of
Rule 17Ad-15 under the Exchange Act (an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the registered
Holder of any Old Notes listed therein, such Old Notes must be endorsed or
accompanied by a properly completed bond power, signed by such registered
Holder as such registered Holder's name appears on such Old Notes.
If the Letter of Transmittal or any Old Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Old Notes will be determined
by the Company in its sole and absolute discretion, which determination will
be final and binding. The Company reserves the absolute right to reject any
and all Old Notes not properly tendered or any Old Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the right to waive any defects,
irregularities or conditions of tender as to particular Old Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Old Notes must be cured within such time as the
Company shall determine. Although the Company intends to notify Holders of
defects or irregularities with respect to tenders of Old Notes, neither the
Company, the Exchange Agent nor any other person shall incur any liability for
failure to give such notification. Tenders of Old Notes will not be deemed to
have been made until such defects or irregularities have been cured or waived.
Any Old Notes received by the Exchange Agent that are not properly tendered
and as to which the defects or irregularities have not been cured or waived
will be returned by the Exchange Agent to the tendering Holders, unless
otherwise provided in the Letter of Transmittal, as soon as practicable
following the Expiration Date.
By tendering, each Holder will represent to the Company, among other things,
that (i) the New Notes to be acquired by the Holder and any beneficial owners
of Old Notes pursuant to the Exchange Offer are being obtained in the ordinary
course of business of the person receiving such New Notes, (ii) the Holder and
each such beneficial owner are not participating, do not intend to participate
and have no arrangement or understanding with any person to participate in the
distribution of such New Notes and (iii) neither the Holder nor any such other
person is an "affiliate," as defined under Rule 405 of the Securities Act, of
the Company. Each broker or dealer that receives New Notes for its own account
in exchange for Old Notes, where such Old Notes were acquired by such broker
or dealer as a result of market-making activities or other trading activities
(other than Old Notes acquired directly from the Company), must acknowledge
that it will deliver a prospectus in connection with any resale of such New
Notes. See "Plan of Distribution."
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
immediately available or (ii) who cannot deliver their Old Notes, the Letter
of Transmittal or any other required documents to the Exchange Agent prior to
the Expiration Date, may effect a tender if:
(a) the tender is made through an Eligible Institution;
(b) prior to the Expiration Date, the Exchange Agent receives from such
Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery (by facsimile transmission, mail or hand delivery)
setting forth the name and address of the Holder, the certificate number(s)
of such Old Notes and the principal amount of Old Notes tendered, stating
that the tender is being made thereby and guaranteeing that, within three
New York Stock Exchange trading days after the Expiration Date, the Letter
of
29
<PAGE>
Transmittal (or facsimile thereof) together with the certificate(s)
representing the Old Notes and any other documents required by the Letter
of Transmittal will be deposited by the Eligible Institution with the
Exchange Agent; and
(c) such properly completed and executed Letter of Transmittal (or
facsimile thereof), as well as the certificate(s) representing all tendered
Old Notes in proper form for transfer and all other documents required by
the Letter of Transmittal are received by the Exchange Agent within three
New York Stock Exchange trading days after the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to Holders who wish to tender their Old Notes according to the guaranteed
delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the Expiration Date.
To withdraw a tender of Old Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to 5:00 p.m., New York City time,
on the Expiration Date. Any such notice of withdrawal must (i) specify the
name of the person having deposited the Old Notes to be withdrawn (the
"Depositor"), (ii) identify the Old Notes to be withdrawn (including the
certificate number or numbers and principal amount of such Old Notes), (iii)
be signed by the Holder in the same manner as the original signature on the
Letter of Transmittal by which such Old Notes were tendered (including any
required signature guarantees) or be accompanied by documents of transfer
sufficient to have the Trustee with respect to the Old Notes register the
transfer of such Old Notes into the name of the person withdrawing the tender
and (iv) specify the name in which any such Old Notes are to be registered, if
different from that of the Depositor. If certificates for Old Notes have been
delivered or otherwise identified to the Exchange Agent, then, prior to the
release of such certificates, the withdrawing Holder must also submit the
serial numbers of the particular certificates to be withdrawn and a signed
notice of withdrawal with signatures guaranteed by an Eligible Institution
unless such Holder is an Eligible Institution. All questions as to the
validity, form and eligibility (including time of receipt) of such notices
will be determined by the Company in its sole discretion, which determination
shall be final and binding on all parties. Any Old Notes so withdrawn will be
deemed not to have been validly tendered for purposes of the Exchange Offer
and no New Notes will be issued with respect thereto unless the Old Notes so
withdrawn are validly retendered. Properly withdrawn Old Notes may be
retendered by following one of the procedures described above under "--
Procedures for Tendering" at any time prior to the Expiration Date.
Any Old Notes which have been tendered but which are not accepted for
payment due to withdrawal, rejection of tender or termination of the Exchange
Offer will be returned as soon as practicable to the Holder thereof without
cost to such Holder.
CONDITIONS
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or exchange New Notes for, any Old Notes,
and may terminate the Exchange Offer as provided herein before the acceptance
of such Old Notes, if:
(a) any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Exchange Offer
which, in the sole judgment of the Company, might materially impair the
ability of the Company to proceed with the Exchange Offer or materially
impair the contemplated benefits of the Exchange Offer to the Company, or
any material adverse development has occurred in any existing action or
proceeding with respect to the Company or any of its subsidiaries; or
(b) any change, or any development involving a prospective change, in the
business or financial affairs of the Company or any of its subsidiaries has
occurred which, in the sole judgment of the Company, might
30
<PAGE>
materially impair the ability of the Company to proceed with the Exchange
Offer or materially impair the contemplated benefits of the Exchange Offer
to the Company; or
(c) any law, statute, rule or regulation is proposed, adopted or enacted,
which, in the sole judgment of the Company, might materially impair the
ability of the Company to proceed with the Exchange Offer or materially
impair the contemplated benefits of the Exchange Offer to the Company; or
(d) any governmental approval has not been obtained, which approval the
Company shall, in its sole discretion, deem necessary for the consummation
of the Exchange Offer as contemplated hereby.
If the Company determines in its sole and absolute discretion that any of the
conditions are not satisfied, the Company may (i) refuse to accept any Old
Notes and return all tendered Old Notes to the tendering Holders, (ii) extend
the Exchange Offer and retain all Old Notes tendered prior to the expiration of
the Exchange Offer, subject, however, to the rights of Holders to withdraw such
Old Notes (see "--Withdrawal of Tenders" above) or (iii) waive such unsatisfied
conditions with respect to the Exchange Offer and accept all properly tendered
Old Notes which have not been withdrawn. If such waiver constitutes a material
change to the Exchange Offer, the Company will promptly disclose such waiver by
means of a prospectus supplement that will be distributed to the registered
Holders, and the Company will extend the Exchange Offer for a period of five to
ten business days, depending upon the significance of the waiver and the manner
of disclosure to the registered Holders, if the Exchange Offer would otherwise
expire during such five to ten business day period.
EXCHANGE AGENT
Harris Trust Company of New York has been appointed as Exchange Agent for the
Exchange Offer. Questions and requests for assistance, requests for additional
copies of this Prospectus or of the Letter of Transmittal and requests for
Notices of Guaranteed Delivery should be directed to the Exchange Agent
addressed as follows:
By Registered or By Overnight Courier: By Hand:
Certified Mail: Harris Trust Company of New York
Harris Trust Company of New York
Harris Trust Company of New York
77 Water Street, 4th Floor Receive Window
Wall Street Station New York, NY 10005 77 Water Street, 5th
P.O. Box 1010 Floor
New York, NY 10268-1010 New York, NY
By Facsimile:
(212) 701-7636
(212) 701-7637
Confirm by telephone:
(212) 701-7618
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, telephone or in person by officers and regular
employees of the Company and its affiliates.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay
the Exchange Agent reasonable and customary fees for its services and will
reimburse it for its reasonable out-of-pocket expenses in connection therewith.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company. Such expenses include fees and expenses of the Exchange
Agent and Trustee, accounting and legal fees and printing costs, among others.
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<PAGE>
The Company will pay all transfer taxes, if any, applicable to the exchange
of Old Notes pursuant to the Exchange Offer. If, however, certificates
representing New Notes or Old Notes for principal amounts not
tendered or accepted for exchange are to be delivered to, or are to be issued
in the name of, any person other than the registered Holder of the Old Notes
tendered, or if tendered Old Notes are registered in the name of any person
other than the person signing the Letter of Transmittal, or if a transfer tax
is imposed for any reason other than the exchange of Old Notes pursuant to the
Exchange Offer, then the amount of any such transfer taxes (whether imposed on
the registered Holder or any other persons) will be payable by the tendering
Holder. If satisfactory evidence of payment of such taxes or exemption
therefrom is not submitted with the Letter of Transmittal, the amount of such
transfer taxes will be billed directly to such tendering Holder.
ACCOUNTING TREATMENT
The New Notes will be recorded at the same carrying value as the Old Notes,
which is face value less accrued original issue discount, as reflected in the
Company's accounting records on the date of the exchange. Accordingly, no gain
or loss for accounting purposes will be recognized. The expenses of the
Exchange Offer and the unamortized expenses related to the issuance of the Old
Notes will be amortized over the term of the New Notes.
OTHER
Participation in the Exchange Offer is voluntary and holders of Old Notes
should carefully consider whether to accept the terms and conditions thereof.
Holders of the Old Notes are urged to consult their financial and tax advisors
in making their own decisions on what action to take with respect to the
Exchange Offer.
As a result of the making of, and upon acceptance for exchange of all
validly tendered Old Notes pursuant to the terms of this Exchange Offer, the
Company will have fulfilled a covenant contained in the terms of the Old Notes
and the Registration Rights Agreement. Holders of the Old Notes who do not
tender their Old Notes in the Exchange Offer will continue to hold such Old
Notes and will be entitled to all the rights, and limitations applicable
thereto, under the Indenture, except for any such rights under the
Registration Rights Agreement which by their terms terminate or cease to have
further effect as a result of the making of this Exchange Offer. All
untendered Old Notes will continue to be subject to the restrictions on
transfer set forth in the Indenture. To the extent that Old Notes are tendered
and accepted in the Exchange Offer, the trading market, if any, for any
remaining Old Notes could be adversely affected. See "Risk Factors--
Consequences of Failure to Exchange."
32
<PAGE>
CAPITALIZATION
The following table sets forth the total cash and cash equivalents and
capitalization of the Company as of August 31, 1997. This table should be read
in conjunction with the consolidated financial statements and related notes
thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF
AUGUST 31, 1997
---------------
(UNAUDITED)
(IN THOUSANDS
EXCEPT SHARE
INFORMATION)
<S> <C>
Cash and cash equivalents...................................... $123,923
========
Long-term debt
14 5/8% Senior Discount Notes due 2004........................ $100,001
14% Senior Discount Notes due 2003............................ 34,203
9% Convertible Subordinated Notes due 2004.................... 29,972
Notes payable and capital lease obligations................... 747
--------
Total long-term debt....................................... 164,923
Redeemable Preferred Stock
9% Preferred Stock, par value $1.00 per share, 30,000 shares
authorized; 10,450 shares issued and outstanding; liquidation
value $1,000 per share....................................... 10
9% Preferred Stock, Series A, par value $1.00 per share,
150,000 shares authorized; 30,209 shares issued and
outstanding; liquidation value $1,000 per share.............. 30
Accumulated unpaid dividends.................................. 235
Additional paid-in capital.................................... 40,265
--------
Total Preferred Stock...................................... 40,540
Common stockholders' deficit
Class A Common Stock, $.01 par value, 30,000,000 shares
authorized, 7,222,510 shares issued and outstanding (1)...... 7
Class A Common Stock held in treasury......................... (1)
Additional paid-in capital.................................... 72,671
Accumulated deficit........................................... (117,771)
--------
Total common stockholders' deficit......................... (45,094)
--------
Total capitalization..................................... $160,397
========
</TABLE>
- --------
(1) Excludes (i) 1,250,660 shares reserved for issuance upon exercise of
options, (ii) 2,989,840 shares reserved for issuance upon exercise of
outstanding warrants, (iii) 738,010 shares reserved for issuance upon
conversion of the 9% Preferred Stock, (iv) 3,432,350 shares reserved for
issuance upon conversion of the Series A Preferred Stock and (v) 2,871,930
shares reserved for issuance upon conversion of the Convertible Notes,
respectively. No shares have been reserved for issuance upon conversion of
any Consent Convertible Notes which may be issued by the Company.
33
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
(DOLLARS IN THOUSANDS)
The following table presents selected historical consolidated financial data
for the period from inception of the Company in April 1994 to December 31,
1994 and for the fiscal years ended December 31, 1995 and 1996. The data for
the periods ending December 31, 1994, 1995 and 1996 has been derived from
consolidated financial statements (including those set forth elsewhere in this
Prospectus) which have been audited by Deloitte & Touche LLP, independent
auditors. The selected financial data as of and for the six-month periods
ending June 30, 1996 and 1997, respectively, are derived from, and should be
read in conjunction with, the unaudited financial statements of the Company
and the related notes thereto included elsewhere in this Prospectus. In the
opinion of management, such interim financial statements reflect all
adjustments (consisting solely of normal recurring adjustments) necessary to
fairly present the information presented for such periods. The information set
forth below should be read in conjunction with the consolidated financial
statements of the Company and the related notes appearing elsewhere in this
Prospectus. Results of operations for the six months ended June 30, 1997 are
not necessarily indicative of results of operations for a full year or
indicative of future periods.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
INCEPTION TO ------------------- ------------------
DECEMBER 31, UNAUDITED
1994 1995 1996 1996 1997
------------ -------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net service revenue..... $ 1,737 $ 7,884 $ 9,814 $ 4,804 $ 11,721
Cost of services........ 1,455 9,076 9,256 4,078 10,520
-------- -------- --------- -------- --------
Gross margin............ 282 (1,192) 558 726 1,201
Sales and marketing
expense................ 2,869 5,867 12,612 3,546 27,335
General and
administrative expense. 4,686 11,100 20,665 6,336 15,013
Interest expense........ 26 734 1,797 20 4,129
Interest and other
income (1)............. 152 646 9,469 8,449 1,013
Minority interest....... -- 150 -- -- --
-------- -------- --------- -------- --------
Net loss................ $ (7,147) $(18,097) $ (25,047) $ (727) $(44,263)
======== ======== ========= ======== ========
Accumulated unpaid
preferred dividends.... $ 707 $ 3,810 $ 225 $ 6,145 $ 235
Net loss to common
shareholders........... $ (7,854) $(21,907) $ (25,272) $ (6,872) $(44,498)
Net loss per common
share.................. $ (65.63) $ (72.42) $ (49.53) $ (16.12) $ (61.70)
Weighted average shares
outstanding............ 119,678 302,520 510,233 426,378 721,251
OTHER DATA:
EBITDA (2).............. $ (7,087) $(15,901) $ (30,390) $ (8,996) $(40,105)
Cash flows from
operating activities... (6,141) (14,308) (24,098) (9,178) (37,505)
Cash flows from
investing activities... (1,708) (2,556) 7,274 9,188 (7,171)
Cash flows from
financing activities... 13,828 24,589 63,689 (549) (422)
Depreciation and
amortization........... 186 2,258 2,329 160 1,042
Capital expenditures.... 1,728 1,740 2,259 345 7,171
Ratio of earnings to
fixed charges (3)...... -- -- -- -- --
<CAPTION>
DECEMBER 31, JUNE 30,
-------------------------------- ------------------
UNAUDITED
1994 1995 1996 1996 1997
------------ -------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents............ $ 5,979 $ 13,705 $ 60,569 $ 13,227 $ 15,720
Total assets............ 12,747 20,471 78,052 19,898 44,146
Long-term debt (net of
current maturities).... 3,176 518 59,864 350 63,466
Redeemable preferred
stock.................. 15,306 44,396 10,045 46,532 10,505
Common stockholders'
deficit................ (7,830) (28,768) (3,606) (31,596) (48,026)
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF AS OF AS OF AS OF AS OF
MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 JUNE 30, 1997
-------------- ------------- ------------------ ----------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Local access line sold. 4,178 3,995 4,630 10,283 35,397 79,321
Local access lines in
service............... 4,178 3,995 4,356 8,364 18,557 65,142
Total employees........ 188 180 225 464 641 766
Direct salesforce...... 63 50 81 206 252 325
</TABLE>
- -------
(1) Interest and other income for the year ended December 31, 1996 and the six
months ended June 30, 1996 includes a gain of $8.1 million realized on the
sale of the Company's switching facilities in Ohio.
(2) EBITDA consists of operating income (loss) before depreciation and
amortization. While EBITDA should not be construed as a substitute for
operating income or a better indicator of liquidity than cash flow from
operating activities, which are determined in accordance with generally
accepted accounting principles, EBITDA is 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 $7.1 million, $17.4 million and $23.3
million, respectively and for the six-month period ended June 30, 1996 and
1997 by $0.7 million and $40.1 million, respectively.
34
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
"Selected Historical Consolidated Financial and Operating Data" and the
consolidated financial statements and notes thereto included elsewhere in this
Prospectus.
OVERVIEW
Initially, the Company entered the local telecommunications market as a
facilities-based CLEC with network facilities in Ohio. Due to the high costs
associated with the initial construction, installation and expansion of each
local network facility, including right-of-way costs, franchise fees,
interconnection charges and other operating expenses and in anticipation of
the impact of the passage of the Telecommunications Act 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. As part of the Company's strategy to
refocus its operations, the Company, through a newly formed wholly owned
acquisition subsidiary, Quest United, Inc. ("Quest"), acquired certain assets
and assumed certain liabilities of Quest America, L.P., a telecommunications
reseller and consulting firm, in October 1995 (the "Quest Acquisition").
The Company negotiated for the first total service resale agreement with
Ameritech for local services, which was signed in November 1995, and
negotiated with NYNEX for a similar comprehensive local resale agreement which
was signed in July 1996. The Company also 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,
through an increase in its customer base and product offerings, this strategy
is expected to have a negative effect on the Company's results of operations
over the short-term. The Company anticipates losses and negative cash flow for
the foreseeable future, attributable in part to significant investments in
operating, sales, marketing, management information systems and general and
administrative expenses. To date, the Company's growth, including capital
expenditures, has been funded primarily by the capital contributions of the
Original Purchasers and by the proceeds from the 1996 Private Placement.
The Company's net service revenue consists primarily of sales revenue from
telecommunications resale services, net of certain adjustments, including
unbillable call records. The Company bills its customers for local and long
distance usage based on the type of local service utilized, the number, time
and duration of calls, the geographic location of the terminating phone
numbers and the applicable rate plan in effect at the time of the call.
Cost of services includes the cost of local and long distance services
charged by carriers for recurring charges, per minute usage charges and
feature charges, as well as the cost of fixed facilities for dedicated
services and special regional calling plans.
Sales and marketing expense consists of the costs of providing sales and
other support services for customers including salaries of salesforce
personnel. General and administrative expense consists of the costs of the
billing and information systems and personnel required to support the
Company's operations and growth as well as all amortization expenses.
Depreciation is allocated throughout sales, marketing, general and
administrative expense based on asset ownership.
The Company has experienced significant growth in the past and, depending on
the extent of its future growth, may experience significant strain on its
management, personnel and information systems. To accommodate this growth, the
Company will continue to implement and improve operational, financial and
management information systems. In an effort to support its growth, the
Company added several senior management positions and over 250 employees in
1996. Also, the Company is implementing new information systems that will
provide improved recordkeeping for customer information and management of
uncollectible accounts and fraud control.
35
<PAGE>
RESULTS OF OPERATIONS
Six Months Ended June 30, 1997 Compared to Six Months Ended June 30, 1996
Net service revenue increased 144% to $11.7 million for the six months ended
June 30, 1997 from $4.8 million for the six months ended June 30, 1996. The
cumulative number of local access lines sold and in service as of June 30,
1997 was 79,321 and 65,142, respectively, compared to 3,995 lines sold and in
service as of June 30, 1996. The substantial increase in net service revenue
and local access lines was due primarily to the significant change in the
Company's business strategy and the corresponding deployment of a large direct
sales organization. This business strategy change resulted in a substantial
increase in the customer base in the Company's geographic markets (from
approximately 1,200 customers at June 30, 1996 to approximately 6,000
customers in service at June 30, 1997).
Gross margin for the six months ended June 30, 1997 increased 66% to $1.2
million compared to $0.7 million for the six months ended June 30, 1996. Gross
margin for the first six months of 1997 for the new resale products was 13.5%,
which was slightly ahead of expectations. Consolidated gross margins are
expected to continue to improve each quarter primarily as the mix of revenues
from higher margin products increases and the mix of revenue from the lower
margin legacy products decreases. Due to the significant change in the
Company's business strategy and corresponding change in cost structure from
the original facilities-based business, the year to year gross margins are not
comparable.
Sales and marketing expense increased $23.8 million from $3.5 million for
the six months ended June 30, 1996 to $27.3 million for the six months ended
June 30, 1997. The increase was due primarily to the aforementioned increase
in the number of sales and marketing employees which resulted in increases to
salaries and benefits of approximately $12.4 million, recruitment, training
and travel costs of approximately $4.0 million, and facility and office
related expenses of approximately $1.9 million. Additionally, advertising and
promotional costs increased approximately $3.8 million due to product launches
in the Company's target markets.
General and administrative expense increased $8.7 million to $15.0 million
for the six months ended June 30, 1997 versus $6.3 million for the six months
ended June 30, 1996. The increase was due primarily to the aforementioned
increase in the number of operations and administrative employees which
resulted in increases to salaries and benefits of approximately $4.5 million,
facility and office costs of approximately $0.8 million, and training and
travel costs of approximately $0.5 million. Additionally, professional fees
increased approximately $0.8 million, primarily relating to the development
and expansion of the Company's customer service, billing and administrative
information systems and facilities.
Interest and other income decreased to $1.0 million for the six months ended
June 30, 1997 from $8.4 million for the six months ended June 30, 1996 due
primarily to an $8.1 million non-recurring gain on the sale of the Company's
switching facilities in Ohio in February 1996.
Interest expense increased to $4.1 million for the six months ended June 30,
1997 from $20,000 for the six months ended June 30, 1996. This increase was
due primarily to interest expense attributable to the 14% Senior Notes and
Convertible Notes issued in September 1996.
As a result of the factors described above, the Company had a net loss of
$44.3 million for the six months ended June 30, 1997 compared to a net loss of
$0.7 million for the six months ended June 30, 1996.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net service revenue increased to $9.8 million for the year ended December
31, 1996 from $7.9 million for the year ended December 31, 1995. The increase
in net service revenue was due primarily to a 36% increase in the customer
base in the Company's geographic markets (from approximately 1,250 customers
at the end of 1995 to approximately 1,700 customers at the end of 1996) and
the revenues attributable to the Quest Acquisition which primarily consisted
of commissions earned from carriers on telecommunications services provided to
their customers. Approximately $1.4 million in increased revenues was
attributable to the addition of new customers, primarily in Ohio, and
approximately $0.5 million was attributable to revenues gained from the Quest
Acquisition.
36
<PAGE>
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 expense increased $6.7 million, or 114%, from $5.9
million for the year ended December 31, 1995 to $12.6 million for the year
ended December 31, 1996. The increase was due primarily to an increase in the
number of sales and marketing employees from approximately 115 at the end of
1995 to over 300 at the end of 1996, which resulted in increases to salaries
and benefits of $3.9 million, travel, training and entertainment costs of $1.0
million and recruitment costs of $0.8 million. Additionally, advertising costs
increased $0.9 million due to product launches in the Company's target
markets.
General and administrative expense increased $9.6 million, or 86%, to $20.7
million for the year ended December 31, 1996 versus $11.1 million for the year
ended December 31, 1995. The increase was due primarily to an increase in the
number of operations and administrative employees from approximately 90 at the
end of 1995 to approximately 160 at the end of 1996, which resulted in
increases to salaries and benefits of $2.5 million and facility costs of $1.2
million. Additionally, fees paid to consultants and other professionals
increased over $1.0 million, primarily relating to the development and
expansion of the Company's customer service, billing and information systems
and facilities. Amortization expense increased $0.8 million due primarily to a
full year of amortization expense related to the Quest Acquisition in 1996
versus approximately eight months in 1995. Additionally, $1.7 million of
expense was incurred relating to the settlement of a derivative action filed
by a minority shareholder.
Interest and other income increased to $9.5 million for the year ended
December 31, 1996 from $0.6 million for the year ended December 31, 1995 due
primarily to an $8.1 million non-recurring gain on the sale of the Company's
switching facilities in Ohio in February 1996.
Interest expense increased to $1.8 million for the year ended December 31,
1996 from $0.7 million for the year ended December 31, 1995. This increase was
due primarily to interest expense attributable to the 14% Senior Notes and
Convertible Notes issued on September 30, 1996.
As a result of the factors described above, the Company's net loss increased
to $25.1 million for the year ended December 31, 1996 from $18.1 million for
the year ended December 31, 1995.
Year Ended December 31, 1995 Compared to Inception to December 31, 1994
The results for fiscal 1995 are not comparable with the results for fiscal
1994 as fiscal 1995 represents a full fiscal year and fiscal 1994 represents
approximately eight months of operations since the Company's inception in
April 1994.
Net service revenue increased to $7.9 million in fiscal 1995 from $1.7
million in fiscal 1994. This increase was due to a full year of operations and
a 34% increase in the customer base (from approximately 930 customers at
December 31, 1994 to approximately 1,250 customers at December 31, 1995).
Cost of services increased to $9.1 million in fiscal 1995 from $1.5 million
in fiscal 1994. The increase was due to the one-time installation costs and
fixed ongoing costs related to the Ohio switching facilities, as well as
increased costs associated with an increase in the number of customers.
Sales and marketing expense increased $3.0 million, or 103%, to $5.9 million
in fiscal 1995 from $2.9 million in fiscal 1994. Approximately $1.5 million of
the increase was due to the impact of a full year of operation in 1995 versus
approximately eight months in 1994. The inclusion of expenses related to the
operations of Quest in 1995 contributed an additional $0.8 million to the
increase.
37
<PAGE>
General and administrative expense increased $6.4 million, or 136%, to $11.1
million in fiscal 1995 from $4.7 million in fiscal 1994. Approximately $2.0
million of the increase was due to the impact of a full year of operation in
1995 versus approximately eight months in 1994. An additional $2.0 million was
attributable to depreciation and amortization and other expenses related to
the Quest Acquisition. The remaining increase is a result of increased
personnel and expenses required to build the Company's customer service and
information systems and office facilities.
Interest and other income increased to $0.6 million in fiscal 1995 from $0.2
million in fiscal 1994, due to significantly higher investable cash balances
in fiscal 1995 resulting from the proceeds of the issuance of $26.3 million of
preferred and common stock, as well as fiscal 1995 being a full year.
Interest expense increased to $0.7 million in fiscal 1995 from $26,000 in
fiscal 1994. This increase was due to interest expense associated with the
capitalized leases for the Ohio switch sites which began in December 1994.
As a result of the factors described above, the Company's net loss increased
to $18.1 million for fiscal 1995 from $7.1 million for fiscal 1994.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1997, the Company had cash and cash equivalents of $15.7
million and working capital of $6.4 million. The increase in the Company's
current assets, excluding cash, and current liabilities is primarily due to
the substantial increase in the size of the business. The Company's operating
activities utilized cash of approximately $37.5 million for the six month
period ended June 30, 1997, versus $9.2 million for the six month period ended
June 30, 1996.
The Company's investing activities have consisted primarily of property and
equipment purchases of $7.2 million for the six month period ended June 30,
1997, and $0.3 million for the six month period ended June 30, 1996. In 1997,
these expenditures were primarily related to sales office expansion in several
of the Company's target markets. In February 1996, the Company received $9.5
million in proceeds from the December 1995 sale of facilities in Ohio.
In 1997, the Company anticipates having approximately $12.0 million of
capital expenditures. A substantial portion of the capital plan has been
allocated to investments in information technology to support the growth of
the customer base with more robust provisioning, billing and customer care
systems. The anticipated continued growth in the customer base in 1998 will
require a similar level of investment in information technology.
On August 18, 1997, the Company raised $30.2 million through the sale of
30,000 shares of its 9.0% Cumulative Convertible Pay-In-Kind Preferred Stock,
Series A (the "Series A Preferred Stock"). Also on August 18, 1997 the Company
received approximately $96.0 million of net proceeds upon the consummation of
the Offering.
On September 30, 1996, the Company raised $10.4 million through the sale to
the Original Purchasers of 10,000 shares of 9.0% 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 MLGAFI of (i) 48,500 units consisting of $48.5 million in
aggregate principal amount at maturity of the 14% Senior Notes and initial
warrants to purchase 790,780 shares of Class A Common Stock, subject to
adjustment under certain circumstances, at an initial exercise price of $.01
per share, and (ii) $36.0 million in aggregate principal amount at maturity of
the Convertible Notes. The aggregate purchase price of such units was
$30,203,375, and the aggregate purchase price of the Convertible Notes was
$27,644,400. In 1995 and 1994, the Company's financing activities consisted
primarily of raising capital in the form of Common Stock and Preferred Stock
placements to venture capital organizations. During 1995 and 1994, the Company
raised $26.3 million and $14.2 million, respectively, net of issuance costs.
In 1995, the Company also assumed notes payable to investors in the Quest
Acquisition.
38
<PAGE>
The Company anticipates that it will require substantial additional capital
during the third quarter of 1998 in order to meet planned capital expenditures
and anticipated negative operating cash flow. Sources of funding for the
Company's further financing requirements may include public offerings or
private placements of equity and/or debt securities and additional capital
contributions from new or existing stockholders. An additional source may
include bank financing, although the Company currently does not have available
a credit facility. There can be no assurance that additional financing will be
available to the Company, or, if available, that it can be obtained on a timely
basis and on terms acceptable to the Company and within limitations contained
in the Indenture and the 14% Senior Note Indenture. Failure to obtain such
financing could result in the delay or abandonment of the Company's development
and expansion plans. See "Risk Factors--Additional Capital Requirements."
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
Code. These operating losses begin to expire in 2009 for federal income tax
purposes. Of the net operating loss carry-forwards remaining at December 31,
1996, $12.3 million can be applied only against future taxable income of the
Company's subsidiary USN Communications Northeast, Inc. (formerly United
Telemanagement Services, Inc.).
INFLATION
Management believes that inflation has not had a material effect on the
Company's results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" which
simplifies the method for computing earnings per share. Under the new
requirements, primary earnings per share will be replaced with basic earnings
per share. The statement, which will not impact the results of operations,
financial position or cash flows of the Company, is effective for financial
statements issued for periods ending after December 15, 1997 and will be
adopted by the Company in the fourth quarter of 1997.
39
<PAGE>
INDUSTRY OVERVIEW
Prior to 1984, AT&T dominated both the local exchange and long distance
marketplace by owning the operating entities that provided both local exchange
and long distance services to most of the U.S. population. While long distance
competition began to emerge in the late 1970s, the critical event triggering
the growth of long distance competition was the breakup of AT&T and the
separation of its local and long distance businesses as mandated by the
Modified Final Judgment relating to the breakup of AT&T (the "MFJ"). To foster
competition in the long distance market, the MFJ prohibited AT&T's divested
local exchange businesses, the RBOCs, from acting as a single source provider
of telecommunications services.
The Telecommunications Act, which was enacted on February 8, 1996, is
considered to be the most comprehensive reform of the nation's
telecommunications laws and will substantially affect the development of
competition for local telecommunications services. Specifically, certain
provisions of the Telecommunications Act provide for: (i) the removal of legal
barriers to entry to the local telecommunications services market; (ii) the
interconnection of ILEC networks with competitors' networks; (iii) the
establishment of procedures and requirements to be followed by the RBOCs,
including the requirement that RBOCs offer local services for resale in order
to enter into the long distance and telecommunications equipment manufacturing
markets; and (iv) the relaxation of the regulation of certain
telecommunications services provided by LECs and others. The Company believes
the Telecommunications Act will promote significant growth in the local
telecommunications market as new market entrants, including resellers such as
the Company, provide expanded service offerings and increased levels of
customer service.
Industry sources estimate that in 1996 the total revenues from local and
long distance telecommunications services were approximately $185 billion, of
which approximately $107 billion were derived from local exchange services and
approximately $78 billion from inter-LATA long distance services. According to
FCC information, aggregate revenues for local and long distance services grew
at a compounded annual rate of approximately 5.5% between 1991 and 1996.
Although the MFJ established the preconditions for competition in the market
for long distance services in 1984, the market for local exchange services has
until recently been virtually closed to competition and has largely been
dominated by regulated monopolies. Efforts to open the local exchange market
began in the late 1980s on a state-by-state basis when competitive access
providers ("CAPs") began offering dedicated private line transmission and
access services. These types of services together currently account for
approximately 12% of the total local exchange revenues. CAPs were restricted,
often by state laws, from providing the other, more frequently used services
such as basic and switched services, which today account for approximately 88%
of local exchange revenues.
The Telecommunications Act further increases the opportunities available to
competitive local providers by requiring the RBOCs and other ILECs to offer
various network elements such as switching, transport and loops (i.e., the
facilities connecting a customer's premises to a LEC central office) on an
unbundled and non-discriminatory basis. RBOCs also are required to offer their
retail services at wholesale rates for resale by other companies, including
the Company. By offering such services, the RBOCs are also meeting certain of
the requirements contained in the Telecommunications Act in order to gain FCC
approval to provide in-region long distance services. The Company believes
regulatory reform, together with increased demand from the large underserved
small and medium-sized business market, will provide growth opportunities for
competitive local carriers who develop integrated billing and information
systems and have significant management and operational expertise. This new
market opportunity will permit competitive providers who can manage the
operational and marketing implementation to offer a full range of local
telecommunications services, including local calling, custom calling features
and intra-LATA toll services to virtually any customer in the United States.
The Company believes that carriers such as the Company providing competitive
local exchange services have the opportunity to gain market share in the local
exchange market just as long distance competitors gained market share from
AT&T in the long distance market. In addition, competitors, including the
Company and major IXCs, will be able to take advantage of the unbundling and
resale requirements imposed on the RBOCs and other ILECs under the
Telecommunications Act, thereby accelerating entry of competitors that
previously have not invested in local distribution facilities.
40
<PAGE>
BUSINESS
INTRODUCTION
USN is one of the fastest growing CLECs in the United States. The Company
offers a bundled package of telecommunications products, including local and
long distance telephony, voice mail, paging, teleconferencing, Internet access
and other enhanced features, tailored to meet the needs of its customers. The
Company primarily targets small and medium-sized businesses with
telecommunications usage of less than $5,000 per month. The Company's strategy
is to continue to increase its customer base by being more flexible,
innovative and responsive to the needs of its target customers than the RBOCs
and the first-tier IXC's, which have historically concentrated their sales and
marketing efforts on residential and large business customers. The Company
primarily differentiates itself with a value-based marketing strategy by
providing an integrated, customized package of telecommunications services on
a single bill and responsive customer care.
The Company is presently providing service to customers in certain states in
the NYNEX region (New York and Massachusetts) and the Ameritech region
(Illinois, Ohio and Michigan) and is currently in negotiations to expand its
unique local services resale agreements throughout the 14-state Bell
Atlantic/NYNEX region and the 5-state Ameritech region. Management anticipates
implementing service in at least six additional states within these regions in
1998. In August 1997, NYNEX merged with Bell Atlantic. The Company continues
to operate in the former NYNEX regions, now a part of the Bell Atlantic
territory. References to NYNEX refer to the portion of the Bell Atlantic
territory previously serviced by NYNEX.
During the first six months of 1997, the Company increased aggregate local
access lines sold from 10,283 lines to 79,321 lines, a compound growth rate of
more than 40% per month. As of June 30, 1997, the Company had 65,142 access
lines in service. Services are primarily marketed through an approximately 325
member direct salesforce in 27 offices located in five states. As part of its
customer-focused product offering, the Company provides personalized customer
service, 24 hours a day, 365 days per year, through its customer care center.
COMPETITIVE ADVANTAGES
Providing local exchange services is a highly complex process that requires
overcoming significant barriers to entry. Since inception, the Company has
spent significant time, resources and capital to enter the local market. In
the process, it has gained substantial experience in this complicated market
segment. Consequently, the Company believes it has the following competitive
advantages:
. Complementary Relationships with RBOCs. The Company believes that the RBOCs'
networks will continue to be the predominant means for providing local
telecommunications services to the Company's target customers for the
foreseeable future. Accordingly, the Company has positioned itself to take
advantage of the opportunities created by the Telecommunications Act by
leveraging its complementary relationships with the RBOCs. The
Telecommunications Act requires the RBOCs to complete a number of
"checklist" items in order to qualify for long distance entry in their local
service areas. By moving aggressively to enter into resale agreements and to
develop electronic interfaces with the RBOCs, the Company believes it has
positioned itself to play a key role in enabling the RBOCs to meet a number
of those requirements. The Company was the first to enter into comprehensive
resale agreements with Ameritech and NYNEX and served as the systems beta
customer for Ameritech, NYNEX and Bell Atlantic. Currently the Company is
one of the largest competitors in the Ameritech and NYNEX markets.
Consequently, the Company is often requested by state and federal regulators
to provide information on the Company's experiences. The Company believes
its complementary relationships with the RBOCs have facilitated the
Company's rapid growth in its existing markets and enabled it to become a
valuable and viable resale channel partner. The Company further believes,
based on discussions with RBOC officials and industry experts, that the
RBOCs will continue to develop strong resale channel partners in an effort
to mitigate the potential negative effects of facilities-based competition.
. Unique Resale Agreements. The Company has executed comprehensive local
exchange resale agreements with Ameritech for the greater metropolitan
Chicago area, Ohio and Michigan, and with NYNEX for the State of New York.
In addition to the cost advantages associated with the term and volume
commitment contracts, these contracts provide "most favored nation" and
other pricing protections designed to maintain the
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competitiveness of rates and position the Company to purchase capacity at
rates at least as favorable as those of other potential resellers of
Ameritech and NYNEX local services. In addition, the Company has executed
interim resale agreements with Ameritech for the State of Wisconsin and with
NYNEX for the State of Massachusetts. The Company is currently in
negotiations to expand its resale agreements throughout the 14-state combined
Bell Atlantic/NYNEX region and the 5-state Ameritech region. The Company
estimates, based on data compiled by the FCC, that the regions covered by the
current comprehensive Ameritech and NYNEX resale agreements include access to
over 10 million business access lines. Management believes that if
negotiations are completed for total service resale agreements in the
combined Bell Atlantic/NYNEX region and the Ameritech region, the Company
will have access to approximately 20 million business access lines. The
Company continuously evaluates opportunities to enter into agreements with
additional IXCs and enhanced and other value-added service providers in order
to aggressively build its customer base as well as to provide additional
services to its existing customers while reducing costs.
. Proprietary Electronic Provisioning and Interface Systems. By serving as the
systems beta customer for Ameritech, NYNEX and Bell Atlantic, the Company
was among the first CLECs to develop electronic provisioning systems for
resale of RBOC services. Development of these provisioning systems is
critical for carriers seeking to grow rapidly in the complex, competitive
local telecommunications market. These systems must address the numerous
technical configurations associated with local service, including correctly
coding customers into data bases for 911, 411, white pages and customer
service, as well as provisioning thousands of local services, known as
universal service ordering codes ("USOCs"). Electronic provisioning between
the Company and its RBOC vendors allows the Company to provision a
significantly greater volume of lines than would be possible if transmitting
orders by mail or facsimile. Moreover, because the proprietary systems
developed by the Company lessen manual input and reduce repetitive data
entry, the Company experiences improved efficiency and accuracy in
transmitted orders, thereby reducing costs and increasing customer
satisfaction. The Company believes it has established an industry leadership
position in the deployment of these systems, and it is committed to the
continuous improvement of its systems.
. Largest Direct Salesforce Among CLECs in Its Markets. The Company's services
are currently sold through an approximately 325 member direct salesforce,
located in 27 offices in Illinois, Ohio, Michigan, New York and
Massachusetts. Additionally, the Company intends to hire approximately 175
new sales people over the next 18 months to implement service in the
Ameritech and combined Bell Atlantic/NYNEX regions. The Company primarily
recruits salespeople with experience in selling competitive
telecommunications services to businesses in the markets where they are
based. The Company's salesforce is trained in-house with a rigorous
customer-focused training program that promotes activity-based selling.
Salespeople are given an incentive through a commission structure, with a
target of 50% of a salesperson's compensation based on performance. The
Company believes its large, experienced, face-to-face salesforce has been,
and will continue to be, vitally important in today's highly competitive
telecommunications industry environment.
GROWTH STRATEGY
The Company's objective is to be a leading provider of integrated local and
long distance services and other telecommunications products to small and
medium-sized businesses. The Company expects to achieve this goal through the
successful implementation of its growth strategy which includes the following:
. Provide an Integrated Telecommunications Solution. A key element in building
its customer base while minimizing churn has been, and will continue to be,
the implementation of a marketing and operating strategy which emphasizes an
integrated telecommunications solution to its target market. To a large
extent, the Company's target customers have not previously been provided the
opportunity to purchase bundled services. The Company attracts and retains
customers by combining responsive customer care with a pricing package to
provide high-quality service at a cost which is usually afforded to only
large business customers. Specifically, the Company provides a single source
and bill for integrated local and long distance telephony, voicemail,
paging, teleconferencing, Internet access and other enhanced and value-added
telecommunications services, with a single point of contact for customer
service, product inquiries, repairs and billing questions.
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Based on its experience, the Company believes that this marketing and
customer service approach has minimized customer acquisition costs and churn.
. Focus on Large, Underserved Market. The Company utilizes a direct sales
approach and primarily focuses its marketing efforts on small and medium-
sized businesses with telecommunications usage of less than $5,000 per
month. The Company believes this target market is best served by a direct
sales approach because most of these customers do not employ in-house
telecommunications specialists and in most cases obtain services from
various vendors. The Company's experience indicates that these customers
prefer a single source for all their telecommunications requirements,
including products, billing and service. The Company believes that the gross
margins on services provided to its target market are generally higher than
for larger business customers. Since the RBOCs and the first-tier IXCs
primarily concentrate their sales and marketing efforts on residential and
large business customers, the Company will continue to focus its marketing
on this underserved market to rapidly expand its customer base.
. Leverage Ubiquitous Networks. The Company believes that a key factor in its
success has been its ability to provide through the RBOC networks the
complete range of local services currently provided by RBOCs across their
entire service territories. There is currently no competing network with the
product breadth, capacity and geographic reach of the RBOC networks. By
contrast, facilities-based CLECs are currently limited primarily to
servicing customers in areas where they have network facilities. In
addition, in light of the significant investments by NYNEX and Ameritech to
continuously upgrade their networks, the Company believes these networks are
substantially more comprehensive than those being built by facilities-based
CLECs.
. Rapid Market Entry. The Company believes its ability to enter a market early
and provide ubiquitous service will continue to allow it to rapidly build a
customer base across a large geographic area prior to the lifting of
regulatory restrictions on the ability of first-tier IXCs and RBOCs to offer
integrated services. As a non-facilities based provider, the Company
believes it is able to build a customer base quickly and efficiently without
incurring significant costs and the developmental delays inherent in
constructing network and transmission facilities. In addition, the Company's
proprietary software interface systems facilitate its rapid customer
acquisition strategy by allowing it to provision high volumes of access
lines.
. Negotiate Additional Agreements with RBOCs. The Company seeks to enter into
additional local exchange resale agreements with RBOCs which position it to
offer a full range of local service over a broad geographic area at a
competitive cost to its targeted businesses. The Ameritech resale agreements
provide pricing protections designed to maintain the competitiveness of
rates and position the Company to purchase capacity at rates at least as
favorable as those of other potential resellers of Ameritech local services.
The NYNEX resale agreement contains similar pricing protections. The Company
intends to negotiate similar pricing protections in all future RBOC resale
agreements. The Company believes, based on its experience and industry
analysts' reports, that the RBOCs have an incentive to continue to negotiate
wholesale agreements with respect to small and medium-sized businesses to
stabilize this revenue base and deter migration of the current RBOCs'
customers to facilities-based CLECs and other new entrant LECs. The Company
further believes, based on its experience with Ameritech and NYNEX, that it
is well positioned to negotiate these types of agreements in other regions.
SALES AND MARKETING
The Company's customers include small and medium-sized businesses which
principally have telecommunications usage of less than $5,000 per month. The
Company believes that the RBOCs and large IXCs historically have chosen not to
concentrate their sales and marketing efforts on this business segment, which
the Company believes represents a significant portion of the
telecommunications market. Through radio and newspaper advertising, as well as
various marketing programs, the Company has sought to establish itself as a
recognized brand name for its products and services emphasizing responsive
customer support, competitive product and pricing packages and a targeted
sales and marketing strategy. The Company had in excess of 6,000 customers as
of June 30, 1997.
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The Company's services are currently sold through an approximately 325
member direct salesforce, located in 27 offices in Illinois, Ohio, Michigan,
New York and Massachusetts. The sales personnel make direct calls to
prospective and existing customers to outline the range of services offered
and discuss the benefits of the Company's integrated service offerings,
enhanced customer care and potential savings. The Company is planning to
supplement its direct sales organization with outbound telemarketing and
indirect sales efforts. The Company believes this marketing approach will
increase market coverage and reduce marketing and customer acquisition costs.
The Company has recruited and continues to recruit a direct salesforce in
each of the markets in which it operates. The Company primarily recruits
salespeople with experience in selling competitive telecommunications services
to businesses in the markets where they are based. The Company's salesforce is
trained in-house with a rigorous customer-focused training program that
promotes activity-based selling. The salesforce makes calls to prospective
customers from potential customer modules created by acquiring business
databases sorted by target characteristics (e.g. size of business and number
of telephone lines). Salespeople are given an incentive through a commission
structure, with a target of 50% of a salesperson's compensation based on such
person's performance.
CUSTOMER CARE
The Company maintains an emphasis on customer care to differentiate itself
from its competitors and reduce churn. By providing each customer with an
account representative, the Company is able to provide ongoing personalized
contact to address the clients' needs. In addition, the Company has
established a 24-hours-per-day, 365-days-per-year, customer care center to
facilitate customer care and customer service requests. At the Company's
customer care centers, customers' calls are answered by experienced customer
care representatives, many of whom are cross-trained in the provisioning
process. The Company believes that the superior customer service, face-to-face
sales process and integrated service offering provide the Company with a
competitive advantage over the existing local service providers.
MANAGEMENT INFORMATION SYSTEMS
The Company is committed to the continued development and successful
implementation of billing and customer care systems that provide accurate and
timely information to both the Company and its customers. The proprietary
electronic interfaces of the Company's management information systems for the
provisioning of services to the Company's customers have been developed in
cooperation with Ameritech and NYNEX, with which the Company has entered into
resale agreements. Provisioning of service to customers is accomplished
through the Company's proprietary systems, which are designed to interface
with the RBOCs' systems through a variety of delivery mechanisms. The Company
believes this method of development has been, and will continue to be a
critical element to successfully providing local telecommunications services
and provides the Company with a competitive advantage, as the RBOCs have an
economic and strategic incentive to work with resellers that have
sophisticated information systems that can electronically interface with the
RBOCs' systems. The Company's experience in developing these systems allows it
to offer services quickly in new markets. The customer care systems have been
developed and continue to be enhanced in a client/server environment allowing
for flexibility to accommodate an expanding customer base, efficient entry
into new markets and rapid development of additional functionality.
The Company's billing systems are designed to provide access to a broad
range of information on individual customers, including their call volume,
patterns of usage and billing history. This same information is used by the
Company to identify customer trends and will allow for proactive support of
the Company's marketing efforts.
The Company currently outsources the rating, printing and mailing of
customer bills. Since these functions require a high volume of processing in a
limited time frame, the Company has determined that currently the most
economical way to process bills is to outsource this function. The customer
usage information for billing
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and the tables and procedures used in the rating of call records are
maintained separately by the Company to manage the ongoing needs of each
customer. Standard management reports are generated for every billing cycle.
VENDOR AGREEMENTS
Introduction
The Company has executed comprehensive local exchange resale agreements,
including the Ameritech resale agreements for the greater metropolitan Chicago
area, Ohio and Michigan, and the NYNEX resale agreement for the State of New
York. In addition, the Company has executed interim resale agreements with
Ameritech for the State of Wisconsin and with NYNEX for the State of
Massachusetts. Originally, the Company entered into an LSO agreement with
NYNEX for the resale of Centrex over a private local network, prior to
adopting its current resale strategy. The Company estimates, based on data
compiled by the FCC, that the regions covered by the Ameritech and NYNEX
resale agreements include access to over 10 million business access lines. The
Company continuously evaluates opportunities to enter into agreements with
additional RBOCs, long distance carriers and enhanced and other value-added
service providers in order to aggressively build its customer base as well as
to provide additional services to its existing customers while reducing costs.
The Company currently has a long distance resale agreement with MCI. Such
agreement allows the Company to offer its customers integrated local and long
distance telecommunications services. In addition, such agreement has allowed
the Company to enter and establish itself as a telecommunications provider in
strategically targeted markets prior to establishing a local exchange resale
agreement.
Ameritech Resale Agreements
Pursuant to the Ameritech resale agreements, the Company purchases local
exchange services at discounted rates based on a ten-year term. These
agreements contain pricing protections designed to maintain the
competitiveness of the Company's discounted rates and position the Company to
purchase capacity at rates at least as favorable as those of competitors that
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 related features including call waiting, call forwarding, caller
ID and three-way calling. The rates for these services are filed with the
public utilities commission of each respective state. The Company also has an
agreement with Ameritech for the resale of certain non-tariffed services to
its customers, including inside wire maintenance.
The Ameritech resale agreements include a Minimum Commitment of resold
access lines per region covered. The Minimum Commitment in Illinois is 150,000
business access lines and in Ohio and Michigan, 100,000 business access lines
and 10,000 residential lines. The Minimum Commitment is not a limitation on
the Company's overall ability to sell access lines at discounted rates.
However, if the Company fails to meet its Minimum Commitment, the Company is
subject to an underutilization charge equal to the number of unutilized lines
multiplied by a fixed average business line rate. The measurement period of
the Minimum Commitment does not commence, however, until the completion of an
18-month "ramp up" period which gives the Company the ability to build its
customer base. In addition, the Ameritech resale agreements provide a
"carryforward" provision designed to minimize the potential for any liability
resulting from a failure to meet the Minimum Commitment by carrying forward
underutilization amounts which may be met in the future.
If the Company does not meet its Minimum Commitment by the end of the ten-
year term with the benefit of the carryforward provision, the Company has the
option to either pay a penalty based on the aggregate number of unutilized
lines or subscribe on a monthly basis to an equivalent number of lines during
the next three-year period. In the event the Company terminates any of the
Ameritech resale agreements prior to their expiration, the Company is subject
to a termination charge.
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In April 1997, the Company entered into an interim resale agreement with
Ameritech for the State of Wisconsin. Although there can be no assurance, the
Company expects to enter into a long-term resale agreement for Wisconsin which
is similar to the other Ameritech resale agreements.
NYNEX Resale Agreement
On July 9, 1996, the Company executed a resale agreement with NYNEX to
provide for the resale of local exchange services for the State of New York at
discounted rates based on a ten-year term. The New York NYNEX resale agreement
contains pricing protections designed to maintain the competitiveness of
discounted rates provided to the Company. Under the New York NYNEX resale
agreement, the Company receives the lowest rate and/or most favorable term
provided to any reseller; however, if a lower rate is provided to a reseller
committing to both a longer term and a greater volume commitment, the Company
receives the lower rate but must negotiate with NYNEX a reasonable transition
to similar commitments. If the Company cannot successfully negotiate such a
transition with NYNEX, then the Company may be unable to maintain the lowest
rate. The level of discounts of resold services varies based on the nature of
the services. The New York NYNEX resale agreement contains a Minimum
Commitment of 100,000 business access lines. In the event the Company does not
satisfy the Minimum Commitment after a trial period and ramp-up period, the
Company is subject to an underutilization charge. However, the New York NYNEX
resale agreement also contains a carryforward provision designed to minimize
the potential of an underutilization charge. The Company has also executed an
interim resale agreement with NYNEX for Massachusetts. This agreement does not
contain a term and volume commitment, but was designed to allow the Company to
begin reselling services in Massachusetts expeditiously in a manner consistent
with state regulatory developments. Although there can be no assurance, it is
expected that the Company and NYNEX will enter into a long-term resale
agreement for Massachusetts similar to the New York NYNEX resale agreement.
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 complements services
provided under the New York 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.
Long Distance Agreements
The Company has an agreement with MCI pursuant to which MCI provides a wide
range of long distance telecommunications services to the Company's customers.
Services offered for resale from MCI include a variety of inbound, outbound,
calling card and international services. In addition, the Company also resells
teleconferencing, debit cards, branded operator services and private line
services.
The Company's long distance carrier agreement with MCI became effective
August 1, 1996 and contains a 33-month term. It requires the Company to
achieve certain monthly dollar targets in order to qualify for discounted
rates on carrier services. The agreement provides for an annual commitment for
each of the remaining two years of the contract term. If the Company does not
meet its annual commitment during any annual period of the term, an
underutilization charge shall apply in an amount equal to 15% of the
difference between the committed amount and the actual usage. However, the
Company may carry forward up to 10% of the initial annual commitment for a
period of up to three months in the following annual period.
Enhanced and Other Value-Added Telecommunications Services
The Company has agreements to offer on a resale basis enhanced and other
value-added services such as Internet access and paging. In addition, the
Company has entered into an agreement for the exclusive rights in the United
States and Canada to distribute a Windows-based teleconferencing product which
allows the
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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 continue to 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. Additionally, the long distance market
is already significantly more competitive than the local exchange market,
because the ILECs, including the RBOCs have historically had a monopoly
position within the local exchange market.
In the local exchange market, the Company also faces competition or
prospective competition from one or more CLECs, which have significantly
greater financial resources than the Company, and from other competitive
providers, including some non-facilities-based providers like the Company. For
example, AT&T, MCI and Sprint, among other carriers, have each begun to offer
local telecommunications services in major U.S. markets using their own
facilities or by resale of the ILECs' or other providers' services. In fact,
certain competitors, including 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 in the
near future likely will begin offering local exchange service in those states,
subject to the joint marketing restrictions under the Telecommunications Act
described below. In addition, some of these competitors have entered into
interconnection agreements with NYNEX and either have begun or in the near
future likely will begin offering local exchange service in New York and
Massachusetts, subject to such joint marketing restrictions. In addition to
these long distance service providers, entities that currently offer or are
potentially capable of offering switched services include CLECs, cable
television companies, electric utilities, other long distance carriers,
microwave carriers, wireless telephone system operators and large customers
who build private networks. Many facilities-based CLECs and long distance
carriers, for example, have committed substantial resources to building their
networks. 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 ILECs, including RBOCs.
Such additional alternatives may provide the CLECs with greater flexibility
and a lower cost structure than the Company. In addition, some of these CLECs
and other facilities-based providers of local exchange service are acquiring
or being acquired by IXCs that are not subject to joint marketing
restrictions. These combined entities may provide a bundled package of
telecommunications products, including local and long distance telephony that
is in direct competition with the products offered by the Company.
With respect to wireless telephone system operators, the FCC in 1996
authorized cellular, personal communications service, and other CMRS providers
to offer wireless services to fixed locations, rather than just to mobile
customers, in whatever capacity such CMRS providers choose. Previously,
cellular providers could provide service to fixed locations only on an
ancillary or incidental basis. This authority to provide fixed as well as
mobile services will enable CMRS providers to offer wireless local loop
service and other services to fixed locations (e.g., office and apartment
buildings) in direct competition with the Company and other providers of
traditional fixed telephone service. In addition, in August 1996 the FCC
promulgated regulations that classify CMRS providers as telecommunications
carriers, thus giving them the same rights to interconnection and reciprocal
compensation under the Telecommunications Act as other non-LEC
telecommunications carriers, including the Company.
Under the Telecommunications Act and related federal and state regulatory
initiatives, barriers to local exchange competition are being removed. The
availability of 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
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that state. The RBOCs are currently allowed to offer certain in-region
"incidental" long distance services (such as cellular, audio and visual
programming and certain interactive storage and retrieval functions) and to
offer virtually all out-of-region long distance services.
In August 1997, the FCC denied the application of Ameritech, the RBOC in
three states where the Company operates, for in-region long distance authority
in Michigan. The Company anticipates that Ameritech will file another
application for Michigan in late 1997 and applications for most or all of its
other states--including Illinois and Ohio--in 1998. Other RBOCs, including
NYNEX in New York, are expected to file such applications in 1998. The FCC will
have 90 days from the date such an application is filed to decide whether to
grant or deny the application. Once the RBOCs are allowed to offer widespread
in-region long distance services, both they and the largest interexchange
carriers will be in a position to offer single-source local and long distance
services similar to those offered by the Company. While new business
opportunities will be made available to the Company through the
Telecommunications Act and other federal and state regulatory initiatives,
regulators are likely to provide the ILECs with an increased degree of
flexibility with regard to pricing of their services as competition increases.
Although the Ameritech and NYNEX resale agreements contain certain pricing
protections, including adjustments in the wholesale rates to be consistent with
any changes in the Ameritech and NYNEX retail rates, if the ILECs elect to
lower their rates and sustain lower rates over time, this may adversely affect
the revenues of the Company and place downward pressure on the rates the
Company can charge. While the Ameritech and NYNEX resale agreements ensure that
the Company will receive any lower rate provided to any other reseller, under
the NYNEX resale agreement if such lower rate is provided to a reseller
committing to both a longer term and a greater volume commitment, the Company
receives the lower rate, but must negotiate with NYNEX a reasonable transition
to similar commitments. If the Company cannot successfully negotiate such a
transition with NYNEX, then the Company may be unable to maintain the lowest
rate. The Company believes the effect of lower rates may be offset by the
increased revenues available by offering new products and services to its
target customers, but there can be no assurance that this will occur. In
addition, if future regulatory decisions afford the LECs excessive pricing
flexibility or other regulatory relief, such decisions could have a material
adverse effect on the Company.
Competition for the Company's products and services is based on price,
quality, network reliability, service features and responsiveness to customer
needs. While the Company believes that it currently has certain advantages
relating to the timing, ubiquity and cost savings resulting from its resale
agreements, there is no assurance that the Company will be able to maintain
these advantages. A continuing trend toward business combinations and alliances
in the telecommunications industry may create significant new competitors to
the Company. Many of the Company's existing and potential competitors have
financial, technical and other resources significantly greater than those of
the Company.
GOVERNMENT REGULATION
The Company is subject to varying degrees of federal, state, local and
international regulation. In the United States, the Company's provision of
local exchange services is regulated by the states. The Company must be
separately certified in each state to offer local exchange services. No state,
however, subjects the Company to price cap or rate-of-return regulation. FCC
approval is required for the resale of international facilities and services.
The FCC has determined that nondominant carriers, such as the Company, are
required to file interstate tariffs on an ongoing basis, setting forth the
Company's rates and operating procedures. Such tariffs can currently be
modified on one day's notice. The FCC recently issued regulations to eliminate
this tariff filing requirement for all nondominant carriers, such as the
Company, and all other nondominant interexchange carriers (except possibly the
RBOCs in certain circumstances), effective in late 1997. Various carriers have
filed suit to overturn the FCC regulations, and the U.S. Court of Appeals for
the D.C. Circuit has stayed the regulations pending its decision in that
appeal, which is not expected until the end of 1997. The FCC has recently ruled
that RBOCs providing out-of-region long distance service through separate
subsidiaries from their local telephone operations qualify for nondominant
treatment. Out-of-region RBOC services provided through unseparated entities,
however, are subject to full dominant carrier regulation, including the
requirement to submit cost support with tariffs and to file tariffs on at least
15 to 45 days' notice, depending on various factors. The FCC has indicated
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that RBOC in-region service, when authorized, will be subject to nondominant
regulatory status. See "Risk Factors--Regulation and Risks of the
Telecommunications Act."
Legislation. On February 8, 1996, President Clinton signed into law the
Telecommunications Act, comprehensive federal telecommunications legislation
affecting all aspects of the telecommunications industry. The
Telecommunications Act establishes a national policy that promotes local
exchange competition. The Telecommunications Act requires that local and state
barriers to entry into the local exchange market be removed and establishes
broad uniform standards under which the FCC and the state commissions are to
implement local competition and co-carrier arrangements in the local exchange
market. Under certain conditions and subject to reasonable exceptions, ILECs
are now required to make available for resale to new entrants all services
offered by the LEC on a retail basis. The Telecommunications Act also imposes
significant obligations on the RBOCs and other ILECs, including the obligation
to interconnect their networks with the networks of competitors. Each ILEC is
required not only to open its network but also to "unbundle" the network. The
FCC issued regulations in August 1996 defining a minimum set of elements which
must actually be unbundled, and each state may augment this list if it wishes.
States have begun and, in a number of cases, completed regulatory proceedings
to determine the pricing of these unbundled network elements and services, and
the results of these proceedings will determine whether it is economically
attractive to use these elements.
The RBOCs have an added incentive to open their local exchange networks to
facilities-based competition because Section 271 of the Telecommunications Act
provides for the removal of the current ban on RBOC provision of in-region
inter-LATA toll service and equipment manufacturing. This ban will be removed
only after the RBOC demonstrates to the FCC, which must consult with the
Department of Justice and the relevant state commissions, that the RBOC has (1)
met the requirements of the Telecommunications Act's 14-point competitive
checklist and (2) entered into an approved interconnection agreement with 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 August 1997, the FCC denied the application of
Ameritech, the RBOC in three states where the Company operates, for in-region
long distance authority in Michigan. The Company anticipates that Ameritech
will file another application for Michigan in late 1997 and applications for
most or all of its other states--including Illinois and Ohio--in 1998. Other
RBOCs, including NYNEX in New York, are expected to file such applications in
1998. If the FCC determines that the RBOC's entry into in-region provision of
long distance in that state is in the public interest and that the RBOC has met
the 14-point checklist, it must authorize the RBOC to provide such services.
SBC Communications Inc., the parent of RBOCs in Oklahoma and other southwestern
states, filed a lawsuit in June 1997 challenging the constitutionality of
Section 271 and seeking to have it declared void. The Company cannot predict
the outcome of this litigation.
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;
nondiscriminatory access to unbundled network elements at just and reasonable
rates; non-discriminatory access to its poles, ducts, conduits, and rights-of-
way; unbundled local loop transmission, unbundled local transport, and
unbundled local switching; non-discriminatory access to 911 services; directory
assistance, operator call completion services, and white pages directory
listings for competing local carriers' customers; non-discriminatory access to
call routing databases; number portability (i.e., the ability of a customer to
keep the same telephone number when switching local telephone service
providers); dialing parity (i.e., the ability of customers of one telephone
service provider to call customers of other providers without dialing access
codes); reciprocal compensation arrangements for the termination of calls
between competing local networks; and permitting resale of its
telecommunications services.
The Telecommunications Act is intended to eliminate state and local statutory
and regulatory barriers to entry, thus accelerating the process of creating a
competitive environment in all markets. This preemption of state laws barring
local competition and the relaxation of regulatory restraints should enhance
the Company's ability to expand its service offerings nationwide. At the same
time, the Telecommunications Act will also substantially increase the
competition the Company will face in its various markets.
49
<PAGE>
The Telecommunications Act permits the Company, as a telecommunications
carrier with less than 5% of nationwide presubscribed access lines, to offer
single-source combined packages of local and long distance services. In
contrast, AT&T, MCI and Sprint may not bundle in an RBOC's territory their
local services resold from an RBOC and in-region long distance service until
the earlier of (i) February 8, 1999 or (ii) the date the RBOC is authorized to
enter the inter-LATA long distance market in that state.
Federal Regulation. The Telecommunications Act in some sections is self-
executing, but in most cases the FCC must issue regulations that identify
specific requirements before the Company and its competitors can proceed to
implement the changes the Telecommunications Act prescribes. The Company
actively monitors all pertinent FCC proceedings and has participated in some
of these proceedings. The FCC already has completed most of these rulemaking
proceedings. The outcome of these various ongoing FCC rulemaking proceedings
or judicial appeals of such proceedings could materially affect the Company's
operations.
In May 1997, the FCC issued new regulations regarding the implementation of
the universal service program and the assessment of access charges on carriers
retaining access to local exchange networks. All telecommunications carriers,
including the Company, that provide interstate services are required to
contribute, on an equitable and nondiscriminatory basis, to the preservation
and advancement of universal service pursuant to a universal service funding
mechanism established by the FCC. Both the access charge and universal service
regimes were substantially revised. As a result of these changes, the costs of
business and multiple residential telephone lines are expected to increase. In
addition, the new regulations require a reseller, such as the Company, to
begin contributing to the universal service programs for low-income consumers
and high-cost, rural and insular areas on the basis of the reseller's
interstate and international revenues. Several parties have appealed various
parts of the new FCC rules, including the revenue basis on which contributions
are determined. The Company is unable to predict the final formula for
universal service contribution or its own level of contribution.
The Telecommunications Act provides that individual state utility
commissions can, consistent with FCC regulations, prohibit resellers from
reselling a particular service to specific categories of customers to whom the
ILEC does not offer that service at retail. In August 1996, the FCC issued
detailed regulations providing that many such limitations are presumptively
unreasonable and that states may enact such prohibitions on resale only in
certain limited circumstances. In particular, the FCC concluded that while it
would be permissible to prohibit the resale of certain residential or other
subsidized services to end users that would be ineligible to receive such
services directly from the LEC, all other "cross-class" selling restrictions,
including those on volume discount and flat-rated offerings to business
customers, would be presumed unreasonable. An ILEC may rebut this presumption,
however, by demonstrating that the class restriction is reasonable and
nondiscriminatory. The FCC also rejected claims by several ILECs to provide
for several exceptions to the general resale obligation. For instance, it
refused to create a general exception for all promotional or discounted
offerings, including contract and customer-specific offerings. The FCC did,
however, conclude that short-term promotional prices (i.e., those offered for
90 days or less) are not "retail rates" and thus are not subject to the
wholesale rate obligation. ILECs may not offer consecutive 90-day promotions
to avoid these resale obligations.
The Telecommunications Act also provides that state commissions shall be
given an opportunity to determine the wholesale rates for local
telecommunications services (i.e., the rates charged by ILECs to resellers
such as the Company) on the basis of retail rates less "avoided costs," i.e.,
marketing, billing, collection and other administrative costs avoided by the
ILEC when it sells at wholesale. In August 1996 the FCC issued detailed
regulations establishing an interim default discount of 17% to 25%. Although
this portion of the FCC's rules has been overturned on appeal (see below), in
practice state commissions have generally adopted discount percentages that
fall within the 17-25% default range.
In August 1996, the FCC also issued regulations that, among other things,
set minimum standards governing the terms and prices of interconnection and
access to unbundled ILEC network elements. These regulations indirectly affect
the price at which the Company's new facilities-based competitors may
ultimately provide service. The Telecommunications Act provides that state
commissions shall determine the rates charged for such
50
<PAGE>
unbundled elements on the basis of cost plus a reasonable profit. The FCC
declined to issue detailed regulations governing the relationship between
these two pricing standards, leaving the interpretation and implementation of
the two standards to the states. The Company is unable to predict the final
form of such state regulation, or its potential impact on the Company or the
local exchange market in general. At the same time, the FCC imposed minimum
obligations regarding the duty of ILECs to negotiate interconnection or resale
arrangements in good faith.
A number of RBOCs, state regulatory commissions and other parties filed
requests for reconsideration by the FCC of various parts of the rules
announced by the FCC in August 1996, including those provisions (a) limiting
competitors' ability to purchase for resale certain types of service that the
RBOC is no longer marketing to new customers ("grandfathered services"), and
(b) establishing pricing methodologies and interim default rates for resold
services and unbundled network elements. The FCC is conducting a proceeding to
consider the various petitions for reconsideration, and a decision is expected
in 1997. In addition, many of the same parties and certain other parties filed
court appeals challenging the same FCC rules. In July 1997, the Eighth Circuit
Federal Court of Appeals struck down certain parts of the rules (including the
provisions establishing pricing methodologies and default rates for resold
services and unbundled network elements). The FCC is expected to appeal the
decision to the U.S. Supreme Court. The Company cannot predict at this time
the outcome of the appeals or reconsideration processes.
In August 1997, the FCC issued rules transferring responsibility for
administering and assigning local telephone numbers from the RBOCs and a few
other LECs to a neutral entity in each geographic region in the U.S. In August
1996, the FCC issued new numbering regulations that (a) prohibit states from
creating new area codes that could unfairly hinder LEC competitors (including
the Company) by requiring their customers to use 10 digit dialing while
existing ILEC customers use 7 digit dialing, and (b) prohibit ILECs (which are
still administering central office numbers pending selection of the neutral
administrator) from charging "code opening" fees to competitors (such as the
Company) unless they charge the same fee to all carriers including themselves.
In addition, each carrier is required to contribute to the cost of numbering
administration through a formula based on net telecommunications revenues. In
July 1996, the FCC released rules to permit both residential and business
consumers to retain their telephone numbers when switching from one local
service provider to another (known as "number portability"). RBOCs are
required to implement number portability in the top 100 markets by October 1,
1997 and to complete it by December 31, 1998. In smaller markets, RBOCs must
implement number portability within six months of a request therefore
commencing December 31, 1998. Other LECs are required to implement number
portability by October 31, 1997 only in those of the top 100 markets where the
feature is requested by another LEC. Non-RBOC LECs are not required to
implement number portability in any additional markets until December 31,
1998, and then only in markets where the feature is requested by another LEC.
The Company already offers number portability as it provides local service
obtained from the incumbent RBOCS. This allows customers to switch to the
Company's services and still retain their existing telephone numbers.
In addition, the FCC recently authorized cellular and other CMRS to provide
for other wireless services to fixed locations (rather than to mobile
customers), including offering wireless local loop service, in whatever
capacity such provider determines. Previously, many CMRS providers could
provide fixed services on only an ancillary or incidental basis. In addition,
in August 1996 the FCC promulgated regulations that classify CMRS providers as
telecommunications carriers, thus giving them the same rights to
interconnection and reciprocal compensation under the Telecommunications Act
as other non-LEC telecommunications carriers, including the Company.
State Regulation. Historically, certain of the Company's resold local and
long distance services 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
51
<PAGE>
impose their own regulation of local exchange services so long as such
regulation is not inconsistent with the requirements of the Telecommunications
Act. In all states where certification is required, the Company's operating
subsidiaries are certificated as common carriers. In all states, the Company
believes that it operates with the appropriate state regulatory authorization.
The Company currently is authorized to provide intrastate toll or a
combination of local and intrastate toll service in more than 40 states. These
authorizations vary in the scope of the intrastate services permitted.
The Telecommunications Act provides that the Company's resale agreements
must be submitted to the applicable state utility commission for approval, and
it places strict limitations on the bases on which a state commission can
reject such an agreement. If the state commission does not act within 90 days
after the agreement is submitted for approval, then the agreement is deemed
approved. In addition, if a state commission fails to act to enforce an
agreement, the FCC can (upon request of a party) take jurisdiction over the
matter. A state commission's decisions regarding implementation and
enforcement of an agreement are appealable to the federal district court in
that state.
PROPERTIES
The Company leases twenty-seven facilities, principally sales facilities, in
Boston, Massachusetts, Chicago, Illinois, Detroit, Michigan, Cleveland and
Columbus, Ohio and New York City, as well as in a number of areas surrounding
such cities and in other significant urban areas in Michigan, New York and
Ohio. The Company maintains its corporate headquarters in Chicago, Illinois.
Although the Company's facilities are adequate at this time, the Company
believes that it will be required to lease additional facilities, particularly
in new metropolitan areas where the Company enters RBOC resale agreements.
EMPLOYEES
As of June 30, 1997, the Company employed 766 people. The Company's
employees are not unionized, and the Company believes its relations with its
employees are good. In connection with its marketing and sales efforts and the
conduct of its other business operations, the Company uses third party
contractors, some of whose employees may be represented by unions or
collective bargaining agreements. The Company believes that its success will
depend in part on its ability to attract and retain highly qualified
employees.
LEGAL MATTERS
From time to time the Company is party to routine litigation and proceedings
in the ordinary course of its business. The Company and its subsidiaries are
not aware of any current or pending litigation that the Company believes would
have a material adverse effect on the Company's results of operations or
financial condition. The Company and its subsidiaries continue to participate
in regulatory proceedings before the FCC and state regulatory agencies
concerning the authorization of services and the adoption of new regulations.
52
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table provides certain information regarding the executive
officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITIONS
---- --- ---------
<S> <C> <C>
Richard J. Brekka....... 36 Chairman of the Board
J. Thomas Elliott....... 50 President, Chief Executive Officer and Director
Dennis B. Dundon........ 52 Chief Operating Officer
Ronald W. Gavillet...... 38 Executive Vice President, Strategy & External Affairs
Gerald J. Sweas......... 49 Executive Vice President and Chief Financial Officer
Ryan Mullaney........... 41 Executive Vice President, Sales
Steven J. Parrish....... 41 Executive Vice President, Operations
Thomas A. Monson........ 37 Vice President, General Counsel and Secretary
Thad J. Pellino......... 35 Vice President, Marketing
Neil A. Bethke.......... 37 Vice President, Information Systems
Ellen C. Craig.......... 59 Vice President, Regulatory Affairs
Lane Foster............. 53 Vice President, Human Resources and Organizational Development
Thomas C. Brandenburg... 61 Director
Dean M. Greenwood....... 54 Director
Donald J. Hofmann, Jr... 39 Director
William A. Johnston..... 45 Director
Ian Kidson.............. 38 Director
Paul S. Lattanzio....... 33 Director
Eugene A. Sekulow....... 66 Director
</TABLE>
Each director serves until his successor is duly elected and qualified.
Officers serve at the discretion of the Board of Directors.
Richard J. Brekka, Chairman of the Board, has been a director of the Company
since April 1994. Mr. Brekka is a Managing Partner of MW&I Partners, a
merchant banking fund, and has formed Dolphin Communications, L.L.C. to make
communications investments in the United States. From 1992 to 1996, he was a
Managing Director of CIBC Wood Gundy Capital ("CIBC"), the merchant banking
division of Canadian Imperial Bank of Commerce, and a director and the
President of CIBC Wood Gundy Ventures, Inc., an indirect wholly owned
subsidiary of Canadian Imperial Bank of Commerce. Mr. Brekka joined CIBC in
February 1992. Currently, Mr. Brekka serves on the board of directors of Orion
Network Systems, Inc., Telesystem International Wireless Inc., and Epoch
Internet. Mr. Brekka received a B.S. degree in finance from the University of
Southern California, and an M.B.A. degree from the University of Chicago.
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 B.A. and M.A. degrees in economics from the University of Windsor.
Dennis B. Dundon, Chief Operating Officer, joined the Company in April 1997.
From 1991 to 1996, Mr. Dundon served as president and chief executive officer
of EMI Communications Corp. ("EMI"), a regional telecommunications company,
until EMI was acquired by Intermedia Communications, Inc. From June 1996 to
March 1997, Mr. Dundon served as Senior Vice President of Intermedia, a CLEC.
From 1988 to 1991, Mr. Dundon was President and owner of DBD Associates, Inc.,
a consulting firm providing services to the telecommunications sector. Mr.
Dundon is a past Chairman and Director of the Competitive Telecommunications
Association. Mr. Dundon holds a B.S. degree from Clarkson University and an
M.B.A. degree from the University of Rochester.
53
<PAGE>
Ronald W. Gavillet, Executive Vice President, Strategy & External Affairs,
has performed the Company's legal, regulatory and strategic functions since
1994. Prior to joining the Company, Mr. Gavillet spent more than four years,
from 1985 to 1987 and from 1992 to 1994, with MCI in a number of senior legal
and regulatory positions. Between these periods at MCI, Mr. Gavillet was in
private law practice representing competitive carriers such as Teleport
Communication Group, Inc., Centex Telemanagement Inc., Centel Corp., Sprint
Corp. and Telesphere Communications Inc. Mr. Gavillet holds B.A. and B.S.
degrees from Southern Illinois University, a J.D. degree from Catholic
University of America's Columbus School of Law and a Master of Management
degree from Northwestern University's Kellogg School of Management and serves
on the Telecommunications Resellers Association Local Services Council.
Gerald J. Sweas, Executive Vice President and Chief Financial Officer,
joined the Company in November 1996. From 1989 to 1996, Mr. Sweas was Vice
President Finance and Administration, Treasurer and Chief Financial Officer of
Norand Corporation, a wireless data communication networks company. Mr. Sweas
holds a B.B.A. degree from Loyola University in Chicago, Illinois and an
M.B.A. degree from the University of Wisconsin (Madison) and is a Certified
Public Accountant.
Ryan Mullaney, Executive Vice President, Sales, joined the Company in
October 1996. From 1995 to 1996, Mr. Mullaney served as Vice President, Sales,
USA West for Citizens Telecom, a medium-sized telecommunications company,
where he managed sales in 13 states. From 1993 to 1995, Mr. Mullaney was
Director of Member Development for McLeod Telemanagement Organization, where
his duties included management of the company's field sales and service
organization. From 1991 to 1993, Mr. Mullaney was National Sales Director of
Centex Telemanagement, responsible for developing sales in the national
market. Mr. Mullaney has a B.A. degree from the University of Nevada, Las
Vegas.
Steven J. Parrish, Executive Vice President, Operations, joined the Company
in January 1996 initially as a consultant and assumed a full-time position.
Prior to joining the Company, Mr. Parrish spent more than 12 years with
Illinois Bell in various planning and operations positions. Mr. Parrish moved
to Ameritech in 1991 where he helped start the Information Industry Services
business unit as Vice President of Business Development and Vice President of
Marketing and Sales for Network Providers. Mr. Parrish holds a bachelor's
degree in electrical engineering from the University of Illinois and an M.B.A.
degree from the Illinois Institute of Technology.
Thomas A. Monson, Vice President, General Counsel and Secretary, joined the
Company in January 1997. From 1989 to 1996, Mr. Monson was Associate General
Counsel of Envirodyne Industries, Inc., a $650 million public company, where
he performed various corporate law, securities regulation, litigation and
corporate operations support activities. Mr. Monson holds a B.S. degree from
the University of Illinois and a J.D. degree from Harvard Law School.
Thad J. Pellino, Vice President, Marketing, joined the Company in August
1995. From 1988 through 1995, Mr. Pellino was with MCI where he held a variety
of marketing and business development positions, which included responsibility
for the design of customized telecommunication packages for mid-size and long
distance carriers. Mr. Pellino received his bachelor's degree in
marketing/business administration from the University of Illinois.
Neil A. Bethke, Vice President, Information Systems, joined the Company
initially as a consultant in 1995 and assumed a full-time position in May
1996. From 1994 to 1996 Mr. Bethke served as principal for New Resources
Corporation, a medium-sized consulting company specializing in client/server
technology development for large service-oriented companies. From 1988 to
1994, Mr. Bethke served at Quantum Chemical Corporation and Sara Lee
Corporation as Director of MIS, responsible for the reengineering of business
processes through document routing and wide area network database management.
Mr. Bethke holds a B.S. degree from the University of Wisconsin.
Ellen C. Craig, Vice President, Regulatory Affairs, joined the Company in
April 1997. From 1994 to 1997, Ms. Craig served as a consultant to investment
banking and telecommunications companies on domestic
54
<PAGE>
and international utilities and telecommunications issues. From 1989 to 1994,
Ms. Craig served as Chairman and Commissioner of the Illinois Commerce
Commission. She holds a B.A. degree from Cardinal Cushing College and a J.D.
degree from The John Marshall Law School.
Lane Foster, Vice President, Human Resources and Organizational Development,
joined the Company in May 1997. From 1991 to 1996, Mr. Foster served as
Director of Human Resources and Corporate Real Estate for Nextel
Communications, a telecommunications company. From 1980 to 1991, Mr. Foster
served as Director of Human Resources for MCI Telecommunications. Mr. Foster
attended the University of North Dakota and graduated from the University of
Southern California--Center for Telecommunications Senior Leadership Program.
Thomas C. Brandenburg, Director, has been a director of the Company since
founding the Company in 1994. Prior to joining the Company, Mr. Brandenburg
was the co-founder and principal of a telecommunications consulting firm with
a service bureau-based enhanced service company. In 1983, Mr. Brandenburg was
the co-founder and principal of LiTel Communications, Inc. (now LCI
International). Mr. Brandenburg holds a B.A. degree from the University of
Notre Dame.
Dean M. Greenwood, Director, was elected as a director of the Company in
February 1997. Mr. Greenwood is Vice President of Prime Management Group and
has been an officer of that company since 1992. Mr. Greenwood is also a
Managing Director of Prime New Ventures. Mr. Greenwood holds a B.B.A. degree
and a J.D. degree from the University of Texas at Austin.
Donald J. Hofmann, Jr., Director, has been a director of the Company since
April 1994. Mr. Hofmann has been a General Partner of Chase Capital Partners
(formerly known as Chemical Venture Partners) since 1992. Chase Capital
Partners is the sole general partner of Chase Venture Capital Associates, L.P.
Prior to joining Chase Capital Partners, he was head of MH Capital Partners,
Inc., the equity investment arm of Manufacturers Hanover. Mr. Hofmann holds a
B.B.A. degree from Hofstra University and an M.B.A. degree from Harvard
Business School.
William A. Johnston, Director, was elected a director of the Company in June
1994. Mr. Johnston has been a Managing Director of 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 Holdings, Inc., Epoch Internet,
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
B.A. degree from Colgate University and an M.A. degree from Syracuse
University School of Management.
Ian M. Kidson, Director, has served as a director of the Company since April
1997. Mr. Kidson is a Managing Director of CIBC Wood Gundy Capital, the
merchant banking division of the Canadian Imperial Bank of Commerce. He joined
CIBC in 1984. Currently, Mr. Kidson serves on the board of directors of
Centennial Security Holdings, Inc. and JBK Arena Co. Mr. Kidson received a
B.S.C. degree and an M.B.A. degree from McMaster University.
Paul S. Lattanzio, Director, was appointed a director of the Company in
August 1995. 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.
Currently, Mr. Lattanzio serves on the board of directors of Administaff,
Inc., an employee leasing company. Mr. Lattanzio received his B.S. degree 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
55
<PAGE>
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. degree in political science and economics and a Ph.D. degree
from Johns Hopkins University.
COMMITTEES OF THE BOARD OF DIRECTORS
The Company has established an Audit Committee, a Finance Committee and a
Compensation Committee. Each of these committees is responsible to the full
Board of Directors, and their activities are therefore subject to approval of
the Board of Directors. The functions performed by these committees are
summarized below.
The Audit Committee consists of Messrs. Hofmann, Greenwood and Sekulow. The
Audit Committee is responsible for reviewing the internal accounting controls
of the Company, meeting and conferring with the Company's certified public
accountants and reviewing the results of the accountants' auditing engagement.
The Finance Committee consists of Messrs. Brekka, Elliott, Hofmann, Johnston
and Lattanzio. The Finance Committee is responsible for evaluating the
Company's capital requirements and overseeing the Company's efforts at meeting
its financial needs through capital markets transactions.
The Compensation Committee consists of Messrs. Brekka, Johnston and
Lattanzio. The Compensation Committee establishes compensation and benefits
for the Company's senior executives. The Committee also determines the number
and terms of stock options granted to employees, directors and consultants of
the Company under the Company's stock option plans.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company's Compensation Committee consists of Messrs. Brekka, Johnston
and Lattanzio, none of whom is currently an employee or officer of the
Company. No executive officer of the Company served during fiscal year 1996 as
a member of a compensation committee or as a director of any entity of which
any of the Company's directors serves as an executive officer.
56
<PAGE>
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information concerning the cash and
non-cash compensation during fiscal year 1996 earned by or awarded to the
Chief Executive Officer, the former Chief Executive Officer and the five other
most highly compensated executive officers of the Company whose combined
salary and bonus exceeded $100,000 during the fiscal year ended December 31,
1996 (the "Named Executive Officers").
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION
---------------- ALL OTHER
YEAR SALARY BONUS COMPENSATION
---- -------- ------- ------------
<S> <C> <C> <C> <C>
J. Thomas Elliott..................... 1996 $182,500 $97,500(1) --
President and Chief Executive Officer 1995(2) 139,165 -- $75,000
1994 -- -- --
Ronald W. Gavillet.................... 1996 167,600 92,500(1) --
Executive Vice President, Strategy 1995 135,000 50,000(3) --
& External Affairs 1994(4) 7,788 -- --
Thad J. Pellino....................... 1996 96,700 33,000(1) --
Vice President, Marketing 1995(5) 31,058 33,125(5) --
1994 -- -- --
Neil A. Bethke........................ 1996(6) 69,711 31,250(1) --
Vice President, Information Systems 1995 -- -- --
1994 -- -- --
Thomas C. Brandenburg................. 1996 190,000 -- --
Former Chief Executive Officer 1995 167,692 -- --
1994 174,615 -- --
Robert J. Luth........................ 1996 150,000 -- 50,000(7)
Former Chief Financial Officer 1995 141,635 37,500(3) 69,806(7)
1994 89,170 -- --
Kevin J. Burke........................ 1996 101,000 -- --
Former Vice President, Network
Engineering 1995 123,808 -- --
and Technical Support 1994 -- -- --
</TABLE>
- --------
(1) Represents the bonus that was earned with respect to 1996 and paid in
1997.
(2) Includes Mr. Elliott's compensation as an officer of Quest America, LP
prior to the acquisition of its business by the Company. The $75,000
included as other compensation represents the amount Mr. Elliott received
for consulting service to the Company prior to the Company's acquisition
of the business of Quest America, LP.
(3) Represents amounts paid in 1996 with respect to bonuses earned in prior
periods, primarily in 1995.
(4) Mr. Gavillet commenced employment with the Company in November 1994.
(5) Mr. Pellino commenced employment with the Company in August 1995.
(6) Mr. Bethke commenced employment with the Company in June 1996.
(7) Includes amounts reimbursed by the Company for life and disability
insurance premiums and temporary living expenses.
57
<PAGE>
OPTION GRANTS
The following table sets forth the aggregate number of post-split stock
options granted to each of the Named Executive Officers during the fiscal year
ended December 31, 1996. Options are exercisable for Class A Common Stock, par
value $.01 per share, of the Company.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATE OF STOCK
NUMBER OF PERCENT OF PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM (1)
OPTIONS EMPLOYEES IN PRICE EXPIRATION --------------------
NAME GRANTED(#) FISCAL YEAR ($/SHARE) DATE 5% 10%
---- ---------- ------------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
J. Thomas Elliott....... 75,000 7.3% $0.15 6/28/06 $ 988,500 $1,473,750
299,250 29.0% 0.15 9/30/06 3,944,115 5,880,263
Ronald W. Gavillet...... 61,500 6.0% 0.15 6/28/06 810,570 1,208,475
218,590 21.2% 0.15 9/30/06 2,881,016 4,295,294
Thad J. Pellino......... 20,000 1.9% 0.15 6/28/06 263,600 393,000
14,940 1.4% 0.15 9/30/06 196,909 293,571
Neil A. Bethke.......... 20,000 1.9% 0.15 6/28/06 263,600 393,000
14,940 1.4% 0.15 9/30/06 196,909 293,571
</TABLE>
- --------
(1) The information disclosed assumes, solely for purposes of demonstrating
potential realizable value of the options, that the per share fair market
value of the Class A Common Stock is $8.80 per share as of August 31, 1997
and increases at the rate indicated, effective as of December 31 of each
subsequent full calendar year during the option term. However, there is no
established trading market for the Class A Common Stock, and no
representation is made that the Class A Common Stock actually has such
value or that the rates of increase in value can or will be achieved.
The following table sets forth certain information concerning the exercise
of post-split stock options by the Named Executive Officers during the fiscal
year ended December 31, 1996 and the December 31, 1996 aggregate value of
unexercised options held by each of the Named Executive Officers.
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES(1)
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY OPTIONS
UNEXERCISED OPTIONS AT AT FISCAL
SHARES FISCAL YEAR-END (#) YEAR-END ($)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ----------- ----------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
J. Thomas Elliott....... -- -- 18,750/355,500 177,188/3,359,475
Ronald W. Gavillet...... -- -- 53,880/264,710 510,706/2,501,510
Thad J. Pellino......... -- -- 5,000/ 29,940 47,250/ 282,933
Neil A. Bethke.......... -- -- 5,000/ 29,940 47,250/ 282,933
Robert J. Luth.......... 20,000 189,000 18,500/ 0 175,565/ 0
</TABLE>
- --------
(1) The information disclosed assumes, solely for purposes of illustrating the
value of in-the-money options, that the per share fair market value of the
Class A Common Stock is $96.00 (on a pre-split basis) 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.
58
<PAGE>
BENEFIT PLANS
1994 Amended and Restated Stock Option Plan
In September 1996, the Board of Directors adopted, and the stockholders
approved, the amended and restated 1994 Stock Option Plan (the "1994 Plan"),
which was originally adopted by the Board of Directors and subsequently
approved by the stockholders in September 1994. A total of 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 Messrs.
Sweas, Mullaney and Monson in connection with their employment agreements
become exercisable with respect to 50% on the one-year anniversary of the date
of grant and with respect to 25% on the 18-month and 24-month anniversaries of
the date of grant. The maximum term of a stock option under the 1994 Plan is
ten years. If an optionee terminates his or her service for reasons other than
death, disability, retirement, resignation or discharge for cause, the
optionee may exercise only those option shares vested as of the date of
termination. If, however, an optionee retires without prior Board of Directors
approval or is terminated for cause, all options previously not exercised
expire and are forfeited. In addition, the Company has the option to
repurchase all or any part of the shares issued or issuable upon exercise, if
an optionee's employment terminates for any reason whatsoever. Options are
subject to adjustment under certain circumstances.
The 1994 Plan may be amended at any time by the Board of Directors, although
certain amendments require the consent of the participants of the 1994 Plan.
The 1994 Plan will terminate in September 2004, unless earlier terminated by
the Board of Directors.
1996 Option Grants Outside of the 1994 Stock Option Plan
In connection with the issuance of the 9% Preferred Stock and the
consummation of the 1996 Private Placement, Messrs. Elliott, Gavillet,
Parrish, Pellino and Bethke were granted 18,234, 11,996, 600, 312 and 312
additional options, respectively, and certain other employees were granted a
total of 1,111 additional options, to purchase a corresponding number of
shares of Class A Common Stock at an exercise price of $1.50 per share. Such
options are exercisable only upon conversion from time to time of the 9%
Preferred Stock, in the case of all such employees, or, as the case may be,
with respect to Messrs. Elliott and Gavillet, of the Convertible Notes, into
shares of Class A Common Stock.
Omnibus Securities Plan
In August 1997, the Board of Directors adopted and the shareholders approved
the Omnibus Securities Plan of USN Communications, Inc. (the "Omnibus
Securities Plan"). A total of 2,750,000 shares have been reserved for issuance
under the Omnibus Securities Plan. The purpose of the Omnibus Securities Plan
is to benefit the Company's stockholders by encouraging high levels of
performance by individuals whose performance is a key element in achieving the
Company's continued success, and to enable the Company to recruit, reward,
retain and motivate employees for the benefit of the Company and its
stockholders. Under the Omnibus Securities Plan, the Company may grant
incentive or non-qualified stock options, stock appreciation rights,
restricted stock awards, performance awards and other stock based awards.
Employees of the Company and its subsidiaries and non-employee directors of
the Company are eligible to participate in the Omnibus Securities Plan. The
Omnibus Securities Plan is administered by the Compensation Committee, which
determines, among other things, the terms and recipients of the awards. The
Omnibus Securities Plan may be amended by the Board of Directors,
59
<PAGE>
although certain amendments require the consent of the participants. The
Omnibus Securities Plan will terminate in 2007 unless earlier terminated by the
Board of Directors.
In September 1997, the Compensation Committee authorized the grant of stock
options to substantially all non-executive officer employees of the Company or
its subsidiaries. These options have an exercise price of $8.80 per share, with
one-third of the options vesting on the earlier of the completion of a
qualified public offering of the Company's Class A Common Stock or the first
anniversary of the date of grant, and with an additional one-third of the
options vesting on each of the two anniversaries following the initial vesting
date. These options cover a total of 958,500 shares. In addition, in September
1997, the Compensation Committee authorized the grant of options for a total of
1,037,000 shares of Class A Common Stock to its 11 executive officers. These
options also have an exercise price of $8.80 per share.
401(k) Plan
In January 1995, the Company adopted the Employee 401(k) Profit Sharing Plan
(the "401(k) Plan") covering all of the Company's employees. Pursuant to the
401(k) Plan, employees may elect to reduce their current compensation by up to
the lesser of 15% of eligible compensation or the statutorily prescribed annual
limit ($9,500 in 1996) and have the amount of such reduction contributed to the
401(k) Plan. The 401(k) Plan permits, but does not require, additional
contributions to the 401(k) Plan by the Company on behalf of all participants.
The Company has not made any contributions to date. The 401(k) Plan is intended
to qualify under Section 401 of the Internal Revenue Code of 1986, as amended,
so that contributions by employees or by the Company to the 401(k) Plan, and
income earned on plan contributions, are not taxable to employees until
withdrawn, and contributions by the Company, if any, will be deductible by the
Company when made.
EMPLOYMENT AGREEMENTS
All of the Company's executive officers have entered into employment
agreements with the Company. Each agreement provides for an initial term of two
or three years and automatic one-year renewals, and sets forth a base salary
and target annual bonus. The annual base salaries for Messrs. Elliott, Dundon,
Gavillet, Sweas, Mullaney and Parrish are $195,000, $185,000, $185,000,
$150,000, $125,000 and $140,000, respectively. Each agreement provides that the
executive shall receive certain payments in the event his or her employment is
terminated other than for cause, including but not limited to all amounts
earned, accrued and owing to the executive and certain severance payments. In
addition, each agreement contains noncompetition and nonsolicitation
provisions.
The employment agreements also provide that, in the event of a Change of
Control, the options held by the executive shall become exercisable and any
restrictions on such options shall lapse. Upon a Change of Control, the Company
shall pay to each of Messrs. Elliott, Gavillet and Sweas, within the 10-day
period following such Change of Control, an amount equal to the pro rata
portion 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.
Mr. Elliott's and Mr. Gavillet's agreements provide for certain anti-dilution
rights with respect to their ownership of common stock, including the right, in
the event the Company sells shares of any class of stock, to purchase a certain
percentage (3.8% for Mr. Elliott and 2.5% for Mr. Gavillet) of such shares on
the same terms and conditions as the shares being sold. In addition, their
agreements provide that if the current stockholders sell any of their shares of
capital stock of the Company to a third party under certain circumstances, each
of Messrs. Elliott and Gavillet has a right to sell the same percentage of his
shares of capital stock as the percentage of shares that the current
stockholders are selling, on the same terms and for the same consideration.
60
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with the Offering, the Company issued and sold 302,090 shares
of Series A Preferred Stock for an aggregate purchase price of $30.2 million.
This new equity was purchased by existing Company stockholders and affiliates
of certain existing stockholders. Also in connection with the Offering, the
Company paid a consent fee to MLAM consisting of the Consent Warrants and an
option to purchase up to $10 million of Consent Convertible Notes.
The Original Purchasers, by requisite vote, waived certain preemptive rights
and registration rights in connection with the Offering and the Consent.
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 MLGAFI pursuant to the 1996 Private Placement. BT
Securities Corporation, Chase Securities Inc. and CIBC Wood Gundy Securities
Corp. are affiliates of BT Capital Partners, Inc., Chase Venture Capital
Associates, L.P. and CIBC Wood Gundy Ventures, Inc., respectively, which are
stockholders of the Company. See "Stock Ownership." BT Securities Corporation,
Chase Securities Inc. and CIBC Wood Gundy Securities Corp., each received
commissions of approximately $188,000 of the $1.9 million in connection with
the 1996 Private Placement.
MLGAFI, an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated,
one of the Initial Purchasers, purchased all of the 14% Senior Notes, the
related warrants and the Convertible Notes issued pursuant to the 1996 Private
Placement, and in connection with the Offering, was granted the Consent
Warrants and an option to purchase the Consent Convertible Notes.
In September 1996, in connection with the 1996 Private Placement, the
Certificate of Incorporation of the Company was amended to provide for the
authorization of two classes of common stock, Class A Common Stock and Class B
Common Stock. 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 1996 Private Placement was converted into one share of Class A Common
Stock. See "Description of Capital Stock--Common Stock."
In connection with the 1996 Private Placement, by requisite vote, the
Original Purchasers waived certain preemptive rights and registration rights
held by them. The Original Purchasers also approved, and the Company took all
necessary action to effect prior to the consummation of the 1996 Private
Placement, the amendment of the terms of the 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 1996 Private Placement, the Original Purchasers
purchased from the Company shares of its 9% Preferred Stock for an aggregate
purchase price of $10 million. For a description of certain of the terms of
the 9% Preferred Stock, see "Description of Capital Stock--Preferred Stock."
In March 1996, the Company effected a recapitalization pursuant to which the
Company issued an aggregate of 1,101,570 shares of Common Stock (which was
converted to Class A Common Stock in September 1996) to the Original
Purchasers for no consideration in order to settle a dispute relating to the
price per share of the Common Stock paid by the Original Purchasers for Common
Stock purchased in 1995. The dispute stemmed from, in part, the Company's
operating performance as compared with the operating performance projected by
the Company at the time of such investment. As part of the recapitalization,
the Company also caused its then-existing Series A-2 Preferred Stock to be
senior to the Series A Preferred Stock with respect to redemption, dividends
and liquidation in further settlement of the dispute referred to above.
In December 1995, Mr. J. Thomas Elliott, President and Chief Executive
Officer of the Company, executed an interest-free promissory note in favor of
the Company in the principal amount of $75,000. Such promissory note was
originally payable by January 2, 1997, but such date has been extended to a
date as yet undetermined.
61
<PAGE>
STOCK OWNERSHIP
The following table sets forth as of September 30, 1997, the number of
shares of Class A Common Stock and the percentage of the outstanding shares of
such class that are beneficially owned by (i) each person that is the
beneficial owner of more than 5% of the outstanding shares of Class A Common
Stock, (ii) each of the directors and the Named Executive Officers of the
Company and (iii) all of the current directors and executive officers of the
Company as a group.
<TABLE>
<CAPTION>
CLASS A
COMMON STOCK
---------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER(1) SHARES OWNED OF CLASS
- --------------------------------------- ------------ --------
<S> <C> <C>
Merrill Lynch Global Allocation Fund, Inc. (2)........... 3,828,635 34.68
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Harbourvest Partners, LLC................................ 3,442,373 37.82
One Financial Center, 44th Floor
New York, New York 10017-3903
Chase Venture Capital Associates, L.P. (3)............... 2,309,717 29.05
380 Madison Ave., 12th Floor
New York, New York 10017-2070
CIBC Wood Gundy Ventures, Inc. (3)....................... 2,309,717 29.05
425 Lexington Avenue
New York, New York 10017-3903
BT Capital Partners, Inc. (3)............................ 1,710,566 22.05
130 Liberty Street
New York, New York 10017-2070
Prime New Ventures....................................... 596,680 7.70
600 Congress Suite 3000
One American Center
Austin, Texas 78701
Richard J. Brekka........................................ -- --
J. Thomas Elliott (4).................................... 205,955 2.82
Ronald W. Gavillet (4)................................... 118,565 1.62
Thomas C. Brandenburg.................................... 109,082 1.51
Robert J. Luth........................................... 38,500 *
Dean M. Greenwood (5)....................................
Donald J. Hofmann, Jr. (5)............................... 2,309,717 24.26
William A. Johnston (5)..................................
Ian M. Kidson(5)......................................... 2,309,717 24.26
Paul S. Lattanzio........................................ -- --
Eugene A. Sekulow........................................ -- --
All directors and executive officers of the Company as a
group (19 persons)...................................... 12,993,669 87.19
</TABLE>
- --------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
Commission and includes voting and investment power with respect to the
shares. As to each stockholder, the percentage ownership is calculated by
dividing (i) the sum of the number of shares of Class A Common Stock owned
by such stockholder plus the number of shares of Class A Common Stock that
such stockholder would receive upon the exercise of currently exercisable
options and warrants or the conversion of convertible securities held by
such stockholder (the "Conversion Shares") by (ii) the sum of the total
number of outstanding shares of Class A Common Stock plus the total number
of such stockholder's Conversion Shares. See also "Risk Factors--Control
by Existing Stockholders; Certain Antitakeover Matters" for a description
of certain circumstances under which MLGAFI may receive additional equity
and equity-related securities of the Company.
(2) Represents Conversion Shares. Also, Merrill Lynch Global Allocation Fund,
Inc. is entitled to receive additional warrants to purchase common stock
under certain circumstances pursuant to the 14% Senior Note Indenture and
the Convertible Note Indenture.
(3) Chase Venture Capital Associates, L.P., CIBC Wood Gundy Ventures, Inc.,
and BT Capital Partners, Inc. are affiliates of Chase Manhattan
Corporation, Canadian Imperial Bank of Commerce, and Bankers Trust New
York Corporation, respectively.
(4) These shares include exercisable options.
(5) Each director disclaims beneficial ownership of any shares of Common Stock
or Preferred Stock which he does not directly own.
62
<PAGE>
DESCRIPTION OF THE NOTES
GENERAL
The Old Notes were and the New Notes will be issued under the Indenture. For
purposes of this Description of the Notes, the term "Company" refers to USN
Communications, Inc. and does not include its subsidiaries except for purposes
of financial data determined on a consolidated basis.
The terms of the Notes include those stated in the Indenture and those made
a part of the Indenture by reference to the Trust Indenture Act of 1939 as in
effect on the date of the Indenture (the "Trust Indenture Act"). The following
summaries of certain provisions of the Indenture do not purport to be complete
and are subject to, and are qualified in their entirety by reference to, the
provisions of the Indenture. The Notes are subject to all such terms, and
holders of the Notes are referred to the Indenture and the Trust Indenture Act
for a complete statement of such terms. Copies of the Indenture are available
from the Company on request. The statements and definitions of terms under
this caption relating to the Notes and the Indenture are summaries and do not
purport to be complete. Such summaries make use of certain terms defined in
the Indenture and are qualified in their entirety by express reference to the
Indenture. Certain terms used herein are defined below under "--Certain
Definitions."
The Old Notes are and the New Notes will be senior unsecured obligations of
the Company, limited in aggregate principal amount at Stated Maturity to
$152,725,000. In addition, the Indenture permits the issuance of the
Additional Notes in connection with the exercise of the Consent Exchange
Option. Under no circumstances will the aggregate principal amount of Notes
that may be issued under the Indenture be increased. The Notes will rank pari
passu in right of payment with all existing and future senior unsecured
indebtedness of the Company, including the 14% Senior Notes, and will be
senior in right of payment to all existing and future subordinated
indebtedness of the Company, including the Convertible Notes and, if issued,
the Consent Convertible Notes. The Notes are effectively subordinated to all
secured indebtedness of the Company to the extent of the assets securing such
indebtedness (including up to $30 million of indebtedness under a Credit
Facility permitted by the Indenture and the 14% Senior Note Indenture). The
Company's Subsidiaries have no direct obligation to pay amounts due on the
Notes and did not and will not guarantee the Notes on their Issue Dates;
however, if a Restricted Subsidiary guarantees any Indebtedness of the
Company, such Restricted Subsidiary will be obligated to guarantee the Notes
on a senior basis. See "--Certain Covenants--Limitation on Issuances of
Guarantees by Restricted Subsidiaries." As a result, the Notes effectively are
subordinated to all existing and future third-party indebtedness and other
liabilities of the Company's Subsidiaries (including trade payables). As of
August 31, 1997, the total outstanding indebtedness and other liabilities
(including trade payables and other non-debt obligations) of the Company that
ranked pari passu in right of payment with the Notes was approximately $34.2
million. As of August 31, 1997, the total liabilities (including trade
payables and other non-debt obligations) of the Company's Subsidiaries on a
combined consolidated basis (after the elimination of loans and advances by
the Company) were approximately $21.1 million. Of that amount, approximately
$0.7 million in long-term indebtedness was secured by Liens on the assets of
the borrowing Subsidiaries.
The operations of the Company are conducted in large part through its
Subsidiaries and, therefore, the Company is dependent upon cash flow from
those entities to meet its obligations. Any rights (other than claims based
upon valid pari passu loans and advances made by the Company) of the Company
and its creditors, including the holders of Notes, to participate in the
distribution of the assets of any of the Company's Subsidiaries upon any
liquidation or reorganization of any such Subsidiary will be subject to the
prior claims of that Subsidiary's creditors (including trade creditors).
Accordingly, the Company anticipates that the primary source of cash to pay
the Company's obligations under the Notes will be derived from the operations
of the Restricted Subsidiaries. The Indenture permits under limited
circumstances the creation of, or the designation of existing Restricted
Subsidiaries as, Unrestricted Subsidiaries. Such Unrestricted Subsidiaries
will not generally
63
<PAGE>
be subject to the covenants applicable to the Company and the Restricted
Subsidiaries. See "Risk Factors--Substantial Leverage," "--Future Cash
Obligations" and "--Holding Company Structure; Source of Repayment of Notes;
Effective Subordination of Notes to Indebtedness of Subsidiaries."
The Old Notes have been designated for trading in the PORTAL Market.
PRINCIPAL, MATURITY AND INTEREST
The Notes are limited in aggregate principal amount at Stated Maturity to
$152,725,000 and will mature on August 15, 2004. The Notes will accrete
interest at the rate of 14 5/8% per annum, compounded semiannually, to an
aggregate principal amount of $152,725,000 by August 15, 2000. Although for
U.S. federal income tax purposes, a significant amount of original issue
discount, taxable as ordinary income, will be recognized by a holder as such
discount accrues from the Issue Date of the Old Notes, no interest will be
payable on the Notes prior to February 15, 2001. See "Certain Federal Income
Tax Considerations--Taxation of the Notes--Original Issue Discount." From and
after August 15, 2000, interest on the Notes will accrue at the rate of 14
5/8% per annum which will be payable in cash semiannually on February 15 and
August 15, commencing February 15, 2001, to the holders of record of Notes at
the close of business on the January 31 and July 31 immediately preceding such
interest payment date. Interest on the Notes will accrue from the most recent
date to which interest has been paid or, if no interest has been paid, from
August 15, 2000. Interest will be computed on the basis of a 360-day year
comprised of twelve 30-day months.
If the Company does not comply with certain deadlines set forth in the
Registration Rights Agreement with respect to the conduct of the Exchange
Offer or the registration of the Notes for resale under a shelf registration
statement, holders of the Notes will be entitled to Special Interest. See
"Registration Rights."
Principal of, premium, if any, and interest and Special Interest, if any, on
the Notes will be payable, and the Notes may be presented for registration of
transfer or exchange, at the office or agency of the Company maintained for
such purpose, which office shall be maintained in the Borough of Manhattan,
The City of New York. At the option of the Company, interest and Special
Interest may be paid by check mailed to the registered holders at their
registered addresses. The Old Notes were and the New Notes will be issued
without coupons and in fully registered form only, in denominations of $1,000
aggregate principal amount at Stated Maturity and integral multiples thereof.
OPTIONAL REDEMPTION
The Old Notes are not and the New Notes will not be redeemable at the option
of the Company prior to August 15, 2002, subject to the provisions of the
following paragraph. Thereafter, the Notes will be subject to redemption at
the option of the Company, in whole or in part, upon not less than 30 nor more
than 60 days' notice, at the redemption prices (expressed as percentages of
principal amount at Stated Maturity thereof) set forth below, plus accrued and
unpaid interest (if any) and Special Interest (if any), if redeemed during the
twelve months beginning August 15 of each year indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2002........................................................... 107.313%
2003........................................................... 103.656%
</TABLE>
Notwithstanding the foregoing, in the event that on or prior to August 15,
2000, the Company consummates one or more Public Equity Offerings of its
Common Stock in an aggregate amount equal to or exceeding $40 million, up to a
maximum of 35% of the aggregate principal amount at Stated Maturity of the
Notes will be redeemable at the option of the Company out of the net proceeds
thereof to the extent that such proceeds consist of cash or cash equivalents.
Such Notes will be redeemable on not less than 30 nor more than 60 days' prior
notice at a redemption price equal to 114.63% of the Accreted Value of the
Notes to be redeemed on the redemption date plus accrued and unpaid interest,
if any, and Special Interest, if any, to the redemption date. Any such
redemption shall occur within 90 days after (but not before) such sale or last
such sale in the case of a series of related transactions; provided, that
immediately after giving effect to such redemption, not less than 65% of the
aggregate principal amount at Stated Maturity of the Notes originally issued
remain outstanding.
64
<PAGE>
MANDATORY REDEMPTION
Except as set forth under "--Repurchase at the Option of Holders upon a
Change of Control,"
and "--Asset Sales," the Company is not required to make mandatory redemption
payments or sinking fund payments with respect to the Notes.
REPURCHASE AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each holder of Notes shall have
the right to require the Company to repurchase all or any part (equal to
$1,000 principal amount at Stated Maturity or an integral multiple thereof) of
such holder's Notes pursuant to an irrevocable and unconditional offer
described below (the "Change of Control Offer") at a purchase price (the
"Change of Control Purchase Price") equal to 101% of the Accreted Value
thereof or 101% of the principal amount thereof, as the case may be, on any
Change of Control Payment Date (as defined), plus accrued and unpaid interest,
if any, and Special Interest, if any, to such Change of Control Payment Date.
Within 30 days following any Change of Control, the Company or the Trustee
(at the expense of the Company) shall mail a notice to each holder stating,
among other things: (1) that a Change of Control Offer is being made pursuant
to the covenant in the Indenture entitled "Repurchase at the Option of Holders
upon a Change of Control" and that all Notes properly tendered will be
accepted for payment; (2) the Change of Control Purchase Price and the
purchase date (the "Change of Control Payment Date"), which shall be no
earlier than 30 days nor later than 60 days from the date such notice is
mailed; (3) that any Notes or portions thereof not properly tendered will
continue to accrete in value or accrue interest, as the case may be, and
accrue Special Interest, if applicable; (4) that, unless the Company defaults
in the payment of the Change of Control Purchase Price, all Notes or portions
thereof accepted for payment pursuant to the Change of Control Offer shall
cease to accrete in value or accrue interest, as the case may be, and accrue
Special Interest, if applicable, from and after the Change of Control Payment
Date; (5) that holders electing to have any Notes or portions thereof
purchased pursuant to a Change of Control Offer will be required to surrender
the Notes, with the form entitled "Option of Holder to Elect Purchase" on the
reverse of the Notes completed, to the Paying Agent at the address specified
in the notice prior to the close of business on the third Business Day
preceding the Change of Control Payment Date; (6) that holders will be
entitled to withdraw their election if the Paying Agent receives, not later
than the close of business on the second Business Day preceding the Change of
Control Payment Date, a telegram, telex, facsimile transmission or letter
setting forth the name of the holder, the principal amount of Notes delivered
for purchase, and a statement that such holder is withdrawing his election to
have such Notes or portions thereof purchased; (7) that holders whose Notes
are being purchased only in part will be issued new Notes equal in principal
amount to the unpurchased portion of the Note or Notes surrendered, which
unpurchased portion must be equal to $1,000 in principal amount at Stated
Maturity or an integral multiple thereof; and (8) the instructions and any
other information necessary to enable holders to accept a Change of Control
Offer or effect withdrawal of such acceptance.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws and regulations, to the extent such
laws and regulations are applicable, in connection with the repurchase of
Notes pursuant to a Change of Control Offer.
On the Change of Control Payment Date, the Company will (1) accept for
payment Notes or portions thereof properly tendered pursuant to the Change of
Control Offer, (2) irrevocably deposit with the Paying Agent in immediately
available funds an amount equal to the Change of Control Purchase Price in
respect of all Notes or portions thereof so tendered, including accrued and
unpaid interest, if any, and Special Interest, if any, thereon and (3)
deliver, or cause to be delivered, to the Trustee the Notes so accepted
together with an Officers' Certificate listing the Notes or portions thereof
tendered to the Company and accepted for payment. The Paying Agent shall
promptly mail to each holder of Notes so accepted payment in an amount equal
to the Change of Control Purchase Price, including interest and Special
Interest, if applicable, for such Notes and the Trustee shall promptly
authenticate and mail to each holder a new Note equal in principal amount at
Stated Maturity to any
65
<PAGE>
unpurchased portion of the Notes surrendered, if any; provided, that each such
new Note shall be in a principal amount at Stated Maturity of $1,000 or any
integral multiple thereof. The Company will announce publicly the results of a
Change of Control Offer on or as soon as practicable after the Change of
Control Payment Date.
The existence of the holders' right to require, subject to certain
conditions, the Company to repurchase Notes upon a Change of Control may deter
a third party from acquiring the Company in a transaction that constitutes a
Change of Control. If a Change of Control Offer is made, there can be no
assurance that the Company will have sufficient funds to pay the Change of
Control Purchase Price for all Notes tendered by holders seeking to accept the
Change of Control Offer. Both the 14% Senior Note Indenture and the
Convertible Note Indenture contain, and if Consent Convertible Notes are
issued, the Consent Convertible Note Indenture would contain, substantially
identical "Change of Control" covenants. In addition, instruments governing
other Indebtedness of the Company may prohibit the Company from purchasing any
Notes prior to their Stated Maturity, including pursuant to a Change of
Control Offer. In the event that a Change of Control Offer occurs at a time
when the Company does not have sufficient available funds to (i) pay the
Change of Control Purchase Price for all Notes tendered pursuant to such
offer, (ii) purchase all validly tendered 14% Senior Notes upon a "Change of
Control" (as defined in the 14% Senior Note Indenture), (iii) purchase all
validly tendered Convertible Notes upon a "Change of Control" (as defined in
the Convertible Note Indenture) and (iv) if Consent Convertible Notes are
issued, purchase all validly tendered Consent Convertible Notes upon a "Change
of Control" (as such would be defined in the Consent Convertible Note
Indenture, if applicable) or at a time when the Company is prohibited from
purchasing the Notes (and the Company is unable either to obtain the consent
of the holders of the relevant Indebtedness or to repay such Indebtedness), an
Event of Default would occur under the Indenture. In addition, one of the
events that constitutes a Change of Control under the Indenture is a sale,
conveyance, transfer or lease of all or substantially all of the assets of the
Company or of the Company and its Restricted Subsidiaries taken as a whole.
The Indenture will be governed by New York law, and there is no established
quantitative definition under New York law of "substantially all" of the
assets of a corporation. Accordingly, if the Company and/or its Restricted
Subsidiaries were to engage in a transaction in which it or they disposed of
less than all of the assets of the Company or less than all of the assets of
the Company and its Restricted Subsidiaries taken as a whole, a question of
interpretation could arise as to whether such disposition was of
"substantially all" of its or their assets, as the case may be, and whether
the Company was required to make a Change of Control Offer.
Except as described herein with respect to a Change of Control, the
Indenture does not contain any other provisions that permit holders of Notes
to require that the Company repurchase or redeem Notes in the event of a
takeover, recapitalization or similar restructuring. The foregoing provisions
may not necessarily afford the holders of the Notes protection in the event of
a highly leveraged transaction, including a reorganization, restructuring,
merger or other similar transaction involving the Company, that may adversely
affect the holders because (i) such transactions may not involve a shift in
voting power or beneficial ownership or, even if they do, may not involve a
shift of the magnitude required under the definition of Change of Control to
require the Company to make a Change of Control Offer or (ii) such
transactions may include an actual shift in voting power or beneficial
ownership to a Permitted Holder which is excluded under the definition of
Change of Control from the amount of shares involved in determining whether or
not the transaction involves a shift of the magnitude required to trigger the
provisions.
ASSET SALES
The Company will not, and will not permit any Restricted Subsidiary to,
consummate an Asset Sale unless (i) no Event of Default under the Indenture
shall have occurred and be continuing or shall occur as a consequence thereof;
(ii) the Company or such Restricted Subsidiary, as the case may be, receives
net consideration at the time of such Asset Sale at least equal to the Fair
Market Value (as evidenced by a Board Resolution of the Company delivered to
the Trustee) of the Property or assets sold or otherwise disposed of; (iii) at
least 75% of the consideration received by the Company or such Restricted
Subsidiary for such Property or assets consists of Cash Proceeds; and (iv) the
Company or such Restricted Subsidiary, as the case may be, uses the Net Cash
Proceeds from such Asset Sale in the manner set forth below.
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Within 270 days after any Asset Sale, the Company or such Restricted
Subsidiary, as the case may be, may at its option reinvest an amount equal to
the Net Cash Proceeds (or any portion thereof) from such Asset Sale in
Telecommunications Assets and/or apply an amount equal to such Net Cash
Proceeds (or remaining Net Cash Proceeds) to the permanent reduction of
Indebtedness of the Company (other than Indebtedness owing to a Restricted
Subsidiary) that is pari passu in right of payment with the Notes, the 14%
Senior Notes, the Convertible Notes and, if issued, the Consent Convertible
Notes or to the permanent reduction of Indebtedness of any Restricted
Subsidiary that is pari passu in right of payment with such Restricted
Subsidiary's Guarantee, Old Senior Note Guarantee, Convertible Note Guarantee
and any guarantee of the Consent Convertible Notes, if applicable (other than
Indebtedness to the Company or another Restricted Subsidiary). Any Net Cash
Proceeds from any Asset Sale that are not used to reinvest in
Telecommunications Assets and/or reduce pari passu Indebtedness of the Company
or Indebtedness of its Restricted Subsidiaries shall constitute Excess
Proceeds.
If at any time the aggregate amount of Excess Proceeds calculated as of such
date exceeds $5 million, the Company shall, within 30 days of the date on
which such Excess Proceeds exceed $5 million, use such Excess Proceeds to make
offers to purchase (each an "Asset Sale Offer") on a pro rata basis from all
holders of Notes and 14% Senior Notes, in an aggregate principal amount equal
to the maximum principal amount that may be purchased out of Excess Proceeds,
at a purchase price (the "Asset Sale Purchase Price") in cash equal to 100% of
the Accreted Value or 100% of the principal amount at Stated Maturity thereof,
as the case may be, in the case of the Notes, or 100% of the "Accreted Value"
(as defined in the 14% Senior Note Indenture) or 100% of the principal amount
at Stated Maturity thereof, as the case may be, in the case of the 14% Senior
Notes, on any purchase date, plus accrued and unpaid interest, if any, and
Special Interest, if any, to such purchase date, in accordance with the
procedures set forth in the applicable indenture and to the substantially
concurrent repayment or repurchase of Pari Passu Indebtedness (if any) if
required by the instruments relating to such Pari Passu Indebtedness (which
repayment or redemption, in the case of a revolving credit arrangement or
multiple advance arrangement, reduces the commitment thereunder). Upon
completion of any Asset Sale Offer (including payment of the Asset Sale
Purchase Price), any surplus Excess Proceeds that were the subject of such
offer shall cease to be Excess Proceeds, and the Company may then use such
amounts for general corporate purposes, including the making of an "Asset Sale
Offer," as defined in and required by the Convertible Note Indenture and, if
Consent Convertible Notes are issued, in the Consent Convertible Note
Indenture, for the Convertible Notes and, if issued, the Consent Convertible
Notes, respectively.
The Company will comply with the requirements of Section 14(e) under the
Exchange Act and any other securities laws and regulations, to the extent such
laws and regulations are applicable, in connection with the repurchase of
Notes pursuant to an Asset Sale Offer.
CERTAIN COVENANTS
Set forth below are certain covenants contained in the Indenture:
Limitation on Indebtedness
The Company will not, and will not permit its Restricted Subsidiaries to,
directly or indirectly, incur any Indebtedness (including Acquired
Indebtedness) and the Company will not issue any Disqualified Stock or permit
any of its Restricted Subsidiaries to issue any Disqualified Stock; provided,
that the Company may incur Indebtedness or issue Disqualified Stock (i) if,
after giving effect to such issuance or incurrence on a pro forma basis, the
Indebtedness to Operating Cash Flow Ratio of the Company does not exceed 5 to
1.0 or (ii) in an amount not to exceed 200% of the aggregate Net Cash Proceeds
received by the Company subsequent to the Issue Date from the issuance or sale
(other than to a Subsidiary) of shares of its Qualified Stock, including
Qualified Stock issued upon the conversion of convertible debt (other than any
conversions of Convertible Notes and, if issued, the Consent Convertible
Notes) or the exercise of options, warrants or rights to purchase Qualified
Stock; provided, that such Net Cash Proceeds shall not be utilized to increase
the amounts available for Restricted Payments pursuant to clause (B) of the
first paragraph of the covenant described under "--Certain Covenants--
Restricted Payments."
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The foregoing limitation will not apply to: (a) Indebtedness existing under
the Credit Facility; provided, that the aggregate principal amount of all such
Indebtedness under the Credit Facility, when taken together with all
Indebtedness of the Company then outstanding which was permitted to have been
incurred under clause (j) below, shall not exceed $45 million at any one time
outstanding, up to $30 million of which may be secured; (b) the Existing
Indebtedness; (c) the incurrence by the Company or any of its Restricted
Subsidiaries of intercompany Indebtedness owing to any of its respective
Wholly-Owned Restricted Subsidiaries; provided, that any such Indebtedness is
junior and subordinate to the Notes and Guarantees, if any, and the 14% Senior
Notes and Old Senior Note Guarantees, if any, and such Indebtedness is held at
all times by the Company or a Wholly-Owned Restricted Subsidiary of the
Company; (d) Indebtedness of any Restricted Subsidiary to the Company or a
Wholly-Owned Restricted Subsidiary of the Company; (e) the incurrence by the
Company or any of its Restricted Subsidiaries of Interest Hedging Obligations
with respect to any floating rate Indebtedness that is permitted by the
covenant described in this paragraph; (f) the incurrence by the Company or any
of its Restricted Subsidiaries of Indebtedness evidenced by the Notes or
Guarantees, if any, pursuant to the Indenture, the 14% Senior Notes and the
Old Senior Note Guarantees, if any, as required by the terms of the 14% Senior
Note Indenture, the Convertible Notes and the Convertible Note Guarantees, if
any, as required by the terms of the Convertible Note Indenture and, if
issued, the Consent Convertible Notes and guarantees of Consent Convertible
Notes, if any, as required by the terms of the Consent Convertible Note
Indenture; (g) Indebtedness in respect of performance, surety or appeal bonds
provided by the Company in the ordinary course of business; (h) Vendor
Financing not to exceed an aggregate principal amount of $5 million at any one
time outstanding; (i) the incurrence by the Company or any of its Restricted
Subsidiaries of Refinancing Indebtedness issued in exchange for, or the
proceeds of which are used to refinance, repurchase, replace, refund or
defease ("Refinance" and correlatively, "Refinanced" and "Refinancing")
Indebtedness permitted pursuant to clause (b) or (f) of this paragraph;
provided, that (i) the amount of such Refinancing Indebtedness shall not
exceed the principal amount of, premium, if any, and accrued interest (and
Special Interest, if any, on the Notes) on the Indebtedness so Refinanced (or
if such Indebtedness was issued with original issue discount, the original
issue price plus amortization of the original issue discount at the time of
the repayment of such Indebtedness) plus the fees, expenses and costs of such
Refinancing and reasonable prepayment premiums, if any, in connection
therewith, (ii) such Refinancing Indebtedness shall have a Stated Maturity no
earlier than the Stated Maturity of Indebtedness being Refinanced, (iii) such
Refinancing Indebtedness shall have an Average Life equal to or greater than
the Average Life of the Indebtedness being Refinanced, (iv) if the
Indebtedness being Refinanced is subordinated in right of payment to the
Notes, such Refinancing Indebtedness shall be subordinated in right of payment
to the Notes on terms at least as favorable to the holders of Notes as those
contained in the documentation governing the Indebtedness being so Refinanced,
and (v) no Restricted Subsidiary shall incur Refinancing Indebtedness to
Refinance Indebtedness of the Company or another Subsidiary; and (j)
Indebtedness of the Company not otherwise permitted to be incurred pursuant to
the covenant described in this paragraph in an amount which shall not exceed
$25 million at any one time outstanding and which amount shall reduce the
amount permitted to be incurred under clause (a) above.
In the event that the Company or any Restricted Subsidiary has incurred
Indebtedness pursuant to clause (c) of the second paragraph of this covenant
owing to a Restricted Subsidiary and that Restricted Subsidiary thereafter
does not remain a "Restricted Subsidiary" as defined in the Indenture, the
aggregate principal amount of such Indebtedness of the Company or a Restricted
Subsidiary, as applicable, owing to such Person at the time of such a change
in Restricted Subsidiary status that was at any time incurred pursuant to
clause (c) of the second paragraph of this covenant, shall be deemed to be
Indebtedness incurred by the Company or a Restricted Subsidiary, as the case
may be, at the time of such change in Restricted Subsidiary status.
Indebtedness incurred by any Person that is not a Restricted Subsidiary of
the Company, which Indebtedness is outstanding at the time such Person becomes
a Restricted Subsidiary of the Company, or is merged into or consolidated
with, the Company or a Restricted Subsidiary, shall be deemed to have been
incurred, at the time such Person becomes a Restricted Subsidiary, or is
merged into or consolidated with the Company or a Restricted Subsidiary. A
guarantee permitted by this covenant to be incurred by the Company or a
Restricted Subsidiary of Indebtedness otherwise permitted to be incurred
pursuant to this covenant is not considered a separate incurrence for purposes
of this covenant.
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Limitation on Issuances of Guarantees by Restricted Subsidiaries
The Indenture provides that the Company may not permit any Restricted
Subsidiary, directly or indirectly, to guarantee any Indebtedness of the
Company ("Guaranteed Indebtedness") unless (i) such Restricted Subsidiary
simultaneously executes and delivers a supplemental indenture to the Indenture
providing for a Guarantee of payment of the Notes by such Restricted
Subsidiary (a "Guarantee") and (ii) such Restricted Subsidiary waives and will
not in any manner whatsoever claim or take the benefit or advantage of, any
rights of reimbursement, indemnity or subrogation or any other rights against
the Company or any other Restricted Subsidiary as a result of any payment by
such Restricted Subsidiary under its Guarantee, provided, that any Restricted
Subsidiary may guarantee any Credit Facility so long as such Restricted
Subsidiary enters into a Guarantee ranking pari passu with its guarantee under
such Credit Facility. If the Guaranteed Indebtedness is pari passu with the
Notes, then the guarantee of such Guaranteed Indebtedness shall be pari passu
with or subordinated to the Guarantee; and if the Guaranteed Indebtedness is
subordinated to the Notes, then the guarantee of such Guaranteed Indebtedness
shall be subordinated to the Guarantee at least to the extent that the
Guaranteed Indebtedness is subordinated to the Notes.
Notwithstanding the foregoing, any Guarantee by a Restricted Subsidiary
shall provide by its terms that it shall be automatically and unconditional
released and discharged upon the release or discharge of the guarantee which
resulted in the creation of such Restricted Subsidiary's Guarantee, except a
discharge or release by, or as a result of, payment under such guarantee.
Limitation on Liens
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, enter into, create, incur, assume or suffer to
exist any Liens of any kind other than Permitted Liens on or with respect to
any of its Property or assets now owned or hereafter acquired, or any interest
therein or any income or profits therefrom, without effectively providing that
the Notes shall be secured equally and ratably with (and provided that the
Notes shall be secured prior to any secured obligation that is subordinated in
right of payment to the Notes) the obligations so secured for so long as such
obligations are so secured.
Limitation on Sale and Leaseback Transactions
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, enter into, assume, guarantee or otherwise become
liable with respect to any Sale and Leaseback Transaction, unless (i) the
Company or such Restricted Subsidiary, as the case may be, receives
consideration at the time of such Sale and Leaseback Transaction at least
equal to the Fair Market Value (as evidenced by a Board Resolution delivered
to the Trustee) of the Property or assets subject to such transaction; (ii)
the Attributable Indebtedness of the Company or such Restricted Subsidiary
with respect thereto is included as Indebtedness and would be permitted by the
covenant described under "--Limitation on Indebtedness" and any Liens granted
thereby would be permitted by the covenant described under "--Limitation on
Liens;" and (iii) the Net Cash Proceeds from such transaction are applied in
accordance with the provisions described under "--Asset Sales."
Restricted Payments
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, make any Restricted Payment unless, at the time of
and after giving effect to such proposed Restricted Payment (i) no Default or
Event of Default under the Indenture shall have occurred and be continuing or
shall occur as a consequence thereof; (ii) after giving effect, on a pro forma
basis, to such Restricted Payment and the incurrence of any Indebtedness, the
net proceeds of which are used to finance such Restricted Payment, the Company
could incur at least $1.00 of additional Indebtedness pursuant to clause (i)
of the first paragraph of the covenant described under "--Limitation on
Indebtedness"; and (iii) after giving effect to such Restricted Payment on a
pro forma basis, the aggregate amount expended or declared for all Restricted
Payments after the Issue Date does not exceed the sum of (A) 50% of the
Consolidated Net Income of the Company (or, if Consolidated Net
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Income shall be a deficit, minus 100% of such deficit) for the period (taken
as one accounting period) beginning on the last day of the fiscal quarter
immediately preceding the Issue Date and ending on the last day of the fiscal
quarter immediately preceding the date of such Restricted Payment, plus (B)
100% of the aggregate Net Cash Proceeds received by the Company subsequent to
the Issue Date from the issuance or sale (other than to a Subsidiary) of
shares of its Qualified Stock, including Qualified Stock issued upon the
conversion of convertible debt (other than the conversion of the Convertible
Notes and, if issued, the Consent Convertible Notes) or the exercise of
options, warrants or rights to purchase Qualified Stock, plus (C) 100% of the
amount of any Indebtedness of the Company or any of its Restricted
Subsidiaries (as expressed on the face of a balance sheet in accordance with
GAAP), or the carrying value of any Disqualified Stock, which has been
converted into, exchanged for or satisfied by the issuance of shares of
Qualified Stock of the Company subsequent to the Issue Date, less the amount
of any cash or the value of any other Property distributed by the Company or
its Restricted Subsidiaries upon such conversion, exchange or satisfaction,
plus (D) 100% of the net reduction in Investments, subsequent to the Issue
Date, in any Person, resulting from payments of interest on Indebtedness,
dividends, repayments of loans or advances, or other transfers of Property
(but only to the extent such interest, dividends, repayments or other
transfers of Property are not included in the calculation of Consolidated Net
Income), in each case to the Company or any Restricted Subsidiary from any
Person (including, without limitation, from Unrestricted Subsidiaries) or from
redesignations of Unrestricted Subsidiaries as Restricted Subsidiaries (valued
in each case as provided in the definition of "Investments"), not to exceed in
the case of any Person the amount of Investments previously made by the
Company or any Restricted Subsidiary in such Person and in each such case
which was treated as a Restricted Payment, minus (E) 100% of the amount of
Investments made pursuant to clauses (v), (vi) and (vii) of the following
paragraph subsequent to the Issue Date.
The foregoing limitations shall not prevent the Company from (i) paying a
dividend on its Capital Stock at any time within 60 days after the declaration
thereof if, on the declaration date, the Company could have paid such dividend
in compliance with the Indenture; (ii) retiring (A) any Capital Stock of the
Company or any Restricted Subsidiary of the Company or (B) Indebtedness of the
Company that is subordinated to the Notes or (C) Indebtedness of a Restricted
Subsidiary of the Company, in exchange for, or out of the proceeds of the
substantially concurrent sale of Qualified Stock of the Company; (iii) so long
as no Default or Event of Default under the Indenture shall have occurred and
be continuing or shall occur as a consequence thereof, retiring any
Indebtedness of the Company subordinated in right of payment to the Notes, the
14% Senior Notes, the Convertible Notes and, if issued, the Consent
Convertible Notes, if any, in exchange for, or out of the proceeds of, the
substantially concurrent incurrence of Indebtedness of the Company (other than
Indebtedness to a Subsidiary of the Company); provided, that such new
Indebtedness (A) is subordinated in right of payment to the Notes, the 14%
Senior Notes, the Convertible Notes and, if issued, the Consent Convertible
Notes, if any, at least to the same extent as, (B) has an Average Life at
least as long as, and (C) has no scheduled principal payments due in any
amount earlier than, any equivalent amount of principal under the Indebtedness
so retired; (iv) so long as no Default or Event of Default under the Indenture
shall have occurred and be continuing or shall occur as a consequence thereof,
retiring any Indebtedness of a Restricted Subsidiary of the Company in
exchange for, or out of the proceeds of, the substantially concurrent
incurrence of Indebtedness of the Company or any Restricted Subsidiary that is
permitted under the covenant described under "--Limitation on Indebtedness"
and that (A) is not secured by any assets of the Company or any Restricted
Subsidiary to a greater extent than the retired Indebtedness was so secured,
(B) has an Average Life at least as long as the retired Indebtedness and (C)
is subordinated in right of payment to the Notes, the 14% Senior Notes, the
Convertible Notes and, if issued, the Consent Convertible Notes, or the
Guarantees, the Old Senior Note Guarantees, the Convertible Note Guarantees,
and any guarantees on the Consent Convertible Notes, as applicable, at least
to the same extent as the retired Indebtedness; (v) so long as no Default or
Event of Default under the Indenture shall have occurred and be continuing or
shall result as a consequence thereof, purchasing, redeeming, retiring or
acquiring any Common Stock of the Company or any Restricted Subsidiary of the
Company held by any member or former member of the Company's (or any of its
Subsidiaries') management pursuant to any management agreement or stock option
plan if in effect as of September 30, 1996 or upon the death, disability,
retirement or termination of employment of such members; provided, that the
aggregate price paid for all such retired Common Stock shall not exceed, in
the aggregate, the sum of $1 million plus the aggregate Cash Proceeds received
by the Company from any
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reissuance of such Common Stock by the Company to members of management of the
Company and its Subsidiaries; (vi) so long as no Default or Event of Default
under the Indenture shall have occurred and be continuing or shall occur as a
consequence thereof, making loans to members of management of the Company as
required pursuant to employment agreements with such members, in an aggregate
principal amount not to exceed $1 million; provided, that any repayment of
such loans (but only to the extent such payments are not included in the
calculation of Consolidated Net Income of the Company) shall reduce the amount
of such Investments; (vii) so long as no Default or Event of Default under the
Indenture shall have occurred and be continuing or shall occur as a
consequence thereof, making Investments in Joint Ventures in an aggregate
amount not to exceed $10 million; provided, that any repayment of loans or
advances, return of capital or other transfer of Property (but only to the
extent such distributions are not included in the calculation of Consolidated
Net Income of the Company) shall reduce the amount of such Investments; and
(viii) so long as no Default or Event of Default under the Indenture shall
have occurred and be continuing, the Company may redeem Convertible Notes
and/or, if issued, Consent Convertible Notes, pursuant to the terms of the
Convertible Note Indenture and/or the Consent Convertible Note Indenture,
respectively, or repurchase Convertible Notes and/or, if issued, Consent
Convertible Notes, pursuant to a "Change of Control Offer," an "Asset Sale
Offer" or a repurchase offer upon a "Termination of Trading" (each as defined
therein) of the Common Stock pursuant to the terms of the Convertible Note
Indenture and/or the Consent Convertible Note Indenture, respectively.
Not later than the date of making of any Restricted Payment or any
Investment made pursuant to clause (vii) of the previous paragraph, the
Company shall deliver to the Trustee an Officers' Certificate stating that
such Restricted Payment or Investment is permitted and setting forth the basis
upon which the required calculations were computed, which calculations may be
based upon the Company's latest available financial statements.
Limitation on Dividends and Other Payment Restrictions Affecting Subsidiaries
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, cause or suffer to exist or become effective or enter
into an encumbrance or restriction (other than pursuant to law or regulation)
on the ability of any Restricted Subsidiary (i) to pay dividends or make any
other distributions in respect of its Capital Stock or pay any Indebtedness or
other obligation owed to the Company or any Restricted Subsidiary of the
Company; (ii) to make loans or advances to the Company or any Restricted
Subsidiary of the Company; or (iii) to transfer any of its Property or assets
to the Company or any other Restricted Subsidiary of the Company, except: (a)
any encumbrance or restriction existing as of the Issue Date pursuant to the
Indenture, the Existing Indebtedness, the 14% Senior Note Indenture and the
Convertible Note Indenture or as of the date of issuance of the Consent
Convertible Notes pursuant to the Consent Convertible Note Indenture if
substantially identical to the Convertible Note Indenture; (b) any encumbrance
or restriction pursuant to an agreement relating to an acquisition of assets
or Property, so long as the encumbrances or restrictions in any such agreement
relate solely to the assets or Property so acquired (and are not or were not
created in anticipation of or in connection with the acquisition thereof); (c)
any encumbrance or restriction relating to any Indebtedness of any Restricted
Subsidiary existing on the date on which such Restricted Subsidiary is
acquired by the Company or any Restricted Subsidiary (other than Indebtedness
incurred by such Restricted Subsidiary in connection with or in anticipation
of its acquisition), (d) customary provisions restricting subletting or
assignment of any lease of the Company or any Restricted Subsidiary or
customary provisions in any telecommunications resale agreements (including
without limitation the existing Ameritech resale agreements, the NYNEX resale
agreement and the long distance agreements of the Company), license agreements
or similar agreements that restrict the assignment of such agreement or any
rights thereunder; (e) any temporary encumbrance or restriction with respect
to a Restricted Subsidiary pursuant to an agreement that has been entered into
for the sale or disposition of all or substantially all of the Capital Stock
of, or Property and assets of, such Restricted Subsidiary; (f) any restriction
on the sale or other disposition of assets or Property securing Indebtedness
as a result of a Permitted Lien on such assets or Property permitted by the
covenant described under "--Limitation on Liens;" and (g) any encumbrance or
restriction that amends, extends, refinances, refunds, renews or replaces any
agreement described in clauses (a) through (c) whether or not among the same
parties, provided, that the terms and conditions of any such encumbrance or
restriction are no less favorable to the holders of the Notes than those under
or pursuant to the agreement amended, extended, refinanced, refunded, renewed
or replaced.
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Limitation on Issuance and Sale of Capital Stock of Restricted Subsidiaries
The Company (i) shall not permit any Restricted Subsidiary to issue any
Capital Stock other than to the Company or a Restricted Subsidiary and (ii)
shall not permit any Person other than the Company or a Restricted Subsidiary
to own any Capital Stock of any Restricted Subsidiary other than directors
qualifying shares, except for (a) a sale of 100% of the Capital Stock of a
Restricted Subsidiary sold in a transaction not prohibited by the covenant
described under "--Asset Sales"; (b) Capital Stock of a Restricted Subsidiary
issued and outstanding on the Issue Date and held by Persons other than the
Company or any Restricted Subsidiary; (c) Capital Stock of a Restricted
Subsidiary issued and outstanding prior to the time that such Person becomes a
Restricted Subsidiary so long as such Capital Stock was not issued in
contemplation of such Person's becoming a Restricted Subsidiary or otherwise
being acquired by the Company; (d) not more than 10 percent of the Common
Stock of USN Solutions, Inc. on a fully diluted basis issued pursuant to the
exercise of the option (the "USN Solutions Option") contemplated by that
certain Memorandum of Understanding, dated July 3, 1996, by and between USN
Solutions, Inc. and Genesys S.A.; and (e) any Disqualified Stock permitted to
be issued under the covenant described under "--Limitation on Indebtedness."
Transactions with Affiliates
The Company will not, and will not permit any of its Restricted Subsidiaries
to, directly or indirectly, sell, lease, transfer, or otherwise dispose of,
any of its Property or assets to, or purchase any Property or assets from, or
enter into any contract, agreement, understanding, loan, advance or guarantee
with or for the benefit of, any Affiliate (each of the foregoing, an
"Affiliate Transaction"), unless (a) such Affiliate Transaction is on terms
that are no less favorable to the Company or such Restricted Subsidiary than
those that would have been obtained in a comparable arm's-length transaction
by the Company or such Restricted Subsidiary with a Person that is not an
Affiliate and (b) the Company delivers to the Trustee (i) with respect to any
Affiliate Transaction involving aggregate payments in excess of $1 million, a
Board Resolution certifying that such Affiliate Transaction complies with
clause (a) above and that such Affiliate Transaction has been approved by a
majority of the disinterested directors who have determined that such
Affiliate Transaction is in the best interests of the Company or such
Restricted Subsidiary and (ii) with respect to any Affiliate Transaction
involving aggregate payments in excess of $5 million, an opinion as to the
fairness from a financial point of view to the Company or such Restricted
Subsidiary issued by an investment banking firm of national standing, or in
the case of a transaction involving a sale or transfer of assets subject to
valuation such as real estate, an appraisal issued by a nationally recognized
appraisal firm, together with an Officers' Certificate to the effect that such
opinion complies with this clause (ii); provided, that the following shall not
be deemed Affiliate Transactions: (i) any employment agreement or consulting
agreement (including stock options) entered into by the Company or any of its
Restricted Subsidiaries in the ordinary course of business and consistent with
industry practice; (ii) any agreement or arrangement with respect to the
compensation of a director of the Company or any Restricted Subsidiary
approved by the Board of Directors and consistent with industry practice;
(iii) transactions between or among the Company, its Wholly-Owned Restricted
Subsidiaries or a majority-owned Restricted Subsidiary (so long as no minority
interest is owned by a Person which is otherwise an Affiliate); (iv)
transactions constituting Restricted Payments permitted by the covenant
described under "--Restricted Payments"; (v) transactions pursuant to
contracts existing on the Issue Date and disclosed in a schedule attached to
the Indenture; (vi) transactions between the Company or its Restricted
Subsidiaries on the one hand, and Merrill Lynch or its Affiliates on the other
hand, involving the provision of financial or consulting services by Merrill
Lynch or its Affiliates; (vii) making loans or advances to officers, employees
or consultants of the Company and its Subsidiaries (including travel and
moving expenses) in the ordinary course of business not to exceed $1 million;
and (viii) the issuance of stock options for Common Stock of the Company
pursuant to any plan approved by the Board of Directors.
Restricted and Unrestricted Subsidiaries
The Indenture provides that the Company may designate a Subsidiary
(including a newly formed or newly acquired Subsidiary) of the Company or any
of its Restricted Subsidiaries as an Unrestricted Subsidiary;
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provided, that so long as the Notes remain outstanding and the Indenture has
not been satisfied or discharged, (i) immediately after giving effect to the
transaction, the Company could incur $1.00 of additional Indebtedness pursuant
to clause (i) of the first paragraph of "--Limitation on Indebtedness" and
(ii) such designation is at the time permitted under "--Restricted Payments."
Notwithstanding any provisions of this covenant all Subsidiaries of an
Unrestricted Subsidiary will be Unrestricted Subsidiaries.
The Indenture further provides that the Company will not designate an
Unrestricted Subsidiary as a Restricted Subsidiary unless, after giving effect
to such designation on a pro forma basis, (i) the Company could incur at least
$1.00 of additional Indebtedness pursuant to clause (i) of the first paragraph
of the covenant described under "--Limitation on Indebtedness" and (ii) no
Default or Event of Default would occur.
Subject to the preceding paragraph, an Unrestricted Subsidiary may be
redesignated as a Restricted Subsidiary. The designation of a Subsidiary as an
Unrestricted Subsidiary or the designation of an Unrestricted Subsidiary as a
Restricted Subsidiary in compliance with the preceding paragraph shall be made
by the Board of Directors pursuant to a Board Resolution delivered to the
Trustee and shall be effective as of the date specified in such Board
Resolution, which shall not be prior to the date such Board Resolution is
delivered to the Trustee.
Limitations on Line of Business
The Indenture provides that neither the Company nor any of its Restricted
Subsidiaries will directly or indirectly engage to any substantial extent in
any line or lines of business activity other than the Telecommunications
Business.
Issuance of Contingent Warrants
The Indenture provides that the Company will be obligated to issue to
holders of the Notes Contingent Warrants, exercisable for Class A Common Stock
representing up to 5% of the Common Stock on a fully-diluted basis as of the
date of such issuance (without including (i) Common Stock issued for fair
market value subsequent to the Closing Date (as determined in the Warrant
Agreement), (ii) Common Stock issuable pursuant to any options, or shares of
Common Stock granted to or purchased by management of the Company, pursuant to
agreements or stock plans existing on the date of the Indenture and either
disclosed in a schedule attached thereto or described herein, or (iii) certain
additional shares of Common Stock issuable pursuant to options, or shares of
Common Stock issuable pursuant to agreements or stock plans, as disclosed in a
schedule attached to the Indenture) after giving effect to the issuance of
such Contingent Warrants, in the event that, on or prior to September 30,
1998, the Company does not effect a Qualified Equity Offering. All Contingent
Warrants will be issued pursuant to the Warrant Agreement with the same rights
thereunder as the Initial Warrants, and holders will have the benefit of the
Registration Rights Agreement.
Waiver of Certain Covenants
The Company may omit in respect of any Notes, in any particular instance, to
comply with the provisions of any covenant or condition described under "--
Certain Covenants," if before or after the time for such compliance the
holders of at least a majority in principal amount at Stated Maturity of the
outstanding Notes (75% in principal amount at Stated Maturity for the covenant
described under "--Issuance of Contingent Warrants") either waive such
compliance in such instance or generally waive compliance with such covenant
or condition, but no such waiver shall extend to or affect such covenant or
condition except to the extent so expressly waived and, until such waiver
shall become effective, the obligations of the Company and the duties of the
Trustee in respect of any such covenant or condition shall remain in full
force and effect.
Reports
The Indenture provides that, whether or not the Company is subject to
Section 13(a) or 15(d) of the Exchange Act, or any successor provision
thereto, the Company shall file with the Commission the annual
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reports, quarterly reports and other documents which the Company would have
been required to file with the Commission pursuant to such Section 13(a) or
15(d) or any successor provision thereto if the Company were subject thereto,
such documents to be filed with the Commission on or prior to the respective
dates (the "Required Filing Dates") by which the Company would have been
required to file them. The Company shall also (whether or not it is required
to file reports with the Commission), within 30 days of each Required Filing
Date, (i) transmit by mail to all holders of Notes, as their names and
addresses appear in the applicable Security Register, without cost to such
holders or Persons, and (ii) file with the Trustee, copies of the annual
reports, quarterly reports and other documents (without exhibits) which the
Company has filed or would have filed with the Commission pursuant to Section
13(a) or 15(d) of the Exchange Act, any successor provisions thereto or this
covenant. The Company shall not be required to file any report with the
Commission if the Commission does not permit such filing.
CONSOLIDATION, MERGER, CONVEYANCE, LEASE OR TRANSFER
The Indenture provides that the Company will not, in any transaction or
series of transactions, consolidate with, or merge with or into, any other
Person or permit any other Person to merge with or into the Company (other
than a merger of a Restricted Subsidiary into the Company in which the Company
is the continuing corporation), or sell, convey, assign, transfer, lease or
otherwise dispose of all or substantially all of the Property and assets of
the Company and the Restricted Subsidiaries taken as a whole to any other
Person, unless:
(i) either (a) the Company shall be the continuing corporation or (b) the
corporation (if other than the Company) formed by such consolidation or
into which the Company is merged, or the Person which acquires, by sale,
assignment, conveyance, transfer, lease or disposition, all or
substantially all of the Property and assets of the Company and the
Restricted Subsidiaries taken as a whole (such corporation or Person, the
"Surviving Entity"), shall be a corporation organized and validly existing
under the laws of the United States of America, any political subdivision
thereof, any state thereof or the District of Columbia, and shall expressly
assume, by a supplemental indenture, the due and punctual payment of the
principal of (and premium, if any) and interest and Special Interest, if
any, on all the Notes and the performance of the Company's covenants and
obligations under the Indenture;
(ii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or
in respect of such transaction or series of transactions), no Default or
Event of Default under the Indenture shall have occurred and be continuing
or would result therefrom;
(iii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or
in respect of such transaction or series of transactions) the Company (or
the Surviving Entity, if the Company is not continuing) would be permitted
to incur $1.00 of additional Indebtedness pursuant to clause (i) of the
first paragraph of the covenant described under "--Limitation on
Indebtedness"; and
(iv) immediately after giving effect to such transaction or series of
transactions on a pro forma basis, the Company (or the Surviving Entity, if
the Company is not continuing) shall have a Consolidated Net Worth equal to
or greater than the Consolidated Net Worth of the Company immediately prior
to such transaction.
The provision of clause (iii) shall not apply to any merger or consolidation
into or with, or any such transfer of all of the Property and assets of the
Company and the Restricted Subsidiaries into, the Company.
In connection with any consolidation, merger, transfer of assets or other
transactions contemplated by this provision, the Company shall deliver, or
cause to be delivered, to the Trustee, in form and substance reasonably
satisfactory to the Trustee, an Officers' Certificate and an opinion of
counsel, each stating that such consolidation, merger, sale, assignment,
conveyance or transfer and the supplemental indenture in respect thereto
comply with the provisions of the Indenture and that all conditions precedent
in the Indenture relating to such transactions have been complied with.
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Upon any transaction or series of transactions that are of the type
described in, and are effected in accordance with, the foregoing paragraphs,
the Surviving Entity shall succeed to, and be substituted for, and may
exercise every right and power of, the Company under the Indenture and the
Notes with the same effect as if such Surviving Entity had been named as the
Company in the Indenture; and when a Surviving Person duly assumes all of the
obligations and covenants of the Company pursuant to the Indenture and the
Notes, except in the case of a lease, the predecessor Person shall be relieved
of all such obligations.
EVENTS OF DEFAULT
Each of the following is an "Event of Default" under the Indenture (except
where otherwise expressly indicated):
(a) default in the payment of interest (or Special Interest, if any) on
any Note issued pursuant to the Indenture when the same becomes due and
payable, and the continuance of such default for a period of 30 days;
(b) default in the payment of the principal of (or premium, if any, on)
any Note issued pursuant to the Indenture at its Stated Maturity, upon
optional redemption, required repurchase (including pursuant to a Change of
Control Offer or an Asset Sale Offer) or otherwise or the failure to make
an offer to purchase any Note as required;
(c) the Company fails to comply with any of its covenants or agreements
contained in "--Limitation on Indebtedness," "--Limitation on Sale and
Leaseback Transactions," "--Restricted Payments," "--Repurchase at the
Option of the Holders upon a Change of Control," "--Asset Sales," "--
Issuance of Contingent Warrants" or "--Consolidation, Merger, Conveyance,
Lease or Transfer";
(d) default in the performance, or breach, of any covenant or warranty of
the Company in the Indenture (other than a covenant or warranty addressed
in (a), (b) or (c) above) and continuance of such Default or breach for a
period of 45 days after written notice thereof has been given to the
Company by the Trustee or to the Company and the Trustee by holders of at
least 25% of the aggregate principal amount at Stated Maturity of the
outstanding Notes;
(e) Indebtedness of the Company or any Restricted Subsidiary is not paid
when due within the applicable grace period, if any, or is accelerated by
the holders thereof and, in either case, the principal amount of such
unpaid or accelerated Indebtedness exceeds $10 million;
(f) the entry by a court of competent jurisdiction of one or more final
judgments against the Company or any Restricted Subsidiary in an uninsured
or unindemnified aggregate amount in excess of $10 million which is not
discharged, waived, appealed, stayed, bonded or satisfied for a period of
60 consecutive days;
(g) the entry by a court having jurisdiction in the premises of (i) a
decree or order for relief in respect of the Company or any Significant
Restricted Subsidiary in an involuntary case or proceeding under U.S.
bankruptcy laws, as now or hereafter constituted, or any other applicable
federal, state, or foreign bankruptcy, insolvency, or other similar law or
(ii) a decree or order adjudging the Company or any Significant Restricted
Subsidiary a bankrupt or insolvent, or approving as properly filed a
petition seeking reorganization, arrangement, adjustment or composition of
or in respect of the Company or any Significant Restricted Subsidiary under
U.S. bankruptcy laws, as now or hereafter constituted, or any other
applicable federal, state or foreign bankruptcy, insolvency, or similar
law, or appointing a custodian, receiver, liquidator, assignee, trustee,
sequestrator or other similar official of the Company or any Significant
Restricted Subsidiary or of any substantial part of the Property or assets
of the Company or any Significant Restricted Subsidiary, or ordering the
winding up or liquidation of the affairs of the Company or any Significant
Restricted Subsidiary, and the continuance of any such decree or order for
relief or any such other decree or order unstayed and in effect for a
period of 60 consecutive days; or
(h) (i) the commencement by the Company or any Significant Restricted
Subsidiary of a voluntary case or proceeding under U.S. bankruptcy laws, as
now or hereafter constituted, or any other applicable federal, state or
foreign bankruptcy, insolvency or other similar law or of any other case or
proceeding to be adjudicated a bankrupt or insolvent; or (ii) the consent
by the Company or any Significant Restricted Subsidiary to the entry of a
decree or order for relief in respect of the Company or any Significant
Restricted
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Subsidiary in an involuntary case or proceeding under U.S. bankruptcy laws,
as now or hereafter constituted, or any other applicable federal, state, or
foreign bankruptcy, insolvency or other similar law or to the commencement
of any bankruptcy or insolvency case or proceeding against the Company or
any Significant Restricted Subsidiary; or (iii) the filing by the Company
or any Significant Restricted Subsidiary of a petition or answer or consent
seeking reorganization or relief under U.S. bankruptcy laws, as now or
hereafter constituted, or any other applicable federal, state or foreign
bankruptcy, insolvency or other similar law; or (iv) the consent by the
Company or any Significant Restricted Subsidiary to the filing of such
petition or to the appointment of or taking possession by a custodian,
receiver, liquidator, assignee, trustee, sequestrator or similar official
of the Company or any Significant Restricted Subsidiary or of any
substantial part of the Property or assets of the Company or any
Significant Restricted Subsidiary, or the making by the Company or any
Significant Restricted Subsidiary of an assignment for the benefit of
creditors; or (v) the admission by the Company or any Significant
Restricted Subsidiary in writing of its inability to pay its debts
generally as they become due; or (vi) the taking of corporate action by the
Company or any Significant Restricted Subsidiary in furtherance of any such
action.
If any Event of Default (other than an Event of Default specified in clause
(g) or (h) above) occurs and is continuing, then and in every such case the
Trustee or the holders of not less than 25% of the outstanding aggregate
principal amount at Stated Maturity of the Notes may declare the Default
Amount, premium, if any, and any accrued and unpaid interest (and Special
Interest, if any) on all such Notes then outstanding to be immediately due and
payable by a notice in writing to the Company (and to the Trustee if given by
holders of such Notes), and upon any such declaration, all amounts payable in
respect of the Notes, will become and be immediately due and payable. If any
Event of Default specified in clause (g) or (h) above occurs, the Default
Amount, premium, if any, and any accrued and unpaid interest (and Special
Interest, if any) on the Notes then outstanding shall become immediately due
and payable without any declaration or other act on the part of the Trustee or
any holder of such Notes. In the event of a declaration of acceleration
because an Event of Default set forth in clause (e) above has occurred and is
continuing, such declaration of acceleration shall be automatically rescinded
and annulled if the event of default triggering such Event of Default pursuant
to clause (e) shall be remedied, or cured or waived by the holders of the
relevant Indebtedness within 60 days after such event of default; provided,
that no judgment or decree for the payment of the money due on the Notes has
been obtained by the Trustee as provided in the Indenture. Under certain
circumstances, the holders of a majority in principal amount at Stated
Maturity of the outstanding Notes, by notice to the Company and the Trustee,
may rescind an acceleration and its consequences. Until August 15, 2000, the
Default Amount shall equal the Accreted Value of the Notes. Thereafter, the
Default Amount shall equal 100% of the principal amount at Stated Maturity of
the Notes. Subject to all provisions of the Indenture and applicable law, the
holders of a majority in aggregate principal amount at Stated Maturity of the
Notes at the time outstanding have the right to direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee, or
exercising any trust or power conferred on the Trustee.
The holders of a majority in aggregate principal amount at Stated Maturity
of the Notes then outstanding by notice to the Trustee may on behalf of the
holders of all such Notes waive any existing Default or Event of Default and
its consequences under the Indenture except a continuing Default or Event of
Default in the payment of interest (and Special Interest, if any) on, premium,
if any on or the principal of, such Notes. Subject to the provisions of the
Indenture relating to the duties of the Trustee, the Trustee is under no
obligation to exercise any of its rights or powers under the Indenture at the
request, order or direction of any of the holders, unless such holders have
offered to the Trustee reasonable security or indemnity. Subject to the
provisions of the Indenture and applicable law, the holders of a majority in
aggregate principal amount at Stated Maturity of the Notes at the time
outstanding have the right to direct the time, method and place of conducting
any proceeding for any remedy available to the Trustee, or exercising any
trust or power conferred upon the Trustee.
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required within 5
Business Days after becoming aware of any Default or Event of Default, to
deliver to the Trustee a statement describing such Default or Event of
Default, its status and what action the Company is taking or proposes to take
with respect thereto.
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AMENDMENT, SUPPLEMENT AND WAIVER
The Company and the Trustee may, at any time and from time to time, without
notice to or consent of any holder of Notes enter into one or more indentures
supplemental to the Indenture (i) to evidence the succession of another Person
to the Company and the assumption by such successor of the covenants and
obligations of the Company in the Indenture and the Notes; (ii) to add to the
covenants of the Company, for the benefit of the holders, or to surrender any
right or power conferred upon the Company by the Indenture; (iii) to add any
additional Events of Default; (iv) to provide for uncertificated Notes in
addition to or in place of certificated Notes; (v) to evidence and provide for
the acceptance of appointment under the Indenture of a successor Trustee; (vi)
to cure any ambiguity in the Indenture, to correct or supplement any provision
in the Indenture which may be inconsistent with any other provision therein or
to add any other provisions with respect to matters or questions arising under
the Indenture; provided, that such actions shall not adversely affect the
interests of the holders in any material respect; (vii) to secure the Notes;
(viii) to provide for Guarantees as required under the Indenture; or (ix) to
comply with the requirements of the Commission in order to effect or maintain
the qualification of the Indenture under the Trust Indenture Act.
With the consent of the holders of not less than a majority in aggregate
principal amount at Stated Maturity of the outstanding Notes, the Company and
the Trustee may enter into one or more indentures supplemental to the
Indenture for the purpose of adding any provisions to or changing in any
manner or eliminating any of the provisions of the Indenture or modifying in
any manner the rights of the holders; provided, that no such supplemental
indenture shall, without the consent of the holder of each outstanding Note:
(i) change the Stated Maturity of the principal of, or any installment of
interest (including Special Interest, if any) on, any Note, or reduce the
Accreted Value or the principal amount thereof at Stated Maturity (or premium,
if any), or the interest thereon that would be due and payable upon Stated
Maturity thereof, or reduce the principal amount at Stated Maturity thereof
that would be due and payable upon acceleration of Maturity thereof, or change
the place of payment where, or the coin or currency in which, any Note, or any
premium or interest (including Special Interest, if any) thereon is payable,
or impair the right to institute suit for the enforcement of any such payment
on or after the Stated Maturity thereof; (ii) reduce the percentage in
principal amount of the outstanding Notes, the consent of whose holders is
necessary for any such supplemental indenture or required for any waiver of
compliance with certain provisions of the Indenture or any Guarantees or
certain Defaults thereunder; (iii) subordinate in right of payment, or
otherwise subordinate, the Notes or any Guarantees to any other Indebtedness;
(iv) modify the obligations of the Company to make offers to purchase Notes
upon a Change of Control or from the proceeds of Asset Sales; or (v) modify
any provision of this paragraph (except to increase any percentage set forth
herein).
The holders of not less than a majority in aggregate principal amount at
Stated Maturity of the outstanding Notes may, on behalf of the holders of all
such Notes, waive any past Default under the Indenture and its consequences,
except Default in the payment of the principal of (or premium, if any) or
interest on any Note, or in respect of a covenant or provision hereof which
under the proviso to the prior paragraph cannot be modified or amended without
the consent of the holder of each outstanding Note affected.
The holders of not less than 75% in aggregate principal amount at Stated
Maturity of the outstanding Notes may, on behalf of the holders of all such
Notes, waive any right to require the Company to issue to the holders of the
Notes Contingent Warrants.
SATISFACTION AND DISCHARGE OF THE INDENTURE, DEFEASANCE
The Company may terminate its obligations under the Notes and the Indenture
when (i) either (A) all outstanding Notes have been delivered to the Trustee
for cancellation or (B) all such Notes not theretofore delivered to the
Trustee for cancellation have become due and payable, will become due and
payable within one year or are to be called for redemption within one year
under irrevocable arrangements satisfactory to the Trustee for the giving of
notice of redemption by the Trustee in the name and at the expense of the
Company, and the Company has irrevocably deposited or caused to be deposited
with the Trustee funds or U.S. Government
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Obligations in an amount sufficient to pay and discharge the entire
indebtedness on the Notes not theretofore delivered to the Trustee for
cancellation, for principal of (premium, if any, on) and interest (including
Special Interest, if any) to the date of deposit or maturity or date of
redemption; (ii) the Company has paid or caused to be paid all sums then due
and payable by the Company under the Indenture; and (iii) the Company has
delivered an Officers' Certificate and an Opinion of Counsel relating to
compliance with the conditions set forth in the Indenture.
The Company, at its election, shall (a) be deemed to have paid and
discharged its debt on the Notes, and the Indenture shall cease to be of
further effect as to all outstanding Notes (except as to (i) rights of
registration of transfer, substitution and exchange of Notes, and the
Company's right of optional redemption, (ii) rights of holders to receive
payments of principal of, premium, if any, and interest (including Special
Interest, if applicable) on the Notes (but not the Change of Control Purchase
Price or the Asset Sale Purchase Price), and any rights of the holders with
respect to such amounts, (iii) the rights, obligations and immunities of the
Trustee under the Indenture, and (iv) certain other specified provisions in
the Indenture) or (b) cease to be under any obligation to comply with certain
restrictive covenants including those described under "--Certain Covenants,"
after the irrevocable deposit by the Company with the Trustee, in trust for
the benefit of the holders, at any time prior to the Stated Maturity of the
Notes of (A) money in an amount, (B) U.S. Government Obligations which through
the payment of interest and principal will provide, not later than one day
before the due date of payment in respect of such Notes, money in an amount,
or (C) a combination thereof sufficient to pay and discharge the principal of,
and interest (including Special Interest, if applicable) on, such Notes then
outstanding on the dates on which any such payments are due in accordance with
the terms of the Indenture and of such Notes. Such defeasance or covenant
defeasance shall be deemed to occur only if certain conditions are satisfied,
including, among other things, delivery by the Company to the Trustee of an
opinion of outside counsel acceptable to the Trustee to the effect that (i)
such deposit, defeasance and discharge will not be deemed, or result in, a
taxable event for federal income tax purposes with respect to the holders; and
(ii) the Company's deposit will not result in such trust or the Trustee being
subject to regulation under the Investment Company Act of 1940.
THE TRUSTEE
Harris Trust and Savings Bank is the Trustee under the Indenture and its
current address is 111 West Monroe, Chicago, Illinois 60603.
The holders of not less than a majority in aggregate principal amount at
Stated Maturity of the outstanding Notes will have the right to direct the
time, method and place of conducting any proceeding for exercising any remedy
available to the Trustee, subject to certain exceptions. Except during the
continuance of an Event of Default under the Indenture, the Trustee will
perform only such duties as are specifically set forth in the Indenture. The
Indenture provides that in case an Event of Default shall occur (which shall
not be cured or waived), the Trustee will be required, in the exercise of its
rights and powers under the Indenture, to use the degree of care of a prudent
person in the conduct of such person's own affairs. Subject to such
provisions, the Trustee will be under no obligation to exercise any of its
rights or powers under the Indenture at the request of any of the holders of
the Notes, unless such holders shall have offered to the Trustee indemnity
satisfactory to it against any loss, liability or expense.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company,
as such, shall have any liability for any obligations of the Company under the
Notes or the Indenture or for any claim based on, in respect of, or by reason
of, such obligations or their creation, solely by reason of its status as a
director, officer, employee, incorporator or stockholder of the Company. By
accepting a Note each holder waives and releases all such liability (but only
such liability). The waiver and release are part of the consideration for
issuance of the Notes. Nonetheless, such waiver may not be effective to waive
liabilities under the federal securities laws and it has been the view of the
Commission that such a waiver is against public policy and is therefore
unenforceable.
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GOVERNING LAW
The Indenture and the Notes are governed by the laws of the State of New
York, without regard to principles of conflicts of law.
TRANSFER AND EXCHANGE
A holder may transfer or exchange Notes in accordance with the Indenture.
The Company, the Registrar and the Trustee may require a holder, among other
things, to furnish appropriate endorsements and transfer documents and the
Company may require a holder to pay any taxes and fees required by law or
permitted by the Indenture.
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any capitalized terms used herein for which no
definition is provided.
"Acquired Indebtedness" means, with respect to any specified Person,
Indebtedness of any other Person existing at the time such other Person merged
with or into or became a Subsidiary of such specified Person, including
Indebtedness incurred in connection with, or in contemplation of, such other
Person merging with or into or becoming a Subsidiary of such specified Person,
but excluding Indebtedness which is extinguished, retired or repaid in
connection with such other Person merging with or into or becoming a
Subsidiary of such specified Person.
"Accreted Value" means, with respect to the Notes, for any Specified Date,
the amount provided below for each $1,000 principal amount at Stated Maturity
of the Notes:
(a) If the Specified Date occurs on one of the following dates (each a
"Semi-Annual Accrual Date"), the Accreted Value will equal the amount set
forth below for such Semi-Annual Accrual Date:
<TABLE>
<CAPTION>
ACCRETED
SEMI-ANNUAL ACCRUAL DATE VALUE
------------------------ --------
<S> <C>
February 15, 1998.............................................. $ 702.67
August 15, 1998................................................ 754.05
February 15, 1999.............................................. 809.19
August 15, 1999................................................ 868.36
February 15, 2000.............................................. 931.86
August 15, 2000................................................ 1,000.00
</TABLE>
(b) if the Specified Date occurs before the first Semi-Annual Accrual
Date, the Accreted Value will equal the sum of (i) $654.78 and (ii) an
amount equal to the product of (y) the Accreted Value of the first Semi-
Annual Accrual Date less the original issue price multiplied by (z) a
fraction, the numerator of which is the number of days from the Issue Date
to the Specified Date, using a 360-day year of twelve 30-day months, and
the denominator of which is the number of days elapsed from the Issue Date
to the first Semi-Annual Accrual Date, using a 360-day year of twelve 30-
day months.
(c) if the Specified Date occurs between two Semi-Annual Accrual Dates,
the Accreted Value will equal the sum of (i) the Accreted Value for the
Semi-Annual Accrual Date immediately preceding such Specified Date and (ii)
an amount equal to the product of (y) the Accreted Value for the
immediately following Semi-Annual Accrual Date less the Accreted Value for
the immediately preceding Semi-Annual Accrual Date multiplied by (z) a
fraction, the numerator of which is the number of days from the immediately
preceding Semi-Annual Accrual Date to the Specified Date, using a 360-day
year of twelve 30-day months, and the denominator of which is 180; or
(d) if the Specified Date occurs after the last Semi-Annual Accrual Date,
the Accreted Value will equal $1,000.
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"Affiliate" means, as to any Person, any other Person which directly or
indirectly controls, or is under common control with, or is controlled by,
such Person; provided that each Unrestricted Subsidiary shall be deemed to be
an Affiliate of the Company and of each other Subsidiary of the Company;
provided that any lender under a Credit Facility shall not be deemed to be an
Affiliate solely as the result of the Credit Facility; and provided, further,
that neither the Company nor any of its Wholly-Owned Restricted Subsidiaries
shall be deemed to be Affiliates of each other; provided, further, that
Merrill Lynch and its Affiliates shall not be deemed to be Affiliates of the
Company solely as a result of such entities holding the Notes, the Old Senior
Notes, the Convertible Notes, the Consent Convertible Notes, the Warrants, the
Consent Warrants or the warrants issued pursuant to the 1996 Private
Placement. For purposes of this definition, "control" (including, with
correlative meanings, the terms "controlling," "under common control with" and
"controlled by"), and as used with respect to any Person, shall mean the
possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
ownership of Voting Stock, by agreement or otherwise; provided, that
beneficial ownership of 10% or more of the Voting Stock of a Person (on a
fully diluted basis) shall be deemed to be control.
"Asset Sale" means, with respect to any Person, any transfer, conveyance,
sale, lease or other disposition (including, without limitation, dispositions
pursuant to any consolidation or merger) by such Person or any of its
Restricted Subsidiaries to any Person other than to such Person or a
Restricted Subsidiary of such Person, in one transaction or a series of
related transactions (each hereinafter referred to as a "Disposition"), of (a)
Capital Stock of or other equity interests in any Restricted Subsidiary (other
than director's qualifying shares) except as provided in clause (iv) of this
definition, (b) all or substantially all of the assets of any division or line
of business of such Person or of any of its Restricted Subsidiaries or (c)
Property or assets of such Person or any of its Restricted Subsidiaries, the
Fair Market Value of which exceeds $500,000, other than (i) a Disposition of
Property in the ordinary course of business and consistent with industry
practice, (ii) a Disposition of Eligible Cash Equivalents, (iii) a Disposition
of an Investment that constitutes a Restricted Payment under the Indenture
permitted under the first paragraph of the covenant described in "--Restricted
Payments," (iv) a Disposition of no more than ten percent of the Common Stock
of USN Solutions, Inc. on a fully-diluted basis pursuant to the exercise of
the USN Solutions Option, (v) a Disposition by the Company in connection with
a transaction permitted under "--Consolidation, Merger, Conveyance, Lease or
Transfer" and (vi) a contribution of assets to any Unrestricted Subsidiary
constituting an Investment permitted by the Indenture.
"Attributable Indebtedness" means, with respect to any Sale and Leaseback
Transaction of any Person, as at the time of determination, the greater of (i)
the capitalized amount in respect of such transaction that would appear on the
balance sheet of such Person in accordance with GAAP and (ii) the present
value (discounted at a rate consistent with accounting guidelines, as
determined in good faith by such Person) of the payments during the remaining
term of the lease (including any period for which such lease has been extended
or may, at the option of the lessor, be extended) or until the earliest date
on which the lessee may terminate such lease without penalty or upon payment
of a penalty (in which case the rental payments shall include such penalty).
"Average Life" means, as of any date, with respect to any debt security or
Disqualified Stock, the quotient obtained by dividing (i) the sum of the
products of (x) the number of years from such date to the dates of each
scheduled principal payment or redemption payment (including any sinking fund
or mandatory redemption payment requirements) of such debt security or
Disqualified Stock multiplied in each case by (y) the amount of such principal
or redemption payment, by (ii) the sum of all such principal or redemption
payments.
"Board of Directors" means, with respect to any Person, the Board of
Directors (or similar governing body) of such Person or any committee of the
Board of Directors (or similar governing body) duly authorized to act on
behalf of such Board (or similar governing body).
"Board Resolution" means a duly adopted resolution of the Board of Directors
of a Person in full force and effect at the time of determination and
certified as such by the Secretary or Assistant Secretary of such Person.
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"Capital Lease Obligation" of any Person means the obligation to pay rent or
other payment amounts under a lease of (or other Indebtedness arrangement
conveying the right to use) real or personal property of such Person which is
required to be classified and accounted for as a capital lease or a liability
on the face of a balance sheet of such Person in accordance with GAAP and the
stated maturity thereof shall be the date of the last payment of rent or any
amount due under such lease prior to the first date upon which such lease may
be terminated by the lessee without payment of a penalty.
"Capital Stock" in any Person means any and all shares, interests,
participations or other equivalents in the equity interest (however
designated) in such Person and any rights (other than Indebtedness convertible
into an equity interest), warrants or options to acquire an equity interest in
such Person.
"Cash Proceeds" means, with respect to any Asset Sale or issuance or sale of
Capital Stock by any Person, the aggregate consideration received in respect
of such sale or issuance by such Person in the form of cash or Eligible Cash
Equivalents; provided that with regard to an Asset Sale, any liabilities (as
shown on the Company's or such Restricted Subsidiary's most recent balance
sheet or in the notes thereto) of the Company or any Restricted Subsidiary
(other than liabilities that are by their terms subordinated to the Notes or
Guarantees, if any, or the Old Senior Notes or the Old Senior Note Guarantees,
if any) which are assumed by the transferee of any such assets and from which
the Company and such Restricted Subsidiary are completely released shall be
deemed Cash Proceeds.
"Change of Control" shall be deemed to occur if (i) the sale, conveyance,
transfer, or lease (other than to the Company or any Wholly-Owned Restricted
Subsidiary of the Company), whether direct or indirect, of all or
substantially all of the assets of the Company or of the Company and its
Restricted Subsidiaries taken as a whole to any "person" or "group" (within
the meaning of Sections 13(d)(3) and 14(d)(2) of the Exchange Act or any
successor provision to either of the foregoing, including any group acting for
the purpose of acquiring, holding or disposing of securities within the
meaning of Rule 13d-5(b)(i) under the Exchange Act) shall have occurred; (ii)
any "person" or "group" (within the meaning of Sections 13(d)(3) and 14(d)(2)
of the Exchange Act or any successor provision to either of the foregoing,
including any group acting for the purpose of acquiring, holding or disposing
of securities within the meaning of Rule 13d-5(b)(i) under the Exchange Act),
other than any Permitted Holder or Permitted Holders, becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act) of more than 35% of
the total voting power of all classes of the Voting Stock of the Company
(including any warrants or options or rights to acquire such Voting Stock),
calculated on a fully diluted basis, and such voting power percentage is
greater than or equal to the total voting power percentage then beneficially
owned by the Permitted Holders in the aggregate; or (iii) during any period of
two consecutive years, individuals who at the beginning of such period
constituted the Board of Directors of the Company (together with any new
directors whose election or appointment by such board or whose nomination for
election by the stockholders of the Company was approved by a vote of a
majority of the directors then still in office who were either directors at
the beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
Board of Directors of the Company then in office.
"Common Stock" of any Person means all Capital Stock of such Person that is
generally entitled to vote in the election of directors of such Person and any
rights (other than Indebtedness convertible into such Capital Stock), warrants
or options to acquire such Capital Stock of such Person.
"Consolidated Interest Expense" means, with respect to any Person for any
period, without duplication (A) the sum of (i) the aggregate amount of cash
and non-cash interest expense (including capitalized interest) of such Person
and its Restricted Subsidiaries for such period as determined on a
consolidated basis in accordance with GAAP in respect of Indebtedness
(including, without limitation, (v) any amortization of debt discount, (w) net
costs associated with Interest Hedging Obligations (including any amortization
of discounts), (x) the interest portion of any deferred payment obligation
calculated in accordance with the effective interest method, (y) all accrued
interest and (z) all commissions, discounts and other fees and charges owed
with respect to letters of credit, bankers' acceptances or similar facilities)
paid or accrued, or scheduled to be paid or accrued, during such period; (ii)
dividends or distributions with respect to Preferred Stock or Disqualified
Stock of such Person (and
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of its Restricted Subsidiaries if paid to a Person other than such Person or
its Restricted Subsidiaries) declared and payable in cash; (iii) the portion
of any rental obligation of such Person or its Restricted Subsidiaries in
respect of any Capital Lease Obligation allocable to interest expense in
accordance with GAAP; (iv) the portion of any rental obligation of such Person
or its Restricted Subsidiaries in respect of any Sale and Leaseback
Transaction allocable to interest expense (determined as if such Sale and
Leaseback Transaction were treated as a Capital Lease Obligation); and (v) to
the extent any Indebtedness of any other Person is guaranteed by such Person
or any of its Restricted Subsidiaries, the aggregate amount of interest paid
or accrued, or scheduled to be paid or accrued, by such other Person during
such period attributable to any such Indebtedness, less (B) to the extent
included in (A) above, amortization or write-off of deferred financing costs
of such Person and its Restricted Subsidiaries during such period and any
charge related to any premium or penalty paid in connection with redeeming or
retiring any Indebtedness of such Person and its Restricted Subsidiaries prior
to its Stated Maturity; in the case of both (A) and (B) above, after
elimination of intercompany accounts among such Person and its Restricted
Subsidiaries and as determined in accordance with GAAP. For purposes of clause
(ii) above, dividend requirements attributable to any Preferred Stock or
Disqualified Stock shall be deemed to be an amount equal to the amount of
dividend requirements on such Preferred Stock or Disqualified Stock times a
fraction, the numerator of which is the amount of such dividend requirements,
and the denominator of which is one minus the applicable combined federal,
state, local and foreign income tax rate of the Company and its Restricted
Subsidiaries (expressed as a decimal), on a consolidated basis, for the fiscal
year immediately preceding the date of the transaction giving rise to the need
to calculate Consolidated Interest Expense.
"Consolidated Net Income" of any Person means, for any period, the aggregate
net income (or net loss) of such Person and its Restricted Subsidiaries for
such period on a consolidated basis determined in accordance with GAAP;
provided that there shall be excluded therefrom, without duplication, (i) all
items classified as extraordinary, unusual or nonrecurring, (ii) the net
income of any Person that is not a Restricted Subsidiary or that is accounted
for by the equity method of accounting which shall be included only to the
extent of the amount of dividends or distributions paid to such Person or its
Restricted Subsidiaries, (iii) the net income of any Person acquired by such
Person or any of its Restricted Subsidiaries in a pooling-of-interests
transaction for any period prior to the date of the related acquisition, (iv)
any gain or loss, net of taxes, realized on the termination of any employee
pension benefit plan, (v) net gains (but not net losses) in respect of Asset
Sales by such Person or its Restricted Subsidiaries, (vi) the net income (but
not net loss) of any Restricted Subsidiary of such Person to the extent that
the payment of dividends or other distributions to such Person is restricted
by the terms of its charter or any agreement, instrument, contract, judgment,
order, decree, statute, rule, governmental regulation or otherwise, except for
any dividends or distributions actually paid by such Restricted Subsidiary to
such Person, and (vii) with regard to a non-Wholly-Owned Restricted
Subsidiary, any aggregate net income (or loss) in excess of such Person's or
such Restricted Subsidiary's pro rata share of such non-Wholly-Owned
Restricted Subsidiary's net income (or loss).
"Consolidated Net Worth" of any Person means the consolidated stockholders'
equity of such Person and its Restricted Subsidiaries, as determined on a
consolidated basis in accordance with GAAP, less amounts attributable to
Disqualified Stock of such Person.
"Convertible Note Guarantees" means the guarantees, if any, of "Restricted
Subsidiaries" (as defined in the Convertible Note Indenture) contained in the
Convertible Note Indenture.
"Convertible Note Indenture" means the indenture, dated as of September 30,
1996, between the Company and Harris Trust and Savings Bank, as trustee
thereunder, relating to the Convertible Notes, as amended and supplemented
from time to time.
"Convertible Notes" means up to $39,100,000 aggregate principal amount at
Stated Maturity of the Company's 9% Convertible Subordinated Discount Notes
due 2004 (of which $36,000,000 aggregate principal amount at Stated Maturity
is outstanding as of the date of this Offering Memorandum).
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"Credit Facility" means one or more credit agreements, loan agreements or
similar agreements providing for working capital advances, term loans, letter
of credit facilities or similar advances, loans or facilities to the Company,
which may, pursuant to the terms of the Indenture, be guaranteed by the
Restricted Subsidiaries, with a bank or syndicate of banks or other financial
institutions, as such may be amended, renewed, extended, supplemented,
refinanced and replaced or refunded from time to time; provided, that the
aggregate principal amount of Indebtedness under the Credit Facility shall not
exceed $45 million at any one time outstanding less the amount of any
mandatory or permitted principal payment or payments from the proceeds of
Asset Sales made under the Credit Facility that, in each case, permanently
reduce the borrowing capacity of the Company thereunder.
"Default" means any event, act or condition, the occurrence of which is, or
after notice or the passage of time or both would be, an Event of Default.
"Disqualified Stock" means any Capital Stock which, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event or otherwise, matures or is
mandatorily redeemable, pursuant to a sinking fund obligation or otherwise, or
is redeemable at the option of the holder thereof or is exchangeable for
Indebtedness at any time, in whole or in part, on or prior to the date on
which the Notes mature.
"EBITDA" means, with respect to any Person for any period, the sum for such
Person for such period of Consolidated Net Income plus, to the extent
reflected in the income statement of such Person for such period from which
Consolidated Net Income is determined, without duplication, (i) Consolidated
Interest Expense, (ii) income tax expense of such Person and its consolidated
Subsidiaries, (iii) depreciation expense, (iv) amortization expense, (v) any
non-cash expense related to the issuance to employees of such Person of
options to purchase Capital Stock of such Person and (vi) any charge related
to any premium or penalty paid in connection with redeeming or retiring any
Indebtedness prior to its Stated Maturity and minus, to the extent reflected
in such income statement, any noncash credits that had the effect of
increasing Consolidated Net Income of such Person for such period. This
definition of EBITDA is used only for the purpose of this "Description of the
Notes" and the Indenture.
"Eligible Cash Equivalents" means (i) securities issued or directly and
fully guaranteed or insured by the United States of America or any agency or
instrumentality thereof (provided that the full faith and credit of the United
States of America is pledged in support thereof), (ii) time deposits,
certificates of deposit or Eurodollar deposits of any commercial bank
organized in the United States having capital and surplus in excess of $500
million with a maturity date not more than one year from the date of
acquisition, (iii) repurchase obligations with a term of not more than seven
days for underlying securities of the types described in clause (i) above
entered into with any bank meeting the qualifications specified in clause (ii)
above, (iv) direct obligations issued by any state of the United States of
America or any political subdivision of any such state or any public
instrumentality thereof maturing, or subject to tender at the option of the
holder thereof within 90 days after the date of acquisition thereof and, at
the time of acquisition, having a rating of A or better from Standard & Poor's
or A-2 or better from Moody's, (v) commercial paper issued by the parent
corporation of any commercial bank organized in the United States having
capital and surplus in excess of $500 million and commercial paper issued by
others having one of the two highest ratings obtainable from either of
Standard & Poor's or Moody's and in each case maturing within 270 days after
the date of acquisition, (vi) overnight bank deposits and bankers' acceptances
at any commercial bank organized in the United States having capital and
surplus in excess of $500 million, (vii) deposits available for withdrawal on
demand with a commercial bank organized in the United States having capital
and surplus in excess of $500 million and (viii) investments in money market
funds substantially all of whose assets comprise securities of the types
described in clauses (i) through (vi).
"Exchange Rate Obligation" means, with respect to any Person, any currency
swap agreements, forward exchange rate agreements, foreign currency futures or
options, exchange rate collar agreements, exchange rate insurance and other
agreements or arrangements, or combination thereof, designed to provide
protection against fluctuations in currency exchange rates.
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"Existing Indebtedness" means Indebtedness of the Company and its Restricted
Subsidiaries outstanding on the Issue Date.
"Fair Market Value" means, with respect to any asset or Property, the sale
value that could be obtained in an arm's-length transaction between an
informed and willing seller under no compulsion to sell and an informed and
willing buyer under no compulsion to buy, as determined in good faith by the
Board of Directors of the Company or a Restricted Subsidiary, as applicable.
"GAAP" means United States generally accepted accounting principles,
consistently applied, as set forth in the opinions and pronouncements of the
Accounting Principles Board of the American Institute of Certified Public
Accountants and statements and pronouncements of the Financial Accounting
Standards Board, or in such other statements by such other entity as may be
approved by a significant segment of the accounting profession of the United
States, that are applicable to the circumstances as of the date of
determination; provided that, except as otherwise specifically provided, all
calculations made for purposes of determining compliance with the terms of the
provisions of the Indenture shall utilize GAAP as in effect on the Issue Date.
"guarantee" means any direct or indirect obligation, contingent or
otherwise, of a Person guaranteeing or having the economic effect of
guaranteeing any Indebtedness of any other Person in any manner (and
"guaranteed," "guaranteeing" and "guarantor" shall have meanings correlative
to the foregoing).
"Guarantee" means a guarantee of the payment of the Notes, as executed and
delivered by a Restricted Subsidiary as required by the covenant described
under "--Limitation on Issuances of Guarantees by Restricted Subsidiaries."
"Guarantor" means a Restricted Subsidiary that executes and delivers a
Guarantee.
"incur" means, with respect to any Indebtedness or other obligation of any
Person, to create, issue, incur (by conversion, exchange or otherwise),
assume, guarantee or otherwise become liable in respect of such Indebtedness
or other obligation or the recording, as required pursuant to GAAP or
otherwise, of any such Indebtedness or obligation on the balance sheet of such
Person (and "incurrence," "incurred," "incurrable" and "incurring" shall have
meanings correlative to the foregoing); provided that a change in GAAP that
results in an obligation of such Person that exists at such time becoming
Indebtedness shall not be deemed an incurrence of such Indebtedness.
Indebtedness otherwise incurred by a Person before it becomes a Restricted
Subsidiary of the Company shall be deemed to have been incurred at the time at
which it becomes a Restricted Subsidiary.
"Indebtedness" means at any time (without duplication), with respect to any
Person, whether recourse is to all or a portion of the assets of such Person,
and whether or not contingent, (i) any obligation of such Person for money
borrowed, (ii) any obligation of such Person evidenced by bonds, debentures,
notes, guarantees or other similar instruments, including, without limitation,
any such obligations incurred in connection with the acquisition of Property,
assets or businesses, excluding trade accounts payable made in the ordinary
course of business which are not more than 90 days overdue or which are being
contested in good faith and by appropriate proceedings, (iii) any
reimbursement obligation of such Person with respect to letters of credit,
bankers' acceptances or similar facilities issued for the account of such
Person, (iv) any obligation of such Person issued or assumed as the deferred
purchase price of Property, assets or services (but excluding trade accounts
payable or accrued liabilities arising in the ordinary course of business,
which in either case are not more than 90 days overdue or which are being
contested in good faith and by appropriate proceedings, and for which adequate
reserves are being maintained on the books of the Company in accordance with
GAAP), (v) any Capital Lease Obligation of such Person, (vi) the maximum fixed
redemption or repurchase price of Disqualified Stock of such Person and, to
the extent held by other Persons, the maximum fixed redemption or repurchase
price of Disqualified Stock of such Person's Restricted Subsidiaries, at the
time of determination, (vii) the notional amount of any Interest Hedging
Obligations or Exchange Rate Obligations of such Person at the time of
determination, (viii) any Attributable Indebtedness with respect to any Sale
and Leaseback Transaction to which such Person is a party and (ix) any
obligation of the type referred to in clauses (i) through (viii) of this
definition
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of another Person and all dividends and distributions of another Person the
payment of which, in either case, such Person has guaranteed or is responsible
or liable, directly or indirectly, as obligor, guarantor or otherwise. For
purposes of the preceding sentence, the maximum fixed repurchase price of any
Disqualified Stock that does not have a fixed repurchase price shall be
calculated in accordance with the terms of such Disqualified Stock as if such
Disqualified Stock were repurchased on any date on which Indebtedness shall be
required to be determined pursuant to the Indenture; provided that if such
Disqualified Stock is not then permitted to be repurchased, the repurchase
price shall be the book value of such Disqualified Stock. The amount of
Indebtedness of any Person at any date shall be the outstanding balance at
such date of all unconditional obligations as described above and the maximum
liability of any guarantees at such date; provided, that for purposes of
calculating the amount of Notes, 14% Senior Notes, Convertible Notes, or, if
issued, the Consent Convertible Notes, as the case may be, outstanding at any
date, the amount of Notes shall be the Accreted Value thereof as of such date,
the amount of 14% Senior Notes shall be the "Accreted Value" (as defined in,
and determined pursuant to, the 14% Senior Note Indenture), the amount of the
Convertible Notes shall be the "Accreted Value" (as defined in, and determined
pursuant to, the Convertible Note Indenture) and the amount of the Consent
Convertible Notes, if issued, shall be the "Accreted Value" (as such would be
defined in and determined pursuant to the Consent Convertible Note Indenture),
unless cash interest has commenced to accrue pursuant to the terms of the
Notes and the Indenture, the 14% Senior Notes and the 14% Senior Note
Indenture, the Convertible Notes and the Convertible Note Indenture or the
Consent Convertible Notes and the Consent Convertible Note Indenture, as the
case may be, in which case the amount of such 14% Senior Notes, Convertible
Notes or, if issued, Consent Convertible Notes, as the case may be,
outstanding at such date shall be the aggregate principal amount thereof at
Stated Maturity; and provided, that for purposes of calculating the amount of
any non-interest bearing or other discount security (other than the Notes, the
14% Senior Notes, the Convertible Notes or, if issued, Consent Convertible
Notes), such Indebtedness shall be deemed to be the principal amount thereof
that would be shown on the balance sheet of the issuer dated such date
prepared in accordance with GAAP but that such security shall be deemed to
have been incurred only on the date of the original issuance thereof.
"Indebtedness to Operating Cash Flow Ratio" means, as at any date of
determination, the ratio of (i) the aggregate amount of Indebtedness of the
Company and its Restricted Subsidiaries on a consolidated basis as of the date
of determination to (ii) the aggregate amount of EBITDA of the Company and its
Restricted Subsidiaries for the four preceding fiscal quarters for which
financial information is available immediately prior to the date of
determination; provided that any Indebtedness incurred or retired by the
Company or any of its Restricted Subsidiaries during the fiscal quarter in
which the date of determination occurs shall be calculated as if such
Indebtedness was so incurred or retired on the first day of the fiscal quarter
in which the date of determination occurs; and provided, further, that (x) if
the transaction giving rise to the need to calculate the Indebtedness to
Operating Cash Flow Ratio would have the effect of increasing or decreasing
Indebtedness or EBITDA in the future, Indebtedness or EBITDA shall be
calculated on a pro forma basis as if such transaction had occurred on the
first day of such four fiscal quarter period preceding the date of
determination, and (y) if during such four fiscal quarter period, the Company
or any of its Restricted Subsidiaries shall have engaged in any Asset Sale,
EBITDA for such period shall be reduced by an amount equal to the EBITDA (if
positive), or increased by an amount equal to the EBITDA (if negative),
directly attributable to the assets which are the subject of such Asset Sale
and any related retirement of Indebtedness as if such Asset Sale and related
retirement of Indebtedness had occurred on the first day of such four fiscal
quarter period or (z) if during such four fiscal quarter period the Company or
any of its Restricted Subsidiaries shall have acquired any material assets
outside the ordinary course of business, EBITDA shall be calculated on a pro
forma basis as if such asset acquisition and related financing had occurred on
the first day of such four fiscal quarter period.
"Interest Hedging Obligation" means, with respect to any Person, an
obligation of such Person pursuant to any interest rate swap agreement,
interest rate cap, collar or floor agreement or other similar agreement or
arrangement designed to protect against or manage such Person's or any of its
Restricted Subsidiaries' exposure to fluctuations in interest rates.
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"Investment" in any Person means any direct, indirect or contingent (i)
advance or loan to, guarantee of any Indebtedness of, extension of credit or
capital contribution to such Person, (ii) acquisition of any shares of Capital
Stock, bonds, notes, debentures or other securities of such Person, or (iii)
acquisition, by purchase or otherwise, of all or substantially all of the
business, assets or stock or other evidence of beneficial ownership of such
Person; provided that Investments shall exclude accounts receivable and other
extensions of trade credit on commercially reasonable terms in accordance with
normal trade practices. The amount of an Investment shall be the original cost
of such Investment, plus the cost of all additions thereto and minus the
amount of any portion of such Investment repaid to such Person in cash as a
repayment of principal or a return of capital, as the case may be, but without
any other adjustments for increases or decreases in value, or write-ups,
write-downs or write-offs with respect to such Investment. In determining the
amount of any Investment involving a transfer of any Property or assets other
than cash, such Property or assets shall be valued at its Fair Market Value at
the time of such transfer. The Company shall be deemed to make an "Investment"
in the amount of the Fair Market Value of the assets of a Subsidiary at the
time that such Subsidiary is designated as an Unrestricted Subsidiary.
"Issue Date" means the date on which the Notes are first authenticated and
delivered under the Indenture.
"Joint Venture" means a Telecommunications Company of which less than 50
percent of the Voting Stock is held by the Company; provided that the
management and operations of such Person are controlled by a Strategic
Investor or by the Company pursuant to (i) the charter documents of such
Person, or (ii) an agreement among the holders of the Voting Stock of such
Person, or (iii) a management agreement between the Company and such Person.
"Lien" means, with respect to any Property or other asset, any mortgage or
deed of trust, pledge, hypothecation, assignment, deposit arrangement,
security interest, lien (statutory or other), charge, easement, encumbrance,
preference, priority or other security or similar agreement or preferential
arrangement of any nature whatsoever on or with respect to such Property or
other asset (including, without limitation, any conditional sale or title
retention agreement having substantially the same economic effect as any of
the foregoing).
"Maturity" means, when used with respect to a Note, the date on which the
principal of such Note becomes due and payable as provided therein or in the
Indenture, whether at Stated Maturity, on the Change of Control Payment Date
or purchase date established pursuant to the terms of the Indenture with
regard to a Change of Control Offer or an Asset Sale Offer, as applicable, or
by declaration of acceleration, call for redemption or otherwise.
"Net Cash Proceeds" means, with respect to the sale of any Property or
assets by any Person or any of its Restricted Subsidiaries, Cash Proceeds
received net of (i) all reasonable out-of-pocket expenses of such Person or
such Restricted Subsidiary incurred in connection with such sale, including,
without limitation, all legal, title and recording tax expenses, commissions
and other fees and expenses incurred (but excluding any finder's fee or
broker's fee payable to any Affiliate of such Person) and all federal, state,
foreign and local taxes arising in connection with such sale that are paid or
required to be accrued as liability under GAAP by such Person or its
Restricted Subsidiaries, (ii) all payments made or required to be made by such
Person or its Restricted Subsidiaries on any Indebtedness which is secured by
such Properties or other assets in accordance with the terms of any Lien upon
or with respect to such Properties or other assets or which must, by the terms
of such Lien, or in order to obtain a necessary consent to such transaction or
by applicable law, be repaid in connection with such sale and (iii) all
contractually required distributions and other payments made to minority
interest holders (but excluding distributions and payments to Affiliates of
such Person) in Restricted Subsidiaries of such Person as a result of such
transaction; provided that, in the event that any consideration for a
transaction (which would otherwise constitute Net Cash Proceeds) is required
to be held in escrow pending determination of whether a purchase price
adjustment will be made, such consideration (or any portion thereof) shall
become Net Cash Proceeds only at such time as it is released to such Person or
its Restricted Subsidiaries from escrow; provided, further, that any non-cash
consideration received in connection with any transaction, which is
subsequently converted to cash, shall be deemed to be Net Cash Proceeds at
such time, and shall thereafter be applied in accordance with the Indenture.
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"Officers' Certificate" means a certificate signed by the Chairman of the
Board, a Vice Chairman of the Board, the President, the Chief Executive
Officer, the Chief Operating Officer or a Vice President, and by the Chief
Financial Officer, the Chief Accounting Officer, the Treasurer, an Assistant
Treasurer, the Secretary or an Assistant Secretary of the Company or a
Restricted Subsidiary and delivered to the Trustee, which shall comply with
the Indenture.
"Old Senior Note Guarantees" means the guarantees, if any, of "Restricted
Subsidiaries" (as defined in the 14% Senior Note Indenture) contained in the
14% Senior Note Indenture.
"Pari Passu Indebtedness" means any Indebtedness (secured or unsecured) of
the Company or any Guarantor that ranks pari passu in right of payment with
the Notes or the Old Senior Notes, or the Guarantees or the Old Senior Note
Guarantees, as applicable.
"Permitted Holders" means J. Thomas Elliott and Ronald W. Gavillet and Chase
Venture Capital Associates, L.P., CIBC Wood Gundy Ventures, Inc., Hancock
Venture Partners IV-Direct Fund, L.P. (currently known as Harbourvest
Partners, LLC), Northwood Capital Partners, LLC, Northwood Ventures, BT
Capital Partners, Inc., Enterprises & Transcommunications, L.P. (currently
known as Prime New Ventures), Merrill Lynch Global Allocation Fund, Inc., and
any of their respective Subsidiaries (or a wholly-owned Subsidiary of the sole
stockholder of any of the foregoing Persons).
"Permitted Investments" means (i) Eligible Cash Equivalents; (ii)
Investments in Property used in the ordinary course of business; (iii)
Investments in the Company or in any Restricted Subsidiary or any Person as a
result of which such Person becomes a Restricted Subsidiary in compliance with
the Indenture; (iv) Investments pursuant to certain agreements or obligations
of the Company or a Restricted Subsidiary, in effect on the Issue Date, to
make such Investments, to the extent and in the manner existing on the Issue
Date; (v) Investments in prepaid expenses, negotiable instruments held for
collection and lease, utility and workers' compensation, performance and other
similar deposits; (vi) Interest Hedging Obligations with respect to any
floating rate Indebtedness that is permitted by the terms of the Indenture to
be outstanding; (vii) bonds, notes, debentures or other debt securities
received as a result of Asset Sales permitted under the covenant described
under "--Asset Sales;" (viii) Investments in existence on the Issue Date; and
(ix) Investments in securities of trade creditors, wholesalers or customers
received pursuant to any plan of reorganization or similar arrangements.
"Permitted Liens" means (i) Liens created by the Indenture or that otherwise
secure the payment of the Notes or the Guarantees, if any; (ii) Liens on
Property or assets of a Person existing at the time such Person is merged into
or consolidated with the Company or any Restricted Subsidiary of the Company
or becomes a Restricted Subsidiary of the Company, provided that such Liens
were in existence prior to the contemplation of such merger or consolidation
and do not secure any Property or assets of the Company or any of its
Restricted Subsidiaries other than the Property or assets subject to the Liens
prior to such merger or consolidation; (iii) Liens on Property or assets
existing at the time of acquisition thereof by the Company or any Restricted
Subsidiary, provided that such Liens were not given in contemplation of such
acquisition; (iv) Liens to secure the payment of all or a part of the purchase
price or construction cost of Property or assets acquired or constructed in
the ordinary course of business after the Issue Date, provided that the
Indebtedness secured by such Liens shall not exceed the lesser of 100% of the
cost or the Fair Market Value of the Property or assets acquired or
constructed and such Liens shall not extend to any other Property or assets;
(v) Liens incurred or deposits made to secure the performance of tenders,
bids, leases not constituting Capitalized Lease Obligations, statutory or
regulatory obligations, surety or appeal bonds, performance bonds or other
obligations of a like nature incurred in the ordinary course of business
consistent with industry practice; (vi) Liens existing as of the Issue Date as
in effect on the Issue Date (vii) any Lien on Property of the Company in favor
of the United States of America or any state thereof, or any instrumentality
of either, to secure certain payments pursuant to any contract or statute;
(viii) any Lien for taxes or assessments or other governmental charges or
levies not then due and payable (or which, if due and payable, are being
contested in good faith and for which adequate reserves are being maintained,
to the extent required by GAAP); (ix) easements, rights-of-way, licenses and
other similar restrictions on the use of Properties or minor imperfections of
title that, in the aggregate, are not material in
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amount and do not in any case materially detract from the Properties subject
thereto or interfere with the ordinary conduct of the business of the Company
or its Restricted Subsidiaries; (x) any Lien to secure obligations under
workers' compensation laws or similar legislation, including any Lien with
respect to judgments which are not currently dischargeable; (xi) any statutory
warehousemen's, materialmen's or other similar Liens for sums not then due and
payable (or which, if due and payable, are being contested in good faith and
with respect to which adequate reserves are being maintained, to the extent
required by GAAP); (xii) Liens in favor of the Company; (xiii) Liens on
Property or assets of the Company securing not more than $30 million aggregate
principal amount at any one time outstanding of Indebtedness incurred under
clause (a) of the second paragraph of the covenant described under "--
Limitation on Indebtedness"; (xiv) Liens securing any Vendor Financing,
provided that such Liens do not extend to any Property or assets other than
the Property or assets the acquisition of which was financed by such
Indebtedness; (xv) Liens securing reimbursement obligations with respect to
letters of credit that encumber documents and other Property relating to such
letters of credit and the products and proceeds thereof; and (xvi) Liens to
secure any permitted extension, renewal, refinancing or refunding (or
successive extensions, renewals, refinancings or refundings), in whole or in
part, of any Indebtedness secured by Liens referred to in the foregoing
clauses (ii), (iii) and (xiv), provided that such Liens do not extend to any
other Property or assets other than the Property and assets which were secured
by the Liens referred to in the foregoing clauses (ii), (iii), and (xiv) and
the principal amount of the Indebtedness secured by such Liens is not
increased.
"Person" means any individual, corporation, partnership, joint venture,
limited liability company, trust, unincorporated organization or government or
any agency or political subdivision thereof or other entity or similar person.
"Preferred Stock" means any Capital Stock of a Person, however designated,
which entitles the holder thereof to a preference with respect to dividends,
distributions or liquidation proceeds of such Person over the holders of other
Capital Stock issued by such Person.
"Property" means, with respect to any Person, any interest of such Person in
any kind of property or asset, whether real, personal or mixed, or tangible or
intangible, excluding Capital Stock in any other Person.
"Public Equity Offering" means an underwritten public offering of Capital
Stock (other than Disqualified Stock) of the Company pursuant to an effective
registration statement filed under the Securities Act.
"Qualified Equity Offering" means one or more Public Equity Offerings, or
other issuance of additional equity securities of the Company, resulting in
net proceeds to the Company of at least $50 million in the aggregate based on
an equity valuation of the Company of at least $160 million.
"Qualified Stock" of any Person means a class of Capital Stock other than
Disqualified Stock.
"Refinancing Indebtedness" means any Indebtedness incurred in connection
with the Refinancing of other Indebtedness.
"Restricted Payment" means (i) a dividend or other distribution declared or
paid on the Capital Stock of the Company or to the Company's stockholders (in
their capacity as such), or declared or paid to any Person other than to the
Company or any Restricted Subsidiary of the Company on the Capital Stock of
any Restricted Subsidiary of the Company, in each case, other than dividends,
distributions or payments made solely in Qualified Stock of the Company or
such Restricted Subsidiary (and other than pro rata dividends, distributions
or payments declared or paid on the Common Stock of USN Solutions, Inc. to any
Person not otherwise an Affiliate of the Company holding such Common Stock as
a result of the exercise of the USN Solutions Option; provided, that the
Company shall receive pro rata dividends, distributions or payments at the
same time and in the same form and composition of consideration as the
dividends, distributions or payments paid to such minority stockholders), (ii)
a payment made by the Company or any of its Restricted Subsidiaries (other
than to the Company or any Restricted Subsidiary of the Company) to purchase,
redeem, acquire or retire any Capital Stock of the Company or of a Restricted
Subsidiary of the Company, (iii) a payment made by the Company or any of
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its Restricted Subsidiaries (other than a payment made solely in Qualified
Stock of the Company) to redeem, repurchase, defease (including an in-
substance or legal defeasance) or otherwise acquire or retire for value
(including pursuant to mandatory repurchase covenants), prior to any scheduled
maturity, scheduled sinking fund or mandatory redemption payment, Indebtedness
of the Company or such Restricted Subsidiary which is subordinate (whether
pursuant to its terms or by operation of law) in right of payment to the
Notes, the 14% Senior Notes, the Convertible Notes and, if issued, the Consent
Convertible Notes, or any Guarantees, Old Senior Note Guarantees, and
Convertible Note Guarantees and any guarantee of the Consent Convertible
Notes, as applicable, or (iv) an Investment in any Person, including an
Unrestricted Subsidiary or the designation of a Subsidiary as an Unrestricted
Subsidiary, other than a Permitted Investment.
"Restricted Subsidiary" means (i) with respect to any Person other than the
Company and its Subsidiaries, a Subsidiary of such Person and (ii) with
respect to the Company and its Subsidiaries, any Subsidiary of the Company
that has not been classified as an "Unrestricted Subsidiary."
"Sale and Leaseback Transaction" means, with respect to any Person, any
direct or indirect arrangement pursuant to which Property is sold or
transferred by such Person or a Restricted Subsidiary of such Person and is
thereafter leased back from the purchaser or transferee thereof by such Person
or one of its Restricted Subsidiaries.
"Significant Restricted Subsidiary" means a Restricted Subsidiary that is a
"significant subsidiary" as defined in Rule 1-02(w) of Regulation S-X under
the Securities Act and the Exchange Act.
"Stated Maturity" means, with respect to any security, the date specified in
such security as the fixed dated on which the payment of principal of such
security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency unless such contingency has occurred), and, when used with respect
to any installment of interest on such security, the fixed date on which such
installment of interest is due and payable.
"Strategic Investor" means, with respect to any relevant transaction, a
Telecommunications Company which, both as of the Business Day immediately
before the day of the closing of such transaction and the Business Day
immediately after the day of closing of such transaction, has, or whose parent
has, an equity market capitalization, a net asset value or annual revenues of
at least $2 billion on a consolidated basis. For purposes of this definition,
the term "parent" means any Person of which the relevant Strategic Investor is
a Subsidiary.
"Subsidiary" means, with respect to any Person, (i) any corporation more
than 50% of the outstanding shares of Voting Stock of which is owned, directly
or indirectly, by such Person, or by one or more other Subsidiaries of such
Person, or by such Person and one or more other Subsidiaries of such Person,
(ii) any general partnership, joint venture or similar entity, more than 50%
of the outstanding partnership or similar interests of which are owned,
directly or indirectly, by such Person, or by one or more other Subsidiaries
of such Person, or by such Person and one or more other Subsidiaries of such
Person and (iii) any limited partnership of which such Person or any
Subsidiary of such Person is a general partner.
"Telecommunications Assets" means, with respect to any Person, assets
(including, without limitation, rights of way, trademarks and licenses to use
copyrighted material) that are utilized by such Person, directly or
indirectly, for the design, development, construction, installation,
integration, operation, management or provision of telecommunications systems
and/or services, including without limitation, any businesses or services in
which the Company is currently engaged and including any computer systems used
in a Telecommunications Business. Telecommunications Assets shall also include
stock, joint venture or partnership interests in another Person, provided that
substantially all of the assets of such other Person consist of
Telecommunications Assets, and provided, further, that if such stock, joint
venture or partnership interests are held by the Company or a Restricted
Subsidiary, such other Person either is, or immediately following the relevant
transaction shall become, a Restricted Subsidiary of the Company pursuant to
the Indenture unless such Person is a Joint Venture. The determination of what
constitutes Telecommunication Assets shall be made by the Board of Directors
and evidenced by a Board Resolution delivered to the Trustee.
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"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, voice, video or data
through owned or leased transmission facilities, (ii) creating, developing or
marketing communications related network equipment, software and other devices
for use in (i) above or (iii) evaluating, participating or pursuing any other
activity or opportunity that is related to those specified in (i) or (ii)
above and includes, without limitation, any business in which the Company and
its Restricted Subsidiaries are currently engaged.
"Telecommunications Company" means any Person substantially all of the
assets of which consist of Telecommunications Assets.
"U.S. Government Obligations" means (x) securities that are (i) direct
obligations of the United States of America for the payment of which the full
faith and credit of the United States of America is pledged or (ii)
obligations of a Person controlled or supervised by and acting as an agency or
instrumentality of the United States of America the payment of which is
unconditionally guaranteed as a full faith and credit obligation by the United
States of America, which in either case, are not callable or redeemable at the
option of the issuer thereof, and (y) depository receipts issued by a bank (as
defined in Section 3(a)(2) of the Securities Act) as custodian with respect to
any U.S. Government Obligation which is specified in clause (x) above and held
by such bank for the account of the holder of such depository receipt, or with
respect to any specific payment of principal or interest on any U.S.
Government Obligation which is so specified and held, provided that (except as
required by law) such custodian is not authorized to make any deduction from
the amount payable to the holder of such depository receipt from any amount
received by the custodian in respect of the U.S. Government Obligation or the
specific payment of principal or interest of the U.S. Government Obligation
evidenced by such depository receipt.
"Unrestricted Subsidiary" means any Subsidiary of the Company that the
Company has classified as an "Unrestricted Subsidiary" and that has not been
reclassified as a Restricted Subsidiary, pursuant to the terms of the
Indenture.
"Vendor Financing" means, with respect to any Person, an obligation owed by
such Person to a vendor of Telecommunications Assets solely in respect of the
purchase price of such assets, provided that the amount of such Indebtedness
does not exceed the Fair Market Value of such assets, and provided, further,
that such Indebtedness is incurred within 90 days of the acquisition of such
assets.
"Voting Stock" means, with respect to any Person, securities of any class or
classes of Capital Stock in such Person entitling the holders thereof (whether
at all times or at the times that such class of Capital Stock has voting power
by reason of the happening of any contingency) to vote in the election of
members of the Board of Directors or comparable body of such Person.
"Wholly-Owned Restricted Subsidiary" means any Restricted Subsidiary, all of
the outstanding Capital Stock (other than directors' qualifying shares) of
which is owned, directly or indirectly, by the Company; provided, that for
purposes of the Indenture, other than for purposes of the definition of
"Consolidated Net Income," USN Solutions, Inc. shall not cease to be a Wholly-
Owned Restricted Subsidiary merely as a result of the exercise of the USN
Solutions Option.
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DESCRIPTION OF THE WARRANTS
In connection with the Offering, the Company issued Initial Warrants to
purchase 2,053,900 shares of Class A Common Stock and undertook to issue,
under certain circumstances, to holders of the Notes Contingent Warrants. The
following is a description of such Warrants.
GENERAL
On August 18, 1997, the Company issued an aggregate of 1,527,250 Initial
Warrants to the purchasers of the Units. The Warrants were issued pursuant to
a Warrant Agreement, dated as of August 15, 1997 (the "Warrant Agreement"),
between the Company and Harris Trust and Savings Bank, as Warrant Agent (the
"Warrant Agent"). The Warrants are subject to all terms in the Warrant
Agreement and holders of Warrants are referred to the Warrant Agreement, a
copy of which is available from the Company on request, for a complete
statement of such terms. The statements and definitions of terms under this
caption relating to the Warrants are summaries and do not purport to be
complete. Such summaries make use of certain terms defined in the Warrant
Agreement and are qualified in their entirety by express reference to the
Warrant Agreement.
Each Warrant is evidenced by a Warrant Certificate and entitles the holder
thereof to purchase 1.34484 shares of Class A Common Stock (each a "Warrant
Share") from the Company at a price (the "Exercise Price") of $.01 per share,
subject to adjustment as described below. Subject to certain limitations, the
Warrants may be exercised at any time on or after the date of the occurrence
of an Exercise Event (as defined in the Warrant Agreement) and on or prior to
the close of business on a date seven years following the Issue Date (the
"Expiration Date"). Warrants that are not exercised by the Expiration Date
will expire. The Company will give notice of expiration not less than 90 nor
more than 120 days prior to the Expiration Date to registered holders of the
then outstanding Warrants.
The aggregate number of Warrant Shares issuable upon exercise of the Initial
Warrants was equal to approximately 11.1% of the outstanding shares of Class A
Common Stock, on a fully-diluted basis, as of the date of the Offering .
In addition, the Company is obligated pursuant to the Indenture to issue to
holders of the Notes Contingent Warrants, exercisable for Class A Common Stock
representing 5.0% of the Common Stock on a fully-diluted basis as of the date
of such issuance (subject to certain exceptions) after giving effect to the
issuance of such Contingent Warrants, in the event that, on or prior to
September 30, 1998, the Company does not effect a Qualified Equity Offering.
All Contingent Warrants will be issued pursuant to the Warrant Agreement with
the same rights thereunder as the Initial Warrants, and holders will have the
benefit of the Registration Rights Agreement. See "Description of the Notes--
Certain Covenants--Issuance of Contingent Warrants."
CERTAIN TERMS
Exercise
In order to exercise all or any of the Warrants represented by a Warrant
Certificate, the holder thereof is required to surrender to the Warrant Agent
the Warrant Certificate, a duly executed copy of the subscription form set
forth in the Warrant Certificate and payment in full of the Exercise Price for
each Warrant Share or other security as to which a Warrant is being exercised.
Payment for securities upon exercise of a Warrant may be made in cash or by
certified check, official bank check or bank cashier's check payable to the
order of the Company. Upon the exercise of any Warrant in accordance with the
Warrant Agreement, the Warrant Agent shall instruct the Company to transfer
promptly to, or upon the written order of, the holder of such Warrant
appropriate evidence of ownership of any Warrant Share or other securities or
property to which such holder is entitled, registered or otherwise placed in
such name or names as such holder may direct in writing, and the Company shall
deliver such evidence of ownership to the person or persons entitled to
receive the same, including, without
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limitation, any cash payable to adjust for fractional interests in Warrant
Shares issuable upon such exercise. If less than all of the Warrants evidenced
by a Warrant Certificate are to be exercised, a new Warrant Certificate will
be issued for the remaining number of Warrants. All Warrant Shares or other
securities issuable by the Company upon the exercise of the Warrants shall be
validly issued, fully paid and nonassessable.
No fractional Warrant Shares will be issued upon exercise of the Warrants.
If any fraction of a Warrant Share would, except for the foregoing provision,
be issuable upon the exercise of any Warrants (or specified portion thereof),
the Company will pay an amount in cash equal to the Current Market Price (as
defined in the Warrant Agreement) per share of Class A Common Stock, as
determined on the trading day immediately preceding the date the Warrant is
presented for exercise, multiplied by such fraction, computed to the nearest
whole cent.
Certificates for Warrants will be issued in global form or registered form
as definitive warrant certificates and no service charge will be made for
registration of transfer or exchange upon surrender of any Warrant Certificate
at the office of the Warrant Agent maintained for that purpose. See "Book-
Entry; Delivery and Form." The Company may require payment of a sum sufficient
to cover any tax or other governmental charge that may be imposed in
connection with any registration or transfer or exchange of Warrant
Certificates.
Holders of Warrants will be able to exercise their Warrants only if a
registration statement relating to the Warrant Shares is then effective under,
or the exercise of such Warrants is exempt from the registration requirements
of, the Securities Act. See "Registration Rights."
Adjustments
Subject to certain exceptions, including the issuance of the Contingent
Warrants, the Consent Convertible Notes and the issuance of warrants to
purchase up to 5% of the Common Stock (on a fully-diluted basis) in connection
with future issuances of debt securities, the Exercise Price and the number of
Warrant Shares issuable upon exercise of the Warrants will be subject to
adjustment on the occurrence of certain events including: (i) the payment by
the Company of dividends (or the making of other distributions) with respect
to Common Stock payable in Common Stock or other shares of the Company's
capital stock, (ii) subdivisions, combinations and reclassifications of Common
Stock, (iii) the issuance to all holders of Common Stock of rights, options or
warrants entitling them to subscribe for Common Stock, or of securities
convertible into or exchangeable for shares of Common Stock, in either case
for consideration per share of Common Stock which is less than the Current
Market Price per share of Common Stock, (iv) the issuance or sale of shares of
Common Stock for consideration per share of Common Stock which is less than
the Current Market Price per share of Common Stock, (v) the distribution to
all holders of Common Stock of any of the Company's assets, debt securities or
any rights or warrants to purchase securities (excluding those rights and
warrants referred to in clause (iii) above and excluding cash dividends or
other cash distributions from current or retained earnings) and (vi) the
issuance of any equity securities of the Company after the Issue Date and on
or prior to September 15, 1997 resulting in net proceeds to the Company of up
to $20 million.
No adjustment in the Exercise Price will be required unless such adjustment
would require an increase or decrease of at least 1.0% in the Exercise Price;
provided, that any adjustment which is not made will be carried forward and
taken into account in any subsequent adjustment.
Mergers, Consolidations and Certain Other Transactions
Except as otherwise provided herein, in the event the Company consolidates
with, merges with or into, or sells all or substantially all of its property
and assets to another Person, each Warrant thereafter shall entitle the holder
thereof to receive upon exercise thereof the number of shares of capital stock
or other securities or property which the holder of a share of Common Stock is
entitled to receive upon completion of such consolidation, merger or sale of
assets. If the Company merges or consolidates with, or sells all or
substantially all of its property and assets to, another Person and, in
connection therewith, consideration to the holders of
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Common Stock in exchange for their shares is payable solely in cash, or in the
event of the dissolution, liquidation or winding-up of the Company, then the
holders of the Warrants will be entitled to receive distributions on an equal
basis with the holders of Common Stock or other securities issuable upon
exercise of the Warrants, as if the Warrants had been exercised immediately
prior to such event, less the Exercise Price. Upon receipt of such payment, if
any, the Warrants will expire and the rights of the holders thereof will
cease.
In case of any such merger, consolidation or sale of assets, the surviving
or acquiring Person and, in the event of any dissolution, liquidation or
winding-up of the Company, the Company, shall deposit promptly with the
Warrant Agent the funds or other consideration, if any, necessary to pay the
holders of the Warrants. After such funds and the surrendered Warrant
Certificate are received, the Warrant Agent shall make payment by delivering a
check in such amount as is appropriate (or, in the case of consideration other
than cash, shall transfer such other consideration as is appropriate) to such
Person or Persons as it may be directed in writing by the holders surrendering
such Warrants.
No Rights as Stockholders
The holders of unexercised Warrants are not entitled, as such, to receive
dividends or other distributions with respect to the Class A Common Stock,
receive notice of any meeting of the stockholders of the Company, consent to
any action of the stockholders of the Company, receive notice of any other
stockholder meetings, or to any other rights as stockholders of the Company.
RESERVATION OF SHARES
The Company has authorized and reserved for issuance such number of shares
of Class A Common Stock as shall be issuable upon the exercise of all
outstanding warrants. Such shares of Class A Common Stock, when paid for and
issued, will be duly and validly issued, fully paid and non-assessable, free
of preemptive rights and free from all taxes, liens, charges and security
interests with respect to the issue thereof.
AMENDMENT
From time to time, the Company and the Warrant Agent, without the consent of
the holders of the Warrants, may amend or supplement the Warrant Agreement for
certain purposes, including, without limitation, curing defects or
inconsistencies or making any change that does not materially adversely affect
the rights of any holder. Any amendment or supplement to the Warrant Agreement
that has a material adverse effect on the interests of the holders of the
Warrants shall require the written consent of the holders of a majority of the
then outstanding Warrants. The consent of each holder of the Warrants affected
shall be required for any amendment pursuant to which the Exercise Price would
be increased or the number of Warrant Shares purchasable upon exercise of
Warrants would be decreased (other than pursuant to adjustments provided in
the Warrant Agreement).
REGISTRATION RIGHTS
Registration of the Warrants. The Company is required, under the terms of
the Registration Rights Agreement, to (i) file a shelf registration statement
with respect to resale of the Initial Warrants by the holders thereof (the
"Warrant Shelf Registration Statement") with the Commission within 60 days
after the date of original issuance of the Initial Warrants; (ii) cause the
Warrant Shelf Registration Statement to be declared effective under the
Securities Act within 120 days after the date of original issuance of the
Initial Warrants; and (iii) keep effective the Warrant Shelf Registration
Statement until the earlier of (A) such time as all Initial Warrants have been
sold thereunder or otherwise or exercised and (B) two years after its
effective date; provided, however, that in the event the Company is required
to issue Contingent Warrants, the Company shall amend the Warrant Shelf
Registration Statement to include the Contingent Warrants and the time period
shall be two years after the issuance of the Contingent Warrants.
The Company will, upon the filing of the Warrant Shelf Registration
Statement, provide to each holder of Warrants copies of the prospectus which
is a part of the Warrant Shelf Registration Statement, notify each such holder
when the Warrant Shelf Registration Statement has become effective and take
certain other actions as are required to permit unrestricted resales of the
Warrants.
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Each holder of Warrants that sells such Warrants pursuant to the Warrant
Shelf Registration Statement generally will be required to be named as a
selling securityholder in the related prospectus and to deliver a prospectus
to the purchaser, will be subject to certain of the civil liability provisions
under the Securities Act in connection with such sales and will be bound by
certain provisions of the Registration Rights Agreement which are applicable
to such holder (including certain indemnification obligations). In addition,
each holder of Warrants will be required to deliver information to be used in
connection with the Warrant Shelf Registration Statement in order to have its
Warrants included in the Warrant Shelf Registration Statement.
Holders of Warrants will be able to exercise their Warrants only if a
registration statement relating to the Warrant Shares is then effective under,
or the exercise of such Warrants is exempt from the registration requirement
of, the Securities Act.
Registration of the Warrant Shares. The Company also is required, under the
terms of the Registration Agreement, to (i) file a shelf registration
statement with respect to the Company's issuance of the Warrant Shares to
holders upon exercise of the Warrants (the "Warrant Shares Shelf Registration
Statement") with the Commission within 270 days after the date of original
issuance of the Initial Warrants, (ii) cause the Warrant Shares Shelf
Registration Statement to be declared effective under the Securities Act
within 360 days after the date of original issuance of the Initial Warrants
and (iii) keep effective the Warrant Shares Shelf Registration Statement (or a
successor registration statement thereto) until seven years after the date of
original issuance of the Initial Warrants or such shorter period that will
terminate when all the Warrant Shares covered by such Warrant Shares Shelf
Registration Statement have been sold pursuant to such Warrant Shares Shelf
Registration Statement or otherwise.
The Company will, upon the filing of the Warrant Shares Shelf Registration
Statement, provide to each holder of Warrant Shares copies of the prospectus
which is a part of the Warrant Shares Shelf Registration Statement, notify
each such holder when the Warrant Shares Shelf Registration Statement has
become effective and take certain other actions, subject to compliance by such
holder with certain conditions in the Registration Rights Agreement, as are
required to permit unrestricted resales of the Warrant Shares.
Each holder of Warrant Shares that sells such Warrant Shares pursuant to the
Warrant Shares Shelf Registration Statement generally will be required to be
named as a selling securityholder in the related prospectus and to deliver a
prospectus to the purchaser, will be subject to certain of the civil liability
provisions under the Securities Act in connection with such shares and will be
bound by certain provisions of the Registration Rights Agreement which are
applicable to such holder (including certain indemnification obligations). In
addition, each holder of Warrant Shares will be required to deliver
information to be used in connection with the Warrant Shares Shelf
Registration Statement in order to have its Warrant Shares included in the
Warrant Shares Shelf Registration Statement.
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DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock of 30,300,000 shares consists of
30,050,000 shares of Common Stock, par value $.01 per share (the "Common
Stock"), of which 30,000,000 shares are designated as Class A Common Stock and
50,000 shares are designated as Class B Common Stock, and 250,000 shares are
designated as Preferred Stock, par value $1.00 per share.
COMMON STOCK
The holders of Common Stock are entitled to receive dividends when and as
dividends are declared by the Board of Directors of the Company out of funds
legally available therefor, provided that if any shares of Preferred Stock are
at the time outstanding, the payment of dividends on the Common Stock or other
distributions may be subject to the declaration and payment of full cumulative
dividends on outstanding shares of Preferred Stock. If stock dividends are
declared, holders of Class A Common Stock will receive shares of Class A
Common Stock and holders of Class B Common Stock will receive shares of Class
B Common Stock.
Except for matters where applicable law requires the approval of one or both
classes of Common Stock voting as separate classes, holders of Class A Common
Stock are entitled to one vote per share on all matters submitted to a vote of
the stockholders, including the election of directors. Unless required by law,
holders of Class B Common Stock are not entitled to voting rights.
Shares of Class A Common Stock are convertible into Class B Common Stock on
a one-to-one basis at any time at the option of the holders thereof.
Upon any liquidation, dissolution or winding up of the affairs of the
Company, whether voluntary or involuntary, any assets remaining after the
satisfaction in full of the prior rights of creditors and the aggregate
liquidation preference of any Preferred Stock then outstanding will be
distributed to the holders of Class A Common Stock and Class B Common Stock,
ratably as a single class in proportion to the number of shares held by them.
In the event of a reorganization, consolidation or merger of the Company,
each holder of a share of Class A Common Stock shall be entitled to receive
the same kind and amount of property receivable by a holder of a share of
Class B Common Stock and each holder of a share of Class B Common Stock shall
be entitled to receive the same kind and amount of property receivable by a
holder of Class A Common Stock.
ADDITIONAL CONTINGENT WARRANTS
The 14% Senior Note Indenture and the Convertible Note Indenture provide
that the Company will be obligated to issue to the holders of the 14% Senior
Notes and holders of the Convertible Notes, respectively, contingent warrants
exercisable for Class A Common Stock in the event that the Company has not
consummated a "Qualified Public Offering" (as defined in the indentures) prior
to March 31, 1998 in the case of the 14% Senior Notes or September 30, 1999,
in the case of the Convertible Notes. The Indenture also provides that the
Company will be obligated to issue to the holders of the Notes, Contingent
Warrants in the event that the Company has not consummated a Qualified Equity
Offering prior to September 30, 1998.
TRANSFER AGENT AND REGISTRAR OF CLASS A COMMON STOCK
The transfer agent and registrar for the Class A Common Stock is Harris
Trust and Savings Bank.
PREFERRED STOCK
The authorized but unissued Preferred Stock may be issued by the Board of
Directors of the Company from time to time in one or more series with such
preferences, terms and rights as the Board of Directors may determine without
further action by the stockholders of the Company. Accordingly, the Board of
Directors has the power to fix the dividend rate and to establish the
provisions, if any, relating to dividends, voting rights, redemption rates,
sinking funds, liquidation preferences and conversion rights for any series of
Preferred Stock
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issued in the future. Currently, the Company has 180,000 shares of Preferred
Stock designated for issuance, 30,000 of which have been designated as 9%
Preferred Stock and 150,000 of which have been designated as Series A Preferred
Stock. As of September 30, 1997, there were 10,917 shares of 9% Preferred Stock
issued and outstanding and 30,209 shares of Series A Preferred Stock issued and
outstanding.
The 9% Preferred Stock and Series A Preferred Stock each has a liquidation
preference and stated value of $1,000 per share. Dividends accrue semiannually
and are fully cumulative. Dividends are payable in additional shares of 9%
Preferred Stock or Series A Preferred Stock, as applicable. In the event of any
liquidation, dissolution or winding up of the Company, holders of the 9%
Preferred Stock and Series A Preferred Stock each will be entitled to receive
their full liquidation preference per share, together with accrued and unpaid
dividends, prior to the distribution of any assets of the Company to holders of
Common Stock.
Shares of the 9% Preferred Stock and the Series A Preferred Stock are not
redeemable at the option of the Company, but are subject to mandatory
redemption in 2006 at the stated value, together with all accrued and unpaid
dividends to the redemption date..
The shares of 9% Preferred Stock and the Series A Preferred Stock are
convertible into shares of Class A Common Stock, at any time, in whole or from
time to time in part, at the option of the holders thereof. In addition, upon
the vote of the Board of Directors at any time on or subsequent to a Qualified
Public Offering Date (as defined in the Certificate of Designations), the
shares of Series A Preferred Stock shall automatically convert into shares of
Class A Common Stock.
One of the effects of undesignated Preferred Stock may be to enable the Board
of Directors to render more difficult or to discourage an attempt to obtain
control of the Company by means of a tender offer, proxy contest, merger or
otherwise, and thereby to protect the continuity of the Company's management.
The issuance of shares of the Preferred Stock pursuant to the Board of
Directors' authority described above may adversely affect the rights of the
holders of Common Stock. For example, Preferred Stock issued by the Company may
rank prior to the Common Stock as to dividend rights, liquidation preference or
both, may have full or limited voting rights and may be convertible into shares
of Common Stock. Accordingly, the issuance of shares of Preferred Stock may
discourage bids for the Common Stock or may otherwise adversely affect the
market price of the Common Stock.
LIMITATION OF LIABILITY OF DIRECTORS
The Certificate of Incorporation provides that a director of the Company will
not be personally liable for monetary damages to the Company or its
stockholders for breach of fiduciary duty as a director, except for liability,
(i) for any breach of the director's duty of loyalty to such corporation or its
stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) for unlawful
payments of dividends or unlawful stock repurchases or redemption as provided
in Section 194 of the DGCL or (iv) for any transaction from which the director
derived an improper personal benefit.
This provision is intended to afford directors additional protection and
limit their potential liability from suits alleging a breach of the duty of
care by a director. As a result of the inclusion of such a provision,
stockholders may be unable to recover monetary damages against directors for
actions taken by them that constitute negligence or gross negligence or that
are otherwise in violation of their fiduciary duty of care, although it may be
possible to obtain injunctive or other equitable relief with respect to such
actions. If equitable remedies are found not to be available to stockholders in
any particular situation, stockholders may not have an effective remedy against
a director in connection with such conduct.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Bylaws provide that directors and officers of the Company shall be
indemnified against liabilities arising from their service as directors and
officers. Additionally, the Company has entered into indemnification agreements
with each of its executive officers and directors to reimburse them for certain
liabilities incurred in connection with the performance of their fiduciary
duties. Section 145 of the DGCL empowers a corporation to indemnify any person
who was or is a party or is threatened to be made a party to any threatened,
pending or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative (other than an action by or in the right of the
corporation) by reason of the fact that he is or was a director, officer,
employee or agent of the corporation or is or was serving at the request of the
corporation as a director, officer, employee or agent
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of another corporation or enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit or proceeding if he acted
in good faith and in a manner he reasonably believed to be in, or not opposed
to, the best interests of the corporation, and, with respect to any criminal
action or proceeding, had no reasonable cause to believe his conduct was
unlawful.
Section 145 also empowers a corporation to indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action or suit by or in the right of the corporation to procure a
judgment in its favor by reason of the fact that such person acted in any of
the capacities set forth above, against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection with the defense or
settlement of such action or suit if he acted under similar standards, except
that no indemnification may be made in respect of any claim, issue or matter
as to which such person shall have been adjudged to be liable to the
corporation unless, and only to the extent that, the Court of Chancery or the
court in which such action was brought shall determine that despite the
adjudication of liability such person is fairly and reasonably entitled to
indemnity for such expenses which the court shall deem proper.
Section 145 further provides that to the extent that a director or officer
of a corporation has been successful in the defense of any action, suit or
proceeding referred to above or in the defense of any claim, issue or matter
therein, he shall be indemnified against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection therewith; that
indemnification provided for by Section 145 shall not be deemed exclusive of
any other rights to which the indemnified party may be entitled; and that the
corporation is empowered to purchase and maintain insurance on behalf of a
director or officer of the corporation against any liability asserted against
him in any such capacity, or arising out of his status as such, whether or not
the corporation would have the power to indemnify him against such liabilities
under Section 145.
There has not been in the past and there is not presently pending any
litigation or proceeding involving a director, officer, employee or agent of
the Company which could give rise to an indemnification obligation on the part
of the Company. In addition, except as described herein, the Board of
Directors is not aware of any threatened litigation or proceeding which may
result in a claim for indemnification.
CERTAIN OTHER INDEBTEDNESS
On September 30, 1996, the Company issued in the 1996 Private Placement
48,500 units consisting of (i) $48.5 million in aggregate principal amount at
stated maturity of the 14% Senior Notes and warrants to purchase shares of
Class A Common Stock, and (ii) $36.0 million in aggregate principal amount at
stated maturity of the Convertible Notes.
The 14% Senior Notes are general, unsecured obligations of the Company and
rank pari passu in right of payment with all existing and future senior
unsecured indebtedness of the Company, including the Notes, and will be senior
in right of payment to all existing and future subordinated indebtedness of
the Company. The 14% Senior Notes were issued with original issue discount
and, until March 30, 2000, accrete interest at a rate of 14% per annum,
compounded semiannually, to an aggregate principal amount of $48.5 million.
Thereafter, cash interest will accrue on the 14% Senior Notes and will be
payable semiannually on March 30 and September 30 of each year, commencing
September 30, 2000. The 14% Senior Note Indenture contains certain covenants
which, among other things, restrict the ability of the Company and certain
subsidiaries to incur additional indebtedness, pay dividends or make
distributions in respect of the Company's capital stock or make certain other
restricted payments, make investments, create restrictions on the ability of
certain subsidiaries to make distributions on their capital stock or to issue
capital stock, create liens, enter into transactions with affiliates or
related persons, sell assets or consolidate, merge or sell all or
substantially all of their assets and engage in businesses other than the
telecommunications business.
The Convertible Notes are senior unsecured obligations of the Company which
are subordinated in right of payment to the 14% Senior Notes and the Notes.
Otherwise, the Convertible Notes rank pari passu in right of payment to all
existing and future senior indebtedness of the Company. The Convertible Notes
were issued with
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original issue discount and, until September 30, 1999, accrete interest at a
rate of 9% per annum, compounded semiannually, to an aggregate principal amount
of $36.0 million. Thereafter, cash interest will accrue on the Convertible
Notes and will be payable semiannually on March 30 and September 30 of each
year, commencing March 30, 2000. The Convertible Note Indenture provides that
an "Event of Default" (as defined in the Old Senior Note Indenture) under the
Old Senior Note Indenture shall constitute an "Event of Default" (as defined in
the Convertible Note Indenture) under the Convertible Note Indenture.
From September 30, 2001 to September 30, 2003, the 14% Senior Notes will be
redeemable at the Company's option, in whole or in part, at the prices set
forth in the 14% Senior Note Indenture plus accrued and unpaid interest, if
any, to the redemption date. In the event the Company elects, on or prior to
September 30, 1999, to redeem Notes out of the proceeds of any Public Equity
Offering, the holders of the 14% Senior Notes shall have the right, but not the
obligation, to cause the Company to offer to repurchase the 14% Senior Notes on
a pro rata basis together with the Notes and to receive the same redemption
premium as the holders of the Notes. From September 30, 2000 until September
30, 2002, all but not less than all of the Convertible Notes may be redeemed if
the closing price per share of the Common Stock over a consecutive 30-day
period is at least 150% of the Conversion Price at a redemption price equal to
100% of the principal amount thereof plus accrued but unpaid interest, if any,
to the redemption date. On or after September 30, 2002, the Convertible Notes
will be redeemable at the Company's option, in whole or in part, at a
redemption price equal to 100% of the principal amount plus accrued and unpaid
interest, if any, to the redemption date.
In connection with the Consent, the Company has agreed to grant to MLGAFI an
option to purchase the Consent Convertible Notes, with terms substantially
similar to the Convertible Notes but with a conversion price based upon the
Company's then current-market value.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following summary describes the material United States federal income tax
consequences of an exchange of Old Notes for New Notes and the ownership of New
Notes, as well as certain potential federal income tax consequences to the
Company with respect to the Notes. Except where noted, it deals only with Old
Notes and New Notes held as capital assets by initial purchasers of Old Notes
that are United States Holders (as defined) and does not deal with special
situations, such as those of foreign persons, dealers in securities, financial
institutions, life insurance companies, holders whose "functional currency" is
not the U.S. dollar, or special rules with respect to integrated transactions
of which the ownership of common stock is a part (such as certain hedging
transactions), or certain "straddle" transactions. Furthermore, the discussion
below is based upon the provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), and regulations, rulings and judicial decisions
thereunder as of the date hereof, and such authorities may be repealed, revoked
or modified so as to result in federal income tax consequences different from
those discussed below. HOLDERS ARE URGED TO CONSULT THEIR TAX ADVISORS
CONCERNING THE FEDERAL INCOME TAX CONSIDERATIONS THAT MAY BE SPECIFIC TO THEM
OF THE EXCHANGE OF OLD NOTES FOR NEW NOTES AND THE OWNERSHIP OF THE NEW NOTES,
AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY OTHER TAXING
JURISDICTION.
Holders should recognize that the present U.S. federal income tax treatment
of an investment in Notes may be modified by legislative, judicial or
administrative action at any time and that such action may affect investments
previously made. In addition, the recently enacted Taxpayer Relief Act of 1997
could affect an investment in Notes in that, among other things, it reduces the
rate of federal income tax imposed on capital gains of individual taxpayers for
capital assets held more than eighteen months (and reduces such rate even
further for capital assets acquired after the year 2000 and held more than five
years). Holders should consult their own tax advisors concerning the effect on
them of such new legislation.
UNITED STATES HOLDERS
As used herein, "United States Holder" means a beneficial owner of a Note who
or which is (i) a citizen or resident of the United States, (ii) a corporation
organized in or under the laws of the United States or any state
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thereof or the District of Columbia, or (iii) a person otherwise subject to
United States federal income taxation on a net income basis in respect of a
Note.
EXCHANGE OF SENIOR NOTES
There should be no federal income tax consequences to holders exchanging Old
Notes for New Notes pursuant to the Exchange Offer since the Exchange Offer
will be by operation of the original terms of the Old Notes, pursuant to a
unilateral act by the Company and will not result in any material alteration in
the terms of the Old Notes. Each exchanging holder will have the same adjusted
tax basis and holding period in the New Notes as it had in the Old Notes
immediately before the exchange.
TAXATION OF THE NOTES
Original Issue Discount. Because the Old Notes were issued with original
issue discount ("OID"), the New Notes will also bear OID that holders generally
will be required to include in income as it accrues on a yield-to-maturity
basis over the term of the New Notes in advance of cash payments attributable
to such income (regardless of whether the holder is a cash or accrual basis
taxpayer). The amount of OID with respect to a New Note will be the excess of
the stated redemption price at maturity of such Note over its issue price. The
stated redemption price at maturity of a Note generally will include all
payments required to be made on the Notes, whether denominated as principal or
interest (other than payments subject to remote or incidental contingencies).
The issue price of the New Notes is equal to the issue price of the Old
Notes. The issue price of the Old Notes, which is the same as the issue price
of the New Notes, was determined by allocating the issue price of the Units
between the Old Notes and the Initial Warrants based on their relative fair
market values. For this purpose, the issue price of a Unit was the initial
price at which a substantial portion of the Units were sold (not including
sales to bond houses, brokers or similar persons or organizations acting in the
capacity of underwriters or wholesalers). With respect to the approximately
$100 million in aggregate proceeds received from the offering of the Units, the
Company allocated approximately $81.9 million to the Old Notes and
approximately $18.1 million to the Initial Warrants. This allocation reflected
the Company's judgment as to the relative values of those instruments at the
time of issuance. The allocation is binding on a holder unless such holder
explicitly discloses on its tax return for the taxable year that includes the
acquisition date of the Unit that its allocation is different from that of the
Company. The allocation is not, however, binding on the Internal Revenue
Service (the "IRS").
A holder of a debt instrument that bears OID is required to include in gross
income an amount equal to the sum of the daily portions of OID for each day
during the taxable year in which the debt instrument is held. The daily
portions of OID are determined by allocating to each day in an accrual period
the pro rata portion of the OID that is allocable to the accrual period. The
amount of OID that is allocable to an accrual period generally is equal to the
product of the adjusted issue price of the Notes at the beginning of the
accrual period (the issue price of the Notes determined as described above,
generally increased by all prior accruals of OID and decreased by the amount of
payments made on the Notes) and the Notes' yield to maturity (the discount
rate, which, when applied to all payments under the Notes, results in a present
value equal to the issue price of the Notes). In the case of the final accrual
period, the allocable OID generally is the difference between the amount
payable at maturity and the adjusted issue price at the beginning of the
accrual period. All payments on a Note generally will be viewed first as a
payment of previously accrued OID (to the extent thereof), with payments
considered made from the earliest accrual period, and then as a payment of
principal.
The Company will furnish annually to the IRS and to holders (other than with
respect to certain exempt holders, including, in particular, corporations)
information with respect to the OID accruing while the Notes were held by the
holders.
Premium. If a holder purchased an Old Note for an amount that is greater than
the Note's stated redemption price at maturity, such holder will be considered
to have purchased such Note with "amortizable bond premium" equal in amount to
such excess, and generally will not be required to include OID in income. A
holder may elect
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to amortize such premium, using a constant yield method, over the remaining
term of the Note with reference to either the amount payable on maturity or,
if it results in a smaller premium attributable to the period through the
earlier call date, with reference to the amount payable on the earlier call
date. An election to amortize bond premium applies to all taxable debt
obligations then owned and thereafter acquired by the holder and may be
revoked only with the consent of the IRS.
If a holder of a New Note (including an original purchaser) purchased the
Old Note exchanged therefor for an amount greater than the Old Note's adjusted
issue price but less than such Note's stated redemption price at maturity,
then the holder will be required to include annual accruals of OID in gross
income in accordance with the rules described above; however, the amount of
OID includable in income will be reduced to reflect such acquisition premium.
The includable OID (as otherwise determined) will be reduced by an amount
equal to the OID multiplied by a fraction, the numerator of which is such
excess and the denominator of which is the OID for the period from the date of
acquisition until the maturity date.
Contingent Warrants; Registration of the Notes. In the event that, on or
prior to September 30, 1998, the Company does not consummate one or more
Public Equity Offerings, or otherwise issue in one or more transactions
additional equity securities of the Company, resulting in net proceeds to the
Company of at least $50 million in the aggregate based on an equity valuation
of the Company of at least $160 million, the Indenture will require the
Company to issue Contingent Warrants to the holders of the Notes. The issuance
of the Contingent Warrants should not result in a deemed taxable exchange of
the Notes for federal income tax purposes. The Company intends to treat the
issuance of Contingent Warrants, if any, as interest for federal income tax
purposes in an amount equal to their fair market value on the date of
issuance.
In the event of a Registration Default, the Company must pay Special
Interest to holders of Notes. See "The Exchange Offer--Purpose and Effect of
the Exchange Offer." This rate increase should not result in a deemed
reissuance or taxable exchange of the Notes.
Although the characterization of such additional interest is uncertain,
Special Interest probably would constitute contingent interest, which
generally is not includable in income before it is fixed or paid. In general,
the Company will not include Special Interest in calculating the amount of OID
that accrues on the Notes before the Special Interest becomes fixed and paid.
However, if the Special Interest becomes fixed or paid, it should be included
in the U.S. Holder's gross income.
Disposition of New Notes. A holder will generally recognize gain or loss
upon the sale, exchange, retirement or other disposition of New Notes equal to
the difference between the amount realized on the disposition and the holder's
adjusted tax basis in the New Notes. A holder's adjusted tax basis in a New
Note will generally be the cost of the Old Note, increased by any OID
previously included in income by such holder and decreased by the amount of
any deductions for amortizable bond premium. Such gain or loss generally would
be capital gain or loss and would be long-term if the holding period for the
New Notes (which includes the holding period of the Old Notes) is more than
one year.
Backup Withholding. Under certain circumstances, a holder may be subject to
backup withholding at a 31% rate on payments received with respect to the New
Notes. This withholding generally applies only if the holder (i) fails to
furnish his or her social security or other taxpayer identification number
("TIN"), (ii) furnishes an incorrect TIN, (iii) is notified by the IRS that he
or she has failed to report payment of interest and dividends properly and the
IRS has notified the Company that he or she is subject to backup withholding
or (iv) fails, under certain circumstances, to provide a certified statement,
signed under penalty of perjury, that the TIN provided is his or her correct
number and that he or she is not subject to backup withholding. Any amount
withheld from a payment to a holder under the backup withholding rules is
allowable as a credit against such holder's federal income tax liability,
provided that the required information is furnished to the IRS. Certain
holders (including, among others, corporations and foreign individuals who
comply with certain certification requirements) are not subject to backup
withholding. Holders should consult their tax advisors as to their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption.
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Certain Potential Federal Income Tax Consequences to the Company and to
Corporate Holders. The Notes will constitute applicable high yield debt
obligations ("AHYDOs") if their yield to maturity is equal to or greater than
the sum of the relevant applicable federal rate (the "AFR") plus five
percentage points, and the Notes are issued with significant OID. Since the
yield to maturity on the Notes exceeds the sum of the AFR plus five percentage
points and the Notes were issued with significant OID, the Notes constitute
AHYDOs. Accordingly, the Company will not be entitled to deduct OID that
accrues with respect to such Notes until amounts attributable to such OID are
paid. In addition, since the Notes constitute AHYDOs and the yield-to-maturity
of the Notes exceeds the sum of the relevant AFR plus six percentage points
(the "Excess Yield"), the Company's deduction for the "disqualified portion"
of the OID accruing on the Notes will be disallowed. In general, the
"disqualified portion" of the OID for any accrual period will be equal to the
product of (i) the Excess Yield divided by the yield-to-maturity on the Notes,
and (ii) the OID for the accrual period. Subject to otherwise applicable
limitations, holders that are U.S. corporations will be entitled to a
dividends-received deduction (generally at a current rate of 70%) with respect
to any disqualified portion of the accrued OID to the extent that the Company
has sufficient current or accumulated earnings and profits. If the
disqualified portion exceeds the Company's current and accumulated earnings
and profits, the excess will continue to be taxed as ordinary OID income in
accordance with the rules described above in "Original Issue Discount."
It is also possible that some or all of the Notes may constitute "corporate
acquisition indebtedness" if, among other things, the proceeds of the Notes
are used to pay for the purchase of stock or at least two-thirds of the
operating assets of another corporation. To the extent the Notes constitute
corporate acquisition indebtedness, under Section 279 of the Code the maximum
amount of interest or OID the Company can deduct with respect thereto in any
taxable year is $5 million, reduced by any interest incurred on indebtedness
to acquire stock or assets but which does not qualify as corporate acquisition
indebtedness.
PLAN OF DISTRIBUTION
Based on interpretations by the staff of the Commission set forth in no-
action letters issued to third parties, including the Exxon Capital Letter,
the Morgan Stanley Letter and similar letters, the Company believes that the
New Notes issued pursuant to the Exchange Offer in exchange for Old Notes may
be offered for resale, resold and otherwise transferred by any Holder thereof
(other than any such Holder which is an "affiliate" of the Company within the
meaning of Rule 405 under the Securities Act), without compliance with the
registration and prospectus delivery provisions of the Securities Act,
provided that such New Notes are acquired in the ordinary course of such
Holder's business and such Holder has no arrangement with any person to
participate in the distribution of such New Notes. Accordingly, any Holder
using the Exchange Offer to participate in a distribution of the New Notes
will not be able to rely on such no-action letters. Notwithstanding the
foregoing, each broker-dealer that receives New Notes for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such New Notes. This Prospectus,
as it may be amended or supplemented from time to time, may be used by a
broker-dealer in connection with any resale of New Notes received in exchange
for Old Notes where such Old Notes were acquired as a result of market-making
activities or other trading activities. The Company has agreed that for a
period of 180 days from the Expiration Date, it will make this Prospectus, as
amended or supplemented, available to any broker-dealer for use in connection
with any such resale. In addition, until , 1997 (90 days from the date
of this Prospectus), all dealers effecting transactions in the New Notes may
be required to deliver a prospectus.
The Company will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the New Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at
prices related to such prevailing market prices or negotiated prices. Any such
resale may be made directly to purchasers or to or through brokers or dealers
who may receive compensation in the form of commissions or concessions from
any such broker-dealer and/or the purchasers of any such New Notes. Any
broker-dealer that resells New Notes that were received by it for its own
account pursuant to the Exchange Offer
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and any broker or dealer that participates in a distribution of such New Notes
may be deemed to be an "underwriter" within the meaning of the Securities Act
and any profit on any such resale of New Notes and any commissions or
concessions received by any such persons may be deemed to be underwriting
compensation under the Securities Act. The Letter of Transmittal states that
by acknowledging that it will deliver, and by delivering, a prospectus as
required, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period of 180 days from the Expiration Date, the Company will send a
reasonable number of additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requests such
documents in the Letter of Transmittal. The Company will pay all the expenses
incident to the Exchange Offer (which shall not include the expenses of any
Holder in connection with resales of the New Notes). The Company has agreed to
indemnify the Initial Purchasers and any broker-dealers participating in the
Exchange Offer against certain liabilities, including liabilities under the
Securities Act.
This Prospectus has been prepared for use by the Initial Purchasers in
connection with offers and sales of the Notes, in market-making transactions
at negotiated prices related to prevailing market prices at the time of sale.
The Initial Purchasers may act as principal or agent in such transactions. The
Initial Purchasers have advised the Company that they currently intend to make
a market in the Notes, but they are not obligated to do so and may discontinue
any such market-making at any time without notice. Accordingly, no assurance
can be given that an active trading market will develop for or as to the
liquidity of the Notes.
LEGAL MATTERS
The validity of the New Notes offered hereby will be passed upon for the
Company by Skadden, Arps, Slate, Meagher & Flom (Illinois).
INDEPENDENT AUDITORS
The consolidated financial statements of the Company included in this
Prospectus as of December 31, 1994, 1995 and 1996, and for the fiscal years
then ended have been audited by Deloitte & Touche LLP, independent auditors,
as stated in their reports included herein.
102
<PAGE>
GLOSSARY
ACCESS CHARGES--The fees paid by IXCs to LECs for originating and
terminating long distance calls on their local networks.
CLEC (Competitive Local Exchange Carrier)--A company that provides its
customers with an alternative to the local telephone company for local
transport of private line, special access and interstate transport of switched
access telecommunications services.
CENTRAL OFFICES--The switching centers or central switching facilities of
the LECs.
CENTREX--Centrex is a service that offers features similar to those of what
is known as a private branch exchange (PBX), except the equipment is located
at the carrier's premises and not at the premises of the customer. These
features include direct dialing within a given phone system, direct dialing of
incoming calls, and automatic identification of outbound calls. This is a
value added service that carriers can provide to a wide range of customers who
do not have the size or the funds to support their own on-site PBX.
CO-CARRIER STATUS--A relationship between competitive local exchange
carriers ("CLECs") that affords the same access to and rights on each other's
networks, and that provides access and services on an equal basis.
COLLOCATION--The ability of a CLEC to connect its network to the LEC's
central offices. Physical collocation occurs when a CLEC places its network
connection equipment inside the LEC's central offices. Virtual collocation is
an alternative to physical collocation pursuant to which the LEC permits a
CLEC to connect its network to the LEC's central offices at competitive
prices, even though the CLEC's network connection equipment is not physically
located inside the central offices.
DEDICATED LINES--Telecommunications lines dedicated or reserved for use
exclusively by particular customers along predetermined routes (in contrast to
telecommunications lines within the LEC's public switched network).
DEDICATED SERVICES--Special access, switched transport and private line
services.
FRAME RELAY--Frame Relay is a high-speed data packet switching service used
to transmit data between computers. Frame Relay supports data units of
variable lengths at access speeds ranging from 56kbs to 1.5 mbs. This service
is ideal for connecting LANS, but is not appropriate for voice and video
applications due to the variable delays that can occur. Frame Relay was
designed to operate at higher speeds on modern fiber optic networks.
ILECS (Incumbent Local Exchange Carriers)--Companies providing local
telephone services.
INTERCONNECTION DECISIONS--Rulings by the FCC announced in September 1992
and August 1993, which require the RBOCs and most other LECs to provide
interconnection in LEC central offices to any CLEC, long distance carrier or
end user seeking such interconnection for the provision of interstate special
access and switched access transport services.
LANS (Local Area Networks)--The interconnection of computers for the purpose
of sharing files, programs and various devices such as work stations, printers
and high-speed modems. LANs may include dedicated computers or file servers
that provide a centralized source of shared files and programs.
LATAS (Local Access and Transport Areas)--The geographically defined areas
in which LECs are authorized by the MFJ to provide local switched services.
LOCAL EXCHANGE AREAS--A geographic area determined by the appropriate state
regulatory authority in which local calls generally are transmitted without
toll charges to the calling or called party.
103
<PAGE>
POP (POINT OF PRESENCE)--Location where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.
PRIVATE LINE--A private, dedicated telecommunications line connecting
different locations (excluding long distance carrier POPs).
PROVISIONING--The process of initiating a carrier's service to a customer.
SPECIAL ACCESS SERVICES--The lease of private, dedicated telecommunications
lines or "circuits" along the network of a LEC or a CLEC, which lines or
circuits run to or from the long distance carrier POPs. Examples of special
access services are telecommunications lines running between POPs of a single
long distance carrier, from one long distance carrier POP to the POP of
another long distance carrier or from a subscriber to its long distance
carrier POP. Special access services do not require the use of switches.
SWITCH--A sophisticated computer that accepts instructions from a caller in
the form of a telephone number. Like an address on an envelope, the numbers
tell the switch where to route the call. The switch opens or closes circuits
or selects the paths or circuits to be used for transmission of information.
Switching is a process of interconnecting circuits to form a transmission path
between users. Switches allow local telecommunications service providers to
connect calls directly to their destination, while providing advanced features
and recording connection information for future billing.
SWITCHED ACCESS SERVICES--The origination or termination of long distance
traffic between a customer premise and an IXC POP via shared local trunks
using a local switch.
SWITCHED TRANSPORT SERVICES--Transportation of switched traffic along
dedicated lines between the LEC central offices and interexchange POPs.
SWITCHED TRAFFIC--Telecommunications traffic along a switched network.
USOC (UNIVERSAL SERVICE ORDERING CODE)--Identifies a particular service or
equipment under tariff (not necessarily universal any longer).
104
<PAGE>
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE SIX MONTH
PERIODS ENDING JUNE 30, 1996 AND 1997 AND AS OF DECEMBER 31, 1996 AND
JUNE 30, 1997............................................................ F-2
INDEPENDENT AUDITORS' REPORT.............................................. F-6
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets............................................. F-7
Consolidated Statements of Operations................................... F-8
Consolidated Statements of Redeemable Preferred Stock................... F-9
Consolidated Statements of Common Stockholders' Deficit................. F-10
Consolidated Statements of Cash Flows................................... F-11
Notes to Consolidated Financial Statements.............................. F-12
</TABLE>
F-1
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER
ASSETS 1997 31, 1996
------ ------------ -----------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents......................... $ 15,720,248 $60,818,478
Accounts receivable, net.......................... 8,029,610 3,004,408
Prepaid expenses.................................. 683,353 187,051
Other receivables................................. 179,128 172,567
------------ -----------
Total current assets............................ 24,612,339 64,182,504
Property and Equipment--Net......................... 10,081,179 3,507,350
Other Assets........................................ 9,452,057 10,362,438
------------ -----------
Total Assets.................................... $ 44,145,575 $78,052,292
============ ===========
<CAPTION>
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND COMMON STOCKHOLDERS' DEFICIT
----------------------------------------
<S> <C> <C>
Current Liabilities:
Accounts payable.................................. $ 9,723,803 $ 7,907,654
Accrued expenses and other liabilities............ 7,953,322 3,176,762
Capital lease obligations--current................ 401,812 277,844
Current maturities on notes payable............... 121,722 386,522
------------ -----------
Total current liabilities....................... 18,200,659 11,748,782
Capital Lease Obligations--Noncurrent............... 478,235 312,280
Notes Payable....................................... 26,513 49,727
14% Senior Discount Notes, net of Original Issue
Discount........................................... 33,429,596 31,242,614
9% Convertible Subordinated Discount Notes, net of
Original Issue Discount............................ 29,531,236 28,259,555
------------ -----------
Total liabilities............................... 81,666,239 71,612,958
Redeemable Preferred Stock:
9% Cumulative Convertible Pay-In-Kind Preferred
stock: par value, $1; 30,000 shares authorized;
10,450 and 10,000 shares outstanding at 1997 and
1996............................................. 10,450 10,000
Accumulated unpaid dividends...................... 235,126 225,000
Additional paid-in capital........................ 10,259,735 9,810,185
------------ -----------
Total redeemable preferred stock................ 10,505,311 10,045,185
Common Stockholders' Deficit:
Common stock: par value, $.01; 2,500,000 shares
authorized; 722,251 and 718,526 shares issued at
1997 and 1996.................................... 7,223 7,185
Additional paid-in capital........................ 54,482,126 54,179,423
Accumulated deficit............................... (102,514,247) (57,791,382)
Common stock held in Treasury: 1997 and 1996--
1,000 shares..................................... (1,077) (1,077)
------------ -----------
Total common stockholders' deficit.............. (48,025,975) (3,605,851)
------------ -----------
Total Liabilities, Redeemable Preferred Stock, and
Common Stockholders' Deficit....................... $ 44,145,575 $78,052,292
============ ===========
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-2
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
30,
------------------------
1997 1996
------------ ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Net service revenue.................................. $ 11,721,290 $4,803,557
Cost of services..................................... 10,519,835 4,078,236
------------ ----------
Gross margin..................................... 1,201,455 725,321
Expenses:
Sales and marketing................................ 27,335,250 3,545,805
General and administrative......................... 15,013,143 6,335,803
------------ ----------
Operating loss....................................... (41,146,938) (9,156,287)
Other income (expense):
Interest income.................................... 1,009,451 352,590
Interest expense................................... (4,129,201) (19,539)
Other income....................................... 3,948 8,096,117
------------ ----------
Other income (expense)--net...................... (3,115,802) 8,429,168
------------ ----------
Net loss............................................. $(44,262,740) $ (727,119)
============ ==========
Accumulated unpaid preferred dividends............... $ 235,126 $6,144,668
============ ==========
Net loss per common share............................ $ (61.70) $ (16.12)
============ ==========
Weighted average common and common equivalent shares
outstanding......................................... 721,251 426,378
============ ==========
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-3
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
30,
-------------------------
1997 1996
------------ -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................... $(44,262,740) $ (727,119)
Adjustments to reconcile net loss to net cash
flows from operating activities:
Depreciation and amortization................... 1,042,319 159,672
Amortization of organization costs and
intangibles.................................... 611,529 357,588
Interest accreted on debt obligation............ 4,083,363 --
Stock compensation award expense................ 298,644 33,000
Gain on disposal of assets...................... -- (8,078,901)
Changes in:
Accounts receivable, net...................... (5,025,205) (1,002,454)
Prepaid expenses.............................. (496,300) 57,866
Other receivables............................. (6,561) (163,850)
Other assets.................................. (342,866) 98,691
Accounts payable.............................. 1,816,148 148,381
Accrued expenses and other liabilities........ 4,776,561 (60,435)
------------ -----------
Net cash flows from operating activities.... (37,505,108) (9,177,561)
Cash flows from investing activities:
Purchase of property and equipment................ (7,171,245) (344,712)
Proceeds from sale of assets...................... -- 9,532,600
------------ -----------
Net cash flows from investing activities.... (7,171,245) 9,187,888
Cash flows from financing activities:
Issuance of common stock.......................... 4,098 3,301
Repurchase of common stock........................ -- (1,077)
Deposits.......................................... 17,018 (230,671)
Repayment of notes payable........................ (288,013) (277,766)
Repayment of capital lease obligations............ (154,980) (43,214)
------------ -----------
Net cash flows from financing activities.... (421,877) (549,427)
------------ -----------
Net decrease in cash................................ (45,098,230) (539,100)
Cash and cash equivalents--Beginning of period...... 60,818,478 13,766,040
Cash and cash equivalents--End of period............ $ 15,720,248 $13,226,940
============ ===========
Supplemental cash flow information:
Dividends Paid in Kind............................ $ 450,000 --
============ ===========
Dividends Declared but Unpaid..................... $ 235,126 $ 2,334,668
============ ===========
Capital Lease Obligations Incurred................ $ 444,903 $ 352,116
============ ===========
Cash Paid for Interest............................ $ 49,862 $ 19,631
============ ===========
Cash Paid for Income Taxes........................ -- --
============ ===========
</TABLE>
See notes to Condensed Consolidated Financial Statements.
F-4
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE PERIOD ENDING JUNE 30, 1997
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The unaudited, condensed consolidated financial statements of USN
Communications, Inc. (the "Company") included herein have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission. The interim financial statements reflect all adjustments which
are, in the opinion of management, necessary for a fair presentation of the
results for the interim periods presented. The condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's latest annual
report on Form 10-K. The results of operations for the interim periods should
not be considered indicative of results to be expected for the full year.
2. GAIN CONTINGENCY
In 1995, a subsidiary of the Company, USN Communications Northeast, Inc.
("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. In the fourth quarter of 1996, USNCN
recorded $867,000 of this claim as revenue. In 1997, this claim was resolved
at the amount previously recorded as revenue, to the mutual satisfaction of
both parties.
3. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
F-5
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
USN Communications, Inc.
Chicago, Illinois
We have audited the accompanying consolidated balance sheets of USN
Communications, Inc. and subsidiaries (the "Company") as of December 31, 1996
and 1995, the related consolidated statements of operations, redeemable
preferred stock, common stockholders' deficit and cash flows for the years
ended December 31, 1996 and 1995 and for the period from April 20, 1994
(Inception) to December 31, 1994. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the
Company as of December 31, 1996 and 1995, and the results of its operations
and its cash flows for the years ended December 31, 1996 and 1995 and for the
period from April 20, 1994 (Inception) to December 31, 1994, in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 20 to the
financial statements, the Company's recurring losses from operations raise
substantial doubt about its ability to continue as a going concern.
Management's plans concerning this matter are also described in Note 20. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
DELOITTE & TOUCHE LLP
Chicago, Illinois
March 14, 1997
F-6
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
ASSETS 1996 1995
------ ----------- ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents........................... $60,569,365 $ 13,705,025
Accounts receivable, net of allowances for doubtful
accounts of $223,000 (1996) and $193,000 (1995).... 3,004,408 1,184,453
Interest receivable................................. 249,113 61,015
Prepaid expenses.................................... 187,051 171,111
Notes receivable.................................... 150,000
Other receivables................................... 22,567
Net assets held for sale............................ 1,453,699
----------- ------------
Total current assets.............................. 64,182,504 16,575,303
Property and Equipment--net........................... 3,507,350 1,214,647
Other Assets.......................................... 10,362,438 2,681,255
----------- ------------
Total Assets...................................... $78,052,292 $ 20,471,205
=========== ============
<CAPTION>
LIABILITIES, REDEEMABLE PREFERRED STOCK AND COMMON
STOCKHOLDERS' DEFICIT
--------------------------------------------------
<S> <C> <C>
Current Liabilities:
Accounts payable.................................... $ 7,907,654 $ 2,734,122
Accrued expenses and other liabilities.............. 3,176,762 1,106,010
Current maturities on notes payable................. 386,522 409,348
Capital lease obligations--current.................. 277,844 75,192
----------- ------------
Total current liabilities......................... 11,748,782 4,324,672
Capital Lease Obligations--Noncurrent................. 312,280 81,391
Notes Payable......................................... 49,727 436,825
14% Senior Discount Notes, net of Original Issue
Discount............................................. 31,242,614
9% Convertible Subordinated Discount Notes, net of
Original Issue Discount.............................. 28,259,555
----------- ------------
Total liabilities................................. 71,612,958 4,842,888
Redeemable Preferred Stock:
9% Cumulative Convertible Pay-In-Kind Preferred
Stock.............................................. 10,000
Series A 10% Senior Cumulative Preferred Stock...... 16,200
Series A-2 10% Senior Cumulative Preferred Stock.... 26,235
Accumulated unpaid dividends........................ 225,000 3,810,000
Additional paid-in capital.......................... 9,810,185 40,543,605
----------- ------------
Total redeemable preferred stock.................. 10,045,185 44,396,040
Common Stockholders' Deficit:
Common stock: $.01 par value;
2,500,000 and 500,000 authorized at 1996 and 1995;
718,526 and 315,729 shares issued at 1996 and 1995
................................................... 7,185 3,137
Additional paid-in capital.......................... 54,179,423 282,955
Accumulated deficit................................. (57,791,382) (29,053,815)
Treasury stock, 1,000 shares at 1996................ (1,077)
----------- ------------
Total common stockholders' deficit................ (3,605,851) (28,767,723)
----------- ------------
Total Liabilities, Redeemable Preferred Stock and
Common Stockholders' Deficit..................... $78,052,292 $ 20,471,205
=========== ============
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
Net service revenue................... $ 9,814,479 $ 7,883,890 $ 1,737,461
Cost of services...................... 9,256,472 9,075,749 1,454,882
------------ ------------ -----------
Gross margin...................... 558,007 (1,191,859) 282,579
------------ ------------ -----------
Expenses:
Sales and marketing................. 12,612,172 5,867,200 2,869,463
General and administrative.......... 20,664,612 11,100,661 4,685,894
------------ ------------ -----------
Operating loss........................ (32,718,777) (18,159,720) (7,272,778)
------------ ------------ -----------
Other income (expense):
Interest income..................... 1,376,429 586,946 152,099
Interest expense.................... (1,797,112) (733,566) (26,110)
Gain on sale of switch-based
facilities......................... 8,078,901
Other income........................ 13,968 59,314
------------ ------------ -----------
Other income (expense)--net....... 7,672,186 (87,306) 125,989
------------ ------------ -----------
Net loss before minority interest..... (25,046,591) (18,247,026) (7,146,789)
Minority interest share in loss of
USNCN................................ 150,000
------------ ------------ -----------
Net loss.............................. $(25,046,591) $(18,097,026) $(7,146,789)
============ ============ ===========
Accumulated unpaid preferred
dividends............................ $ 225,000 $ 3,810,000 $ 707,000
============ ============ ===========
Net loss per common share............. $ (49.53) $ (72.42) $ (65.63)
============ ============ ===========
Weighted average common and common
equivalent shares outstanding........ 510,233 302,520 119,678
============ ============ ===========
</TABLE>
See notes to consolidated financial statements.
F-8
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
SERIES
9% PIK SERIES A A-2 ACCUMULATED ADDITIONAL
PREFERRED PREFERRED PREFERRED UNPAID PAID-IN-
STOCK STOCK STOCK DIVIDENDS CAPITAL TOTAL
--------- --------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, April 20, 1994.
Issuance of 16,200
shares of Series A
10% Senior Cumulative
preferred stock...... $16,200 $15,212,824 $15,229,024
Costs incurred related
to issuance of stock. (630,474) (630,474)
Accumulated unpaid
preferred dividends.. $ 707,000 707,000
------- ---------- ----------- -----------
Balance, December 31,
1994................... 16,200 707,000 14,582,350 15,305,550
Issuance of 26,235
shares of Series A-2
10% Senior Cumulative
preferred stock...... $26,235 26,208,765 26,235,000
Costs incurred related
to issuance of stock. (247,510) (247,510)
Accumulated unpaid
preferred dividends.. 3,103,000 3,103,000
------- ------- ---------- ----------- -----------
Balance, December 31,
1995................... 16,200 26,235 3,810,000 40,543,605 44,396,040
Accumulated unpaid
preferred dividends.. 3,465,976 3,465,976
Conversion of Series A
and A-2 Preferred
Stock to Class A
Common Stock......... (16,200) (26,235) (7,275,976) (40,543,605) (47,862,016)
Issuance of 10,000
shares of 9% PIK
preferred stock...... $10,000 9,990,000 10,000,000
Costs incurred related
to issuance of 9% PIK
preferred stock...... (179,815) (179,815)
Accumulated unpaid
preferred dividends
on 9% PIK preferred
stock................ 225,000 225,000
------- ------- ------- ---------- ----------- -----------
Balance, December 31,
1996................... $10,000 $ 225,000 $ 9,810,185 $10,045,185
======= ======= ======= ========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-9
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE
PERIOD FROM APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
ADDITIONAL COMMON
COMMON PAID-IN ACCUMULATED STOCK HELD
STOCK CAPITAL DEFICIT IN TREASURY TOTAL
------ ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Balance, April 20, 1994.
Issuance of 177,840
shares of common
stock................ $1,778 $ 236,661 $ $238,439
Costs incurred related
to issuance of stock. (214,860) (214,860)
Accumulated unpaid
preferred dividends.. $ (707,000) (707,000)
Net loss.............. (7,146,789) (7,146,789)
------ ----------- ------------ ------------
Balance, December 31,
1994................... 1,778 21,801 (7,853,789) (7,830,210)
Issuance of 135,899
shares of common
stock................ 1,359 263,644 265,003
Costs incurred related
to issuance of stock. (2,490) (2,490)
Accumulated unpaid
preferred dividends.. (3,103,000) (3,103,000)
Net loss.............. (18,097,026) (18,097,026)
------ ----------- ------------ ------------
Balance, December 31,
1995................... 3,137 282,955 (29,053,815) (28,767,723)
Conversion of Series A
and A-2 Preferred
Stock to Class A
Common Stock......... 2,676 47,859,340 47,862,016
Issuance of 5,000
shares of common
stock................ 50 5,450 5,500
Compensation grants of
22,000 shares of
common stock......... 220 32,780 33,000
Repricing of common
stock................ 1,102 (1,102)
Repurchase of 1,000
shares of common
stock................ $(1,077) (1,077)
Issuance of stock
warrants............. 6,000,000 6,000,000
Accumulated unpaid
preferred dividends.. (3,690,976) (3,690,976)
Net loss.............. (25,046,591) (25,046,591)
------ ----------- ------------ ------- ------------
Balance, December 31,
1996................... $7,185 $54,179,423 $(57,791,382) $(1,077) $ (3,605,851)
====== =========== ============ ======= ============
</TABLE>
F-10
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss............................ $(25,046,591) $(18,097,026) $(7,146,789)
Adjustments to reconcile net loss to
net cash flows from operating
activities:
Depreciation and amortization..... 558,236 1,288,991 159,685
Amortization of organization costs
and intangibles.................. 1,770,936 969,271 26,376
Interest accreted on debt
obligation....................... 1,654,394
Stock compensation award expense.. 33,000
Gain on disposal of assets........ (8,078,901) (16,274)
Changes in:
Accounts receivable............. (1,819,956) (322,245) (862,208)
Interest receivable............. (188,098) (61,015)
Prepaid expenses................ (38,468) 13,082 (37,624)
Other receivables............... (172,567)
Other assets.................... (14,948)
Account payable................. 4,819,840 1,578,757 953,465
Accrued expenses and other
liabilities.................... 2,424,642 338,412 766,532
------------ ------------ -----------
Net cash flows from operating
activities................... (24,098,481) (14,308,047) (6,140,563)
------------ ------------ -----------
Cash flows from investing activities:
Purchase of property and equipment.. (2,258,969) (1,739,542) (1,728,327)
Proceeds from sale of assets........ 9,532,600
Purchase of subsidiary.............. (892,287)
Organization costs.................. (161,702)
Cash acquired from purchase of
subsidiaries....................... 331,975
Issuance of noncurrent notes
receivable......................... (150,000)
Proceeds from note receivable....... 76,204
------------ ------------ -----------
Net cash flows from investing
activities................... 7,273,631 (2,555,625) (1,708,054)
------------ ------------ -----------
Cash flows from financing activities:
Proceeds from Senior Notes.......... 30,203,375
Proceeds from Convertible Notes..... 27,644,400
Debt acquisition costs.............. (2,920,239)
Issuance of preferred stock......... 10,000,000 26,235,000 14,850,000
Issuance of common stock............ 5,500 265,003 150,000
Costs incurred related to issuance
of stock........................... (179,815) (250,000) (845,334)
Repurchase of common stock.......... (1,077)
Deposits............................ (494,603) (20,855) (555,270)
Proceeds from borrowings............ 180,000
Payments on assumed indebtedness.... (350,412) (1,459,458)
Proceeds from notes payable......... 46,645 73,504
Repayment of notes payable.......... (59,512) (71,588) (8,330)
Repayment of capital lease
obligation......................... (158,427) (155,272) (16,731)
------------ ------------ -----------
Net cash flows from financing
activities................... 63,689,190 24,589,475 13,827,839
------------ ------------ -----------
Net increase in cash.................. 46,864,340 7,725,803 5,979,222
Cash and cash equivalents--Beginning
of year.............................. 13,705,025 5,979,222
------------ ------------ -----------
Cash and cash equivalents--End of
year................................. $ 60,569,365 $ 13,705,025 $ 5,979,222
============ ============ ===========
Supplemental cash flow information--
See Note 3
</TABLE>
See notes to consolidated financial statements.
F-11
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995 AND PERIOD FROM
APRIL 20, 1994 (INCEPTION) TO DECEMBER 31, 1994
1. ORGANIZATION AND ACQUISITIONS
USN Communications, Inc., formerly United USN, Inc. ("USN") was incorporated
under the laws of the State of Delaware on April 20, 1994 and was initially
funded in 1994 through capital contributions totaling $15 million in cash,
before financing costs. In June 1995 and September 1996, USN received
additional capital contributions of approximately $26 million and $10 million,
respectively. USN holds controlling investments in three companies: US Network
Corporation, USN Communications Northeast, Inc. (formerly United
Telemanagement Services, Inc.), and USN Communications Midwest, Inc. USN and
its subsidiaries operate in a single business segment, primarily as a reseller
of a broad range of telecommunications services in various cities in the
Midwest and the Northeast regions of the U.S.
On April 20, 1994, USN purchased US Network Corporation ("US Network") and
its 100% subsidiary, FoneNet/Ohio, Inc., in exchange for 1,350 shares of
United's preferred stock and 31,500 shares of its common stock. This
transaction was accounted for as a purchase and was valued at US Network's net
book value of approximately $467,000. The consolidated financial statements
include the results of operations of US Network since April 20, 1994.
In July 1994, USN purchased a 50.1% ownership interest in USN Communications
Northeast, Inc. ("USNCN") for approximately $2 million. USNCN provides
telecommunications services to business customers in New York and
Massachusetts. USN has had substantive control of USNCN since its inception.
Therefore, the consolidated financial statements include the results of
operations for USNCN since its commencement of operations in 1994. In December
1995, USN's ownership in USNCN increased to 83.9% as a result of additional
investments approximating $9.4 million. In July 1996, USN's ownership in USNCN
increased to 100% as a result of an additional investment of $150,000.
In June 1995, USNCN (through a newly formed subsidiary, Quest United, Inc.)
purchased specific assets and assumed certain liabilities of an independent
telephone services company Quest America, L.P. ("Quest"), for cash of $950,000
and notes payable to investors of Quest of $842,985 (the "Acquisition"). The
Acquisition has been accounted for as a purchase, and such assets and
liabilities were recorded at their then fair values (which approximated their
historical cost bases) as of the Acquisition date. The excess of the cost of
the Acquisition over the net assets acquired has been ascribed to various
intangible assets (principally customer lists, employment contracts and work
force in place). The consolidated statement of operations for the year ended
December 31, 1996 and 1995 include Quest's revenues and expenses from the
Acquisition date forward.
In January 1995, USN Communications Midwest, Inc. ("USNCM") was incorporated
as a wholly owned subsidiary of USN. USNCM began operations in July 1996 and
provides telecommunication services to business customers in Illinois, Ohio
and Michigan.
2. SUMMARY OF ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation
of the accompanying consolidated financial statements follows:
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
F-12
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Principles of Consolidation--The accompanying consolidated financial
statements include the accounts of USN Communications, Inc. and its
subsidiaries (the "Company"). Significant intercompany balances and
transactions have been eliminated in consolidation.
Revenue Recognition--The Company recognizes revenues in the period in which
telephone services are provided. For the operating unit which the Company has
operated as a commission agent only, revenues are recorded at the net
commissions earned.
Cash and Cash Equivalents--Cash and cash equivalents are defined as cash in
banks, time deposits and highly liquid short-term investments with initial
maturities of three months or less.
Recourse Provisions--Until June 1996, USNCN utilized a third-party billing
and collection agency (the "Agency") to process and factor its accounts
receivable, yet retained the risk of loss on amounts that were deemed to be
uncollectible in the normal course of business. The Agency charged USNCN an
allowance for estimated bad debts on factored accounts receivable, subject to
the recourse provisions, using prior collection experience and industry
statistics. Adjustments were made between actual loss experience and estimated
bad debt expenses on a periodic basis by the Agency. At December 31, 1996,
there were no factored receivables subject to such adjustment. At December 31,
1995, factored receivables of approximately $828,000 were subject to such
adjustment.
Fair Value of Financial Instruments--The carrying values of financial
instruments included in current assets and liabilities approximate fair values
due to the short-term maturities of these instruments. The carrying values of
long-term debt and notes payable are reasonable estimates of their fair values
as the interest rates approximate rates currently available to the Company for
instruments with similar terms and remaining maturities.
Property and Equipment--Purchases of property and equipment are carried at
cost. Depreciation is provided on the straight-line basis. Furniture and
fixtures are depreciated over five years. Computer equipment is depreciated
over three years. Leasehold improvements and assets leased under capital
leases are amortized over the shorter of the related lease term or the
estimated useful life of the asset.
Intangible Assets--Costs incurred in the formation of the Company are being
amortized on a straight-line basis over five years. The intangible assets
associated with the acquisition of Quest are being amortized on a straight-
line basis over two years. Debt acquisition costs are being amortized over the
life of the related debt. The value of the warrants issued with the Senior
Notes are being amortized over the life of those notes.
Stock-based Compensation--During 1996, the Company implemented Statement of
Financial Accounting Standards No. 123 "Accounting for Stock Based
Compensation" ("SFAS No. 123"). SFAS No. 123 allows the Company to recognize
compensation under the "intrinsic value" method prescribed by Accounting
Principles Board Opinion No. 25, and requires the pro forma disclosure of net
income and earnings per share as if the fair value method had been applied.
Reclassifications--Certain prior year amounts have been reclassified to
conform to the current year presentation.
F-13
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- ---------- ----------
<S> <C> <C> <C>
Capital lease obligations incurred (Notes
5
and 9).................................. $591,967 $3,398,105 $3,137,119
======== ========== ==========
Fair value of Quest America Management
L.P. noncash assets acquired in 1995.... $ 414,726
Consideration incurred in connection with
the Acquisition (including $950,000 in
cash advances) (Note 1)................. 3,104,588
----------
Liabilities assumed...................... $2,689,862
==========
Note payable incurred to finance
insurance policies (Note 11)............ $ 58,650 $ 72,000
========== ==========
Fair value of US Network's noncash assets
acquired................................ $ 623,659
Common and preferred stock issued in
connection with the acquisition (Note
1)...................................... 467,463
----------
Liabilities assumed...................... $ 156,196
==========
Note payable to UTS minority shareholder. $ 149,708
Proceeds received upon issuance of note
payable................................. (73,504)
----------
Note receivable from UTS minority
shareholder............................. $ 76,204
==========
</TABLE>
Cash paid for interest in 1996 and 1995 was approximately $32,000 and
$613,000, respectively. No cash was paid in 1994 for interest and in 1996,
1995 and 1994 for income taxes.
4. RELATED PARTY TRANSACTIONS
Notes receivable at December 31, 1996 includes a $75,000 non-interest
bearing note due to the Company from a corporate officer.
F-14
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. NET ASSETS HELD FOR SALE
On December 29, 1995, the Company entered into an agreement to sell its
switch-based facilities in Ohio for $9.5 million in cash plus the assumption
of capital and operating leases. The transaction closed on February 29, 1996
and a gain of approximately $8.1 million was realized and recorded at that
time. The Company will continue to serve its Ohio customer base as a reseller
of telecommunication services.
The net assets held at December 31, 1995 in conjunction with this sale were
as follows:
<TABLE>
<S> <C>
Switching equipment........................................... $6,233,557
Leasehold improvements........................................ 1,781,260
Outside plant and equipment................................... 423,424
Furniture and equipment....................................... 318,355
----------
8,756,596
Less accumulated depreciation................................. (1,181,587)
----------
Net property and equipment.................................... 7,575,009
Deposits...................................................... 100,532
----------
Total assets.................................................. 7,675,541
Less liabilities assumed:
Accrued liabilities......................................... 15,204
Capital lease obligations................................... 6,206,638
----------
Net assets held for sale...................................... $1,453,699
==========
</TABLE>
Additionally, approximately $2.0 million in operating leases were assumed by
the buyer. The Company remains contingently liable on capital and operating
leases assumed by the buyer until expiration.
6. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consist of:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Furniture and equipment........................... $3,940,719 $1,364,479
Leasehold improvements............................ 392,601 117,902
---------- ----------
4,333,320 1,482,381
Less accumulated depreciation..................... (825,970) (267,734)
---------- ----------
Total......................................... $3,507,350 $1,214,647
========== ==========
</TABLE>
F-15
<PAGE>
USN COMMUNICATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. OTHER ASSETS
Other assets at December 31 consist of:
<TABLE>
<CAPTION>
1996 1995
----------- ----------
<S> <C> <C>
Stock warrants (net of accumulated amortization:
1996--$214,286).................................. $ 5,785,714
Debt acquisition costs (net of accumulated
amortization: 1996--$98,064)..................... 2,822,175
Deposits.......................................... 1,044,098 $ 426,902
Goodwill (net of accumulated amortization:
1996--$2,337,015; 1995--$923,850) ............... 588,819 2,001,985
Organization costs (net of accumulated
amortization:
1996--$118,853; 1995--$73,432)................... 108,257 153,677
Other............................................. 13,375 98,691
----------- ----------
Total............................................. $10,362,438 $2,681,255
=========== ==========
</TABLE>
8. ACCRUED EXPENSES
Accrued expenses at December 31 consist of:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Payroll and benefits................................ $1,515,197 $ 548,775
Professional services............................... 814,388 163,540
Excise taxes........................................ 575,790 117,812
Rent................................................ 6,600 4,380
Interest payable.................................... 21,764
Other............................................... 264,787 249,739
---------- ----------
Total............................................... $3,176,762 $1,106,010
========== ==========
</TABLE>
9. CAPITAL LEASE OBLIGATIONS
The Company leases certain furniture and equipment under capital leases at
December 31 as follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Furniture and equipment............................... $841,359 $221,855
Less accumulated amortization......................... (261,905) (73,003)
-------- --------
Total................................................. $579,454 $148,852
======== ========
</TABLE>
Future minimum lease payments at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997.......................... $ 341,883
1998.......................... 288,865
1999.......................... 54,422
---------
Total minimum lease payments.. 685,170
Less imputed interest......... (95,046)
---------
Present value of minimum lease
payments..................... 590,124
Less current portion.......... (277,844)
---------
Long-term lease obligations... $ 312,280
=========
</TABLE>
F-16
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. OPERATING LEASES
The Company leases certain office space and equipment under operating
leases. Future minimum lease commitments under noncancelable operating leases
as of December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997......................... $ 2,113,254
1998......................... 2,206,947
1999......................... 1,737,457
2000......................... 1,530,196
Thereafter................... 2,531,822
-----------
Total.................... $10,119,676
===========
</TABLE>
Rent expense for the years ended December 31, 1996 and 1995 and the period
from April 20, 1994 to December 31, 1994 was approximately $1,024,000,
$867,000 and $214,000, respectively.
11. NOTES PAYABLE
The Company issued a note payable of $58,650 in 1995 to finance an insurance
policy. The note was payable in nine monthly installments through August 1996.
Interest was payable at 6.45%. The principal balance was paid in full at
December 31, 1996.
In 1995, the Company issued an additional note payable of $46,353 to finance
improvements to an office space. The note requires monthly principal payments
of $831 through July 2001. Interest is payable at 8%. At December 31, 1996 and
1995, the outstanding principal balances were $37,573 and $44,777,
reepectively.
In connection with the acquisition of Quest, USNCN assumed notes payable to
investors of Quest. The notes bear interest at 8% and the balances outstanding
at December 31, 1996 and 1995 total $398,676 and $749,088, respectively. The
notes require quarterly principal and interest payments in 1996 and 1997 and
in the first quarter of 1998.
Maturities on notes payable are as follows:
<TABLE>
<S> <C>
1997............................ $386,522
1998............................ 27,204
1999............................ 8,474
2000............................ 9,178
2001............................ 4,871
--------
Total....................... $436,249
========
</TABLE>
12. PRIVATE PLACEMENT OFFERING
On September 30, 1996, the Company received approximately $55 million in
cash, net of commissions paid, in exchange for 48,500 units consisting of
$48.5 million aggregate principal amount at maturity of 14% Senior Discount
Notes ("Senior Notes") due 2003 and warrants to purchase 61,550 shares of
Class A Common Stock, and 36,000 units consisting of $36 million aggregate
principal amount at maturity of 9% Convertible Subordinated Notes
("Convertible Notes") due 2004.
The Senior Notes were sold at a unit price, before commissions, of $622.75
per $1,000 face amount. These notes will accrete interest at an annual rate of
14% from September 30, 1996 to March 31, 2000. Thereafter, the notes will bear
interest at an annual rate of 14%, and will be paid semiannually in arrears,
on the aggregate principal amount at maturity of $48.5 million.
F-17
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Convertible Notes were sold at a unit price, before commissions, of
$767.90 per $1,000 face amount. These notes will accrete interest at an annual
rate of 9% from September 30, 1996 to September 30, 1999. Thereafter, the
notes will bear interest at an annual rate of 9%, and will be paid
semiannually in arrears, on the aggregate principal amount at maturity of $36
million.
13. REDEEMABLE PREFERRED STOCK
The Board of Directors authorized 20,000 shares of Series A 10% Senior
Cumulative Preferred Stock ("Series A") and 30,000 shares of Series A-2 10%
Senior Cumulative Preferred Stock ("Series A-2"), with par values of $1 in
1994 and 1995, respectively. On December 31, 1995, 16,200 shares of Series A
and 26,235 shares of Series A-2 were outstanding.
In September 1996, the Board of Directors and the existing shareholders
approved the conversion of all outstanding Series A and Series A-2 Preferred
Stock to shares of Class A Common Stock. The conversion was consummated on
September 30, 1996 and 267,630 shares of Class A Common Stock were issued in
exchange for the outstanding Series A and Series A-2 Preferred Stock,
including dividends accrued through the conversion date.
In September 1996, the Board of Directors authorized the issuance of up to
30,000 shares of $1 par value preferred stock designated as 9% Cumulative
Convertible Pay-in-Kind Preferred Stock ("9% Preferred Stock"). In connection
with the Private Placement Offering (Note 12), the Company issued 10,000
shares of its 9% Preferred Stock to its existing shareholders, for an
aggregate purchase price of $10.0 million.
Dividends--Dividends on the 9% Preferred Stock accrue semiannually at a rate
of 9% per annum, are fully cumulative and are payable through the issuance of
additional shares of 9% Preferred Stock. No dividends have been declared or
paid on the preferred stock.
Liquidation--Upon any liquidation, dissolution or winding up of the Company,
holders of the 9% Preferred Stock will be entitled to receive their full
liquidation preference and stated value of $1,000 per share, together with
accrued and unpaid dividends, prior to the distribution of any assets of the
Company to the holders of Class A Common Stock.
Redemption--Shares of 9% Preferred Stock are not redeemable at the option of
the Company, but are subject to mandatory redemption in 2006 at the stated
value, together with all accrued and unpaid dividends to the redemption date.
Conversion--Each share of 9% Preferred Stock is convertible into 7.0623
shares of Class A Common Stock, at any time, in whole or in part, at the
option of the holders thereof.
14. COMMON STOCK
In 1996, a 1995 transaction in which Class A Common Stock was issued was
repriced, whereby the number of shares issued increased from 135,899 to
246,056 and the purchase price decreased from $1.95 to $1.077 per share.
Dividends--The holders of Class A Common Stock are entitled to receive
dividends as dividends are declared by the Board of Directors of the Company
out of funds legally available therefor, provided that if any shares of
Preferred Stock are at the time outstanding, the payment of dividends on the
Class A Common Stock or other distributions may be subject to the declaration
and payment of full cumulative dividends on outstanding shares of Preferred
Stock.
F-18
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Liquidation--Upon any liquidation, dissolution or winding up of the affairs
of the Company, whether voluntary or involuntary, any assets remaining after
the satisfaction in full of the prior rights of creditors and the aggregate
liquidation preference of any Preferred Stock then outstanding will be
distributed to the holders of Class A Common Stock.
15. STOCK OPTION PLAN
The Company has granted options to acquire shares of common stock to certain
officers and other employees under the 1994 Stock Option Plan. These options
generally become exercisable at a rate of 25% every six months over a period
of two years after the date of grant, although with respect to certain grants
no vesting occurs until twelve months after the grant date.
In connection with the financing described in Note 12 and the issuance of
the 9% Preferred Stock described in Note 13, the Company granted 31,961
options to purchase Class A Common Stock at an exercise price of $1.50 per
share. These options were not issued under the 1994 Stock Option Plan, but
rather were issued pursuant to separate stock option agreements between the
Company and the option holders. 6,637 of these options become exercisable as
the Convertible Notes are converted to Class A Common Stock, and 25,324 of
these options become exercisable as shares of 9% Preferred Stock are converted
to Class A Common Stock.
Stock option transactions are summarized as follows:
<TABLE>
<CAPTION>
PRICE PER PRICE PER PRICE PER
1996 SHARE 1995 SHARE 1994 SHARE
------- ----------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January
1...................... 19,050 $ 1.10 21,300 $1.10
Granted................. 103,324 1.10-96.00 21,300 $1.10
Exercised............... (5,000) 1.10
Cancelled............... (6,475) 1.10 (2,250) 1.10
------- ------ ------
Outstanding at December
31..................... 110,899 1.10-96.00 19,050 1.10 21,300 1.10
======= ====== ======
Options exercisable at
December 31............ 10,662 1.10-1.50 10,024 1.10 --
======= ====== ======
</TABLE>
For pro forma information regarding net loss and loss per common share, the
fair value for the options awarded in 1996 and 1994 was estimated as of the
date of the grant using a Black-Scholes option valuation model with the
following weighted average assumptions for 1996 and 1994, respectively: risk-
free interest rates of 4.95% and 4.97%; dividend yields of 0%; and an expected
life of the option of ten years.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting period. Therefore, in the year
of adoption and subsequently affected years, the effect of applying SFAS 123
for providing pro forma net loss and loss per common share are not likely to
be representative of the effects on reported income in future years. The
effect on the Company's reported net loss, on a pro forma basis, was not
material for 1996, 1995 and 1994.
The Black-Scholes option valuation model used by the Company was developed
for use in estimating the fair value of fully tradable options which have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. It is management's opinion that the Company's
stock options have characteristics significantly different from those of
traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options.
F-19
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. EMPLOYEE BENEFIT PLAN
On January 1, 1995, the Company adopted a qualified 401(k) plan covering all
eligible employees in which the Company contributions are discretionary.
Employees are permitted to make annual contributions through salary deductions
up to 15% of their annual salary. The plan can be amended or terminated at any
time by the Board of Directors. The Company made no contributions to the plan
in 1996 or 1995.
17. INCOME TAXES
The Company incurred net losses of $25,046,591, $18,097,026 and $7,146,789
in 1996, 1995 and 1994, respectively. Accordingly, no provision for current
Federal or state income taxes has been made to the financial statements.
The Company's deferred tax asset components are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
Net operating loss carry-forwards............. $ 18,285,000 $ 9,121,000
Accrued liabilities and asset valuation
reserves..................................... 172,000 195,000
Amortization of intangibles................... 790,000 309,000
------------ -----------
Subtotal.................................. 19,247,000 9,625,000
Valuation allowance........................... (19,247,000) (9,625,000)
------------ -----------
Total..................................... $ -- $ --
============ ===========
</TABLE>
As of December 31, 1996 and 1995 the Company had not recognized deferred
income tax assets related to deductible temporary differences and cumulative
net operating losses. The ability of the Company to fully realize deferred tax
assets in future years is contingent upon its success in generating sufficient
levels of taxable income before the statutory expiration periods for utilizing
such net operating losses lapses. After an assessment of all available
evidence, including historical and projected operating trends, the Company was
unable to conclude that realization of such deferred tax assets in the near
future was more likely than not. Accordingly, a valuation allowance was
recorded to offset the full amount of such assets.
At December 31, 1996, the Company had net operating loss carry-forwards for
income tax purposes of approximately $46,120,000. The expiration periods for
utilizing these operating losses begin in 2009 for Federal tax purposes. Of
the net operating loss carry-forwards available at December 31, 1996,
$12,286,000 can be applied only against future taxable income of USNCN. In
addition, if the Company or the Company's subsidiaries experience an
"ownership change" within the meaning of Section 382 of the Internal Revenue
Code of 1986, as amended (the "Code"), the net operating loss carry-forwards
allocable to such entity will be subject to an annual limitation in an amount
generally equal to the value of the entity immediately before the ownership
change at the long-term tax-exempt rate (the "Section 382 limitation"). Any
unused Section 382 limitation in one year is added to the limitation for the
next year. Generally, an ownership change occurs with respect to an entity if
the aggregate increase in the percentage stock ownership (by value) of such
entity by one or more of its five-percent stockholders exceeds 50 percentage
points within a testing period. The tax laws for determining whether an
ownership change of an entity has occurred are complex and subject to
differing interpretations in certain respects. It is possible that the Company
or the Company's subsidiaries have experienced an ownership change under
Section 382 of the Code and that the Company or the Company's subsidiaries may
experience an ownership change as a result of the Company's future
transactions including, but not limited to, the issuance of the Warrants and
consummation of one or more public offerings of Common Stock. In such event,
the ability of the Company or the Company's subsidiaries to utilize their
operating loss carry-forwards to offset future taxable income would be subject
to limitations as discussed above.
F-20
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. MINORITY INTEREST IN USNCN
In September 1996, all minority shareholders interests' in USNCN were
repurchased, increasing the Company's ownership of USNCN's outstanding common
stock to 100%. Prior to this transaction , no minority interest in USNCN had
been recorded, as losses applicable to the minority interest in USNCN exceeded
the minority interest in the equity capital of USNCN, and there was no
obligation of the minority interest to make good on such losses.
19. COMMITMENTS
In 1995 and 1996 the Company entered into agreements with two independent
telecommunications companies ("TelCos") to allow the Company to resell the
TelCos local telephone service in various regional markets. The agreements
have terms of up to ten years and contain minimum purchase commitments of
local access lines, ranging from zero to 150,000 lines. These commitments are
measured by the number of lines in place on the last day of each 12-month
period. The agreements allow for ramp-up periods before any commitment levels
are required to be met. So long as the Company maintains cumulative net
shortfalls lower than established caps, no payments will be due to the TelCos
other than for normal usage. Even if no lines were sold by the Company, the
earliest required payment for any shortfall amount is in 1999.
In July 1996, the Company entered into an agreement with a third
telecommunications company to allow the Company to resell long distance
telephone service. The agreement is for a term of 33 months and contains an
annual purchase commitment of $12 million, with a minimum monthly commitment
of $600,000 to qualify for the contract rates. The agreement allows for a
ramp-up period before commitment levels are required to be met.
In 1994, USNCN executed an exclusive agreement with an independent
telecommunications company ("TelCo One"), whereby TelCo One allows USNCN to
establish a local private network on its infrastructure in which to provide
service to customers. The majority of USNCN's local service customers are
provided access to this network and, accordingly, a substantial portion of
USNCN's revenue is earned through the use of these access rights. Under this
agreement, TelCo One provides network maintenance and access to telephone
switches. The initial term of the agreement expires in 2004.
20. FUTURE OPERATING PLANS
Although the Company had working capital of approximately $52.4 million and
total redeemable preferred stock and common stockholders' deficit of
approximately $6.4 million, projected cash usage in 1997 combined with an
anticipated net loss in 1997, absent the infusion of additional capital
resources, is anticipated to fully deplete the Company's working capital prior
to December 31, 1997. Such events would raise substantial doubt about the
Company's ability to continue as a going concern. Although the Company's
management believes that the Company will be able to raise sufficient funds,
through capital contributions or additional equity or debt financings, to meet
its operating expenses and other cash requirements, there can be no assurance
that the Company would be able to complete such contributions or financing, or
that any such contributions or financing would be completed on terms
satisfactory to the Company.
21. CONTINGENCIES
Loss Contingency--In April 1995, a derivative action was filed by a minority
interest owner of USNCN against the Company and specific officers and
directors. In July 1996, the Company settled the dispute for $1.7 million.
F-21
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Gain Contingency--In 1995, USNCN submitted a claim of approximately $1.4
million with TelCo One requesting that certain revenues, purportedly not
billed by TelCo One to its customers, be paid to USNCN. During 1996, USNCN has
recorded $867,000 of this claim as revenue. TelCo One is in the process of
reviewing USNCN's remaining claim and has not formally concluded on the amount
or terms of a settlement. While USNCN believes its claim has merit, it is
unable to predict, at this time, whether they will be successful in fully
resolving this matter favorably.
* * * * *
F-22
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED HEREIN OTHER THAN THOSE CON-
TAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESEN-
TATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER
TO BUY ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER OR SO-
LICITATION IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AU-
THORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUAL-
IFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER TO
SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUN-
DER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Disclosure Regarding Forward-Looking Statements............................ 3
Prospectus Summary......................................................... 4
Recent Developments........................................................ 7
Risk Factors............................................................... 14
Use of Proceeds............................................................ 24
The Exchange Offer......................................................... 25
Capitalization............................................................. 33
Selected Historical Consolidated Financial and Operating Data.............. 34
Management's Discussion and Analysis
of Financial Condition and Results
of Operations............................................................. 35
Industry Overview: The Local Telecommunications Service Industry........... 40
Business................................................................... 41
Management................................................................. 53
Certain Relationships and Related Transactions............................. 60
Stock Ownership............................................................ 62
Description of the Notes................................................... 63
Description of the Warrants................................................ 91
Description of Capital Stock............................................... 95
Certain Other Indebtedness................................................. 97
Certain Federal Income Tax Considerations.................................. 98
Plan of Distribution....................................................... 101
Legal Matters.............................................................. 102
Independent Auditors....................................................... 102
Glossary................................................................... 103
Index to Consolidated Financial Statements................................. F-1
</TABLE>
------------
UNTIL , 1998 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE NEW NOTES OFFERED HEREBY, WHETHER OR NOT PARTICI-
PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
----------------
PROSPECTUS
----------------
LOGO
USN COMMUNICATIONS,INC.
$152,725,000
14 5/8% SERIES B
SENIOR DISCOUNT NOTES
DUE 2004
, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law ("DGCL") empowers a
corporation, subject to certain limitations, to indemnify its directors and
officers against expenses (including attorneys' fees, judgments, fines and
certain settlements) actually and reasonably incurred by them in connection
with any suit or proceeding to which they are a party so long as they acted in
good faith and in a manner reasonably believed to be in or not opposed to the
best interests of the corporation, and, with respect to a criminal action or
proceeding, so long as they had no reasonable cause to believe their conduct
to have been unlawful. The Registrant's Certificate of Incorporation and By-
laws provide that the Registrant shall indemnify its directors and such
officers, employees and agents as the Board of Directors may determine from
time to time, to the fullest extent permitted by Section 145 of the DGCL. The
Registrant has entered into indemnification agreements with its directors and
certain of its officers, employees and agents, which provide that the
Registrant shall indemnify such parties pursuant to Section 145 of the DGCL.
Section 102 of the DGCL permits a Delaware corporation to include in its
certificate of incorporation a provision eliminating or limiting a director's
liability to a corporation or its stockholders for monetary damages for
breaches of fiduciary duty. The enabling statute provides, however, that
liability for breaches of the duty of loyalty, acts or omissions not in good
faith or involving intentional misconduct, or knowing violation of the law,
and the unlawful purchase or redemption of stock or payment of unlawful
dividends or the receipt of improper personal benefits cannot be eliminated or
limited in this manner. The Registrant's Certificate of Incorporation and By-
laws include a provision which eliminates, to the fullest extent permitted,
director liability for monetary damages for breaches of fiduciary duty.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1* Amended and Restated Certificate of Incorporation of the Registrant.
3.2 Amended Certificate of Designations, Powers, Rights and Preferences of
9% Cumulative Convertible Pay-In-Kind Preferred Stock (the "9%
Preferred Stock") of the Registrant.
3.3+ Bylaws of the Registrant.
3.4 Certificate of Designations, Powers, Rights and Preferences of 9%
Cumulative Convertible Pay-In-Kind Preferred Stock, Series A, of the
Registrant.
4.1* Indenture, dated as of August 18, 1997, by and between the Registrant
and Harris Trust and Savings Bank, as Trustee, for the Registrant's 14
5/8% Senior Discount Notes due 2004 (the "Indenture").
4.2* Form of the Registrant's 14 5/8% Series B Senior Discount Notes due
2004.
4.3* Registration Rights Agreement dated as of August 18, 1997, by and
among the Registrant and the Initial Purchasers named therein.
4.4* Warrant Agreement, dated as of August 18, 1997, by and between the
Registrant and Harris Trust and Savings Bank, as Warrant Agent.
5.1* Legal Opinion of Skadden, Arps, Slate, Meagher & Flom (Illinois).
10.1+ Indenture, dated as of September 30, 1996, by and between the
Registrant and Harris Trust and Savings Bank, as Trustee, for the
Registrant's 9% Convertible Subordinated Discount Notes due 2004.
10.2+ Employment Agreement, dated as of July 18, 1996, by and between the
Registrant and J. Thomas Elliott.
10.3+ Employment Agreement, dated as of July 18, 1996, by and between the
Registrant and Ronald W. Gavillet.
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S> <C>
10.4+ Form of Employment Agreement between the Registrant and
certain officers of the Registrant.
10.5* Amended and Restated 1994 Stock Option Plan of the Registrant.
10.6+ Form of Indemnification Agreement between the Registrant and
certain directors and officers of the Registrant.
10.7+ Consulting Agreement, dated January 24, 1995, by and between
the Registrant and Eugene A. Sekulow.
10.8+ Promissory Note, dated December 15, 1995, between the
Registrant and J. Thomas Elliott.
10.9+ Purchase Agreement, dated as of September 25, 1996, by and
among the Registrant and the purchasers named therein,
relating to the 9% Preferred Stock.
10.10+ Purchase Agreement, dated as of April 20, 1994, by and among
the Registrant, CIBC Wood Gundy Ventures, Inc. ("CIBC") and
Chemical Venture Capital Associates ("Chemical").
10.11+ Stockholders Agreement, dated as of April 20, 1994, by and
among the Registrant, CIBC, Chemical and the stockholders of
the Registrant listed on a schedule attached thereto (the
"Stockholders").
10.12+ Registration Rights Agreement, dated as of April 20, 1994, by
and among the Registrant, CIBC and Chemical.
10.13+ First Amendment to Purchase Agreement, dated as of June 10,
1994, by and among the Registrant, CIBC, Chemical and Hancock
Venture Partners IV--Direct Fund, L.P. ("Hancock," and
together with CIBC and Chemical, the "Initial Investors").
10.14+ First Amendment to Stockholders Agreement, dated as of June
10, 1994, by and among the Registrant, the Initial Investors
and the Stockholders.
10.15+ First Amendment to Registration Rights Agreement, dated as of
June 10, 1994, by and among the Registrant and the Initial
Investors.
10.16+ Third Amendment to Purchase Agreement, dated as of November 1,
1994, by and among the Registrant and the Initial Investors.
10.17+ Fourth Amendment to Purchase Agreement, dated as of June 22,
1995, by and among the Registrant and the Initial Investors.
10.18+ Purchase Agreement, dated as of June 22, 1995, by and among
the Registrant, CIBC, Chemical, Hancock, BT Capital Partners,
Inc., Northwood Capital Partners LLC and Northwood Ventures
(collectively, the "Investors").
10.19+ Amended and Restated Stockholders Agreement, dated as of June
22, 1995, by and among the Registrant and the Investors.
10.20+ Amended and Restated Registration Agreement, dated as of June
22, 1995, by and among the Registrant and the Investors.
10.21+ First Amendment to Purchase Agreement, dated as of July 21,
1995, by and among the Registrant, the Investors and
Enterprises & Transcommunications, L.P. (collectively, the
"Original Purchasers").
10.22+ Amended and Restated Stockholders Agreement, dated as of July
21, 1995, by and among the Registrant, the Original Purchasers
and the Stockholders.
10.23+ Asset Purchase Agreement, dated as of June 13, 1995, by and
among United Telemanagement Services, Inc. ("UTS"), Quest
United, Inc. ("Quest United"), Quest America Management, Inc.
("QAM"'), Edward H. Lavin, Jr. ("Lavin"), J. Thomas Elliott
("Elliott") and Quest America, LP ("Quest").
10.24+ Amendment No. 1 to Asset Purchase Agreement, dated as of
October 27, 1995, by and among UTS, Quest United, QAM, Lavin,
Elliott, and Quest.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S> <C>
10.25+ Second Amendment to Purchase Agreement, dated as of March 5,
1996, by and among the Registrant and the Original Purchasers.
10.26+ Resale Local Exchange Service Agreement, dated July 8, 1996,
by and between New York Telephone Company and UTS.
10.27+ Resale Local Exchange Service Confirmation of Service Order,
dated October 31, 1995, by and between the Registrant and
Ameritech Information Industry Services ("Ameritech") on
behalf of Illinois Bell Telephone Company.
10.28+ Agreement for Resale Services, dated as of April 26, 1996, by
and between the Registrant and Ameritech on behalf of
Ameritech Michigan.
10.29+ Local Exchange Telecommunications Services Resale Agreement,
dated May 21, 1996, by and between the Registrant and
Ameritech on behalf of The Ohio Bell Telephone Company.
10.30** Indenture, dated as of September 30, 1996, by and between the
Registrant and Harris Trust and Savings Bank, as trustee, for
the Registrant's 14% Senior Discount Notes due 2003 (the "14%
Senior Note Indenture").
10.31+ Registration Rights Agreement, dated as of September 30, 1996,
by and among the Registrant and the purchasers named therein.
10.32+ Warrant Agreement, dated as of September 30, 1996, by and
between the Registrant and Harris Trust and Savings Bank, as
warrant agent, and Amendment 1 thereto.
10.33++ Supplemental Indenture, dated as March 17, 1997, by and
between the Company and the Trustee, to the 14% Senior Note
Indenture.
10.34++ Employment Agreement, dated as November 18, 1996, by and
between the Company and Gerald J. Sweas.
10.35++ Employment Agreement, dated as of October 21, 1996, by and
between the Company and Ryan Mullaney.
10.36* Supplemental Indenture No. 2, dated as of August 18, 1997, by
and between the Company and the Trustee, to the 14% Senior
Note Indenture.
10.37* Consent Warrant Agreement, dated as of August 25, 1997, by and
between the Registrant and Harris Trust and Savings Bank, as
Warrant Agent.
10.38* Supplemental Indenture No. 1, dated as of August 18, 1997 by
and between the Company and the Trustee, to the Convertible
Note Indenture.
12.1* Computation of Earnings to Fixed Charges.
21.1+ Subsidiaries of the Registrant.
23.1 Consent of Deloitte & Touche LLP.
23.2* Consent of Skadden, Arps, Slate, Meagher & Flom (Illinois)
(included in its opinion filed as Exhibit 5.1 hereto).
25.1 Statement of Eligibility and Qualification on form T-1 under
the Trust Indenture Act of 1939 of Harris Trust and Savings
Bank, as Trustee under the Indenture.
99.1 Form of Letter of Transmittal.
99.2 Form of Notice of Guaranteed Delivery.
99.3 Form of Letter to Brokers, Dealers, Commercial Banks, Trust
Companies and Other Nominees.
99.4 Form of Letter to Clients.
99.5 Guidelines for Certification of Taxpayer Identification Number
on Form W-9.
</TABLE>
- --------
*To be filed by amendment.
II-3
<PAGE>
**Incorporated by reference to the Registrant's Registration Statement on Form
S-1, file number 333-16947.
+Incorporated by reference to the Registrant's Registration Statement on Form
S-4, file number 333-16265.
++Incorporated by reference to the Registrant's Form 10-K, file number 333-
16265, filed on March 31, 1997.
(b) Financial Data Schedules
None.
All schedules are omitted because the required information is not present in
amounts sufficient to require submission of the schedule or because the
information required is included in the financial statements or notes thereto.
ITEM 22. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement;
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high and of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
change in volume and price represent no more than 20 percent change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
The undersigned Registrant hereby further undertakes:
(4) That insofar as indemnification for liabilities arising under the
Securities Act of 1933, as amended, may be permitted to directors, officers
and controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to
a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.
II-4
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THE
REGISTRANT HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED, IN THE CITY OF CHICAGO,
STATE OF ILLINOIS ON OCTOBER 10, 1997.
USN COMMUNICATIONS, INC.
/s/ J. Thomas Elliott
By: _________________________________
J. Thomas Elliott
President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS
BELOW CONSTITUTES AND APPOINTS J. THOMAS ELLIOTT, GERALD SWEAS AND THOMAS A.
MONSON WITH FULL POWER TO ACT ALONE, HIS TRUE AND LAWFUL ATTORNEYS-IN-FACT,
WITH THE POWER OF SUBSTITUTION, FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN
ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS (INCLUDING POST-
EFFECTIVE AMENDMENTS) TO THIS REGISTRATION STATEMENT, AND TO SIGN ANY
REGISTRATION STATEMENT FOR THE SAME OFFERING COVERED BY THIS REGISTRATION
STATEMENT THAT IS TO BE EFFECTIVE UPON FILING PURSUANT TO RULE 462(B)
PROMULGATED UNDER THE SECURITIES ACT OF 1933, AND ALL POST-EFFECTIVE AMENDMENTS
THERETO, AND TO FILE THE SAME, WITH ALL EXHIBITS THERETO, AND OTHER DOCUMENTS
IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING
UNTO SAID ATTORNEYS-IN-FACT FULL POWER AND AUTHORITY TO DO AND PERFORM EACH AND
EVERY ACT AND THING REQUISITE AND NECESSARY TO BE DONE AS FULLY TO ALL INTENTS
AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON, HEREBY RATIFYING AND CONFIRMING
ALL THAT SAID ATTORNEYS-IN-FACT MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE
HEREOF.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON THE DATES
AND IN THE CAPACITIES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ J. Thomas Elliott President, Chief Executive
____________________________________ Officer and Director
J. Thomas Elliott (Principal Executive
Officer)
/s/ Richard J. Brekka Chairman of the Board
____________________________________
Richard J. Brekka
/s/ Donald J. Hofmann, Jr. Director
____________________________________
Donald J. Hofmann, Jr.
/s/ Paul S. Lattanzio Director
____________________________________
Paul S. Lattanzio
/s/ Thomas C. Brandenburg Director
____________________________________
Thomas C. Brandenburg
/s/ William A. Johnston Director
____________________________________
William A. Johnston
/s/ Eugene A. Sekulow Director
____________________________________
Eugene A. Sekulow
/s/ Dean M. Greenwood Director
____________________________________
Dean M. Greenwood
/s/ Ian Kidson Director
____________________________________
Ian Kidson
/s/ Gerald J. Sweas Executive Vice President and
____________________________________ Chief Financial Officer
Gerald J. Sweas (Principal Financial
Officer and Principal
Accounting Officer)
</TABLE>
II-5
<PAGE>
Exhibit 3.2
USN COMMUNICATIONS, INC.
FIRST AMENDMENT TO
CERTIFICATE OF DESIGNATIONS,
POWERS, RIGHTS AND PREFERENCES
OF
9.0% CUMULATIVE CONVERTIBLE
PAY-IN-KIND PREFERRED STOCK
J. Thomas Elliott, being the duly elected President and Chief
Executive Officer of USN Communications, Inc. (formerly United USN, Inc.), a
corporation organized and existing under and by virtue of the Delaware General
Corporation Law (the "Corporation"), hereby certifies as follows:
1. That the Corporation was originally incorporated in the State of
Delaware on April 7, 1994.
2. That the Certificate of Designations, Powers, Rights and
Preferences (the "Certificate of Designations") of 9.0% Cumulative Convertible
Pay-In-Kind Preferred Stock (the "9% Preferred Stock") was filed originally in
the State of Delaware on September 26, 1996.
3. That the Board of Directors of the Corporation, in accordance with
Section 141 of the Delaware General Corporation Law, adopted resolutions dated
as of August 11, 1997 which provide as follows:
RESOLVED, that the Corporation's certificate of designations (the
"Certificate of Designations") with respect to the 9% Preferred Stock be
amended as hereinafter set forth, and that such amendment be, and it hereby
is, adopted and approved in all respects; and
FURTHER RESOLVED, that the appropriate officers of the Corporation are
hereby authorized, empowered and directed to execute such documents and
certificates, make such filings (including the filing of the amendment to
such Certificate of Designations with the Secretary of State of the State
of Delaware) and take such other actions as are necessary or appropriate to
<PAGE>
carry out the intent of the foregoing resolutions.
4. That additional resolutions directed that the amendment to the
Certificate of Designations be submitted to the holders of the common stock, par
value $.01 per share (the "Common Stock"), of the Corporation and the holders of
the 9% Preferred Stock for their consideration and approval.
5. That the holders of a majority of the outstanding Common Stock and
the holders of a majority of the 9% Preferred Stock, in accordance with Section
242 of the Delaware General Corporation Law, adopted resolutions effective as of
August 11, 1997 providing for the adoption of the amendment to the Certificate
of Designations.
6. That the text of Article Third, Section 2 of the Certificate of
Designations is amended and restated in its entirety as follows:
"2. Priority of Preferred Stock. So long as any Preferred Stock
remains outstanding, neither the Corporation nor any Subsidiary (as defined
herein) shall redeem, purchase or otherwise acquire directly or indirectly any
of the Corporation's equity securities other than the 9% Preferred Stock and the
9% Cumulative Convertible Pay-In-Kind Preferred Stock, Series A (collectively,
the "Junior Securities"), nor shall the Corporation directly or indirectly pay
or declare any dividend or make any distribution upon any Junior Securities;
provided, that the Corporation may purchase shares of the Corporation's common
stock, par value $0.01 per share, in accordance with the provisions of Section 6
of that certain Purchase Agreement, dated as of June 22, 1995, by and among the
Corporation and certain investors, as such agreement may from time to time be
amended in accordance with its terms, or Section 7 of that certain Purchase
Agreement, dated as of April 20, 1994, by and among the Corporation and certain
investors, as such agreement may from time to time be amended in accordance with
its terms."
2
<PAGE>
IN WITNESS WHEREOF, USN Communications, Inc. has caused this First
Amendment to Certificate of Designations to be executed by J. Thomas Elliott,
its President, as of this 12th day of August, 1997.
USN COMMUNICATIONS, INC.
By: /s/ J. Thomas Elliott
---------------------------
J. Thomas Elliott
President and
Chief Executive Officer
<PAGE>
EXHIBIT 3.4
USN COMMUNICATIONS, INC.
CERTIFICATE OF DESIGNATIONS,
POWERS, RIGHTS AND PREFERENCES
OF
9.0% CUMULATIVE CONVERTIBLE
PAY-IN-KIND PREFERRED STOCK, SERIES A
___________________________________________
Pursuant to Section 151(g) of the General
Corporation Law of the State of Delaware
___________________________________________
USN COMMUNICATIONS, INC. (the "Corporation"), a corporation organized
and existing under and by virtue of the provisions of the General Corporation
Law of the State of Delaware (the "DGCL"), certifies as follows:
FIRST: That the Corporation was originally incorporated in the State
of Delaware on April 7, 1994;
SECOND: The Amended and Restated Certificate of Incorporation of the
Corporation (the "Certificate of Incorporation"), authorizes the issuance of
250,000 shares of Preferred Stock, par value $1.00 per share and, further,
authorizes the Board of Directors of the Corporation (the "Board of Directors"),
by resolution or resolutions, at any time and from time to time, to divide and
establish any or all of the unissued shares of Preferred Stock into one or more
classes or series, and without limiting the generality of the foregoing, to fix
and determine the designation of each such class or series, the number of shares
which shall constitute such class or series and certain relative rights and
preferences of the shares of each class or series so established.
<PAGE>
THIRD: The Board of Directors of the Corporation pursuant to
authority conferred upon the Board of Directors under the Certificate of
Incorporation and a meeting on August 11, 1997 of the Board of Directors, at
which a quorum was present and acting throughout, did duly adopt the following
resolutions authorizing the issuance of a series of the Corporation's Preferred
Stock, par value $1.00 per share, and setting forth the terms and provisions of
said Preferred Stock:
RESOLVED, that the Board of Directors, pursuant to authority vested in it
by the provisions of the Certificate of Incorporation, hereby authorizes
the creation and issuance of a series of the Corporation's Preferred Stock,
par value $1.00 per share, which shall in the aggregate consist of up to
150,000 shares of the 250,000 shares of Preferred Stock that the
Corporation now has authority to issue, and hereby fixes the powers,
designations, dividend rate, redemption provisions, voting powers, rights
on liquidation or dissolution, and other preferences and relative
participating, optional or other rights, and the qualifications,
limitations or restrictions thereof (in addition to those set forth in said
Certificate of Incorporation) as follows:
1. Designation. The Preferred Stock of the Corporation created and
authorized for issuance hereby shall be designated as "9.0% Cumulative
Convertible Pay-In-Kind Preferred Stock, Series A" (hereinafter the "Series A
Preferred Stock") which initially will consist of 150,000 shares of such Series
A Preferred Stock.
2. Priority of Series A Preferred Stock. So long as any Series A
Preferred Stock remains outstanding, neither the Corporation nor any Subsidiary
(as defined herein) shall redeem, purchase or otherwise acquire directly or
indirectly any of the Corporation's equity securities other than the 9%
Cumulative Convertible Pay-In-Kind Preferred Stock and the Series A Preferred
Stock (collectively, the "Junior Securities"), nor shall the Corporation
directly or indirectly pay or declare any dividend or make any distribution upon
any Junior Securities; provided, that the Corporation may purchase shares of
the Corporation's common stock, par value $.01 per share, in accordance with the
provisions of Section 6 of
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that certain Purchase Agreement, dated as of June 22, 1995, by and among the
Corporation and certain investors, as such agreement may from time to time by
amended in accordance with its terms, or Section 7 of that certain Purchase
Agreement, dated as of April 20, 1994, by and among the Corporation and certain
investors, as such agreement may from time to time be amended in accordance with
its terms.
As used herein, "Subsidiary" means, with respect to any person, any
corporation, partnership, association or other business entity of which (i) if a
corporation, a majority of the total voting power of shares of stock entitled
(without regard to the occurrence of any contingency) to vote in the election of
directors, managers or trustees thereof is at the time owned or controlled,
directly or indirectly, by that person or one or more of the other Subsidiaries
of that person or a combination thereof, or (ii) if a partnership, association
or other business entity, a majority of the partnership or other similar
ownership interest thereof is at the time owned or controlled, directly or
indirectly, by any person or one or more Subsidiaries of that person or a
combination thereof. For purposes hereof, a person or persons shall be deemed
to have a majority ownership interest in a partnership, association or other
business entity if such person or persons shall be allocated a majority of
partnership, association or other business entity gains or losses or shall be or
control the managing general partner of such partnership, association or other
business entity.
3. Dividends.
(a) Holders of shares of Series A Preferred Stock shall be
entitled to receive out of funds legally available for the payment of dividends
("Legally Available Funds"), cumulative dividends for each share of Series A
Preferred Stock payable at a rate per annum of 9.0% per share in additional
shares of Series A Preferred Stock. Dividends on the shares of Series A
Preferred Stock shall accrue semiannually on August 18 and February 18 (or at
such additional times and for such interim periods, if any, as determined by the
Board of Directors) (each of such dates being a "Dividend Accrual Date"), except
that if such date is a Saturday, Sunday or legal holiday then such dividend
shall be accruable on the next date that is not a Saturday, Sunday or legal
holiday or on which banks in the State of New York are permitted to be closed (a
"Business
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<PAGE>
Day"). Each of such semiannual dividend accruals shall be fully cumulative and
shall accrue (whether or not declared), on a daily basis from the first day of
the semiannual period in which such dividend may be accruable as provided
herein; provided, however, that with respect to the first dividend accrual date
following the issuance of shares of Series A Preferred Stock, such dividend
shall accrue from the date of issuance of Series A Preferred Stock. All accrued
but unpaid dividends shall be compounded semiannually at an annual rate of 9.0%.
The Board of Directors shall declare and pay such accrued dividends at such time
and to the extent permitted by law. No fractional shares of Series A Preferred
Stock shall be issued, so that the number of shares to be paid as a dividend
pursuant to this paragraph shall be rounded to the nearest whole number of
shares. Such dividends shall be paid to the holders of record at the close of
business on the date specified by the Board of Directors at the time such
dividend is declared; provided, however, that such declaration date shall not be
more than 60 days nor less than 10 days prior to the respective Dividend Accrual
Date.
(b) All dividends paid with respect to shares of Series A
Preferred Stock pursuant to Section 3(a) shall be paid pro rata to the holders
entitled thereto. All additional shares of Series A Preferred Stock issued as
dividends on the Series A Preferred Stock shall be deemed issued on the
applicable Dividend Accrual Date, and will thereupon be duly authorized, validly
issued, fully paid and nonassessable and free and clear of all liens and
charges.
(c) Prior to the payment of any dividend declared by the Board of
Directors, the Corporation shall take all action necessary, including, without
limitation, amending its Certificate of Incorporation or this Certificate of
Designations, to ensure that the Corporation has a sufficient number of
authorized but unissued shares of Series A Preferred Stock to pay such dividend.
(d) Holders of shares of Series A Preferred Stock shall be
entitled to receive the dividends provided for in section 3(a) hereof in
preference to and in priority over any dividends upon any of the Junior
Securities.
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<PAGE>
4. Liquidation Preference. Upon any liquidation, dissolution or
winding up of the Corporation, each holder of Series A Preferred Stock shall be
entitled to be paid, before any distribution or payment is made upon any Junior
Securities, an amount per share in cash equal to One Thousand Dollars ($1,000)
(the "Liquidation Value") plus all accrued and unpaid dividends on all shares of
Series A Preferred Stock held by such holder, and the holders of Series A
Preferred Stock shall not be entitled to any further payment. If upon any such
liquidation, dissolution or winding up of the Corporation, the Corporation's
assets to be distributed among the holders of shares of Series A Preferred Stock
are insufficient to permit payment to such holders of the aggregate amount that
they are entitled to be paid, then the entire assets to be distributed shall be
distributed ratably among such holders based upon the aggregate Liquidation
Value plus all accrued and unpaid dividends on shares of Series A Preferred
Stock held by each such holder. Prior to the time of any liquidation,
dissolution or winding up of the Corporation, the Corporation shall declare for
payment all accrued and unpaid dividends with respect to shares of Series A
Preferred Stock. The Corporation shall mail written notice of such liquidation,
dissolution or winding up, not less than 60 days prior to the payment date
stated therein, to each record holder of Series A Preferred Stock. Neither the
consolidation or merger of the Corporation into or with any other entity or
entities, nor the sale or transfer by the Corporation of all or any part of its
assets, nor the reduction of the capital stock of the Corporation, shall be
deemed to be a liquidation, dissolution or winding up of the Corporation within
the meaning of this Section 4, unless such sale or transfer shall be in
connection with a plan of liquidation, dissolution or winding up of the
Corporation.
5. Redemption.
(a) Mandatory Redemption. To the extent permitted by law, as
mandatory redemption for the retirement of the outstanding shares of Series A
Preferred Stock, the Corporation shall redeem, out of Legally Available Funds on
March 26, 2006 (the "Mandatory Redemption Date"), all of the shares of Series A
Preferred Stock initially issued and then outstanding, at a price per share of
Series A Preferred Stock equal to the Liquidation Value plus an amount in cash
equal to all accrued but unpaid dividends to
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<PAGE>
the Mandatory Redemption Date. Immediately prior to authorizing or making such
redemption with respect to shares of Series A Preferred Stock, the Corporation,
by resolution of its Board of Directors shall, to the extent of any Legally
Available Funds, declare a dividend on shares of Series A Preferred Stock
payable on the Mandatory Redemption Date in an amount equal to any accrued and
unpaid dividends on shares of Series A Preferred Stock as of such date and, if
the Corporation does not have sufficient Legally Available Funds to declare and
pay all dividends accrued at the time of such redemption, any remaining accrued
and unpaid dividends shall be added to the redemption price. If the Corporation
shall fail to discharge its obligation to redeem the aforementioned outstanding
shares of Series A Preferred Stock required to be redeemed pursuant to this
section 5(a) (the "Mandatory Redemption Obligation"), the Mandatory Redemption
Obligation shall be discharged as soon as the Corporation is able to discharge
such Mandatory Redemption Obligation. If and so long as the Mandatory
Redemption Obligation shall not be fully discharged, (i) dividends on such
Series A Preferred Stock shall continue to accrue and be added to the dividend
payable pursuant to the second preceding sentence and (ii) the Corporation shall
not declare or pay any dividend or make any distribution on its securities not
otherwise permitted by this Certificate of Designations.
(b) Notice of Redemption. Upon the redemption by the
Corporation of shares of Series A Preferred Stock pursuant to Section 5(a)
above, a notice of such redemption shall be given by first-class mail, postage
prepaid, mailed not less than 30 nor more than 60 days prior to the Mandatory
Redemption Date, to each holder of record of the shares of Series A Preferred
Stock to be redeemed, at such holder's address as the same appears on the stock
books of the Corporation's transfer agent. Each such notice shall state: (i) the
Mandatory Redemption Date; (ii) the number of shares of Series A Preferred Stock
to be redeemed; (iii) the redemption price; (iv) the place or places where
certificates for such shares are to be surrendered for payment of the redemption
price; (v) that payment will be made upon presentation and surrender of such
Series A Preferred Stock; (vi) that dividends on the shares of Series A
Preferred Stock to be redeemed shall cease to accrue following the Mandatory
Redemption Date; and (vii) that accrued and unpaid dividends up to and including
the Mandatory Redemption Date will be paid in
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<PAGE>
accordance with the terms herein. Notice having been mailed as aforesaid, on
and after the Mandatory Redemption Date, unless the Corporation shall be in
default in providing money for the payment of the redemption price (including an
amount equal to any accrued and unpaid dividends up to and including the
Mandatory Redemption Date), (x) dividends on the shares of Series A Preferred
Stock so called for redemption shall cease to accrue, (y) said shares shall be
deemed no longer outstanding and (z) all rights of the holders thereof as
stockholders of the Corporation (except the right to receive from the
Corporation the monies payable upon redemption, without interest thereon, upon
surrender of the certificates evidencing such shares) shall cease. The
Corporation's obligation to provide monies in accordance with the preceding
sentence shall be deemed fulfilled if, on or before the Mandatory Redemption
Date, the Corporation shall deposit with a bank or trust company having an
office or agency in the Borough of Manhattan, City of New York, and having a
capital and surplus of at least $500,000,000, the principal amount of funds
necessary for such redemption, in trust for the account of the holders of the
shares to be redeemed (and so as to be and continue to be available therefor),
with irrevocable instructions and authority to such bank or trust company that
such funds be applied to the redemption of the shares of Series A Preferred
Stock so called for redemption. Any interest accrued on such funds shall be
paid to the Corporation from time to time. Any funds so deposited and unclaimed
at the end of three years from the Mandatory Redemption Date shall be released
or repaid to the Corporation, after which, subject to any applicable laws
relating to escheat or unclaimed property, the holder or holders of such shares
of Series A Preferred Stock so called for redemption shall look only to the
Corporation for payment of the redemption price.
Upon surrender in accordance with said notice of the certificates for
any such shares of Series A Preferred Stock so redeemed (properly endorsed or
assigned for transfer, if the Board of Directors shall so require and the notice
shall so state), such shares shall be redeemed by the Corporation at the
applicable redemption price aforesaid.
Notwithstanding the foregoing, if the Corporation's notice of
redemption has been given pursuant to this Section 5 and any holder of shares of
Series A Pre-
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<PAGE>
ferred Stock shall, prior to the close of business on the third Business Day
preceding the Redemption Date, give written notice to the Corporation pursuant
to this Section 5(b) hereof of the conversion of any or all of the shares to be
redeemed held by such holder (accompanied by a certificate or certificates for
such shares, duly endorsed or assigned to the Corporation), then the conversion
of such shares to be redeemed shall become effective as provided in Section 7.
Any shares so converted shall be counted as shares as to which the Mandatory
Redemption Obligation has been satisfied in full.
6. Voting Rights. (a) Except as herein provided or as otherwise
required by law, holders of Series A Preferred Stock shall have no voting
rights. Whenever, at any time or times, dividends payable on the shares of
Series A Preferred Stock at the time outstanding shall be cumulatively in
arrears for two consecutive semiannual dividend periods, the holders of all
shares of Series A Preferred Stock and any shares of securities of the
Corporation upon which like voting rights have been conferred and are
exercisable (the Series A Preferred Stock and any such other securities,
collectively for purposes of this Section 6, the "Defaulted Preferred Stock"),
shall be entitled to elect one director of the Corporation at the Corporation's
next annual meeting of stockholders and at each subsequent annual meeting of
stockholders; provided, however, the shares of Defaulted Preferred Stock shall
be entitled to exercise their voting rights at a special meeting of the holders
of shares of Defaulted Preferred Stock as set forth in Section 6(b) and Section
6(c). At elections for such directors, each holder of Series A Preferred Stock
shall be entitled to one vote for each share held (the holders of shares of any
other series of Defaulted Preferred Stock ranking on such a parity being
entitled to such number of votes, if any, for each share of stock held as may be
granted to them). Upon the vesting of such right of the holders of Defaulted
Preferred Stock, the maximum authorized number of members of the Board of
Directors shall be automatically increased by one and the vacancy so created
shall be filled by vote of the holders of outstanding Defaulted Preferred Stock
as hereinafter set forth. The right of holders of Defaulted Preferred Stock,
voting separately as a class without regard to series, to elect a member of the
Board of Directors as aforesaid shall continue until such time as all dividends
accumulated and unpaid on the Defaulted Preferred Stock shall have been
8
<PAGE>
paid or declared and funds set aside for payment in full, at which time such
right shall terminate, except as herein or by law expressly provided, subject to
revesting in the event of each and every subsequent default of the character
above mentioned.
(b) Whenever such voting right shall have vested, such right may
be exercised initially either at a special meeting of the holders of shares of
Defaulted Preferred Stock called as hereinafter provided, or at any annual
meeting of stockholders held for the purpose of electing directors, and
thereafter at such meeting or by the written consent of such holders pursuant to
Section 228 of the DGCL.
(c) At any time when such voting right shall have vested in the
holders of shares of Defaulted Preferred Stock entitled to vote thereon, and if
such right shall not already have been initially exercised, an officer of the
Corporation shall, upon the written request of the holders of record of 10% of
the shares of such Defaulted Preferred Stock then outstanding, addressed to the
Secretary of the Corporation, call a special meeting of holders of shares of
such Defaulted Preferred Stock. Such meeting shall be held at the earliest
practicable date upon the notice required for special meetings of stockholders
at the place for holding annual meetings of stockholders of the Corporation or,
if none, at a place designated by the Secretary of the Corporation. If such
meeting shall not be called by the proper officers of the Corporation within 30
days after the personal service of such written request upon the Secretary of
the Corporation, or within 30 days after mailing the same within the United
States, by registered mail, addressed to the Secretary of the Corporation at its
principal office (such mailing to be evidenced by the registry receipt issued by
the postal authorities), then holders of record of 10% of the shares of
Defaulted Preferred Stock then outstanding may designate in writing any person
to call such meeting at the expense of the Corporation, and such meeting may be
called by such person so designated upon the notice required for special
meetings of stockholders and shall be held at the same place as is elsewhere
provided in this paragraph. Any holder of shares of Defaulted Preferred Stock
then outstanding that would be entitled to vote at such meeting shall have
access to the stock books of the Corporation's transfer agent for the purpose of
causing a meeting of stockholders to be called
9
<PAGE>
pursuant to the provisions of this paragraph. Notwithstanding the provisions of
this paragraph, however, no such special meeting shall be called or held during
a period within 45 days immediately preceding the date fixed for the next annual
meeting of stockholders of the Corporation.
(d) Subject to the provisions hereof, the director elected
pursuant to this Section 6 shall serve until the next annual meeting or until
his or her successor shall be elected and qualified. Any director elected by the
holders of Defaulted Preferred Stock may be removed by, and shall not be removed
otherwise than by, the vote of the holders of a majority of the outstanding
shares of the Defaulted Preferred Stock who were entitled to participate in such
election of directors, voting as a separate class, without regard to series, at
a meeting called for such purpose or by written consent as permitted by law and
the Certificate of Incorporation and by-laws of the Corporation. Upon any
termination of the right of the holders of Defaulted Preferred Stock to vote for
a director as herein provided, the term of office of the director then in office
elected by the holders of Defaulted Preferred Stock, voting as a class, without
regard to series, shall terminate immediately. Whenever the term of office of
the director elected by the holders of Defaulted Preferred Stock, voting as a
class, without regard to series, shall so terminate and the special voting
powers vested in the holders of Defaulted Preferred Stock shall have expired,
the number of directors shall be such number as may be provided for in the
Corporation's by-laws irrespective of any increase made pursuant to the
provisions of this Section 6.
(e) So long as any shares of Series A Preferred Stock remain
outstanding, the Corporation will not establish, create, authorize or issue any
shares of securities of the Corporation the terms of which shall provide
specifically that such series shall rank on parity with, or senior to, the
Series A Preferred Stock without the prior written consent of the holders of a
majority of the shares of Series A Preferred Stock then outstanding.
7. Conversion Rights. (a) Each share of Series A Preferred Stock may
be converted, at any time and at the option of the holder, into approximately
11.362 fully paid, non-assessable shares of the Corporation's Class A Common
Stock, par value $.01 per share (the "Class A Common Stock"), the precise number
of shares to be set forth from
10
<PAGE>
time to time in the records of the Corporation maintained by the Secretary of
the Corporation, on and subject to the terms and conditions of this Section 7.
(b) The number of shares of Class A Common Stock issuable upon
conversion of each share of Series A Preferred Stock shall be determined by the
Conversion Price in effect on the date of conversion (calculated as to each
conversion to the nearest 1/100th of a share). The Conversion Price shall
initially equal approximately $88.01267, the precise Conversion Price to be set
forth from time to time in the records of the Corporation maintained by the
Secretary of the Corporation; provided, however, that such Conversion Price
shall be adjusted and readjusted from time to time as provided in this Section 7
and, as so adjusted and readjusted, shall remain in effect until a further
adjustment or readjustment thereof is required by this Section 7.
(c) Except as may be provided by the Board of Directors, upon
conversion of any shares of Series A Preferred Stock, the Corporation shall not
be obligated to make any payment or adjustment with respect to dividends accrued
on such shares of Series A Preferred Stock through the date of conversion unless
the holder of such shares of Series A Preferred Stock being converted was the
record holder of such shares on the record date for the payment of such
dividends.
(d) Upon surrender to the Corporation at the office of the
transfer agent or such other place or places, if any, as the Board of Directors
may determine, of certificates duly endorsed to the Corporation or in blank for
shares of Series A Preferred Stock to be converted together with appropriate
evidence of the payment of any transfer or similar tax, if required, and written
instructions to the Corporation requesting conversion of such shares and
specifying the name and address of the person, corporation, firm or other entity
to whom such shares of Class A Common Stock are to be issued, the Corporation
shall issue the number of full shares of Class A Common Stock rounded to the
nearest whole number issuable upon conversion thereof as of the time of such
surrender and as promptly as practicable thereafter will deliver certificates
for such shares of Class A Common Stock. No fractional shares of Common Stock
shall be issued. Upon surrender of a certificate representing shares of Series A
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<PAGE>
Preferred Stock to be converted in part, in addition to the foregoing, the
Corporation shall also issue to such holder a new certificate representing any
unconverted shares of Series A Preferred Stock represented by the certificate
surrendered for conversion.
(e) The Corporation shall pay all documentary, stamp, or similar
issue or transfer tax due on the issue of shares of Class A Common Stock
issuable upon conversion of shares of Series A Preferred Stock provided,
however, that the holder of shares of Series A Preferred Stock so converted
shall pay any such tax which is due because such shares are to be issued in the
name other than that of such holder.
(f) The Conversion Price in effect at any time shall be adjusted
as follows:
(1) If the Corporation shall, at any time or from time to
time, effect a subdivision of the outstanding Class A Common Stock or Class
B Common Stock, par value $.01 per share (the "Class B Common Stock and,
together with the Class A Common Stock, the "Common Stock"), the Conversion
Price in effect immediately before such subdivision shall be
proportionately decreased and, conversely, if the Corporation shall, at any
time or from time to time, effect a combination of the outstanding Common
Stock, the Conversion Price in effect immediately before such combination
shall be proportionately increased. Any adjustment under this subdivision
shall become effective at the close of business on the record date fixed
for the applicable subdivision or combination.
(2) In the event the Corporation shall, at any time or from
time to time, make or issue to all holders of shares of Common Stock (or
fix a record date for the determination of holders of Common Stock entitled
to receive), a dividend or other distribution payable in shares of Common
Stock, then the Conversion Price then in effect shall be decreased as of
the time of such issuance (or, in the event such a record date shall have
been fixed, as of the close of business on such record date) in accordance
with the following formula:
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<PAGE>
O
C/1/ = C x ------
0 + N
where:
C/1/ = the adjusted Conversion Price.
C = the current Conversion Price.
O = the number of shares of Common Stock
outstanding immediately prior to the
applicable issuance (or the close of
business on the record date).
N = the number of additional shares of
Common Stock issued in payment of such
dividend of distribution.
(g) No adjustment in the Conversion Price need be made unless the
adjustment pursuant to Section 7(f)(1) and (2) would require an increase or
decrease of at least 1% in the Conversion Price.
(h) No adjustment need be made for a change in the par value of the
Common Stock.
(i) Whenever the Conversion Price is adjusted, the Corporation shall
promptly mail to holders of Series A Preferred Stock a notice of adjustment
briefly stating the facts requiring the adjustment and the manner of computing
it.
(j) The Corporation shall reserve and at all times keep available,
free from preemptive rights, out of its authorized but unissued stock, for the
purpose of effecting the conversion of shares of Series A Preferred Stock, such
number of shares of its duly authorized Class A Common Stock as shall from time
to time be sufficient to effect the conversion of all outstanding shares of
Series A Preferred Stock.
8. Mandatory Conversion of Series A Preferred Stock. Upon a vote of
the Board of Directors at any time, each outstanding share of Series A Preferred
Stock shall automatically convert into 11.362 fully paid and non-assessable
shares of Class A Common Stock (such number of
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<PAGE>
shares to be subject to adjustment as provided in the foregoing Section 7), the
precise number of shares to be set forth from time to time in the records of the
Corporation maintained by the Secretary of the Corporation; provided, however,
that no such vote shall be effective prior to the Qualified Public Offering Date
(as defined), unless such vote and conversion are conditioned and made effective
upon the occurrence of the Qualified Public Offering Date. Fractional shares
shall be converted into equivalent fractional shares of Class A Common Stock
(or, at the discretion of the Board of Directors, eliminated in return for
payment therefor in cash at the fair market value thereof as determined in good
faith by the Board of Directors). For purposes of this Section 8, "Qualified
Public Offering Date" means the closing date of an underwritten public offering
of capital stock of the Company pursuant to an effective registration statement
filed under the Securities Act resulting in net proceeds to the Company of at
least $35,000,000 at a per share public offering price of at least 150% of the
then current Conversion Price in effect on the Qualified Public Offering Date.
9. Limitation and Rights Upon Insolvency. Notwithstanding any other
provision of this Certificate of Designations, the Corporation shall not be
required to pay any dividend on, or to pay any amount in respect of any
redemption of, shares of Series A Preferred Stock at a time when immediately
after making such payment the Corporation is or would be rendered insolvent (as
defined by applicable law), provided that the obligation of the Corporation to
make any such payment shall not be extinguished in the event the foregoing
limitation applies.
10. Shares to Be Retired. Any share of Series A Preferred Stock
converted, redeemed or otherwise acquired by the Corporation shall be retired
and cancelled and shall not be reissued, sold or transferred.
11. Record Holders. The Corporation and the Corporation's transfer
agent may deem and treat the record holder of any shares of Series A Preferred
Stock as the true and lawful owner thereof for all purposes, and neither the
Corporation nor the Corporation's transfer agent shall be affected by any notice
to the contrary.
12. Registration on Transfer. The Corporation shall keep at its
principal office a register for the
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<PAGE>
registration of Series A Preferred Stock. Upon the surrender of any certificate
representing Series A Preferred Stock at such place, the Corporation shall, at
the request of the record holder of such certificate, execute and deliver (at
the Corporation's expense) a new certificate or certificates in exchange
therefor representing in the aggregate the number of shares represented by the
surrendered certificate. Each such new certificate shall be registered in such
name and shall represent such number of shares of Series A Preferred Stock as is
requested by the holder of the surrendered certificate and shall be
substantially identical in form to the surrendered certificate, and dividends
shall accrue on the shares of Series A Preferred Stock represented by such new
certificate or certificates from the date to which dividends have been fully
paid on such Series A Preferred Stock represented by the surrendered
certificate.
13. Replacement. Upon receipt of evidence reasonably satisfactory to
the Corporation (an affidavit of the registered holder shall be satisfactory) of
the ownership and the loss, theft, destruction or mutilation of any certificate
evidencing shares of Series A Preferred Stock, and in the case of any such loss,
theft or destruction, upon receipt of indemnity reasonably satisfactory to the
Corporation (provided that if the holder is a financial institution or other
institutional investor, its own agreement shall be satisfactory), or, in the
case of any such mutilation, upon surrender of such certificate, the Corporation
shall (at its own expense) execute and deliver in lieu of such certificate a new
certificate of like kind representing the number of shares of Series A Preferred
Stock represented by such lost, stolen or mutilated certificate, and dividends
shall accrue on the shares of Series A Preferred Stock represented by such new
certificate from the date to which dividends have been fully paid on such shares
of Series A Preferred Stock represented by the lost, stolen, destroyed or
mutilated certificate.
14. Notice. Except as may otherwise be provided for herein, all
notices referred to herein shall be in writing, and all notices hereunder shall
be deemed to have been given upon, the earlier of receipt of such notice or
three Business Days after the mailing of such notice if sent by registered mail
(unless first-class mail shall be specifically permitted for such notice under
the terms of this Certificate of Designations) with postage prepaid, ad-
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<PAGE>
dressed: if to the Corporation, to its offices at 10 South Riverside Plaza,
Suite 401, Chicago, Illinois 60606 (Attention: General Counsel) or to an agent
of the Corporation designated as permitted by the Certificate of Incorporation
or, if to any holder of shares of Series A Preferred Stock, to such holder at
the address of such holder of Series A Preferred Stock as listed in the stock
record books of the Corporation (which may include the records of the
Corporation's transfer agent); or to such other address as the Corporation or
holder, as the case may be, shall have designated by notice similarly given.
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<PAGE>
IN WITNESS WHEREOF, USN Communications, Inc. has caused this
Certificate of Designations, Powers, Preferences and Rights to be executed by J.
Thomas Elliott, its President and Chief Executive Officer as of this 13th day of
August 1997.
USN COMMUNICATIONS, INC.
By:/s/ J. Thomas Elliott
---------------------
J. Thomas Elliott
President and Chief
Executive Officer
<PAGE>
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
Board of Directors and Stockholders of
USN Communications, Inc.
Chicago, Illinois
We consent to the use in this Registration Statement, dated October 10, 1997, of
USN Communications, Inc. on Form S-4 of our report dated March 14, 1997,
accompanying the consolidated financial statements of USN Communications, Inc.
and subsidiaries, appearing in the Prospectus, which is part of this
Registration Statement.
We also consent to the reference to us under the headings "Selected Historical
Consolidated Financial and Operating Data" and "Independent Auditors" in such
Offering Memorandum.
DELOITTE & TOUCHE LLP
October 10, 1997
Chicago, Illinois
<PAGE>
EXHIBIT 25.1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM T-1
Statement of Eligibility
Under the Trust Indenture Act of 1939
of a Corporation Designated to Act as Trustee
Check if an Application to Determine Eligibility
of a Trustee Pursuant to Section 305(b)(2) ______
HARRIS TRUST AND SAVINGS BANK
(Name of Trustee)
Illinois 36-1194448
(State of Incorporation) (I.R.S. Employer Identification No.)
111 West Monroe Street, Chicago, Illinois 60603
(Address of principal executive offices)
Judith Bartolini, Harris Trust and Savings Bank,
311 West Monroe Street, Chicago, Illinois, 60606
312-461-2527 phone 312-461-3525 facsimile
(Name, address and telephone number for agent for service)
USN COMMUNICATIONS, INC.
(Name of obligor)
Delaware 36-3947804
(State of Incorporation) (I.R.S. Employer Identification No.)
10 South Riverside Plaza, Suite 401
Chicago Illinois 60606
(Address of principal executive offices)
14 5/8% Series B Senior Discount Notes due 2004
(Title of indenture securities)
<PAGE>
1. GENERAL INFORMATION. Furnish the following information as to the Trustee:
(a) Name and address of each examining or supervising authority to which
it is subject.
Commissioner of Banks and Trust Companies, State of Illinois,
Springfield, Illinois; Chicago Clearing House Association, 164 West
Jackson Boulevard, Chicago, Illinois; Federal Deposit Insurance
Corporation, Washington, D.C.; The Board of Governors of the Federal
Reserve System,Washington, D.C.
(b) Whether it is authorized to exercise corporate trust powers.
Harris Trust and Savings Bank is authorized to exercise corporate
trust powers.
2. AFFILIATIONS WITH OBLIGOR. If the Obligor is an affiliate of the Trustee,
describe each such affiliation.
The Obligor is not an affiliate of the Trustee.
3. thru 15.
NO RESPONSE NECESSARY
16. LIST OF EXHIBITS.
1. A copy of the articles of association of the Trustee is now in effect
which includes the authority of the trustee to commence business and to
exercise corporate trust powers.
A copy of the Certificate of Merger dated April 1, 1972 between Harris
Trust and Savings Bank, HTS Bank and Harris Bankcorp, Inc. which
constitutes the articles of association of the Trustee as now in effect
and includes the authority of the Trustee to commence business and to
exercise corporate trust powers was filed in connection with the
Registration Statement of Louisville Gas and Electric Company, File No.
2-44295, and is incorporated herein by reference.
2. A copy of the existing by-laws of the Trustee.
A copy of the existing by-laws of the Trustee was filed in connection
with the Registration Statement of Commercial Federal Corporation, File
No. 333-20711, and is incorporated herein by reference.
3. The consents of the Trustee required by Section 321(b) of the Act.
(included as Exhibit A on page 2 of this statement)
4. A copy of the latest report of condition of the Trustee published
pursuant to law or the requirements of its supervising or examining
authority.
(included as Exhibit B on page 3 of this statement)
1
<PAGE>
SIGNATURE
Pursuant to the requirements of the Trust Indenture Act of 1939, the Trustee,
HARRIS TRUST AND SAVINGS BANK, a corporation organized and existing under the
laws of the State of Illinois, has duly caused this statement of eligibility to
be signed on its behalf by the undersigned, thereunto duly authorized, all in
the City of Chicago, and State of Illinois, on the 8th day of October, 1997.
HARRIS TRUST AND SAVINGS BANK
/s/ J. Bartolini
By: _____________________________
J. Bartolini
Vice President
EXHIBIT A
The consents of the trustee required by Section 321(b) of the Act.
Harris Trust and Savings Bank, as the Trustee herein named, hereby consents that
reports of examinations of said trustee by Federal and State authorities may be
furnished by such authorities to the Securities and Exchange Commission upon
request therefor.
HARRIS TRUST AND SAVINGS BANK
/s/ J. Bartolini
By: _____________________________
J. Bartolini
Vice President
2
<PAGE>
EXHIBIT B
Attached is a true and correct copy of the statement of condition of Harris
Trust and Savings Bank as of June 30, 1997, as published in accordance with a
call made by the State Banking Authority and by the Federal Reserve Bank of the
Seventh Reserve District.
[LOGO OF HARRIS BANK]
Harris Trust and Savings Bank
111 West Monroe Street
Chicago, Illinois 60603
of Chicago, Illinois, And Foreign and Domestic Subsidiaries, at the close of
business on June 30, 1997, a state banking institution organized and operating
under the banking laws of this State and a member of the Federal Reserve System.
Published in accordance with a call made by the Commissioner of Banks and Trust
Companies of the State of Illinois and by the Federal Reserve Bank of this
District.
Bank's Transit Number 71000288
<TABLE>
<CAPTION>
THOUSANDS
ASSETS OF DOLLARS
<S> <C>
Cash and balances due from depository institutions:
Non-interest bearing balances
and currency and coin........................ $ 1,707,824
Interest bearing balances.................. $ 628,916
Securities:........................................
a. Held-to-maturity securities $ 0
b. Available-for-sale securities $ 3,766,727
Federal funds sold and securities
purchased under agreements to resell in
domestic offices of the bank and
of its Edge and Agreement
subsidiaries, and in IBF's:
Federal funds sold....................... $ 275,425
Securities purchased under $ 0
agreements to resell....................
Loans and lease financing receivables:
Loans and leases, net of
unearned income......................... $8,346,198
LESS: Allowance for loan and $ 110,230
lease losses............................ ----------
Loans and leases, net of
unearned income, allowance, and
reserve
(item 4.a minus 4.b)..................... $ 8,235,968
Assets held in trading accounts.................... $ 164,281
Premises and fixed assets (including
capitalized leases)............................... $ 199,292
Other real estate owned............................ $ 524
Investments in unconsolidated
subsidiaries and associated companies............. $ 69
Customer's liability to this bank on
acceptances outstanding........................... $ 46,107
Intangible assets.................................. $ 287,575
Other assets....................................... $ 670,230
-----------
TOTAL ASSETS $15,982,938
</TABLE> ===========
3
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES
Deposits:
<S> <C> <C>
In domestic offices............................. $ 9,243,162
Non-interest bearing....................... $3,411,145
Interest bearing........................... $5,832,017
In foreign offices, Edge and
Agreement subsidiaries, and IBF's.............. $ 1,738,871
Non-interest bearing....................... $ 34,386
Interest bearing........................... $1,704,485
Federal funds purchased and securities
sold under agreements to repurchase in
domestic offices of the bank and of
its Edge and Agreement subsidiaries,
and in IBF's:
Federal funds purchased & securites
sold under agreements to repurchase............ $ 2,985,911
Trading Liabilities 62,083
Other borrowed money:.............................
a. With remaining maturity of one year or less $ 244,781
b. With remaining maturity of more than one year $ 0
Bank's liability on acceptances executed and outstanding $ 46,107
Subordinated notes and debentures................. $ 325,000
Other liabilities................................. $ 119,695
-----------
TOTAL LIABILITIES $14,765,610
===========
EQUITY CAPITAL
Common stock...................................... $ 100,000
Surplus........................................... $ 600,715
a. Undivided profits and capital reserves....... $ 534,395
b. Net unrealized holding gains (losses) on
available-for-sale securities ($17,782)
-----------
TOTAL EQUITY CAPITAL $ 1,217,328
===========
Total liabilities, limited-life
preferred stock, and equity capital.............. $15,982,938
===========
</TABLE>
I, Steve Neudecker, Vice President of the above-named bank, do hereby
declare that this Report of Condition has been prepared in conformance with the
instructions issued by the Board of Governors of the Federal Reserve System and
is true to the best of my knowledge and belief.
STEVE NEUDECKER
7/30/97
We, the undersigned directors, attest to the correctness of this Report of
Condition and declare that it has been examined by us and, to the best of our
knowledge and belief, has been prepared in conformance with the instructions
issued by the Board of Governors of the Federal Reserve System and the
Commissioner of Banks and Trust Companies of the State of Illinois and is true
and correct.
EDWARD W. LYMAN,
ALAN G. McNALLY,
RICHARD JAFFEE
Directors.
4
<PAGE>
LETTER OF TRANSMITTAL
TO TENDER FOR EXCHANGE
14 5/8% SENIOR DISCOUNT NOTES DUE 2004
OF
USN COMMUNICATIONS, INC.
PURSUANT TO THE PROSPECTUS DATED , 1997
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON
, 1998, UNLESS EXTENDED.
TO: HARRIS TRUST COMPANY OF NEW YORK, AS EXCHANGE AGENT
By Registered or By Overnight Courier: By Hand:
Certified Mail: Harris Trust Company of New York
Harris Trust Company of
Harris Trust Company of 77 Water Street, 4th Floor New York
New York New York, NY 10005 Receive Window
Wall Street Station 77 Water Street, 5th
P.O. Box 1010 Floor
New York, NY 10268-1010 New York, NY
By Facsimile:
(212) 701-7636
(212) 701-7637
Confirm by telephone:
(212) 701-7618
Delivery of this instrument to an address other than as set forth above or
transmission of instructions via a facsimile number other than the one listed
above will not constitute a valid delivery. The instructions accompanying this
Letter of Transmittal should be read carefully before this Letter of
Transmittal is completed.
The undersigned acknowledges that he or she has received the Prospectus,
dated , 1997 (the "Prospectus"), of USN Communications, Inc. (the
"Company") and this Letter of Transmittal (the "Letter of Transmittal"), which
together constitute the Company's offer (the "Exchange Offer") to exchange its
14 5/8% Series B Senior Discount Notes due 2004 (the "New Notes") for an equal
principal amount of its 14 5/8% Senior Discount Notes due 2004 (the "Old
Notes" and, together with the New Notes, the "Notes"). The terms of the New
Notes are identical in all material respects to the Old Notes, except that the
New Notes have been registered under the Securities Act of 1933, as amended
(the "Securities Act"), and, therefore, will not bear legends restricting
their transfer and will not contain certain provisions relating to an increase
in the interest rate which were included in the Old Notes under certain
circumstances relating to the timing of the Exchange Offer. The term
"Expiration Date" shall mean 5:00 p.m., New York City time, on ,
1998, unless the Company, in its sole discretion, extends the Exchange Offer,
in which case the term shall mean the latest date and time to which the
Exchange Offer is extended. Capitalized terms used but not defined herein have
the meaning given to them in the Prospectus.
The Letter of Transmittal is to be used by Holders of Old Notes if
certificates are to be forwarded herewith. Holders of Old Notes whose
certificates are not immediately available, or who are unable to deliver their
certificates and all other documents required by this Letter of Transmittal to
the Exchange Agent on or prior to the Expiration Date, must tender their Old
Notes according to the guaranteed delivery procedures set forth in "The
Exchange Offer--Guaranteed Delivery Procedures" section of the Prospectus. See
Instruction 1.
<PAGE>
The term "Holder" with respect to the Exchange Offer means any person in
whose name Old Notes are registered on the books of the Company or any other
person who has obtained a properly completed bond power from the registered
holder. The undersigned has completed, executed and delivered this Letter of
Transmittal to indicate the action the undersigned desires to take with
respect to the Exchange Offer. Holders who wish to tender their Old Notes must
complete this Letter of Transmittal in its entirety.
The undersigned acknowledges that if it is a broker-dealer holding Old Notes
acquired for its own account as a result of market-making activities or other
trading activities (other than Old Notes acquired directly from the Company),
such Holder may be deemed to be an "Underwriter" within the meaning of the
Securities Act and, therefore, must deliver a prospectus meeting the
requirements of the Securities Act in connection with any resale of New Notes
received in respect of such Old Notes pursuant to the Exchange Offer.
Notwithstanding the foregoing, the undersigned shall not be deemed to admit
that it is an "Underwriter" within the meaning of such term under the
Securities Act.
PLEASE READ THE ENTIRE LETTER OF TRANSMITTAL
CAREFULLY BEFORE COMPLETING THE LETTER OF TRANSMITTAL
DESCRIPTION OF 14 5/8% SENIOR DISCOUNT NOTES DUE 2004
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AGGREGATE PRINCIPAL AMOUNT
PRINCIPAL TENDERED (MUST
NAMES AND ADDRESS(ES) OF AMOUNT BE IN INTEGRAL
REGISTERED HOLDER(S) CERTIFICATE REPRESENTED BY MULTIPLES
(PLEASE FILL IN, IF BLANK) NUMBER(S) CERTIFICATE(S) OF $1,000)*
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
Total
- -----------------------------------------------------------------------------------------------
</TABLE>
*Unless indicated in the column labeled "Principal Amount Tendered," any
tendering Holder of 14 5/8% Senior Discount Notes due 2004 will be deemed to
have tendered the entire aggregate principal amount represented by the
column labeled "Aggregate Principal Amount Represented by Certificate(s)."
If the space provided above is inadequate, list the certificate numbers and
principal amounts on a separate signed schedule and affix the list to this
Letter of Transmittal.
The minimum permitted tender is $1,000 in principal amount. All other tenders
must be integral multiples of $1,000.
[_]CHECK HERE IF TENDERED OLD NOTES ARE BEING DELIVERED PURSUANT TO A NOTICE
OF GUARANTEED DELIVERY PREVIOUSLY SENT TO THE EXCHANGE AGENT AND COMPLETE
THE FOLLOWING (SEE INSTRUCTION 1):
Name(s) of Registered Holder(s) ____________________________________________
Window Ticket Number (if any) ______________________________________________
Date of Execution of Notice of Guaranteed Delivery _________________________
Name of Institution which Guaranteed Delivery ______________________________
[_]CHECK HERE IF YOU ARE A BROKER-DEALER AND WISH TO RECEIVE 10 ADDITIONAL
COPIES OF THE PROSPECTUS AND 10 COPIES OF ANY AMENDMENTS OR SUPPLEMENTS
THERETO.
Name: ______________________________________________________________________
Address: ___________________________________________________________________
----------------------------------------------------------------------
2
<PAGE>
SPECIAL REGISTRATION INSTRUCTIONS SPECIAL DELIVERY INSTRUCTIONS
(SEE INSTRUCTIONS 4, 5 AND 6) (SEE INSTRUCTIONS 4, 5 AND 6)
To be completed ONLY if To be completed ONLY if
certificates for Old Notes in a certificates for Old Notes in a
principal amount not tendered, or principal amount not tendered, or
New Notes issued in exchange for New Notes issued in exchange for
Old Notes accepted for exchange, Old Notes accepted for exchange,
are to be issued in the name of are to be sent to someone other
someone other than the than the undersigned, or to the
undersigned. undersigned at an address other
than that shown above.
Issue certificate(s) to:
Deliver certificate(s) to:
Name: _____________________________
(Please Print) Name: _____________________________
(Please Print)
Address: __________________________
Address: __________________________
-----------------------------------
(Include Zip Code) -----------------------------------
(Include Zip Code)
-----------------------------------
(Tax Identification or Social -----------------------------------
Security No.) (Tax Identification or Social
Security No.)
Ladies and Gentlemen:
Subject to the terms and conditions of the Exchange Offer, the undersigned
hereby tenders to the Company the principal amount of Old Notes indicated
above. Subject to and effective upon the acceptance for exchange of the
principal amount of Old Notes tendered in accordance with this Letter of
Transmittal, the undersigned sells, assigns and transfers to, or upon the
order of, the Company all right, title and interest in and to the Old Notes
tendered hereby. The undersigned hereby irrevocably constitutes and appoints
the Exchange Agent its agent and attorney-in-fact (with full knowledge that
the Exchange Agent also acts as the agent of the Company) with respect to the
tendered Old Notes with full power of substitution to (i) deliver certificates
for such Old Notes to the Company and deliver all accompanying evidences of
transfer and authenticity to, or upon the order of, the Company and (ii)
present such Old Notes for transfer on the books of the Company and receive
all benefits and otherwise exercise all rights of beneficial ownership of such
Old Notes, all in accordance with the terms of the Exchange Offer. The power
of attorney granted in this paragraph shall be deemed to be irrevocable and
coupled with an interest.
The undersigned hereby represents and warrants that he or she has full power
and authority to tender, sell, assign and transfer the Old Notes tendered
hereby and that the Company will acquire good and unencumbered title thereto,
free and clear of all liens, restrictions, charges and encumbrances and not
subject to any adverse claim, when the same are acquired by the Company. The
undersigned and any beneficial owner of Old Notes hereby further represent
that any New Notes acquired in exchange for Old Notes tendered hereby will
have been acquired in the ordinary course of business of the undersigned and
any such beneficial owner of Old Notes receiving such New Notes, that neither
the Holder nor any such beneficial owner is participating in, intends to
participate in or has an arrangement or understanding with any person to
participate in the distribution of such New Notes and that neither the Holder
nor any such beneficial owner is an "affiliate," as defined in Rule 405 under
the Securities Act, of the Company. The undersigned and each beneficial owner
acknowledge and agree that any person participating in the Exchange Offer for
the purpose of distributing the New Notes must comply with the registration
and prospectus delivery requirements of the Securities Act in connection with
any secondary resale transactions of the New Notes acquired by such person and
may not rely on the position of the Staff of the Securities and Exchange
Commission set forth in the no-action letters discussed in the Prospectus
under the caption "The Exchange Offer." If the undersigned is not a broker-
dealer, the undersigned represents that it is
3
<PAGE>
not engaged in, and does not intend to engage in, a public distribution of New
Notes. The undersigned and each beneficial owner will, upon request, execute
and deliver any additional documents deemed by the Exchange Agent or the
Company to be necessary or desirable to complete the assignment, transfer and
purchase of the Old Notes tendered hereby.
For purposes of the Exchange Offer, the Company shall be deemed to have
accepted validly tendered Old Notes when, as and if the Company has given oral
or written notice thereof to the Exchange Agent.
If any tendered Old Notes are not accepted for exchange pursuant to the
Exchange Offer for any reason, certificates for any such unaccepted Old Notes
will be returned, without expense, to the undersigned at the address shown
below or at a different address as may be indicated herein under "Special
Delivery Instructions" as promptly as practicable after the Expiration Date.
All authority conferred or agreed to be conferred by this Letter of
Transmittal shall survive the death, incapacity or dissolution of the
undersigned, and every obligation of the undersigned under this Letter of
Transmittal shall be binding upon the undersigned's heirs, personal
representatives, successors and assigns.
The undersigned understands that tenders of Old Notes pursuant to the
procedures described under the caption "The Exchange Offer--Procedures for
Tendering" in the Prospectus and in the instructions hereto will constitute a
binding agreement between the undersigned and the Company upon the terms and
subject to the conditions of the Exchange Offer, subject only to withdrawal of
such tenders on the terms set forth in the Prospectus under the caption "The
Exchange Offer--Withdrawal of Tenders."
Unless otherwise indicated under "Special Registration Instructions," please
issue the certificates representing the New Notes issued in exchange for the
Old Notes accepted for exchange and any certificates for Old Notes not
tendered or not exchanged, in the name(s) of the undersigned. Similarly,
unless otherwise indicated under "Special Delivery Instructions," please send
the certificates representing the New Notes issued in exchange for the Old
Notes accepted for exchange and any certificates for Old Notes not tendered or
not exchanged (and accompanying documents, as appropriate) to the undersigned
at the address shown below the undersigned's signature(s). In the event that
both "Special Registration Instructions" and "Special Delivery Instructions"
are completed, please issue the certificates representing the New Notes issued
in exchange for the Old Notes accepted for exchange in the name(s) of, and
return any certificates for Old Notes not tendered or not exchanged to, the
person(s) so indicated. The undersigned understands that the Company has no
obligation pursuant to the "Special Registration Instructions" and "Special
Delivery Instructions" to transfer any Old Notes from the name of the
registered Holder(s) thereof if the Company does not accept for exchange any
of the Old Notes so tendered.
Holders who wish to tender their Old Notes and whose Old Notes are not
immediately available or who cannot deliver their certificates and all other
documents required by this Letter of Transmittal to the Exchange Agent prior
to the Expiration Date, may tender their Old Notes according to the guaranteed
delivery procedures set forth in the Prospectus under the caption "The
Exchange Offer--Guaranteed Delivery Procedures." See Instruction 1 regarding
the completion of this Letter of Transmittal printed below.
4
<PAGE>
PLEASE SIGN HERE WHETHER OR NOT
OLD NOTES ARE BEING PHYSICALLY TENDERED HEREBY
X Date:____________________
--------------------------------------------------
X Date:____________________
--------------------------------------------------
Signature(s) of Registered Holder(s) or Authorized Signatory
Area Code and Telephone Number: _____________________________________________
The above lines must be signed by the registered holder(s) as their
name(s) appear(s) on the Old Notes or by person(s) authorized to become
registered holder(s) by a properly completed bond power from the registered
holder(s), a copy of which must be transmitted with this Letter of
Transmittal. If the Old Notes to which this Letter of Transmittal relate are
held of record by two or more joint holders, then all such holders must sign
this Letter of Transmittal. If signature is by a trustee, executor,
administrator, guardian, attorney-in-fact, officer of a corporation or other
person acting in a fiduciary or representative capacity, then such person
must (i) set forth his or her full title below and (ii) unless waived by the
Company, submit evidence satisfactory to the Company of such person's
authority so to act. See Instruction 4 regarding the completion of this
Letter of Transmittal printed below.
Name(s): ____________________________________________________________________
(Please Print)
-----------------------------------------------------------------------------
Capacity: ___________________________________________________________________
Address: ____________________________________________________________________
(Include Zip Code)
Signature(s) Guaranteed by an Eligible Institution:
(If required by Instruction 4)
-----------------------------------------------------------------------------
(Authorized Signature)
-----------------------------------------------------------------------------
(Title)
-----------------------------------------------------------------------------
(Name of Firm)
Date: ___________________
5
<PAGE>
INSTRUCTIONS
FORMING PART OF THE TERMS AND CONDITIONS
OF THE EXCHANGE OFFER
1. DELIVERY OF THIS LETTER OF TRANSMITTAL AND OLD NOTES; GUARANTEED DELIVERY
PROCEDURES. The tendered Old Notes as well as a properly completed and duly
executed copy of this Letter of Transmittal or facsimile hereof and any other
documents required by this Letter of Transmittal must be received by the
Exchange Agent at its address set forth herein prior to 5:00 p.m., New York
City time, on the Expiration Date. The method of delivery of the tendered Old
Notes, this Letter of Transmittal and all other required documents to the
Exchange Agent is at the election and risk of the Holder and, except as
otherwise provided below, the delivery will be deemed made only when actually
received by the Exchange Agent. Instead of delivery by mail, it is recommended
that the Holder use an overnight or hand delivery service. In all cases,
sufficient time should be allowed to assure timely delivery. No Letter of
Transmittal or Old Notes should be sent to the Company.
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
immediately available or (ii) who cannot deliver their Old Notes, this Letter
of Transmittal or any other documents required hereby to the Exchange Agent
prior to the Expiration Date must tender their Old Notes according to the
guaranteed delivery procedures set forth in the Prospectus. Pursuant to such
procedure: (a) such tender must be made by or through an Eligible Institution
(defined below); (b) prior to the Expiration Date, the Exchange Agent must
have received from the Eligible Institution a properly completed and duly
executed Notice of Guaranteed Delivery (by facsimile transmission, mail or
hand delivery) setting forth the name and address of the Holder, the
certificate number or numbers of such Old Notes and the principal amount of
Old Notes tendered, stating that the tender is being made thereby and
guaranteeing that, within three New York Stock Exchange trading days after the
Expiration Date, this Letter of Transmittal (or facsimile hereof) together
with the certificate(s) representing the Old Notes and any other required
documents will be deposited by the Eligible Institution with the Exchange
Agent; and (c) such properly completed and executed Letter of Transmittal (or
facsimile hereof), as well as the certificate(s) representing all tendered Old
Notes in proper form for transfer and all other documents required by this
Letter of Transmittal must be received by the Exchange Agent within three New
York Stock Exchange trading days after the Expiration Date, all as provided in
the Prospectus under the caption "The Exchange Offer--Guaranteed Delivery
Procedures." Any Holder who wishes to tender his or her Old Notes pursuant to
the guaranteed delivery procedures described above must ensure that the
Exchange Agent receives the Notice of Guaranteed Delivery prior to 5:00 p.m.,
New York City time, on the Expiration Date. Upon request to the Exchange
Agent, a Notice of Guaranteed Delivery will be sent to Holders who wish to
tender their Old Notes according to the guaranteed delivery procedures set
forth above.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance of tendered Old Notes, and withdrawal of tendered Old
Notes will be determined by the Company in its sole discretion, which
determination will be final and binding. The Company reserves the absolute
right to reject any and all Old Notes not properly tendered or any Old Notes
the Company's acceptance of which would, in the opinion of counsel for the
Company, be unlawful. The Company also reserves the right to waive any
irregularities or conditions of tender as to particular Old Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in this Letter of Transmittal) shall be firm and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Old Notes must be cured within such time as the
Company shall determine. Neither the Company, the Exchange Agent nor any other
person shall be under any duty to give notification of defects or
irregularities with respect to tenders of Old Notes, nor shall any of them
incur any liability for failure to give such notification. Tenders of Old
Notes will not be deemed to have been made until such defects or
irregularities have been cured or waived. Any Old Notes received by the
Exchange Agent that are not properly tendered and as to which the defects or
irregularities have not been cured or waived will be returned by the Exchange
Agent to the tendering Holders, unless otherwise provided in this Letter of
Transmittal, as soon as practicable following the Expiration Date.
6
<PAGE>
2. TENDER BY HOLDER. Only a Holder of Old Notes may tender such Old Notes in
the Exchange Offer. Any beneficial owner of Old Notes who is not the
registered holder and who wishes to tender should arrange with such registered
holder to execute and deliver this Letter of Transmittal on such owner's
behalf or must, prior to completing and executing this Letter of Transmittal
and delivering his or her Old Notes, either make appropriate arrangements to
register ownership of the Old Notes in such owner's name or obtain a properly
completed bond power from the registered holder.
3. PARTIAL TENDERS. Tenders of Old Notes will be accepted only in integral
multiples of $1,000. If less than the entire principal amount of any Old Notes
is tendered, the tendering Holder should fill in the principal amount tendered
in the fourth column of the box entitled "Description of 14 5/8% Senior
Discount Notes due 2004" above. The entire principal amount of any Old Notes
delivered to the Exchange Agent will be deemed to have been tendered unless
otherwise indicated. If the entire principal amount of all Old Notes is not
tendered, then Old Notes for the principal amount of Old Notes not tendered
and a certificate or certificates representing New Notes issued in exchange
for any Old Notes accepted will be sent to the Holder at his or her registered
address, unless a different address is provided in the appropriate box on this
Letter of Transmittal, promptly after the Old Notes are accepted for exchange.
4. SIGNATURES ON THE LETTER OF TRANSMITTAL; BOND POWERS AND ENDORSEMENTS;
GUARANTEE OF SIGNATURES. If this Letter of Transmittal (or facsimile hereof)
is signed by the registered holder(s) of the Old Notes tendered hereby, the
signature must correspond with the name(s) as written on the face of the Old
Notes without alteration, enlargement or any change whatsoever.
If this Letter of Transmittal (or facsimile hereof) is signed by the
registered holder or holders of Old Notes tendered and the certificate or
certificates for New Notes issued in exchange therefor is to be issued (or any
untendered principal amount of Old Notes is to be reissued) to the registered
holder and neither the "Special Delivery Instructions" nor the "Special
Registration Instructions" has been completed, then such holder need not and
should not endorse any tendered Old Notes, nor provide a separate bond power.
In any other case, such holder must either properly endorse the Old Notes
tendered or transmit a properly completed separate bond power with this Letter
of Transmittal with the signatures on the endorsement or bond power guaranteed
by an Eligible Institution.
If this Letter of Transmittal (or facsimile hereof) is signed by a person
other than the registered holder or holders of any Old Notes listed, such Old
Notes must be endorsed or accompanied by appropriate bond powers in each case
signed as the name of the registered holder or holders appears on the Old
Notes.
If this Letter of Transmittal (or facsimile hereof) or any Old Notes or bond
powers are signed by trustees, executors, administrators, guardians,
attorneys-in-fact, or officers of corporations or others acting in a fiduciary
or representative capacity, such persons should so indicate when signing, and,
unless waived by the Company, evidence satisfactory to the Company of their
authority so to act must be submitted with this Letter of Transmittal.
Endorsements on Old Notes or signatures on bond powers required by this
Instruction 4 must be guaranteed by an Eligible Institution which is a member
of (a) the Securities Transfer Agents Medallion Program, (b) the New York
Stock Exchange Medallion Signature Program or (c) the Stock Exchange Medallion
Program.
Except as otherwise provided below, all signatures on this Letter of
Transmittal must be guaranteed by a firm that is a member of a registered
national securities exchange or the National Association of Securities
Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States or an "eligible guarantor institution"
within the meaning of Rule 17Ad-15 under the Securities Exchange Act of 1934,
as amended (an "Eligible Institution"). Signatures on this Letter of
Transmittal need not be guaranteed if (a) this Letter of Transmittal is signed
by the registered holder(s) of the Old Notes tendered herewith and such
holder(s) have not completed the box set forth herein entitled "Special
Registration Instructions" or the box entitled "Special Delivery Instructions"
or (b) such Old Notes are tendered for the account of an Eligible Institution.
7
<PAGE>
5. SPECIAL REGISTRATION AND DELIVERY INSTRUCTIONS. Tendering Holders should
indicate, in the applicable box or boxes, the name and address to which New
Notes or substitute Old Notes for principal amounts not tendered or not
accepted for exchange are to be issued or sent, if different from the name and
address of the person signing this Letter of Transmittal. In the case of
issuance in a different name, the taxpayer identification or social security
number of the person named must also be indicated.
6. TRANSFER TAXES. The Company will pay all transfer taxes, if any,
applicable to the exchange of Old Notes pursuant to the Exchange Offer. If,
however, certificates representing New Notes or Old Notes for principal
amounts not tendered or accepted for exchange are to be delivered to, or are
to be registered in the name of, any person other than the registered holder
of the Old Notes tendered hereby, or if tendered Old Notes are registered in
the name of any person other than the person signing this Letter of
Transmittal, or if a transfer tax is imposed for any reason other than the
exchange of Old Notes pursuant to the Exchange Offer, then the amount of any
such transfer taxes (whether imposed on the registered holder or on any other
persons) will be payable by the tendering Holder. If satisfactory evidence of
payment of such taxes or exemption therefrom is not submitted with this Letter
of Transmittal, the amount of such transfer taxes will be billed directly to
such tendering Holder.
Except as provided in this Instruction 6, it will not be necessary for
transfer tax stamps to be affixed to the Old Notes listed in this Letter of
Transmittal.
7. WAIVER OF CONDITIONS. The Company reserves the right, in its sole
discretion, to amend, waive or modify specified conditions in the Exchange
Offer in the case of any Old Notes tendered.
8. MUTILATED, LOST, STOLEN OR DESTROYED OLD NOTES. Any tendering Holder
whose Old Notes have been mutilated, lost, stolen or destroyed should contact
the Exchange Agent at the address indicated herein for further instructions.
9. REQUESTS FOR ASSISTANCE OR ADDITIONAL COPIES. Questions and requests for
assistance and requests for additional copies of the Prospectus or this Letter
of Transmittal may be directed to the Exchange Agent at the address specified
in the Prospectus. Holders may also contact their broker, dealer, commercial
bank, trust company or other nominee for assistance concerning the Exchange
Offer.
(DO NOT WRITE IN SPACE BELOW)
<TABLE>
<CAPTION>
CERTIFICATE
SURRENDERED OLD NOTES TENDERED OLD NOTES ACCEPTED
- ------------------------------------------------------------------
<S> <C> <C>
- ------------------------------------------------------------------
</TABLE>
Delivery Prepared by Checked by Date
8
<PAGE>
USN COMMUNICATIONS, INC.
NOTICE OF GUARANTEED DELIVERY
OF
14 5/8% SENIOR DISCOUNT NOTES DUE 2004
As set forth in the Prospectus, dated , 1997 (as the same may be
amended from time to time, the "Prospectus"), of USN Communications, Inc. (the
"Company") under the caption "The Exchange Offer--Guaranteed Delivery
Procedures," this form or one substantially equivalent hereto must be used to
accept the Company's offer (the "Exchange Offer") to exchange its 14 5/8%
Series B Senior Discount Notes due 2004 (the "New Notes"), which have been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
for an equal principal amount of its 14 5/8% Senior Discount Notes due 2004
(the "Old Notes"), if (i) certificates representing the Old Notes to be
exchanged are not lost but are not immediately available or (ii) time will not
permit all required documents to reach the Exchange Agent prior to the
Expiration Date. This form may be delivered by an Eligible Institution by mail
or hand delivery or transmitted, via facsimile, to the Exchange Agent at its
address set forth below not later than 5:00 p.m., New York City Time, on
, 1998. All capitalized terms used herein but not defined herein
shall have the meanings ascribed to them in the Prospectus.
The Exchange Agent is:
HARRIS TRUST COMPANY OF NEW YORK
By Registered or By Overnight Courier: By Hand:
Certified Mail: Harris Trust Company of New York
Harris Trust Company of
Harris Trust Company of 77 Water Street, 4th FloorNew York
New York New York, NY 10005 Receive Window
Wall Street Station 77 Water Street, 5th
P.O. Box 1010 Floor
New York, NY 10268-1010 New York, NY
By Facsimile:
(212) 701-7636
(212) 701-7637
Confirm by telephone:
(212) 701-7618
DELIVERY, OR TRANSMISSION VIA FACSIMILE, OF THIS INSTRUMENT TO AN ADDRESS OTHER
THAN AS SET FORTH ABOVE WILL NOT CONSTITUTE A VALID DELIVERY.
Ladies and Gentlemen:
The undersigned hereby tender(s) for exchange to the Company, upon the terms
and subject to the conditions set forth in the Prospectus and Letter of
Transmittal, receipt of which is hereby acknowledged, the principal amount of
Old Notes set forth below pursuant to the guaranteed delivery procedures set
forth in the Prospectus under the caption "The Exchange Offer--Guaranteed
Delivery Procedures."
The undersigned understands and acknowledges that the Exchange Offer will
expire at 5:00 p.m., New York City time, on , 1998, unless extended
by the Company. With respect to the Exchange Offer, "Expiration Date" means
such time and date, or if the Exchange Offer is extended, the latest time and
date to which the Exchange Offer is so extended by the Company.
All authority herein conferred or agreed to be conferred by this Notice of
Guaranteed Delivery shall survive the death or incapacity of the undersigned
and every obligation of the undersigned under this Notice of Guaranteed
Delivery shall be binding upon the heirs, personal representatives, executors,
administrators, successors, assigns, trustees in bankruptcy and other legal
representatives of the undersigned.
<PAGE>
Principal Amount of Old Notes
Exchanged: $ ________________________
SIGNATURES
Certificate Nos. of Old Notes (if
available)
-----------------------------------
Signature of Owner
-------------------------------------
-----------------------------------
Signature of Owner (if more than -------------------------------------
one)
Total $ _____________________________
Dated:
IF OLD NOTES WILL BE DELIVERED BY
Name(s): __________________________ BOOK-ENTRY TRANSFER, PROVIDE THE DE-
POSITORY TRUST COMPANY ("DTC") AC-
COUNT NO.:
----------------------------
(Please Print)
Account No.: ________________________
Address: __________________________
-----------------------------
-----------------------------
(Include Zip Code)
Area Code and
Telephone No. _____________________
Capacity (full title), if signing
in a
representative capacity____________
Taxpayer Identification or
Social Security No.: ______________
GUARANTEE OF DELIVERY
(NOT TO BE USED FOR SIGNATURE GUARANTEE)
The undersigned, a firm which is a member of a registered national
securities exchange or of the National Association of Securities Dealers,
Inc., or is a commercial bank or trust company having an office or
correspondent in the United States, or is otherwise an "eligible guaranteed
institution" within the meaning of Rule 17Ad-15 under the Securities Exchange
Act of 1934, as amended, guarantees deposit with the Exchange Agent of the
Letter of Transmittal (or facsimile thereof), together with the Old Notes
tendered hereby in proper form for transfer (or confirmation of the book-entry
transfer of such Old Notes into the Exchange Agent's account at the Book-Entry
Transfer Facility described in the Prospectus under the caption "The Exchange
Offer--Guaranteed Delivery Procedures" and in the Letter of Transmittal) and
any other required document, all by 5.00 p.m., New York City time, on the
third New York Stock Exchange trading day following the Expiration Date.
Name of Firm: _______________________ -------------------------------------
Authorized Signature
Address: ____________________________
Name: _______________________________
- -------------------------------------
Title: ______________________________
Area Code and Telephone No.: ________
Date: _______________________________
NOTE: DO NOT SEND OLD NOTES WITH THIS FORM. ACTUAL SURRENDER OF OLD NOTES
MUST BE MADE PURSUANT TO, AND BE ACCOMPANIED BY, THE LETTER OF TRANSMITTAL.
2
<PAGE>
USN COMMUNICATIONS, INC.
OFFER TO EXCHANGE ITS
14 5/8% SERIES B SENIOR DISCOUNT NOTES DUE 2004
FOR ANY AND ALL OF ITS OUTSTANDING
14 5/8% SENIOR DISCOUNT NOTES DUE 2004
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON
, 1998 UNLESS EXTENDED.
To Brokers, Dealers, Commercial Banks, , 1997
Trust Companies and Other Nominees:
USN Communications, Inc., a Delaware corporation, (the "Company") is
offering upon the terms and conditions set forth in the Prospectus, dated
, 1997 (as the same may be amended from time to time, the
"Prospectus"), and in the related Letter of Transmittal enclosed herewith, to
exchange (the "Exchange Offer") its 14 5/8% Series B Senior Discount Notes due
2004 (the "New Notes") for an equal principal amount of its 14 5/8% Senior
Discount Notes due 2004 (the "Old Notes" and together with the New Notes, the
"Notes"). As set forth in the Prospectus, the terms of the New Notes are
identical in all material respects to the Old Notes, except for certain
transfer restrictions relating to the Old Notes and except that the New Notes
will not contain certain provisions relating to an increase in the interest
rate which were included in the Old Notes under certain circumstances relating
to the timing of the Exchange Offer. Old Notes may only be tendered in
integral multiples of $1,000.
THE EXCHANGE OFFER IS SUBJECT TO CERTAIN CONDITIONS. SEE "THE EXCHANGE
OFFER--CONDITIONS" IN THE PROSPECTUS.
Enclosed herewith for your information and forwarding to your clients are
copies of the following documents:
1. The Prospectus, dated , 1997.
2. The Letter of Transmittal to exchange Notes for your use and for the
information of your clients. Facsimile copies of the Letter of Transmittal
may be used to exchange Notes.
3. A form of letter which may be sent to your clients for whose accounts
you hold Old Notes registered in your name or in the name of your nominee,
with space provided for obtaining such client's instructions with regard to
the Exchange Offer.
4. A Notice of Guaranteed Delivery.
5. Guidelines of the Internal Revenue Service for Certification of
Taxpayer Identification Number on Substitute Form W-9.
6. A return envelope addressed to Harris Trust Company of New York, the
Exchange Agent.
YOUR PROMPT ACTION IS REQUESTED. WE URGE YOU TO CONTACT YOUR CLIENTS AS
PROMPTLY AS POSSIBLE. PLEASE NOTE THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.,
NEW YORK CITY TIME, ON , 1998, UNLESS EXTENDED. PLEASE FURNISH
COPIES OF THE ENCLOSED MATERIALS TO THOSE OF YOUR CLIENTS FOR WHOM YOU HOLD
OLD NOTES REGISTERED IN YOUR NAME OR IN THE NAME OF YOUR NOMINEE AS QUICKLY AS
POSSIBLE.
In all cases, exchanges of Old Notes accepted for exchange pursuant to the
Exchange Offer will be made only after timely receipt by the Exchange Agent of
(a) certificates representing such Old Notes, (b) the Letter of Transmittal
(or facsimile thereof) properly completed and duly executed with any required
signature guarantees, and (c) any other documents required by the Letter of
Transmittal.
<PAGE>
If holders of Old Notes wish to tender, but it is impracticable for them to
forward their certificates for Old Notes prior to the expiration of the
Exchange Offer or to comply with the book-entry transfer procedures on a
timely basis, a tender may be offered by following the guaranteed delivery
procedure described in the Prospectus under "The Exchange Offer--Guaranteed
Delivery Procedures."
The Exchange Offer is not being made to (nor will tenders be accepted from
or on behalf of) holders of Old Notes residing in any jurisdiction in which
the making of the Exchange Offer or the acceptance thereof would not be in
compliance with the laws of such jurisdiction.
The Company will not pay any fees or commissions to brokers, dealers or
other persons for soliciting exchanges of Notes pursuant to the Exchange
Offer. The Company will, however, upon request, reimburse you for customary
clerical and mailing expenses incurred by you in forwarding any of the
enclosed materials to your clients. The Company will pay or cause to be paid
any transfer taxes payable on the transfer of Notes to it, except as otherwise
provided in Instruction 6 of the Letter of Transmittal.
Questions and requests for assistance with respect to the Exchange Offer or
for copies of the Prospectus and Letter of Transmittal may be directed to the
Exchange Agent at its address set forth in the Prospectus or at (312) 461-
3525.
Very truly yours,
USN Communications, Inc.
NOTHING CONTAINED HEREIN OR IN THE ENCLOSED DOCUMENTS SHALL CONSTITUTE YOU
OR ANY OTHER PERSON THE AGENT OF THE COMPANY, OR ANY AFFILIATE THEREOF, OR
AUTHORIZE YOU OR ANY OTHER PERSON TO MAKE ANY STATEMENT OR USE ANY DOCUMENT ON
BEHALF OF ANY OF THEM IN CONNECTION WITH THE OFFER OTHER THAN THE ENCLOSED
DOCUMENTS AND THE STATEMENTS CONTAINED THEREIN.
2
<PAGE>
USN COMMUNICATIONS, INC.
OFFER TO EXCHANGE ITS
14 5/8% SERIES B SENIOR DISCOUNT NOTES DUE 2004
FOR ANY AND ALL OF ITS OUTSTANDING
14 5/8% SENIOR DISCOUNT NOTES DUE 2004
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON
, 1998 (THE "INITIAL EXPIRATION DATE"), UNLESS EXTENDED.
To Our Clients:
Enclosed for your consideration is a Prospectus, dated , 1997 (as
the same may be amended from time to time, the "Prospectus"), and a Letter of
Transmittal (the "Letter of Transmittal") relating to the offer by USN
Communications, Inc. (the "Company") to exchange (the "Exchange Offer") its 14
5/8% Series B Senior Discount Notes due 2004 (the "New Notes") for an equal
principal amount of its 14 5/8% Senior Discount Notes due 2004 (the "Old
Notes") upon the terms and conditions set forth in the Prospectus and in the
related Letter of Transmittal. As set forth in the Prospectus, the terms of
the New Notes are identical in all material respects to the Old Notes, except
for certain transfer restrictions relating to the Old Notes and except that
the New Notes will not contain certain provisions relating to an increase in
the interest rate which were included in the Old Notes under certain
circumstances relating to the timing of the Exchange Offer. The Exchange Offer
is subject to certain customary conditions. See "The Exchange Offer" in the
Prospectus. Old Notes may be tendered only in integral multiples of $1,000.
The material is being forwarded to you as the beneficial owner of Old Notes
carried by us for your account or benefit but not registered in your name. An
exchange of any Old Notes may only be made by us as the registered Holder and
pursuant to your instructions. Therefore, the Company urges beneficial owners
of Old Notes registered in the name of a broker, dealer, commercial bank,
trust company or other nominee to contact such Holder promptly if they wish to
exchange Old Notes in the Exchange Offer.
Accordingly, we request instructions as to whether you wish us to exchange
any or all such Old Notes held by us for your account or benefit, pursuant to
the terms and conditions set forth in the Prospectus and Letter of
Transmittal. We urge you to read carefully the Prospectus and Letter of
Transmittal before instructing us to exchange your Old Notes.
Your instructions to us should be forwarded as promptly as possible in order
to permit us to exchange Old Notes on your behalf in accordance with the
provisions of the Exchange Offer. The Exchange Offer expires at 5:00 pm., New
York City time, on , 1997, unless extended. With respect to the
Exchange Offer, "Expiration Date" means the Initial Expiration Date, or if the
Exchange Offer is extended, the latest time and date to which the Exchange
Offer is so extended by the Company. Tender of Old Notes may be withdrawn at
any time prior to 5:00 p.m., New York City time, on the Expiration Date.
Your attention is directed to the following:
1. The Exchange Offer is for the exchange of $1,000 principal amount of
the New Notes for each $1,000 principal amount of the Old Notes, of which
$152,725,000 aggregate principal amount of the Old Notes was outstanding as
of August 18, 1997. The terms of the New Notes are identical in all
material respects to the Old Notes, except for certain transfer
restrictions relating to the Old Notes and except that the New Notes will
not contain certain provisions relating to an increase in the interest rate
which were included in the Old Notes under certain circumstances relating
to the timing of the Exchange Offer.
2. THE EXCHANGE OFFER IS SUBJECT TO CERTAIN CONDITIONS. SEE "THE EXCHANGE
OFFER--CONDITIONS" IN THE PROSPECTUS.
<PAGE>
3. The Exchange Offer and withdrawal rights will expire at 5:00 p.m., New
York City time, on , 1997, unless extended.
4. The Company has agreed to pay the expenses of the Exchange Offer.
5. Any transfer taxes incident to the transfer of Notes from the
tendering Holder to the Company will be paid by the Company, except as
provided in the Prospectus and the Letter of Transmittal.
The Exchange Offer is not being made to, nor will exchanges be accepted from
or on behalf of, holders of Old Notes residing in any jurisdiction in which
the making of the Exchange Offer or acceptance thereof would not be in
compliance with the laws of such jurisdiction.
If you wish us to exchange any or all of your Old Notes held by us for your
account or benefit, please so instruct us by completing, executing and
returning to us the instruction form that appears below. THE ACCOMPANYING
LETTER OF TRANSMITTAL IS FURNISHED TO YOU FOR INFORMATIONAL PURPOSES ONLY AND
MAY NOT BE USED BY YOU TO EXCHANGE OLD NOTES HELD BY US AND REGISTERED IN YOUR
NAME FOR YOUR ACCOUNT OR BENEFIT.
2
<PAGE>
INSTRUCTIONS
The undersigned acknowledge(s) receipt of your letter and the enclosed
material referred to therein relating to the Exchange Offer of USN
Communications, Inc.
This will instruct you to exchange the aggregate principal amount of Old
Notes indicated below (or, if no aggregate principal amount is indicated
below, all Old Notes) held by you for the account or benefit of the
undersigned, pursuant to the terms of and conditions set forth in the
Prospectus and the Letter of Transmittal.
Aggregate Principal Amount of Old Notes to be exchanged
$ *
*I (WE) UNDERSTAND THAT IF I (WE) -------------------------------------
SIGN THESE INSTRUCTION FORMS WITHOUT -------------------------------------
INDICATING AN AGGREGATE PRINCIPAL SIGNATURE(S)
AMOUNT OF OLD NOTES IN THE SPACE -------------------------------------
ABOVE, ALL OLD NOTES HELD BY YOU FOR -------------------------------------
MY (OUR) ACCOUNT WILL BE EXCHANGED. -------------------------------------
-------------------------------------
(PLEASE PRINT NAME(S) AND ADDRESS
HERE)
DATED: ______________________________
-------------------------------------
(AREA CODE AND TELEPHONE NUMBER)
-------------------------------------
(TAXPAYER IDENTIFICATION OR SOCIAL
SECURITY NUMBER)
- --------
* UNLESS OTHERWISE INDICATED, IT WILL BE ASSUMED THAT ALL OF YOUR OLD NOTES
ARE TO BE EXCHANGED.
3
<PAGE>
GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION
NUMBER ON SUBSTITUTE FORM W-9
GUIDELINES FOR DETERMINING THE PROPER IDENTIFICATION NUMBER TO GIVE THE
PAYER.--Social Security numbers have nine digits separated by two hyphens:
i.e. 000-00-0000. Employer identification numbers have nine digits separated
by only one hyphen: i.e. 00-0000000. The table below will help determine the
number to give the payer.
- --------------------------------------- ---------------------------------------
<TABLE>
<CAPTION>
GIVE THE EMPLOYER
FOR THIS TYPE OF ACCOUNT: IDENTIFICATION
NUMBER OF --
-----------------------------------
<S> <C>
9. A valid trust, estate, or The legal entity
pension trust (Do not furnish
the identifying
number of the
personal
representative or
trustee unless
the legal entity
itself is not
designated in the
account
title.)(5)
10. Corporate account The corporation
11. Religious, charitable, or The organization
educational organization
account
12. Partnership account held The partnership
in the name of the business
13. Association, club, or The organization
other tax-exempt
organization
14. A broker or registered The broker or
nominee nominee
15. Account with the The public entity
Department of Agriculture
in the name of a public
entity (such as a State or
local government, school
district, or prison) that
receives agricultural
program payments
</TABLE>
<TABLE>
<CAPTION>
GIVE THE
FOR THIS TYPE OF ACCOUNT: SOCIAL SECURITY
NUMBER OF--
- -----------------------------------------------
<S> <C>
1. An individual's account The individual
2. Two or more individuals The actual owner
(joint account) of the account
or, if combined
funds, any one of
the
individuals(1)
3. Husband and wife (joint The actual owner
account) of the account
or, if
joint funds,
either person(1)
4. Custodian account of a The minor(2)
minor (Uniform Gift to
Minors Act)
5. Adult and minor (joint The adult or, if
account) the minor is the
only contributor,
the minor(1)
6. Account in the name of The ward, minor,
guardian or committee for a or incompetent
designated ward, minor, or person(3)
incompetent person
7. a. The usual revocable The grantor-
savings trust account trustee(1)
(grantor is also
trustee)
b. So-called trust account The actual
that is not a legal or owner(1)
valid trust under State
law
8. Sole proprietorship The owner(4)
account
</TABLE>
---------------------------------------
(1) List first and circle the name of the person whose number you furnish.
- ---------------------------------------
(2) Circle the minor's name and furnish the minor's social security number.
(3) Circle the ward's, minor's or incompetent person's name and furnish such
person's social security number.
(4) Show the name of the owner.
(5) List first and circle the name of the legal trust, estate, or pension
trust.
NOTE: If no name is circled when there is more than one name, the number will
be considered to be that of the first name listed.
<PAGE>
GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION
NUMBER OF SUBSTITUTE FORM W-9
PAGE 2
OBTAINING A NUMBER
If you don't have a taxpayer identification number or you don't know your
number, obtain Form SS-5, Application for a Social Security Number Card, or
Form SS-4, Application for Employer Identification Number, at the local office
of the Social Security Administration or the Internal Revenue Service and
apply for a number.
PAYEES EXEMPT FROM BACKUP WITHHOLDING
Payees specifically exempted from backup withholding on ALL payments include
the following:
.A corporation.
.A financial institution.
. An organization exempt from tax under section 501(a), or an individual
retirement plan.
. The United States or any agency or instrumentality thereof.
. A State, the District of Columbia, a possession of the United States, or
any subdivision or instrumentality thereof.
. A foreign government, a political subdivision of a foreign government, or
any agency or instrumentality thereof.
. An international organization or any agency, or instrumentality thereof.
. A registered dealer in securities or commodities registered in the U.S.
or a possession of the U.S.
. A real estate investment trust.
. A common trust fund operated by a bank under section 584(a)
. An exempt charitable remainder trust, or a non-exempt trust described in
section 4947(a)(1).
. An entity registered at all times under the Investment Company Act of
1940.
. A foreign central bank of issue.
Payments of dividends and patronage dividends not generally subject to backup
withholding include the following:
. Payments to nonresident aliens subject to withholding under section 1441.
. Payments to partnerships not engaged in a trade or business in the U.S.
and which have at least one nonresident partner.
. Payments of patronage dividends where the amount received is not paid in
money.
. Payments made by certain foreign organizations.
. Payments made to a nominee.
Payments of interest not generally subject to backup withholding include the
following:
. Payments of interest on obligations issued by individuals. Note: You may
be subject to backup withholding if this interest is $600 or more and is
paid in the course of the payer's trade or business and you have not pro-
vided your correct taxpayer identification number to the payer.
. Payments of tax-exempt interest (including exempt-interest dividends un-
der section 852).
. Payments described in section 6049(b)(5) to non-resident aliens.
. Payments on tax-free covenant bonds under section 1451.
. Payments made by certain foreign organizations.
. Payments made to a nominee.
Exempt payees described above should file Form W-9 to avoid possible erroneous
backup withholding. FILE THIS FORM WITH THE PAYER, FURNISH YOUR TAXPAYER
IDENTIFICATION NUMBER, WRITE "EXEMPT" ON THE FACE OF THE FORM, AND RETURN IT
TO THE PAYER. IF THE PAYMENTS ARE INTEREST, DIVIDENDS, OR PATRONAGE DIVIDENDS,
ALSO SIGN AND DATE THE FORM.
Certain payments other than interest, dividends, and patronage dividends,
that are not subject to information reporting are also not subject to backup
withholding. For details, see the regulations under sections 6041, 6041A(a),
6045, and 6050A.
PRIVACY ACT NOTICE.--Section 6109 requires most recipients of dividend, inter-
est, or other payments to give taxpayer identification numbers to payers who
must report the payments to IRS. IRS uses the numbers for identification pur-
poses. Payers must be given the numbers whether or not recipients are required
to file tax returns. Beginning January 1, 1993, payers must generally withhold
31% of taxable interest, dividend, and certain other payments to a payee who
does not furnish a taxpayer identification number to a payer. Certain penal-
ties may also apply.
PENALTIES
(1) PENALTY FOR FAILURE TO FURNISH TAXPAYER IDENTIFICATION NUMBER.--If you
fail to furnish your taxpayer identification number to a payer, you are sub-
ject to a penalty of $50 for each such failure unless your failure is due to
reasonable cause and not to willful neglect.
(2) FAILURE TO REPORT CERTAIN DIVIDEND AND INTEREST PAYMENTS.--If you fail to
include any portion of an includible payment for interest, dividends, or pat-
ronage dividends in gross income, such failure will be treated as being due to
negligence and will be subject to a penalty of 5% on any portion of an under-
payment attributable to that failure unless there is clear and convincing evi-
dence to the contrary.
(3) CIVIL PENALTY FOR FALSE INFORMATION WITH RESPECT TO WITHHOLDING.--If you
make a false statement with no reasonable basis which results in no imposition
of backup withholding, you are subject to a penalty of $500.
(4) CRIMINAL PENALTY FOR FALSIFYING INFORMATION.--Falsifying certifications or
affirmations may subject you to criminal penalties including fines and/or im-
prisonment.
FOR ADDITIONAL INFORMATION CONTACT YOUR TAX CONSULTANT OR THE INTERNAL REVENUE
SERVICE
