<PAGE>
Prospectus Supplement No. 1
Filed Pursuant to Rule 424(b)(3)
(To Prospectus dated May 12, 1998)
Registration No. 333-47933
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED MAY 12, 1998)
LOGO
USN COMMUNICATIONS, INC.
9% CONVERTIBLE SUBORDINATED NOTES DUE 2004
9% CONSENT CONVERTIBLE SUBORDINATED NOTES DUE 2006
WARRANTS TO PURCHASE COMMON STOCK
COMMON STOCK
This Prospectus Supplement supplements information contained in that certain
Prospectus, dated May 12, 1998 (the "Prospectus"), relating to (i) $36.0
million in aggregate principal amount at maturity of 9% Convertible
Subordinated Notes due 2004 (the "Original Notes"), (ii) $13.0 million in
aggregate principal amount at maturity of 9% Consent Convertible Subordinated
Notes due 2006 (the "Consent Notes" and, together with the Original Notes, the
"Convertible Notes"), (iii) 1,590,266 warrants to purchase an aggregate of
2,989,840 shares, subject to adjustment under certain circumstances, of Common
Stock, par value $.01 per share (the "Common Stock") of USN Communications,
Inc. (the "Company") at an initial exercise price of $.01 per share
(collectively, the "Warrants") and (iv) up to 7,726,129 shares of Common Stock
which includes (a) up to 4,736,289 shares of Common Stock issuable upon
conversion of the Convertible Notes (the "Convertible Note Shares") and (b)
2,989,840 shares of Common Stock issuable upon exercise of the Warrants
(collectively, the "Warrant Shares") which may be offered for sale from time
to time by the selling securityholders (the "Selling Securityholders"). The
Prospectus Supplement is not complete without, and may not be delivered or
utilized except in connection with, the Prospectus, including any amendments
or supplements thereto. The Prospectus also relates to the initial issuance of
the Convertible Note Shares by the Company. The Convertible Notes, the
Warrants, the Convertible Note Shares and the Warrant Shares are collectively
referred to as the "Securities." The Company will not receive any proceeds
from the sale of the Securities by the Selling Securityholders but will
receive proceeds upon the exercise of the Warrants of $.01 per share.
The Prospectus is hereby amended and supplemented to include the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 filed with
the Securities and Exchange Commission on May 15, 1998, attached as Annex A
hereto.
----------------
SEE "RISK FACTORS," BEGINNING ON PAGE 15 OF THE PROSPECTUS, FOR A DISCUSSION
OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS IN THE
SECURITIES.
----------------
THE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
----------------
The date of this Prospectus Supplement is June 9, 1998.
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
ANNEX A
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition period from to
COMMISSION FILE NO. 333-16265
USN COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 36-3947804
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION
OR ORGANIZATION)
10 SOUTH RIVERSIDE PLAZA, SUITE 401, 60606
CHICAGO, ILLINOIS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (312) 906-3600
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of April 30, 1998, there were 23,137,513 shares outstanding of the
registrant's Common Stock, par value $.01 per share.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................... $ 108,162,625 $ 87,454,418
Marketable equity securities.................... 12,341,365 8,180,824
Accounts receivable, net of allowances for
doubtful accounts of $7,684,000 at 1998 and
$4,537,000 at 1997.............................. 47,521,094 23,917,093
Inventory........................................ 1,217,187 --
Other current assets............................ 2,621,170 1,443,575
------------- -------------
Total current assets.......................... 171,863,441 120,995,910
Property and equipment--net...................... 22,762,708 16,802,065
Goodwill, net of accumulated amortization of
$369,000 at 1998................................ 49,611,970 --
Other assets..................................... 50,822,231 33,402,271
------------- -------------
Total assets.................................. $ 295,060,350 $ 171,200,246
============= =============
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND
COMMON STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable................................ $ 28,457,007 $ 20,485,168
Accrued expenses and other liabilities.......... 19,648,351 7,178,373
Capital lease obligations and notes payable..... 618,440 559,223
------------- -------------
Total current liabilities..................... 48,723,798 28,222,764
14 5/8% Senior Discount Notes, net of Original
Issue Discount................................. 133,285,939 105,486,381
14% Senior Discount Notes, net of Original
Issue Discount................................. 12,969,222 35,790,140
9% Convertible Subordinated Discount Notes, net
of Original Issue.............................. 31,546,854 30,867,615
Discount
9% Consent Convertible Notes, net of Original
Issue Discount................................. 10,187,500 --
Capital lease obligations and notes payable..... 652,954 555,960
------------- -------------
Total liabilities............................. 237,366,267 200,922,860
REDEEMABLE PREFERRED STOCK:
9% Cumulative Convertible Pay-In-Kind Preferred
Stock: par value $1;
30,000 shares authorized at 1997; 10,920
shares outstanding at
December 31, 1997.............................. -- 10,920
9% Cumulative Convertible Pay-In-Kind Preferred
Stock, Series A: par value $1; 150,000 shares
authorized at 1997; 45,209 shares outstanding
at December 31, 1997........................... -- 45,209
Accumulated unpaid dividends.................... -- 1,516,355
Additional paid-in-capital...................... -- 55,704,861
------------- -------------
Total redeemable preferred stock.............. -- 57,277,345
COMMON STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.01 par value, 100,000,000
shares authorized at March
31, 1998 and 30,000,000 shares authorized at
December 31, 1997; 22,082,333 and 7,282,511
shares issued at March 31, 1998 and December
31, 1997, respectively......................... 220,823 72,826
Additional paid-in capital...................... 259,826,741 74,642,145
Treasury stock, 10,000 shares at December 31,
1998 and 1997.................................. (1,077) (1,077)
Accumulated other comprehensive income:
Unrealized gain on available-for-sale
securities..................................... 12,341,365 8,180,824
Accumulated deficit............................. (214,693,769) (169,894,677)
------------- -------------
Total common stockholders' equity (deficit)... 57,694,083 (86,999,959)
------------- -------------
Total liabilities, redeemable preferred stock,
and common stockholders' equity (deficit).... $ 295,060,350 $ 171,200,246
============= =============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
S-2
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH
31,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
NET SERVICE REVENUE $ 32,420,538 $ 3,916,839
COST OF SERVICES................................... 26,636,511 3,435,022
------------ ------------
Gross profit................................... 5,784,027 481,817
EXPENSES:
Sales and marketing.............................. 24,425,177 10,190,647
General and administrative....................... 20,087,841 6,462,343
------------ ------------
OPERATING LOSS..................................... (38,728,991) (16,171,173)
OTHER INCOME (EXPENSE):
Interest income.................................. 1,568,417 643,290
Interest expense................................. (7,062,533) (2,036,327)
Other income..................................... 2,749 3,305
------------ ------------
Other income (expense)--net.................... (5,491,367) (1,389,732)
------------ ------------
NET LOSS........................................... $(44,220,358) $(17,560,905)
============ ============
ACCUMULATED PREFERRED DIVIDENDS.................... $ 578,734 $ 225,000
============ ============
NET LOSS TO COMMON SHAREHOLDERS.................... $(44,799,092) $(17,785,905)
============ ============
NET LOSS PER COMMON SHARE --BASIC AND DILUTED...... $ (3.12) $ (2.48)
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING......... 14,366,749 7,175,250
============ ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
S-3
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1998 AND YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
SERIES A
9% PIK 9% PIK ACCUMULATED ADDITIONAL
PREFERRED PREFERRED UNPAID PAID-IN
STOCK STOCK DIVIDENDS CAPITAL TOTAL
--------- --------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1996................... $ 10,000 $ 225,000 $ 9,810,185 $ 10,045,185
Issuance of 920 shares
of 9% PIK Preferred
Stock as payment of
dividends.............. 920 (920,251) 919,331 --
Issuance of 45,209
shares of Series A 9%
PIK Preferred Stock.... $ 45,209 45,163,863 45,209,072
Costs incurred related
to issuance of Series A
9% PIK Preferred Stock. (188,518) (188,518)
Accumulated dividends on
9% PIK Preferred Stock. 940,957 940,957
Accumulated dividends on
Series A 9% PIK
Preferred Stock........ 1,270,649 1,270,649
--------- -------- ------------ ------------ ------------
BALANCE, DECEMBER 31,
1997................... 10,920 45,209 1,516,355 55,704,861 57,277,345
--------- -------- ------------ ------------ ------------
Accumulated dividends on
9% PIK Preferred Stock. 113,847 113,847
Accumulated dividends on
Series A 9% PIK
Preferred Stock........ 464,887 464,887
Conversion of 9% PIK and
Series A 9% PIK
Preferred Stock to
common stock........... (10,920) (45,209) (2,095,089) (55,704,861) (57,856,079)
--------- -------- ------------ ------------ ------------
BALANCE, MARCH 31, 1998. $ -- $ -- $ -- $ -- $ --
========= ======== ============ ============ ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
S-4
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
(DEFICIT) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1998 AND YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL COMMON OTHER
COMMON PAID-IN STOCK HELD COMPREHENSIVE ACCUMULATED
STOCK CAPITAL IN TREASURY INCOME DEFICIT TOTAL
-------- ------------ ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1996................... $ 71,853 $ 54,114,755 $(1,077) $ (57,791,382) $ (3,605,851)
Issuance of 97,251
shares of common stock. 973 531,125 532,098
Compensation expense on
stock options.......... 644,538 644,538
Issuance of stock
warrants............... 19,351,727 19,351,727
Accumulated dividends on
9% PIK Preferred Stock. (940,957) (940,957)
Accumulated dividends on
Series A 9% PIK
Preferred Stock........ (1,270,649) (1,270,649)
Comprehensive income
(loss):
Net loss.............. (109,891,689) (109,891,689)
Other comprehensive
income (loss), net of
tax:
Unrealized gain of
available-for-sale
securities......... $ 8,180,824 8,180,824
-------------
Comprehensive loss.... (101,710,865)
-------- ------------ ------- ----------- ------------- -------------
BALANCE, DECEMBER 31,
1997................... 72,826 74,642,145 (1,077) 8,180,824 (169,894,677) (86,999,959)
-------- ------------ ------- ----------- ------------- -------------
Issuance of 8,669,636
shares of common stock. 86,696 137,981,195 138,067,891
Costs incurred related
to issuance of stock... (10,764,324) (10,764,324)
Accumulated dividends on
9% PIK Preferred Stock. (113,847) (113,847)
Accumulated dividends on
Series A 9% PIK
Preferred Stock........ (464,887) (464,887)
Conversion of 9% PIK and
Series A 9% PIK
Preferred Stock to
common stock........... 61,301 57,794,778 57,856,079
Compensation expense on
stock options.......... 172,947 172,947
Comprehensive income
(loss):
Net loss.............. (44,220,358) (44,220,358)
Other comprehensive
income (loss), net of
tax:
Unrealized gain of
available-for-sale
securities......... 4,160,541 4,160,541
-------------
Comprehensive loss.... (40,059,817)
-------- ------------ ------- ----------- ------------- -------------
BALANCE, MARCH 31, 1998. $220,823 $259,826,741 $(1,077) $12,341,365 $(214,693,769) $ 57,694,083
======== ============ ======= =========== ============= =============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
S-5
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH
31,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................... $(44,220,358) $(17,560,905)
Adjustments to reconcile net loss to net cash
flows from operating activities:
Depreciation and amortization................... 2,152,404 361,243
Amortization of organization costs and
intangibles.................................... 62,546 364,646
Non-cash interest on debt obligations........... 7,017,247 2,016,191
Stock compensation award expense................ 172,947 125,697
Changes in:
Accounts receivable........................... (18,361,904) (1,342,077)
Allowance for doubtful accounts............... 1,244,661 120,032
Other current assets.......................... (269,147) (199,945)
Other assets.................................. -- (294,338)
Accounts payable.............................. 2,868,484 (1,291,659)
Accrued expenses.............................. 9,089,488 779,384
------------ ------------
Net cash flows from operating activities.... (40,243,632) (17,041,763)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment................ (5,763,436) (2,917,385)
Purchase of subsidiary, net of cash acquired...... (69,053,616) --
------------ ------------
Net cash flows from investing activities.... (74,817,052) (2,917,385)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Consent Convertible Notes........... 10,000,000 --
Issuance of common stock.......................... 138,067,891 --
Costs incurred related to issuance of stock....... (10,764,324) --
Deposits.......................................... (1,390,224) 32,550
Repayment of capital lease obligations and notes
payable.......................................... (144,452) (154,053)
------------ ------------
Net cash flows from financing activities.... 135,768,891 (121,503)
------------ ------------
NET INCREASE (DECREASE) IN CASH................... 20,708,207 (20,080,651)
CASH AND CASH EQUIVALENTS--Beginning of period.... 87,454,418 60,818,478
------------ ------------
CASH AND CASH EQUIVALENTS--End of period.......... $108,162,625 $ 40,737,827
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Conversion of Preferred Stock to Common Stock..... $ 57,856,079 --
============ ============
Dividends Paid in Kind............................ $ 2,095,089 $ 450,000
============ ============
Declared Dividends................................ $ 578,734 $ 225,000
============ ============
Capital Lease Obligations Incurred................ $ 287,617 --
============ ============
Cash Paid for Interest............................ $ 45,286 $ 26,464
============ ============
Cash Paid for Income Taxes........................ -- --
============ ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
S-6
<PAGE>
USN COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
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,
consisting only of normal recurring 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. NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its
components. Other comprehensive income consists solely of unrealized gains on
available-for-sale securities.
3. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Billed............................................. $21,191 $10,790
Unbilled........................................... 34,014 17,664
Gross accounts receivable.......................... 55,205 28,454
Allowance for doubtful accounts.................... (7,684) (4,537)
Net accounts receivable............................ $47,521 $23,917
</TABLE>
Unbilled accounts receivable comprises access charges, features and usage
for revenue earned but not yet billed to customers. Substantially all unbilled
accounts receivable were billed within 45 days after the quarter.
4. PRIVATE PLACEMENT OFFERINGS
In August 1997, in connection with the 1997 private placement offering, the
Company issued an option to the holders of the 14% Senior Discount Notes due
2006 (the "14% Senior Notes") to purchase $13.0 million aggregate principal
amount at maturity of the Company's 9% Convertible Subordinated Discount Notes
due 2006 ("Consent Notes") for an aggregate purchase price of $10 million and
convertible into common stock at a conversion price of $10.121 per share based
on accreted value at the time of conversion. Pursuant to the option, which was
exercised by the holders in October 1997, the Consent Notes were sold in
January 1998 at a price before commissions of $767.90 per $1,000 face amount.
These notes will accrete interest at an annual rate of 9%, compounded
semiannually, until January 13, 2001. Thereafter interest will be paid
semiannually in arrears in cash.
In March 1998, the holders of the 14% Senior Notes exchanged $31.5 million
aggregate principal amount at maturity of the Company's 14% Senior Notes for
$33.6 million aggregate principal amount at maturity of the Company's 14 5/8%
Senior Discount Notes due 2004 (the "14 5/8% Senior Notes").
S-7
<PAGE>
5. CHANGES IN EQUITY
In February 1998, the Company issued and sold 8,600,000 shares of Common
Stock (of which 600,000 shares were sold pursuant to the underwriters' over-
allotment options) in its initial public offering for net proceeds of
approximately $127.0 million. In March 1998, the Company issued and sold
28,861 additional shares solely to cover underwriters' over-allotment options
for net proceeds of $0.4 million. In conjunction with the initial public
offering, all of the Company's outstanding 9% Preferred Stock and Series A 9%
Preferred Stock, including dividends accrued through the conversion date, were
converted to 6,130,175 shares of Class A Common Stock. Subsequently, all of
the shares of the Company's Class A Common Stock were converted to an equal
number of the Company's newly created common stock.
6. ACQUISITION
On February 20, 1998, the Company used a portion of the net proceeds from
its initial public offering to acquire all of the outstanding capital stock of
Hatten Communications Holding Company, Inc., a Connecticut corporation
("Hatten Communications"), pursuant to a Stock Purchase Agreement dated
January 7, 1998, for approximately $69.1 million, net of cash acquired,
including the repayment of approximately $14.0 million of existing
indebtedness and the payment of certain fees and expenses.
The acquisition was recorded under the purchase method of accounting, and
accordingly, the results of operations of Hatten Communications have been
included in the consolidated financial statements since the date of
acquisition. The purchase price has been allocated to assets acquired and
liabilities assumed based on their fair market value at the date of the
acquisition as summarized below (in thousands):
<TABLE>
<S> <C>
Current assets................................................... $ 8,317
Long-term assets................................................. 1,291
Intangible assets................................................ 17,961
Goodwill......................................................... 49,981
Current liabilities.............................................. (8,496)
Purchase price................................................... $69,054
</TABLE>
Goodwill of $50.0 million is being amortized on a straight-line basis over
15 years. Additionally, the fair market value ascribed to the acquired
customer list of $15.0 million, included in intangible assets, is being
amortized on a straight-line basis over 5 years. Management is in the process
of reviewing the final allocation of the purchase price.
The following table reflects unaudited pro forma combined results of
operations of the Company and Hatten Communications on the basis that the
acquisition had taken place on January 1, 1997 (in thousands, except per share
data):
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
MARCH 31, MARCH 31,
1998 1997
--------- ---------
<S> <C> <C>
Net service revenue................................. $ 43,156 $ 11,899
Net loss to common shareholders..................... $(48,706) $(20,284)
Net loss per common share B--basic and diluted...... $ (3.39) $ (2.83)
Weighted average common shares outstanding.......... 14,367 7,175
</TABLE>
S-8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
In 1994, 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, LP., a telecommunications
reseller and consulting firm (the "Quest Acquisition").
The Company negotiated for the first total service resale agreement with
Ameritech Corporation for local services, which was signed in November 1995,
and negotiated with NYNEX Corporation (now Bell Atlantic Corporation) for a
comprehensive local resale agreement which was signed in July 1996. The
Company also consummated various other agreements in 1996 with certain
carriers for the resale of long distance and enhanced and other value-added
services. The Company commenced the marketing and provisioning of services
under those agreements during the latter half of 1996. Although management
believes that its current strategy will have a positive effect on the
Company's results of operations over the long-term, through an increase in its
customer base and product offerings, this strategy is expected to have a
negative effect on the Company's results of operations over the short-term.
The Company anticipates losses and negative cash flow for the foreseeable
future, attributable in part to significant investments in operating, sales,
marketing, management information systems and general and administrative
expenses. To date, the Company's growth, including capital expenditures, has
been funded primarily by capital contributions, sales of preferred stock and
by the proceeds from the private placement or public offering of debt and
equity securities.
In August 1997, the beneficial holders of all of the 14% Senior Notes and
the 9% Convertible Subordinated Notes due 2003 (the "Convertible Notes")
consented (the "Consent") to the amendment of the indentures with respect to
the 14% Senior Notes and the Convertible Notes to allow the Company to
consummate the private placement of the 14 5/8% Senior Notes. In connection
with the Consent, the Company paid a consent fee to such holders consisting of
warrants to purchase 145,160 shares of Common Stock, at an exercise price of
$.01 per share. The Company also granted to such holders an option to purchase
the Consent Notes, which have terms substantially similar to the Convertible
Notes, for an aggregate purchase price of $10.0 million. The option was
exercised in October 1997 and the Consent Notes were issued in January 1998.
Additionally, the Company granted to holders of the 14% Senior Notes an
option, for a specified period of time, to exchange all, or a portion, of the
14% Senior Notes for 14 5/8% Senior Notes having an accreted value equal to
the accreted value of such 14% Senior Notes at the time of such exchange. In
March 1998, such holders exchanged $31.5 million aggregate principal amount at
maturity of 14% Senior Notes for $33.6 million aggregate principal amount at
maturity of 14 5/8% Senior Notes.
In February 1998, the Company issued and sold 8,600,000 shares of its Common
Stock (of which 600,000 shares were sold pursuant to the underwriters' over-
allotment options) in its initial public offering for net proceeds of
approximately $127.0 million. In March 1998, the Company issued and sold
28,861 additional shares solely to cover underwriters' over-allotment options
for net proceeds of $0.4 million. Also, in February 1998, the Company
completed the acquisition of Hatten Communications for approximately $69.1
million, which included the repayment of approximately $14.0 million of
existing indebtedness and the payment of certain fees and expenses. The first
quarter 1998 results include the operations of Hatten Communications from the
acquisition date.
S-9
<PAGE>
The Company's net service revenue consists primarily of sales revenue from
telecommunications resale services net of certain adjustments, including
credits and allowances. The Company bills its subscribers for local, long
distance and other service usage based on the type of service utilized, the
number, time and duration of calls, the geographic location of the terminating
phone numbers and the applicable rate plan in effect at the time of the call.
Cost of service includes the cost of local, long distance and other 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 bad debts and all amortization
expenses. Depreciation is allocated throughout sales, marketing, general and
administrative expense based on asset ownership.
The Company has experienced significant growth in the past and, depending on
the extent of its future growth, may experience significant strain on its
management, personnel and information systems. To accommodate this growth, the
Company will continue to implement and improve operational, financial and
management information systems. In an effort to support its growth, the
Company added several senior management positions and over 600 employees in
1997 and over 400 employees in the first quarter of 1998. Also, the Company is
implementing new information systems that will provide improved recordkeeping
for customer information and management of uncollectible accounts and fraud
control.
RESULTS OF OPERATIONS
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Net service revenue increased to $32.4 million for the three months ended
March 31, 1998 from $3.9 million for the three months ended March 31, 1997.
The number of local access lines in service at March 31, 1998 was 226,084
compared to 18,557 as of March 31, 1997. The net increase in access lines was
54,122 lines for the first quarter of 1998 compared to 10,193 lines for the
first quarter of 1997. The increase in net service revenue was due primarily
to the substantial increase in the Company's installed base and the
corresponding increase in the customer base in the Company's geographic
markets.
Gross profit increased to $5.8 million for the three months ended March 31,
1998 from $0.5 million for the three months ended March 31, 1997. The increase
in gross profit is attributable to the above mentioned increase in customer
base. The gross margin percentage was 17.8% for the first quarter of 1998, up
from 12.3% for the first quarter of 1997 and 14.4% for the fourth quarter of
1997. The acquisition of Hatten Communications in the first quarter of 1998
contributed to the favorable increase in the gross profit percentage.
Sales and marketing expenses increased $14.2 million, or 139%, from $10.2
million for the three months ended March 31, 1997 to $24.4 million for the
three months ended March 31, 1998. The increase was due primarily to an
increase in the number of sales and marketing employees from approximately 420
at March 31, 1997 to approximately 835 at March 31, 1998 to support the growth
in customer base. This increase in headcount resulted in increases to salaries
and benefits of approximately $9.8 million, travel and training costs of
approximately $1.7 million, recruitment costs of approximately $1.3 million
and facility and office related expenses of approximately $0.9 million. These
increases were offset by a decrease of $1.0 million in advertising costs.
General and administrative expenses increased $13.6 million, or 209%, to
$20.1 million for the three months ended March 31, 1998 versus $6.5 million
for the three months ended March 31, 1997. The increase was due primarily to
an increase in the number of operations and administrative employees from
approximately 200 at March 31, 1997 to approximately 615 at March 31, 1998 to
support the growth in the customer base, which
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resulted in increases to salaries and benefits of approximately $3.6 million,
increased bad debt expense of approximately $2.2 million, billing costs of
approximately $2.0 million, fees paid to consultants and other professionals
of approximately $1.9 million and facility related costs of approximately $1.4
million.
Interest and other income increased to $1.6 million for the three months
ended March 31, 1998 from $0.6 million for the three months ended March 31,
1997 due primarily to an increase in the average cash and cash equivalents
balance for the three month period ended March 31, 1998 versus the three month
period ended March 31, 1997.
Interest expense increased to $7.1 million for the three months ended March
31, 1998 from $2.0 million for the three months ended March 31, 1997. This
increase was due primarily to interest expense attributable to the 14 5/8%
Senior Notes issued in August 1997 and the Consent Notes issued in January
1998.
As a result of the factors described above, the Company had a net loss of
$44.2 million for the three months ended March 31, 1998 compared to a net loss
of $17.6 million for the three months ended March 31, 1997. The first quarter
1998 EBITDA was a negative $36.5 million versus a negative $15.4 million in
the first quarter of 1997.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has funded its operations primarily through
proceeds from the issuance of debt and equity securities. As of March 31,
1998, the Company had cash and cash equivalents of $108.2 million and working
capital of $123.1 million. The Company's operating activities utilized cash of
approximately $40.2 million for the three months ended March 31, 1998 and
$17.0 million for the three months ended March 31, 1997.
The Company's investing activities for the three months ended March 31, 1998
of $74.8 million consists of $69.1 million for the purchase of Hatten
Communications and property and equipment purchases of $5.8 million related to
the development of systems infrastructure and the increase in computer
equipment and office buildouts related to the corresponding increase in
headcount. For the three months ended March 31, 1997, the Company's investing
activities consisted of $2.9 million of property and equipment purchases for
sales office expansion in the Company's geographic markets.
The Company's financing activities generated $135.8 million for the three
months ended March 31, 1998. In January 1998, the Company issued $13.0 million
aggregate principal amount at maturity of Consent Notes for an aggregate
purchase price of $10.0 million. In February 1998, the Company issued and sold
8,600,000 shares of Common Stock (of which 600,000 shares were sold pursuant
to the underwriters' over-allotment options) in its initial public offering
for net proceeds of approximately $127.0 million. In March 1998, the Company
issued and sold 28,861 additional shares solely to cover underwriters' over-
allotment options for net proceeds of $0.4 million. Cash utilized for
financing activities for the three months ended March 31, 1997 of
approximately $122,000 related primarily to the repayment of capital lease
obligations and notes payable.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company is party to routine litigation and proceedings
in the ordinary course of its business. The Company and its subsidiaries are
not aware of any current or pending litigation that the Company believes would
have a material adverse effect on the Company's results of operations or
financial condition. The Company and its subsidiaries continue to participate
in regulatory proceedings before the FCC and state regulatory agencies
concerning the authorization of services and the adoption of new regulations.
ITEM 2. CHANGES IN SECURITIES
In February 1998, in connection with the Company's initial public offering,
all of the Company's 9% Preferred Stock and Series A 9% Preferred Stock,
including dividends accrued through the conversion date, were converted into
shares of the Company's Class A Common Stock. Such Class A Common Stock, along
with the Company's Class A Common Stock previously outstanding, was converted
into the Company's Common Stock, par value $.01 per share, in connection with
the initial public offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27. Financial Data Schedule
(b) REPORTS ON FORM 8-K
Form 8-K dated January 8, 1998 to report the execution of a definitive
agreement for the acquisition, by the Company, of Hatten Communications.
Form 8-K dated March 6, 1998 to report the closing of the acquisition, by
the Company, of Hatten Communications.
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<PAGE>
SIGNATURE
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
USN Communications, Inc.
(Registrant)
/s/ Gerald J. Sweas
-------------------------------------
Executive Vice President and Chief
Financial Officer (Duly authorized
officer and principal financial
officer of the registrant)
Date: May 15, 1998
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<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBIT DESCRIPTION PAGE
------- ------------------- ------------
<C> <S> <C>
27 Financial Data Schedule 17
</TABLE>
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