<PAGE> 1
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-41273
PROSPECTUS
$150,000,000
[ACSI LOGO]
OFFER TO EXCHANGE ITS 12 3/4% JUNIOR REDEEMABLE PREFERRED STOCK DUE 2009,
WHICH HAS BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED,
FOR ANY AND ALL OUTSTANDING SHARES OF ITS 12 3/4% JUNIOR REDEEMABLE PREFERRED
STOCK DUE 2009
The Exchange Offer will expire at 5:00p.m., New York City time, on January
22, 1998, unless extended.
------------------------
American Communications Services, Inc. (the "Company" or "ACSI") hereby
offers, upon the terms and subject to the conditions set forth in this
Prospectus and the accompanying letter of transmittal (the "Letter of
Transmittal" and, together with this Prospectus, the "Exchange Offer"), to
exchange its 12 3/4% Junior Redeemable Preferred Stock due 2009 (the "New
Preferred Stock") which has been registered under the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to a Registration Statement of which
this Prospectus is a part, for any and all outstanding shares of its 12 3/4%
Junior Redeemable Preferred Stock due 2009 (the "Old Preferred Stock"), of which
150,000 shares are outstanding as of the date hereof. The New Preferred Stock
will have and the Old Preferred Stock has a liquidation preference of $1,000 per
share (the "Liquidation Preference"). The New Preferred Stock and the Old
Preferred Stock are collectively referred to herein as the "Preferred Stock."
The Company will accept for exchange any and all Old Preferred Stock that is
validly tendered and not withdrawn on or prior to 5:00 P.M., New York City time,
on the date the Exchange Offer expires (the "Expiration Date"), which will be
January 22, 1998 (20 business days following the commencement of the Exchange
Offer), unless the Exchange Offer is extended. Tenders of Old Notes may be
withdrawn at any time prior to 5:00 P.M., New York City time, on the Expiration
Date. The Exchange Offer is not conditioned upon any minimum number of shares of
Old Preferred Stock being tendered for exchange. No fractional shares of Old
Preferred Stock may be tendered. See "The Exchange Offer."
The obligations of the Company with respect to the New Preferred Stock will
be identical to the obligations of the Company with respect to the Old Preferred
Stock and holders will be entitled to the benefits of the same Certificate of
Designation (as defined), which governs both the Old Preferred Stock and the New
Preferred Stock. The form and terms of the New Preferred Stock are generally the
same as the form and terms of the Old Preferred Stock, except that the New
Preferred Stock does not contain terms with respect to dividend rate step-up
provisions and the New Preferred Stock has been registered under the Securities
Act and therefore will not bear legends restricting the transfer thereof. See
"Description of the Preferred Stock." The dividend rate step-up provisions are
intended to benefit holders of the Old Preferred Stock if the Company breaches
its obligations under the Registration Rights Agreement (as defined). By
consummating the Exchange Offer, the Company will satisfy its obligations to the
holders of the Old Preferred Stock, and hence the New Preferred Stock will not
contain dividend rate step-up provisions. See "Description of the Preferred
Stock -- Exchange Offer; Registration Rights."
Dividends on the New Preferred Stock will accrue from the date of issuance,
are cumulative and will be payable quarterly, in arrears, on January 15, April
15, July 15 and October 15 of each year (each, a "Dividend Payment Date")
commencing January 15, 1998, at a rate per annum of 12 3/4% of the Liquidation
Preference thereof. Dividends will also accrue and cumulate on any accrued and
unpaid dividends. Dividends may be paid, at the Company's option, on any
Dividend Payment Date, either in cash or by the issuance of additional shares of
New Preferred Stock (and, at the Company's option, payment of cash in lieu of
fractional shares) with an aggregate Liquidation Preference equal to the amount
of such dividends; provided, however, that after October 15, 2002, to the extent
and for so long as the Company is not precluded from paying cash dividends on
the New Preferred Stock by the terms of any agreement or instrument governing
any of its then outstanding indebtedness, the Company shall pay dividends in
cash. The New Preferred Stock will be redeemable at the Company's option, in
whole or in part, at any time on or after October 15, 2003 at the redemption
prices set forth herein, plus, without duplication, accrued and unpaid dividends
to the date of redemption. In addition, prior to October 15, 2000, the Company
may, at its option, redeem shares of New Preferred Stock having a Liquidation
Preference of up to an aggregate of 35% of the initial aggregate Liquidation
Preference at a redemption price of 112.75%, plus, without duplication, accrued
and unpaid dividends to the date of redemption, with the net proceeds of (i) one
or more public common equity offerings generating cash proceeds of at least $25
million or (ii) the sale of capital stock generating cash proceeds of at least
$25 million to an Eligible Equity Investor (as defined herein); provided that
after any such redemption shares of New Preferred Stock having a Liquidation
Preference of at least 65% of the initial aggregate Liquidation Preference
remain outstanding. The Company is required to redeem all the New Preferred
Stock outstanding on October 15, 2009 at a redemption price equal to 100% of the
Liquidation Preference thereof, plus, without duplication, accrued and unpaid
dividends to the date of redemption. Upon a Change of Control (as defined), the
Company will be required, subject to certain conditions, to offer to purchase
all outstanding shares of the New Preferred Stock at a price equal to 101% of
the Liquidation Preference thereof, or, if such offer to purchase cannot be
made, to reset the dividend rate on the New Preferred Stock so that, after such
reset, the Preferred Stock would have a market value of 101% of the Liquidation
Preference thereof. See "Description of the Preferred Stock."
The New Preferred Stock will rank (i) senior to all existing and future
Junior Stock (as defined), (ii) on a parity with all existing and future Parity
Stock (as defined) and (iii) junior to the Company's 14 3/4% Redeemable
Preferred Stock due 2008 (of which approximately $77.5 million aggregate
liquidation preference was outstanding at September 30, 1997). In addition, the
New Preferred Stock will rank junior in right of payment to all indebtedness and
other obligations of the Company and its subsidiaries. As of September 30, 1997,
there was approximately $474.4 million of outstanding indebtedness (including
trade payables and other liabilities) of the Company and its subsidiaries.
Based on interpretations by the staff of the SEC, as set forth in no-action
letters issued to third parties, the Company believes that the New Preferred
Stock issued pursuant to the Exchange Offer may be offered for resale, resold or
otherwise transferred by holders thereof (other than any holder that is an
"affiliate" of the Company as defined under Rule 405 of the Securities Act),
provided that such New Preferred Stock is acquired in the ordinary course of
such holders' business and such holders are not engaged in, and do not intend to
engage in, a distribution of such New Preferred Stock and have no arrangement
with any person to participate in the distribution of such New Preferred Stock.
However, the staff of the SEC has not considered the Exchange Offer in the
context of a no-action letter and there can be no assurance that the staff of
the SEC would make a similar determination with respect to the Exchange Offer as
in such other circumstances. By tendering the Old Preferred Stock in exchange
for New Preferred Stock, each holder, other than a broker-dealer, will represent
to the Company that: (i) it is not an "affiliate" of the Company (as defined
under Rule 405 of the Securities Act); (ii) any New Preferred Stock to be
received by it were acquired in its ordinary business; and (iii) it is not
engaged in, and does not intend to engage in, a distribution of such New
Preferred Stock and has no arrangement or understanding to participate in a
distribution of the New Preferred Stock. Each broker-dealer that receives New
Preferred Stock 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 Preferred Stock. 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 resales of New Preferred Stock
received in exchange for Old Preferred Stock where such Old Preferred Stock was
acquired by such broker-dealer as a result of market-making activities or other
trading activities. The Company has agreed that, starting on the Expiration Date
and ending on the close of business 180 days after 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."
Prior to this Exchange Offer, there has been no public market for the Old
Preferred Stock or the New Preferred Stock. If such a market were to develop,
the New Preferred Stock could trade at prices that may be higher or lower than
its liquidation preference. The Company does not intend to apply for listing or
quotation of the New Preferred Stock on any securities exchange or stock market.
Therefore, there can be no assurance as to the liquidity of any trading market
for the New Preferred Stock or that an active public market for the New
Preferred Stock will develop. See "Risk Factors -- Lack of Public Market;
Exchange Offer."
Bear Stearns & Co. Inc. (the "Initial Purchaser") has agreed that it will
act as a market-maker for the New Preferred Stock. However, the Initial
Purchaser is not obligated to so act and it may discontinue any such
market-making at any time without notice. The Company will not receive any
proceeds from this Exchange Offer. The Company has agreed to pay the expenses of
the Exchange Offer. No underwriter is being used in connection with this
Exchange Offer.
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY HOLDERS OF
OLD PREFERRED STOCK WHO TENDER THEIR OLD PREFERRED STOCK IN THE EXCHANGE OFFER,
SEE "RISK FACTORS" BEGINNING ON PAGE 14 OF THIS PROSPECTUS.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
The date of this Prospectus is December 23, 1997.
<PAGE> 2
ADDITIONAL INFORMATION
The Company is subject to the informational reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") and in
accordance therewith files reports, proxy and information statements and other
information with the SEC. Such reports, proxy and information statements and
other information may be inspected and copied at the public reference facilities
of the SEC at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, or at its regional offices located at Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center,
Suite 1300, New York, New York 10048. Copies of such material can be obtained
from the SEC by mail at prescribed rates, or in certain cases by accessing the
SEC's World Wide Web site at http://www.sec.gov. Requests should be directed to
the SEC's Public Reference Section, Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549. The Company's Common Stock is quoted on
the Nasdaq National Market and material filed by the Company can be inspected at
the offices of the National Association of Securities Dealers, Inc., 1735 K
Street N.W., Washington, D.C. 20006.
The Company has filed with the SEC a registration statement on Form S-4
(herein, together with all amendments and exhibits, referred to as the
"Registration Statement") under the Securities Act with respect to the New
Preferred Stock offered hereby. This Prospectus, which forms a part of the
Registration Statement, does not contain all of the information set forth or
incorporated by reference in the Registration Statement and the exhibits and
schedules thereto, certain parts of which are omitted in accordance with the
rules and regulations of the SEC. For further information with respect to the
Company and the New Preferred Stock offered hereby, reference is made to the
Registration Statement. This Prospectus contains summaries of the material terms
and provisions of certain documents and, in each instance, reference is made to
the copy of such document filed as an exhibit to the Registration Statement.
Copies of the Registration Statement and the exhibits thereto may be inspected,
without charge, at the offices of the SEC at the address set forth above.
Certain statements contained in "Risk Factors," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business,"
including statements regarding the development of the Company's businesses, the
markets for the Company's services and products, the Company's anticipated
capital expenditures, regulatory reform and other statements contained herein
regarding matters that are not historical facts, are forward-looking statements
(as such term is defined in the Private Securities Litigation Reform Act of
1995). Because such statements include risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, those discussed under "Risk Factors." The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any of the forward-looking statements contained
herein to reflect any change in the Company's expectations, with regard thereto
or any changes in events, conditions or circumstances on which any statement is
based.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents previously filed with the SEC (File No. 0-25314)
are hereby incorporated by reference into this Prospectus:
(i) the Company's Annual Report on Form 10-KSB for the fiscal year
ended June 30, 1996;
(ii) the Company's Annual Report on Form 10-KSB/A for the fiscal year
ended June 30, 1996;
(iii) the Company's Transition Report on Form 10-KSB for the fiscal
period from July 1, 1996 to December 31, 1996;
(iv) the Company's Transition Report on Form 10-KSB/A for the fiscal
period from July 1, 1996 to December 31, 1996;
(v) the Company's Quarterly Reports on Form 10-QSB for the quarterly
periods ended March 31, June 30 and September 30, 1997;
i
<PAGE> 3
(vi) the Company's Current Reports on Form 8-K, dated January 8, 1997,
January 9, 1997, February 7, 1997, July 29, 1997, October 24, 1997 and
November 7, 1997; and
(vii) the description of the Company's Common Stock contained in its
registration statement on Form 8-A filed with the SEC on December 23, 1994,
including any amendments or reports filed for the purpose of updating such
description.
All documents subsequently filed by the Company pursuant to Section 13(a),
13(c), 14 or 15(d) of the Exchange Act prior to the Expiration Date to which
this Prospectus relates shall be deemed to be incorporated by reference into
this Prospectus and to be part hereof from the date of filing thereof.
Any statement contained in a document incorporated by reference herein
shall be deemed to be modified or superseded for purposes of this Prospectus to
the extent that a statement contained herein or in any other subsequently filed
document which also is incorporated herein modifies or replaces such statement.
Any statement so modified or superseded shall not be deemed, in its unmodified
form, to constitute a part of this Prospectus.
This Prospectus incorporates documents by reference which are not presented
herein or delivered herewith. These documents are available from Riley M.
Murphy, Executive Vice President -- Legal and Regulatory Affairs, American
Communications Services, Inc., at the Company's executive offices located at 131
National Business Parkway, Suite 100, Annapolis Junction, MD 20701, telephone
(301) 617-4200. In order to ensure timely delivery of the documents, any request
should be made by January 14, 1998.
ii
<PAGE> 4
SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and notes thereto appearing
elsewhere or incorporated by reference in this Prospectus. Subsequent to June
30, 1996, the Company changed its fiscal year-end from June 30 to December 31.
Accordingly, all data for the fiscal period ended December 31, 1996 are for the
six-month period then ended. Please refer to the "Glossary" for the definitions
of certain capitalized terms used herein and elsewhere in this Prospectus. As
used in this Prospectus, unless the context otherwise requires, "ACSI" or the
"Company" refers to American Communications Services, Inc. and its subsidiaries.
THE COMPANY
American Communications Services, Inc. ("ACSI" or the "Company") provides a
broad range of integrated local voice and data communications services primarily
to commercial customers in mid-sized markets in the southern United States. As a
competitive local exchange carrier ("CLEC"), the Company has constructed its own
local fiber optic networks in 32 markets, is now evaluating additional markets
in which it may construct local networks and expects to offer services on its
own networks or on a resale basis in up to 50 markets by the end of 1998. The
Company uses its own facilities and leases network capacity from others to
provide long distance carriers, Internet service providers ("ISPs") and
business, government and institutional end-users with an alternative to the
incumbent local phone companies for high-quality voice, data, video transport
and other telecommunications services. The Company believes that its customers
choose ACSI's telecommunications services because of the reliability and breadth
of the Company's services, discounted pricing relative to the incumbent local
exchange carrier ("ILEC") and a high level of customer service.
From the formation of the Company through 1996, the Company derived
substantially all of its revenues from the sale of dedicated services to
interexchange carriers ("IXCs") and ISPs. Since the passage of the
Telecommunications Act of 1996 (the "Federal Telecommunications Act"), however,
the Company has enhanced its product offerings to meet the needs of commercial
end-users, and is aggressively expanding the sales and marketing capabilities
necessary to deliver these products to such customers. Specifically, the Company
introduced local switched voice services, including local exchange services
(dial tone) in late 1996, and has also added capabilities to provide other
services such as high speed video conferencing, frame relay, asynchronous
transfer mode ("ATM") and Internet access.
PRODUCTS AND SERVICES
The Company currently provides a wide range of local telecommunications
services including dedicated and private line, local switched voice services,
high-speed data services and Internet services. The Company's SONET-based local
fiber optic networks and its coast-to-coast leased high broadband backbone data
network ("ACSINet") are designed to support this wide range of enhanced
communications services, provide increased network reliability and reduce costs
for its customers, as follows:
- Dedicated Services. The Company's special access services, switched
transport services and private line services provide high capacity
non-switched interconnections: (1) between points of presence ("POPs") of
the same IXC; (2) between POPs of different IXCs; (3) between large
business and government end-users and their selected POPs; (4) between an
IXC POP and an ILEC central office, or between two such central offices;
and (5) between different locations of business or government end-users.
During 1996, such dedicated services provided substantially all of the
Company's revenues.
- Local Switched Voice Services. The Company began offering local switched
voice services (including dial tone) in late 1996. As of September 30,
1997, the Company offered such local switched services using its own
facilities in 9 markets and offered such services on a resale basis in a
total of 32 markets. The Company expects to offer facilities-based
services in 16 of the markets in which it has operational local networks
by the end of 1997, and it expects to offer local services on a resale
basis in additional markets. As an adjunct to its local switched
services, the Company anticipates providing calling card and other
interLATA services by the end of fiscal 1997.
1
<PAGE> 5
- Data Services. During 1996, the Company deployed ACSINet and as of
September 30, 1997 had a total of 44 data POPs. ACSI provides a full
range of high-speed data services over this network, including Internet
connectivity, frame relay, ATM and managed services (such as network
design, configuration and installation) to businesses, government, health
care providers, educational institutions and ISPs for local and wide area
network solutions.
STRATEGY
The Company's objective is to become a full-service alternative to the ILEC
primarily for business, government and institutional end-users in its markets by
offering superior products with excellent customer service at competitive
prices. In order to achieve this objective, the Company seeks to:
Leverage Existing Infrastructure.
The Company believes that its integrated telecommunications networks, both
its local fiber networks and ACSINet, are capable of providing a broad range of
voice and data communications services to its customers. The Company is focusing
its efforts on improving penetration in the markets it already serves by
continuing to offer additional services. The Company believes that providing
switched local voice services permits it to increase the traffic and revenue
associated with its networks. The Company also recently began providing
calling-card, teleconferencing and other long distance services. In markets in
which it does have operational networks, the Company's decision to pursue a
resale strategy would help position the Company as a full-service provider,
capable of providing its customers with a one-stop-shopping alternative to the
ILEC. In markets in which it does not currently have an operational network,
this resale strategy may position the Company to eventually construct networks
in those markets, which networks would benefit immediately from an existing
customer base.
Develop Direct and Indirect Sales Channels to Commercial End-Users.
The Company has divided its sales and marketing efforts into three
different channels: direct sales to end-users, sales to IXCs and ISPs and sales
of private-label services through alternative distribution channels.
- Direct Sales. The Company's local sales force continues to focus on the
commercial end-users in each of the markets it serves. The Company
believes that its local, customer-oriented, single point-of-service sales
structure facilitates greater customer care in both the sales and
customer service processes and helps the Company differentiate itself as
a customer-focused telecommunications services provider. The Company's
major account sales force targets large national accounts. As of
September 30, 1997, the Company's sales force in this area was made up of
178 sales people, which represents an increase of 123 sales people since
December 31, 1996, and is expected to increase to 210 sales people by the
end of 1997.
- Sales to IXCs and ISPs. The Company sells dedicated services to long
distance carriers and ISPs who use the Company's products and services to
provide local access for their own products. For example, the Company
recently entered into an agreement with MCImetro in which, subject to
certain conditions, MCI has agreed to name ACSI as its preferred local
provider for dedicated and transport services in 21 ACSI markets for at
least a five-year period. See "Recent Developments."
- Sales Through Alternative Distribution Channels. As of September 30,
1997, the Company had executed 63 sales agency agreements and is actively
recruiting additional telecommunications sales agents to market the
Company's services. In addition, the Company intends to expand
distribution of its services by attempting to contract with IXCs,
utilities, cable television service providers ("CATVs"), out-of-region
regional Bell operating companies ("RBOCs"), other ILECs and cellular and
other wireless communication providers to resell the Company's products
and services under their own private labels. The Company is presently
recruiting a dedicated sales force to serve in the support of sales
through these and other alternative distribution channels.
2
<PAGE> 6
Market the Company's Services Under the ACSI Brand Name.
The Company is establishing the ACSI brand name by marketing and packaging
its broad array of communications services directly to end-users. In markets in
which it has local networks established, both switched services and data
services are marketed under the ACSI brand name; in markets in which the Company
has no network installed, it resells local switched services under the ACSI
brand name. In both types of markets, the Company also pursues opportunities to
bundle its services together to strengthen the ACSI identity as a full-service
provider of telecommunications services.
Provide Superior Customer Service.
The Company is developing and implementing an integrated customer care
strategy that is intended to provide a heightened level of responsive customer
service across its full range of existing and planned products and services.
This strategy comprises infrastructure, training, performance monitoring and
image/brand recognition and would serve to leverage the Company's operational
support systems, other information/financial systems and customer care
organizations. For example, the Company has made significant capital investments
in its integrated network management platform, which monitors and manages all
voice and data network elements. The Company expects to have completed customer
care and billing systems by as early as the end of 1998, which are intended to
improve the Company's provision of integrated customer service on a cost
efficient basis. These and other quality management and improvement programs,
when implemented, are expected to enable the Company to differentiate itself in
the marketplace by providing a level of customer care and customer service that
is of a higher quality than that which is available in today's market.
Expand Resale of Exchanged Local Voice Services.
Management believes that the Company can successfully enter new markets
with lower capital investment by acting as a reseller of either local switched
voice or data services. This strategy is intended to allow the Company to build
brand name awareness and develop a customer base without incurring the initial
capital costs typically incurred by facilities-based entrants. This strategy
also enables the Company to make capital decisions based on where its customers
are most highly concentrated. Once the Company has established a customer base,
the Company plans to invest in extending its network infrastructure in those
markets that it already serves.
Accelerate Financial Return on Incremental Expenditures.
The Company is pursuing opportunities that accelerate the return on the
Company's invested capital. The Company believes that it will achieve an earlier
return on its investment by focusing on new customer applications in existing
markets rather than continuing to increase the number of new networks built. For
this reason, the Company has modified its earlier goal of constructing 50 local
networks by the end of 1998, is now evaluating additional markets in which it
may construct local networks and is establishing a presence in additional
markets through resale of switched services and data POPs. The Company plans to
redeploy into customer applications in existing markets the capital that was
scheduled to be used to develop those additional networks. While management
continues to believe in the long-term return on capital afforded by the
constructed networks, it believes that the investment in customer applications
will have a more immediate return. As part of this strategy, the Company has
also implemented a shift in its incentive-based compensation for a number of its
key executives away from new network development and growth to revenue and
EBITDA (as defined herein).
3
<PAGE> 7
MANAGEMENT TEAM
The Company's senior management is among the most experienced in the
emerging competitive local telecommunications industry. Members of ACSI's
executive team developed and/or operated CAP networks in 25 major metropolitan
markets for companies such as MFS Communications and Teleport Communications
Group. Key executives include:
ANTHONY J. POMPLIANO, CHAIRMAN OF THE BOARD OF DIRECTORS, had more than 30
years of experience in the telecommunications industry before joining ACSI in
August 1993. He was co-founder and President of Metropolitan Fiber Systems, the
predecessor organization to MFS Communications, a publicly-traded CLEC that was
acquired by WorldCom, Inc. in December 1996. Mr. Pompliano served as President,
CEO and Vice Chairman of MFS Communications from April 1988 until March 1991.
JACK E. REICH, PRESIDENT AND CHIEF EXECUTIVE OFFICER, had 22 years of
telecommunications industry and management experience before joining ACSI in
December 1996. For two and one-half years prior to joining ACSI, Mr. Reich was
employed by Ameritech, Inc. as President of its Custom Business Service
Organization, where he was responsible for full business marketing to
Ameritech's largest customers for telecommunications services, advanced data
services, electronic commerce and managed services/outsource initiatives. Prior
to that, he served as President of MCI's Multinational Accounts organization and
also served as MCI's Vice President of Products Marketing.
DAVID L. PIAZZA, CHIEF FINANCIAL OFFICER, joined the Company on March 24,
1997. For ten years prior to joining the Company, Mr. Piazza was employed by MFS
Communications in a variety of finance and senior management positions, most
recently as the Senior Vice President and Chief Financial Officer of MFS
Telecom, Inc., a subsidiary of MFS Communications.
RILEY M. MURPHY, GENERAL COUNSEL, EXECUTIVE VICE PRESIDENT -- LEGAL AND
REGULATORY AFFAIRS AND SECRETARY, had 12 years of experience in the private
practice of telecommunications regulatory law for interexchange, cellular,
paging and other competitive telecommunications services prior to joining the
Company in April 1994. Since February 1995, she has served as an officer and
director of the Association for Local Telecommunications Services.
RECENT DEVELOPMENTS
Junior Preferred Stock Offering. On October 16, 1997, the Company
consummated the sale of 150,000 shares (the "Junior Preferred Stock Offering"
and, together with the Unit Offering and the Debt Offering, the "Recent
Offerings") of the Old Preferred Stock. Total net proceeds to the Company from
the Junior Preferred Stock Offering were approximately $145.7 million.
Management Change. Effective September 3, 1997, George M. Tronsrue, III
resigned from his position as President and Chief Operating Officer -- Strategy
and Technology Development. The Company and Mr. Tronsrue have entered into a
separation agreement.
Debt Offering. On July 23, 1997, the Company consummated the sale of $220
million aggregate principal amount (the "Debt Offering") of its 13 3/4% Senior
Notes due 2007 (the "2007 Notes"). Of the total net proceeds of $208 million,
the Company placed approximately $70 million, representing funds sufficient to
pay the first five semi-annual interest payments on the 2007 Notes, into an
escrow account for the benefit of the holders thereof.
Unit Offering. On July 10, 1997, the Company consummated the issuance and
sale of 75,000 units (the "Unit Offering"), consisting of its 14 3/4% Redeemable
Preferred Stock due 2008 (the "14 3/4% Preferred Stock") and warrants (the
"Warrants") to purchase approximately 6,023,800 shares (subject to adjustment)
of common stock (the "Common Stock"). Total net proceeds to the Company from the
Unit Offering were approximately $67 million.
Common Equity Offering. On April 15, 1997, the Company consummated (i) the
issuance and sale of 5,060,000 shares of Common Stock (inclusive of the May 14,
1997 exercise by the underwriters of their over-
4
<PAGE> 8
allotment option) at a price per share of $5.00 in an underwritten public
offering and (ii) the issuance and sale directly to certain of its principal
stockholders of 3,600,000 shares of Common Stock at a purchase price of $4.70
per share (together, the "Common Stock Offering"). Total net proceeds to the
Company from the Common Stock Offering were approximately $40 million.
MCImetro Agreement. Effective March 6, 1997, the Company and MCImetro
entered into an agreement in which MCI named ACSI as its preferred local
provider for dedicated and transport services in 21 ACSI markets for at least a
five year period. Pursuant to this preferred provider agreement, MCI will
migrate current dedicated transport circuits in these markets to ACSI and ACSI
will be listed as the first choice provider in MCI's provisioning system for all
new dedicated access circuits in the designated markets and on June 19, 1997,
executed an agreement giving MCI the option to purchase loop transport services
from ACSI where ACSI has collocations with the ILEC and MCI has deployed its own
local switch. The parties also have agreed to use their best efforts to execute
an agreement pursuant to which MCI will resell local switched services in at
least 10 of the 21 identified markets on a wholesale basis. In connection with
these agreements (collectively, the "MCI Transaction"), ACSI issued MCI warrants
to purchase up to 620,000 shares of ACSI's Common Stock at $9.86 per share,
subject to number and price adjustment in certain circumstances. ACSI has also
agreed to issue warrants to purchase up to an aggregate of approximately 1.7
million additional shares of ACSI's Common Stock at fair market value on the
date of grant in tranches every six months after execution of the preferred
provider agreement, subject to, and based upon, certain increases in revenues to
ACSI generated under that agreement. On September 30, 1997, the Company issued
37,582 of such warrants with an exercise price of $9.503 per share. Of the
620,000 warrants issued to MCI on March 6, 1997, 360,000 warrants have vested
and the remaining 260,000 warrants will vest only upon execution of the switched
services resale agreement. MCI has certain registration rights with respect to
any shares of Common Stock issued to MCI in connection with the MCI Transaction.
Cybergate Acquisition. On January 17, 1997, the Company acquired 100% of
the outstanding capital stock of Cybergate, Inc. in exchange for 1,030,000
shares of Common Stock plus up to an additional 150,000 shares if certain
performance goals are achieved (the "Cybergate Acquisition"). Cybergate, a
Florida-based ISP, delivers high-speed data communications services, including
computer network connections and related infrastructure services, that provide
both commercial and residential customers access to the Internet through their
personal computers and the use of a modem. Cybergate had over 200 commercial
dedicated line accounts and 13,000 consumer accounts at December 31, 1996
compared to 25 commercial accounts and 7,500 consumer accounts at December 31,
1995. Cybergate had revenues of approximately $4.9 million and EBITDA of
approximately $750,000 for the year ended December 31, 1996. The Company
believes the Cybergate Acquisition will help ACSI achieve its goal of becoming a
major provider of high-speed data communications services in the southern United
States. The Cybergate Acquisition provides ACSI with the ability to offer direct
Internet access to end-user commercial and consumer customers as well as to
provide private label Internet services for the Company's strategic distribution
partners throughout all of the Company's markets.
5
<PAGE> 9
THE EXCHANGE OFFER
REGISTRATION RIGHTS
AGREEMENT...............The Old Preferred Stock was sold by the Company on
October 16, 1997, to the Initial Purchaser, which placed
the Old Preferred Stock with institutional investors. In
connection therewith, the Company executed and delivered
for the benefit of the holders of the Old Preferred
Stock the Registration Rights Agreement (as defined)
providing, among other things, for the Exchange Offer.
THE EXCHANGE OFFER......The New Preferred Stock is being offered in exchange for
any and all outstanding shares of Old Preferred Stock.
As of the date hereof, 150,000 shares of Old Preferred
Stock, with an aggregate Liquidation Preference of
$150,000,000, are outstanding. Since the New Preferred
Stock will be recorded in the Company's accounting
records at the same carrying value as the Old Preferred
Stock, no gain or loss will be recognized by the Company
upon the consummation of the Exchange Offer. See "The
Exchange Offer -- Accounting Treatment." Holders of the
Old Preferred Stock 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.
Based on interpretations by the staff of the SEC, as set
forth in no-action letters issued to third parties, the
Company believes that holders of Old Preferred Stock
(other than any holder who is an "affiliate" of the
Company within the meaning of Rule 405 under the
Securities Act) who exchange their Old Preferred Stock
for New Preferred Stock pursuant to the Exchange Offer
may offer such New Preferred Stock for resale, resell
such New Preferred Stock and otherwise transfer such New
Preferred Stock without compliance with the registration
and prospectus delivery provisions of the Securities
Act; provided such New Preferred Stock is acquired in
the ordinary course of the holder's business and such
holders are not engaged in, and do not intend to engage
in, a distribution of such New Preferred Stock and have
no arrangement or understanding with any person to
participate in a distribution of such New Preferred
Stock. The staff of the SEC has not considered the
Exchange Offer in the context of a no-action letter and
there can be no assurance that the staff of the SEC
would make a similar determination with respect to the
Exchange Offer. Each broker-dealer that receives New
Preferred Stock for its own account in exchange for Old
Preferred Stock, where such Old Preferred Stock was
acquired by such broker-dealer as a result of
market-making activities or other trading activities,
must acknowledge that it will deliver a prospectus in
connection with any resale of such New Preferred Stock.
See "Plan of Distribution." To comply with the
securities laws of certain jurisdictions, it may be
necessary to qualify for sale or register the New
Preferred Stock prior to offering or selling such New
Preferred Stock. The Company has agreed, pursuant to the
Registration Rights Agreement and subject to certain
specified limitations therein, to register or qualify
the New Preferred Stock for offer or sale under the
securities or "blue sky" laws of such jurisdictions as
may be necessary to permit the holders of New Preferred
Stock to trade the New Preferred Stock without any
restrictions or limitations under the securities laws of
the several states of the United States. If a holder of
Old Preferred Stock does not exchange such Old Preferred
Stock for New Preferred Stock pursuant to the Exchange
Offer, such Old Preferred Stock will continue to be
subject to the restrictions on transfer contained in the
legend thereon. In general, the Old Preferred Stock may
not be offered or sold, unless registered under the
6
<PAGE> 10
Securities Act, except pursuant to an exemption from, or
in a transaction not subject to, the Securities Act and
applicable state securities laws. See "Risk
Factors -- Consequences of Failure to Exchange" and
"Description of the Preferred Stock -- Exchange Offer;
Registration Rights."
EXPIRATION DATE.........5:00 p.m., New York City time, on January 22, 1998 (20
business days following the commencement of the Exchange
Offer), 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.
CONDITIONS TO THE
EXCHANGE OFFER..........The Exchange Offer is subject to certain customary
conditions, which may be waived by the Company. See "The
Exchange Offer -- Conditions." Except for the
requirements of applicable Federal and state securities
laws, there are no Federal or state regulatory
requirements to be complied with or obtained by the
Company in connection with the Exchange Offer. NO VOTE
OF THE COMPANY'S SECURITYHOLDERS IS REQUIRED TO EFFECT
THE EXCHANGE OFFER AND NO SUCH VOTE (OR PROXY THEREFOR)
IS BEING SOUGHT HEREBY.
PROCEDURES FOR TENDERING
OLD PREFERRED STOCK.....Each holder of Old Preferred Stock 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 Preferred Stock to
be exchanged and any other required documentation to the
Exchange Agent (as defined) at the address set forth
herein and therein. See "The Exchange
Offer -- Procedures for Tendering."
WITHDRAWAL RIGHTS.......Tenders of Old Preferred Stock 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 Preferred
Stock, a written or facsimile transmission notice of
withdrawal must be received by the Exchange Agent at its
address set forth below under "Exchange Agent" prior to
5:00 p.m., New York City time, on the Expiration Date.
ACCEPTANCE OF
OLD PREFERRED STOCK
AND DELIVERY OF
NEW PREFERRED STOCK.....Subject to certain conditions, the Company will accept
for exchange any and all shares of Old Preferred Stock
which are properly tendered in the Exchange Offer prior
to 5:00 p.m., New York City time, on the Expiration
Date. The New Preferred Stock issued pursuant to the
Exchange Offer will be delivered promptly following the
Expiration Date. See "The Exchange Offer -- Terms of the
Exchange Offer."
CERTAIN TAX
CONSIDERATIONS..........The exchange of New Preferred Stock for Old Preferred
Stock will not constitute a taxable exchange for U.S.
Federal income tax purposes. See "Certain Federal Income
Tax Considerations."
EXCHANGE AGENT..........The Bank of New York is serving as exchange agent (the
"Exchange Agent") in connection with the Exchange Offer.
7
<PAGE> 11
USE OF PROCEEDS.........There will be no proceeds to the Company from the
Exchange Offer. The net proceeds to the Company from the
Junior Preferred Stock Offering were approximately
$145.7 million, after deducting discounts and other
offering expenses payable by the Company. The Company
plans to continue to use the net proceeds from the
Junior Preferred Stock Offering to fund sales,
marketing, and product development costs incurred in
connection with the Company's growth, to expand voice
and data network density and to fund negative operating
cash flow. See "Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital
Resources."
8
<PAGE> 12
SUMMARY OF TERMS OF NEW PREFERRED STOCK
The Exchange Offer relates to the exchange of up to 150,000 shares of Old
Preferred Stock, having an aggregate Liquidation Preference of $150,000,000, for
up to an equal number of shares of New Preferred Stock. The obligations of the
Company with respect to the New Preferred Stock will be identical to the
obligations of the Company with respect to the Old Preferred Stock and holders
will be entitled to the benefits of the same Certificate of Designation, which
governs both the Old Preferred Stock and the New Preferred Stock. The form and
terms of the New Preferred Stock are generally the same as the form and terms of
the Old Preferred Stock, except that the New Preferred Stock does not contain
terms with respect to dividend rate step-up provisions and the New Preferred
Stock has been registered under the Securities Act and therefore will not bear
legends restricting the transfer thereof. See "Description of the Preferred
Stock."
COMPARISON WITH OLD PREFERRED STOCK
FREELY TRANSFERABLE........ Generally, the New Preferred Stock will be freely
transferable under the Securities Act by holders
who are not "affiliates" of the Company. The New
Preferred Stock otherwise will be substantially
identical in all material respects (including
dividend rate and maturity) to the Old Preferred
Stock (except with respect to the dividend rate
step-up provisions). See "The Exchange
Offer -- Terms of the Exchange Offer."
REGISTRATION RIGHTS........ The holders of Old Preferred Stock currently are
entitled to certain registration rights pursuant to
a registration rights agreement (the "Registration
Rights Agreement") dated as of October 16, 1997,
between the Company and the Initial Purchaser.
However, upon consummation of the Exchange Offer,
subject to certain exceptions, holders of Old
Preferred Stock who do not exchange their Old
Preferred Stock for New Preferred Stock in the
Exchange Offer will no longer be entitled to
registration rights and will not be able to offer
or sell their Old Preferred Stock, unless such Old
Preferred Stock is subsequently registered under
the Securities Act (which, subject to certain
limited exceptions, the Company will have no
obligation to do), except pursuant to an exemption
from, or in a transaction not subject to, the
Securities Act and applicable state securities
laws. See "Risk Factors -- Consequences of Failure
to Exchange."
9
<PAGE> 13
THE NEW PREFERRED STOCK
LIQUIDATION PREFERENCE... $1,000 per share.
DIVIDENDS................ Cumulative dividends at the rate per annum of
12 3/4% of the Liquidation Preference and payable
quarterly beginning January 15, 1998, and accruing
from the date of issuance. Dividends will also
accrue and cumulate on any accrued and unpaid
dividends. Dividends may be paid, at the Company's
option, on any dividend payment date either in cash
or by the issuance of additional shares of New
Preferred Stock (and, at the Company's option,
payment of cash in lieu of fractional shares);
provided, however, that after October 15, 2002, to
the extent and for so long as the Company is not
precluded from paying cash dividends on the New
Preferred Stock by the terms of any agreement or
instrument governing any of its then outstanding
indebtedness, the Company shall pay dividends in
cash.
OPTIONAL REDEMPTION...... The New Preferred Stock will be redeemable at the
option of the Company, in whole or in part, at any
time on or after October 15, 2003, at the
redemption prices set forth herein, plus, without
duplication, accrued and unpaid dividends to the
date of redemption. In addition, prior to October
15, 2000, the Company may, at its option, redeem
shares of New Preferred Stock having a Liquidation
Preference of up to an aggregate of 35% of the
initial aggregate Liquidation Preference at a
redemption price of 112.75% plus, without
duplication, accrued and unpaid dividends to the
date of redemption, with the net proceeds of (i)
one or more public common equity offerings
generating cash proceeds of at least $25 million or
(ii) the sale of capital stock generating cash
proceeds of at least $25 million to an Eligible
Equity Investor (as defined herein); provided that
after any such redemption shares of Preferred Stock
having an aggregate Liquidation Preference of at
least 65% of the initial aggregate Liquidation
Preference remain outstanding.
MANDATORY REDEMPTION..... The Company is required to redeem the New Preferred
Stock outstanding on October 15, 2009 at a
redemption price equal to 100% of the Liquidation
Preference thereof, plus, without duplication,
accrued and unpaid dividends to the date of
redemption.
RANKING.................. The New Preferred Stock will rank (i) senior to all
existing and future Junior Stock; (ii) on a parity
with all existing and future Parity Stock; and
(iii) junior to the 14 3/4% Preferred Stock and any
future Senior Stock (each as defined) that may be
issued upon the prior consent of holders of
two-thirds of the outstanding shares of New
Preferred Stock. In addition, the New Preferred
Stock will rank junior in right of payment to all
indebtedness and other obligations of the Company
and its subsidiaries. As of September 30, 1997
(after giving effect to certain transactions
effected subsequent thereto), there was outstanding
approximately $474.4 million of indebtedness
(including trade payables and other liabilities) of
the Company and its subsidiaries. See "Description
of the Preferred Stock -- Ranking."
VOTING RIGHTS............ The New Preferred Stock will be non-voting, except
that the affirmative vote of holders of two-thirds
of the outstanding shares of New Preferred Stock,
voting as a class, will be necessary to (i) amend
certain rights of the holders of the New Preferred
Stock (other than the covenants
10
<PAGE> 14
contained in the Certificate of Designation (as
defined), as to which the affirmative vote of the
holders of a majority of the outstanding shares
will be required) and (ii) permit the issuance of
any class of preferred stock that ranks senior to
the New Preferred Stock (other than any shares of
14 3/4% Preferred Stock issued as dividends
thereon, including as Additional Dividends (as
defined in the Certificate of Designation relating
to the 14 3/4% Preferred Stock)).
In addition, if the Company (i) fails to pay cash
dividends for six or more quarterly dividend
periods (whether or not consecutive) beginning
October 15, 2002, (ii) fails to pay dividends,
either in cash or by the issuance of additional
shares of New Preferred Stock, for six or more
quarterly dividend periods (whether or not
consecutive), whether before or after October 15,
2002, (iii) fails to comply with the Change of
Control covenant contained in the Certificate of
Designation, (iv) fails to comply with any other
covenant contained in the Certificate of
Designation for a period of 30 days after notice of
such failure, (v) is subject to certain material
defaults on its outstanding debt or (vi) fails to
redeem all of the outstanding New Preferred Stock
on October 15, 2009, then the holders of a majority
of the then outstanding shares of New Preferred
Stock, voting as a class, shall be entitled to
elect the lesser of (x) two directors to the
Company's Board of Directors and (y) such number of
directors as will constitute 25% of the number of
members of the Company's Board of Directors, and
the Company shall take such action as may be
required to cause the total number of directors of
the Company to be increased by such number.
CHANGE OF CONTROL........ Within 30 days of the occurrence of a Change of
Control (as defined herein), the Company will be
required to offer to purchase all outstanding
shares of New Preferred Stock (a "Change of Control
Offer") at a purchase price in cash equal to 101%
of the Liquidation Preference thereof, plus,
without duplication, accumulated and unpaid
dividends and Additional Dividends, if any, thereon
to the date of purchase; provided, however, that no
such Change of Control Offer shall be required to
be made prior to the later of (i) the Stated
Maturity (as defined in the indentures relating to
the Existing Notes (as defined)) of the last to
mature of the Company's Existing Notes and (ii) the
retirement of all of the outstanding 14 3/4%
Preferred Stock. If such Change of Control Offer
would not be permitted by reason of the foregoing
proviso, then, in lieu thereof, the holders of
two-thirds of the New Preferred Stock will be
entitled to designate an Independent Financial
Advisor (as defined) to determine, within 20 days
of such designation, in the opinion of such firm,
the appropriate dividend rate that the Preferred
Stock should bear so that, after such reset, the
New Preferred Stock would have a market value of
101% of the Liquidation Preference. If, for any
reason and within 5 days of the designation of an
Independent Financial Advisor, by the holders, such
Independent Financial Advisor is unacceptable to
the Company, the Company shall designate a second
Independent Financial Advisor to determine, within
15 days of such designation, in its opinion, such
an appropriate reset dividend rate for the New
Preferred Stock. In the event that the two
Independent Financial Advisors cannot agree, within
25 days of the designation of an Independent
Financial Advisor by the holders of two-thirds of
the New Preferred Stock, on the appropriate reset
dividend rate, the two Independent Financial
11
<PAGE> 15
Advisors shall, within 10 days of such 25th day,
designate a third Independent Financial Advisor,
which, within 15 days of designation, will
determine, in its opinion, such an appropriate
reset rate which is between the two rates selected
by the first two Independent Financial Advisors;
provided, however, that the reset rate shall in no
event be less than 12 3/4% per annum or greater
than 15 1/4% per annum. The reasonable fees and
expenses, including reasonable fees and expenses of
legal counsel, if any, and customary
indemnification, of each of the three
above-referenced Independent Financial Advisors
shall be borne by the Company. Upon determination
of the reset rate, the New Preferred Stock shall
accrue and cumulate dividends at the reset rate as
of the date of occurrence of the Change of Control.
CERTAIN COVENANTS........ The Certificate of Designation will contain
covenants that limit the ability of the Company and
its subsidiaries to incur indebtedness and to
impose restrictions on dividends and other payments
to the Company by its subsidiaries as well as the
ability of the Company to merge or consolidate with
or sell all or substantially all of its assets to
any other person. The Certificate of Designation
will contain provisions that allow for the
modification and amendment of the covenants
contained in the Certificate of Designation by a
vote of holders owning a majority of the
outstanding shares of Preferred Stock (including
the covenant relating to a Change of Control,
except during the pendency of a Change of Control
Offer). In addition, the holders of a majority of
the outstanding shares of Preferred Stock, on
behalf of all holders of Preferred Stock, may waive
compliance by the Company with certain provisions
of the Certificate of Designation.
RISK FACTORS
See "Risk Factors" for a discussion of certain factors that should be
considered by holders of Old Preferred Stock before tendering their Old
Preferred Stock in the Exchange Offer.
ACSI is a Delaware corporation. The Company's principal executive offices
are located at 131 National Business Parkway, Suite 100, Annapolis Junction,
Maryland 20701, and its telephone number is (301) 617-4200.
Certain statements contained in "Risk Factors," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business,"
including statements regarding the development of the Company's businesses, the
markets for the Company's services and products, the Company's anticipated
capital expenditures, regulatory reform and other statements contained herein
regarding matters that are not historical facts, are forward-looking statements
(as such term is defined in the Private Securities Litigation Reform Act of
1995). Because such statements include risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, those discussed under "Risk Factors." The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any of the forward-looking statements contained
herein to reflect any change in the Company's expectations, with regard thereto
or any changes in events, conditions or circumstances on which any statement is
based.
12
<PAGE> 16
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE, NETWORK AND STATISTICAL DATA)
<TABLE>
<CAPTION>
SIX MONTHS NINE MONTHS
ENDED FISCAL PERIOD ENDED ENDED NINE MONTHS
FISCAL YEAR ENDED JUNE 30, DECEMBER 31, DECEMBER 31,(1) SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------ ------------------- -------------- -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1995 1996 1995 1996 1996 1997
-------- ------------------- ------------ ------------------- -------------- -------------------
<CAPTION>
PRO PRO PRO
ACTUAL FORMA(2) ACTUAL FORMA(2) ACTUAL FORMA(2)
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA:
Revenues............. $ 389 $ 3,415 $ 7,138 $ 989 $ 6,990 $ 9,626 5,239 $ 35,847 $ 36,065
Operating expenses... 14,797 24,543 29,027 7,966 34,434 37,548 28,535 94,044 94,290
Loss from
operations......... (14,408) (21,128) (21,889) (6,977) (27,444) (27,922) (23,296) (58,197) (58,225)
Interest and other
income............. 218 4,410 4,410 777 2,757 2,773 5,093 3,893 3,898
Interest and other
expense............ (170) (10,477) (10,824) (2,835) (10,390) (10,619) (13,653) (25,336) (25,338)
Loss before minority
interest........... (14,746) (27,195) (28,303) (9,035) (35,077) (35,768) (31,856) (79,640) (79,665)
Minority
interest(3)........ 48 413 413 156 160 160 353 -- --
Net loss............. (14,698) (26,782) (27,890) (8,879) (34,917) (35,608) (31,503) (79,640) (79,665)
Net loss per common
share.............. $ (3.30) $ (4.96) $ (4.40) $ (1.82) $ (5.48) $ (4.84) $ (5.22) $ (3.45) $ (3.44)
Weighted average
shares
outstanding........ 4,772 6,185 7,215 5,901 6,734 7,764 6,614 $ 24,140 24,197
OTHER DATA:
Deficiency in
earnings to cover
combined fixed
charges and
preferred stock
dividends(4)....... (16,353) (34,117) (35,225) (11,652) (39,348) (40,039) (38,302) (86,778) (86,803)
EBITDA(5)............ $ (7,443) $(14,901) $(14,418) $ (4,855) $(21,822) $(21,620) $(16,520) $(40,796) $(40,766)
Depreciation and
amortization....... 498 3,078 4,322 763 4,912 5,592 4,717 16,077 16,135
Capital
expenditures....... 15,303 60,856 61,667 17,657 64,574 64,832 64,933 103,851 103,851
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
------------------------------
PRO FORMA FOR
THE JUNIOR
PREFERRED STOCK
ACTUAL OFFERING(6)
-------- -----------------
<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents...................................................................... $149,874 $ 295,524
Total assets................................................................................... 500,605 646,255
Long-term liabilities.......................................................................... 449,774 449,774
Redeemable stock and options................................................................... 53,793 199,443
Stockholders' equity (deficit)................................................................. (27,583) (27,583)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1995 1996 1996 1996 1996 1997 1997 1997
------------ --------- -------- ------------- ------------ --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Network and Selected
Statistical Data(7):
Networks in
operation........... 9 10 15 19 21 28 31 32
Route miles........... 136 200 386 543 697 908 957 977
Fiber miles........... 5,957 9,466 28,476 32,774 48,792 75,867 82,693 85,976
Buildings connected... 100 133 216 532 595 858 1,083 1,239
VGE circuits in
service............. 82,055 125,208 137,431 267,894 384,134 554,883 886,375 989,285
Employees............. 111 142 199 272 322 502 559 669
</TABLE>
- ---------------
(1) Subsequent to June 30, 1996, the Company changed its fiscal year-end from
June 30 to December 31. All data for the fiscal period ended December 31,
1996 is for the six month period ended December 31, 1996.
(2) Pro forma to give effect to the Cybergate Acquisition as if consummated at
the beginning of the earliest period presented.
(3) Minority interest represents a 7.25% ownership of AT&T Credit Corporation in
the Company's subsidiaries that operate its networks in Louisville, Fort
Worth, Greenville, Columbia and El Paso. See "Description of Certain
Indebtedness."
(4) For purposes of computing this amount earnings (loss) consists of earnings
(loss) before minority interest and fixed charges. Fixed charges consists of
interest expense (including amortization of debt issuance costs) and
one-third of rent expense which is deemed to be representative of interest
expense.
(5) EBITDA consists of net income (loss) before net interest, income taxes,
depreciation and amortization, noncash stock compensation and, in fiscal
year ended June 30, 1995, debt conversion expense of $385,000. It is a
measure commonly used in the telecommunications industry and is presented to
assist in understanding the Company's operating results. However, it is not
intended to represent cash flow or results of operations in accordance with
generally accepted accounting principles ("GAAP"). Noncash compensation
expense associated with employee stock options was $6.4 million and $2.7
million in fiscal years ended June 30, 1995 and 1996, respectively, $1.2
million and $550,000 in the six months ended December 31, 1995 and fiscal
period ended December 31, 1996, respectively and $1.7 million and $1.3 in
the nine months ended September 30, 1996 and 1997, respectively. See Note 6
of "Notes to Consolidated Financial Statements."
(6) As adjusted for the Junior Preferred Stock Offering the net proceeds of
which were approximately $145.7 million.
(7) Network and Selected Statistical Data are derived from ACSI's records.
13
<PAGE> 17
RISK FACTORS
Holders of Old Preferred Stock should carefully consider the following risk
factors, as well as other information set forth or incorporated by reference in
this Prospectus, before tendering their Old Preferred Stock in the Exchange
Offer. The risk factors set forth below (other than "Consequences of Failure to
Exchange") are generally applicable to the Old Preferred Stock as well as the
New Preferred Stock.
CONSEQUENCES OF FAILURE TO EXCHANGE
Holders of Old Preferred Stock who do not exchange their Old Preferred
Stock for New Preferred Stock pursuant to the Exchange Offer will continue to be
subject to the restrictions on transfer of such Old Preferred Stock as set forth
in the legend thereon as a consequence of the issuance of the Old Preferred
Stock pursuant to exemptions from, or in transactions not subject to, the
registration requirements of the Securities Act and applicable state securities
laws. In general, the Old Preferred Stock may not be offered or sold, unless
registered under the Securities Act, except pursuant to an exemption from, or in
a transaction not subject to, the Securities Act and applicable state securities
laws. The Company does not currently anticipate that it will register the Old
Preferred Stock under the Securities Act. Based on interpretations by the staff
of the SEC, as set forth in no-action letters to third parties, the Company
believes that the New Preferred Stock issued pursuant to the Exchange Offer in
exchange for Old Preferred Stock may be offered for resale, resold or otherwise
transferred by holders thereof (other than any such holder that is an
"affiliate" of the issuer 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 Preferred Stock is acquired in the
ordinary course of such holders' business and such holders are not engaged in,
and do not intend to engage in, a distribution of such New Preferred Stock and
have no arrangement or understanding with any person to participate in the
distribution of such New Preferred Stock. The staff of the SEC has not
considered the Exchange Offer in the context of a no-action letter and there can
be no assurance that the staff of the SEC would make a similar determination
with respect to the Exchange Offer. Each broker-dealer that receives New
Preferred Stock 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 Preferred Stock. 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 resales of New Preferred Stock
received in exchange for Old Preferred Stock where such Old Preferred Stock were
acquired by such broker-dealer as a result of market-making activities or other
trading activities. The Company has agreed that, for a period of 180 days after
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." However,
to comply with the securities laws of certain jurisdictions, if applicable, the
New Preferred Stock may not be offered or sold unless they have been registered
or qualified for sale in such jurisdictions or an exemption from registration or
qualification is available and is complied with. To the extent that Old
Preferred Stock are tendered and accepted in the Exchange Offer, the trading
market for untendered and tendered but unaccepted Old Preferred Stock could be
adversely affected.
NEGATIVE CASH FLOW; ANTICIPATED FUTURE LOSSES; SIGNIFICANT FUTURE CAPITAL
REQUIREMENTS; NEED FOR ADDITIONAL CASH.
The Company has never been profitable, has never generated positive cash
flow from consolidated operations and, since its inception, has incurred
significant net operating losses and negative cash flow. As of June 30, 1996,
December 31, 1996 and September 30, 1997, the Company had accumulated deficits
of $47.5 million, $82.4 million and $162.1 million, respectively. During the
fiscal period ended December 31, 1996, the Company incurred a net operating loss
of $27.4 million and generated negative cash flow from operations of $6.7
million. During the nine months ended September 30, 1997, the Company incurred a
net operating loss of $58.2 million and generated negative cash flow from
operations of $69.4 million. The Company expects to continue to incur operating
losses and negative cash flow from operations for at least the next several
years in connection with implementing and marketing its local switched voice and
high-speed data
14
<PAGE> 18
services and establishing and expanding its local networks. The Company
currently expects to begin to generate positive cash flow from operations in the
year 2000. However, there can be no assurance that the Company's networks or any
of its other services will ever provide a revenue base adequate to achieve or
sustain profitability or to generate positive cash flow or that the Company will
begin to generate positive cash flow by the year 2000.
The Company's further development and enhancement of new services,
including local switched voice and high-speed data services, as well as the
continued development, construction, expansion, operation and potential
acquisition of local networks, will require substantial capital expenditures.
The Company's ability to fund these expenditures is dependent upon the Company's
ability to raise substantial financing. As of September 30, 1997, the Company
had raised approximately $475 million from debt and equity financings, $31.2
million of which had been advanced under a $31.2 million secured credit facility
with AT&T Credit Corporation, a subsidiary of AT&T Corporation (the "AT&T Credit
Facility"), approximately $96.1 million of which had been raised from the
issuance of $190.0 million principal amount of the Company's 13% Senior Discount
Notes due 2005 (the "2005 Notes") and warrants to purchase 2,432,000 shares of
Common Stock at $7.15 per share (the "2005 Warrants"), approximately $61.8
million of which had been raised from the issuance of $120.0 million principal
amount of the Company's 12 3/4% Senior Discount Notes due 2006 (the "2006 Notes"
and, with the 2005 Notes and the 2007 Notes, the "Existing Notes"),
approximately $40.0 million of which had been raised in the Common Stock
Offering, approximately $67 million of which had been raised in the Unit
Offering and approximately $138 million of which had been raised in the Debt
Offering. The 2005 Notes were issued under the indenture dated November 14,
1995, the 2006 Notes were issued under the indenture dated March 21, 1996 and
the 2007 Notes were issued under an indenture dated July 23, 1997 (collectively,
the "Existing Indentures"). The Company estimates that from September 30, 1997
through December 31, 1997 and December 31, 1998, remaining capital required for
implementation of its integrated networks and its other services and to fund
negative cash flow will be approximately $40.0 million and $144.0 million,
respectively. At September 30, 1997, the Company had approximately $149.9
million of cash and cash equivalents available for this purpose. The Company
continues to use the estimated net proceeds from Unit Offering, the Debt
Offering and the Junior Preferred Stock Offering principally to fund sales,
marketing and product development costs incurred in connection with the
Company's growth, to expand voice and data network density and to fund negative
operating cash flow. The Company continues to consider potential acquisitions or
other strategic arrangements that may fit the Company's strategic plan. Any such
acquisitions or strategic arrangements that the Company might consider are
likely to require additional equity or debt financing, which the Company will
seek to obtain as required, and may also require that the Company obtain the
consent of its debt holders.
Management anticipates that the Company's current cash resources are
sufficient to fund the Company's continuing negative cash flow and required
capital expenditures into the first quarter of 2000. Without an infusion of
additional cash, the Company will exhaust its cash resources during the first
quarter of 2000. To meet its additional remaining capital requirements and to
successfully implement its strategy, the Company will be required to sell
additional equity securities, increase its existing credit facility, acquire
additional credit facilities or sell additional debt securities, certain of
which would require the consent of the Company's debt holders. Accordingly,
there can be no assurance that the Company will be able to obtain the additional
financing necessary to satisfy its cash requirements or to implement its
strategy successfully, in which event the Company will be unable to fund its
ongoing operations, which have a material adverse effect on its business,
results of operations and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
SUBSTANTIAL LEVERAGE; RECENT DEFAULT; FUTURE CASH OBLIGATIONS
Since inception, the Company's consolidated cash flow from operations has
been negative. As a result, the Company has been required to pay its fixed
charges (including interest on existing indebtedness) and operating expenses
with the proceeds from sales of its debt and equity securities. As a result of
the issuance of the Existing Notes, the Company will be required to satisfy
substantially higher periodic cash debt service obligations in the future.
Commencing in the year 2001, cash interest on the 2005 Notes and 2006 Notes will
15
<PAGE> 19
be payable semi-annually at the rate of 13% per annum (approximately $24.7
million per year) and 12 3/4% per annum (approximately $15.3 million per year),
respectively. The full accreted value of the 2005 Notes and 2006 Notes of $190.0
million and $120.0 million, respectively, will become due on November 1, 2005
and April 1, 2006, respectively. In addition, the Company will have substantial
cash interest requirements with respect to the Notes issued in the Private
Placement. As of September 30, 1997, the Company (through five of its
subsidiaries) had approximately $31.2 million in debt outstanding under the AT&T
Credit Facility. The credit provided under the AT&T Credit Facility must be
used, if at all, by the five subsidiaries (operating local networks in
Louisville, Fort Worth, Greenville, Columbia and El Paso) to which funds have
already been advanced. As of September 30, 1997, the Company had approximately
$449.8 million of consolidated outstanding long-term indebtedness. As of
September 30, 1997, the total consolidated liabilities of the Company were
approximately $474.4 million. It is expected that the Company and its
subsidiaries will incur additional indebtedness, including increasing the
borrowing capacity under the AT&T Credit Facility to $35 million the maximum
amount permitted to be incurred under the Indenture (as defined herein) and the
Existing Indentures. Many factors, some of which are beyond the Company's
control, will affect its performance and, therefore, its ability to meet its
ongoing obligations to repay the Notes, the Existing Notes and its other debt.
There can be no assurance that the Company will be able to generate sufficient
cash flow or otherwise obtain funds in the future to cover interest and
principal payments associated with the Existing Notes and its other debt. See
"Description of Certain Indebtedness."
On June 11, 1997, the Company notified the trustee under each of the
indentures relating to the 2005 Notes and the 2006 Notes that, as of June 10,
1997, it had approximately $13.0 million in the aggregate of ordinary course
trade accounts payable that were more than 60 days overdue. As of June 30, 1997,
the Company had approximately $17.4 million in the aggregate of ordinary course
trade accounts payable that were more than 60 days overdue. These overdue
amounts constituted Indebtedness of the Company, as that term is defined in each
of the indentures relating to the 2005 Notes and the 2006 Notes. The incurrence
by the Company of such Indebtedness is not permitted under each such indenture
and, therefore, constituted an Event of Default (as defined in the indentures
relating to the 2005 Notes and the 2006 Notes) under each such indenture. The
Company used a portion of the proceeds of the Unit Offering to pay in full all
ordinary course trade accounts payable that were more than 60 days overdue to
cure such Event of Default.
In addition, in connection with the Unit Offering the Company issued the
14 3/4% Preferred Stock, dividends on which may be paid, at the Company's
option, either in cash or by the issuance of additional shares of 14 3/4%
Preferred Stock; provided, however, that after June 30, 2002, to the extent and
so long as the Company is not precluded from paying cash dividends on the
14 3/4% Preferred Stock by the terms of any then outstanding indebtedness or any
other agreement or instrument to which the Company is then subject, the Company
shall pay dividends on the 14 3/4% Preferred Stock in cash.
In connection with the Junior Preferred Stock Offering, the Company issued
the Preferred Stock, dividends on which may be paid, at the Company's option,
either in cash or by the issuance of additional shares of Preferred Stock;
provided, however, that after October 15, 2002, to the extent and for so long as
the Company is not precluded from paying cash dividends on the Preferred Stock
by the terms of any agreement or instrument governing any of its then
outstanding indebtedness, the Company shall pay dividends in cash.
The level of the Company's indebtedness and its other obligations could
have important consequences to holders of the Preferred Stock, including the
following: (i) the debt service requirements of the Company's existing
indebtedness and any additional indebtedness could make it difficult for the
Company to make payments in respect of the Preferred Stock; (ii) the ability of
the Company to obtain any necessary financing in the future for working capital,
capital expenditures, debt service requirements or other purposes may be
limited; (iii) any cash flow from the operations of certain of the Company's
subsidiaries may need to be dedicated to debt service payments and might not be
available for other purposes; (iv) the Company's level of indebtedness could
limit its flexibility in planning for, or reacting to, changes in its business;
(v) the Company is more highly leveraged than most of its competitors, which may
place it at a competitive disadvantage; and (vi) the Company's high degree of
indebtedness will make it more vulnerable to a downturn in its business.
16
<PAGE> 20
HOLDING COMPANY STRUCTURE; SOURCE OF PAYMENTS IN RESPECT OF PREFERRED STOCK
As a holding company that conducts virtually all of its business through
its subsidiaries, ACSI has no source of operating cash flow other than from
dividends and distributions from its subsidiaries. In order to pay cash
dividends on the Preferred Stock or to redeem or repurchase the Preferred Stock,
ACSI will be required to obtain distributions from its subsidiaries, refinance
its indebtedness, raise funds in a public or private equity or debt offering, or
sell some or all of its or its subsidiaries' assets. As of September 30, 1997,
the total liabilities of the Company's subsidiaries (after the elimination of
loans and advances by the Company to its subsidiaries) were approximately $54.8
million. Of that amount, approximately $31.2 million in indebtedness was secured
by first priority liens in favor of AT&T on all the assets of the borrowing
subsidiaries and a pledge of the stock of such subsidiaries. See "Description of
Certain Indebtedness." Moreover, the indentures governing the Existing Notes and
the Certificate of Designation relating to the Preferred Stock limit the
Company's ability to incur additional indebtedness and the AT&T Credit Facility
imposes restrictions on the ability of certain subsidiaries of ACSI that incur
indebtedness thereunder to transfer funds to ACSI in the form of dividends or
other distributions. The AT&T Credit Facility and the indentures governing the
Existing Notes also impose restrictions on the ability of such subsidiaries to
raise capital by incurring additional indebtedness. These factors could limit
ACSI's ability to meet its obligations with respect to the Preferred Stock.
Under Delaware law, the Company is permitted to pay dividends on its
capital stock, including the Preferred Stock, only out of its surplus or, in the
event that it has no surplus, out of its net profits for the year in which a
dividend is declared or for the immediately preceding fiscal year. In order to
pay dividends in cash, the Company must have surplus or net profits equal to the
full amount of the cash dividend at the time such dividend is declared. In
determining the Company's ability to pay dividends, Delaware law permits the
board of directors of the Company to revalue the Company's assets and
liabilities from time to time to their fair market values in order to establish
the amount of the Company's surplus. The Company cannot predict what the value
of its assets or the amount of its liabilities will be in the future and,
accordingly, there can be no assurance that the Company will be able to pay
dividends on the Preferred Stock.
RANKING OF PREFERRED STOCK
The Preferred Stock will, with respect to dividend rights and rights on
liquidation, winding-up and dissolution, rank senior to all classes of common
stock and junior to the 14 3/4% Preferred Stock and to each other class of
capital stock or series of preferred stock that, by its terms, ranks senior to
the Preferred Stock. The Company may not authorize any new class of preferred
stock that ranks senior to the Preferred Stock (other than any shares of 14 3/4%
Preferred Stock issued as dividends thereon, including as Additional Dividends
(as defined in the Certificate of Designation relating to the Preferred Stock)
without the approval of the holders of at least two-thirds of the shares of
Preferred Stock then outstanding, voting or consenting, as the case may be, as
one class. However, all claims of the holders of the Preferred Stock, including
without limitation, claims with respect to dividend payments, redemption
payments, mandatory repurchase payments or rights upon liquidation, winding-up
or dissolution, shall rank junior to the claims of the holders of any debt of
the Company and all other creditors of the Company. Future agreements of the
Company may restrict or prohibit the Company from redeeming the Preferred Stock.
See "Description of the Preferred Stock -- Ranking, -- Mandatory Redemption
and -- Voting Rights."
CERTAIN FINANCIAL AND OPERATING RESTRICTIONS
The Existing Indentures, the AT&T Credit Facility, the Indenture and the
Certificate of Designation relating to the Preferred Stock impose operating and
financial restrictions on the Company and its subsidiaries. These restrictions
affect, and in certain cases significantly limit or prohibit, among other
things, the ability of the Company and its subsidiaries to incur additional
indebtedness or create liens on their assets, pay dividends, sell assets, engage
in mergers or acquisitions or make investments. Failure to comply with any of
these restrictions could limit the availability of borrowings or result in a
default thereunder. See "Description of the Preferred Stock -- Certain
Covenants" and "Description of Certain Indebtedness." In addition, the terms of
any debt or equity financings undertaken by the Company to meet its future cash
requirements could restrict
17
<PAGE> 21
the Company's operational flexibility and thereby adversely affect the Company's
business, results of operations and financial condition.
RAPID EXPANSION OF OPERATIONS
Subject to the sufficiency of its cash resources, the Company plans to
continue to expand its business rapidly. There can be no assurance that a market
will develop for any of the Company's services, that the Company's
implementation of these services will be technically or economically feasible,
that the Company will be able to market them successfully or that the Company
will be able to operate these services profitably. Any failure of the Company to
implement its growth strategy or manage its expanded operations effectively will
have a material adverse effect on the Company's business, operating results and
financial condition.
MANAGEMENT OF RAPID GROWTH
The Company's future performance will depend, in large part, upon its
ability to manage its growth effectively. The Company's rapid growth has placed,
and in the future will continue to place, a significant strain on its
administrative, operational and financial resources. In the past year, the
Company has effected a management reorganization in connection with which the
Company hired several new members of senior management and saw the departure of
several significant employees and former members of senior management. The
Company anticipates that continued growth will require it to integrate its
newest senior management members successfully and to recruit and hire a
substantial number of new managerial, finance, accounting and support personnel.
Failure to retain and attract additional management personnel who can manage the
Company's growth effectively would have a material adverse effect on the Company
and its growth. To manage its growth successfully, the Company will also have to
continue to improve and upgrade operational, financial, accounting and
information systems, controls and infrastructure as well as expand, train and
manage its employee base. In the event the Company is unable to upgrade its
financial controls and accounting and reporting systems adequately to support
its anticipated growth, the Company's business, results of operation and
financial condition would be materially adversely affected. In addition, the
demands on the Company's marketing and sales resources have grown rapidly with
the Company's rapidly expanding network and service offerings. The Company is
taking steps to improve marketing support of its expanded operations and plans
to increase its existing sales force during 1997 and 1998. There can be no
assurance, however, that the Company will be successful in attracting, retaining
or effectively managing and motivating such personnel or that its expanded sales
force can successfully market the Company's services or that the failure of
either of the foregoing to occur would not have a material adverse effect on the
Company's business, operating results and financial condition.
DEPENDENCE ON BILLING, CUSTOMER SERVICES AND INFORMATION SYSTEMS
Sophisticated information and processing systems are vital to the Company's
growth and its ability to monitor costs, bill customers, provision customer
orders and achieve operating efficiencies. Billing and information systems for
the Company's historical lines of business have been produced largely in-house
with partial reliance on third-party vendors. These systems have generally met
the Company's needs due in part to the low volume of customer billing. As the
Company transitions to the provisioning of local services and as its long
distance and Internet operations continue to expand, the need for sophisticated
billing and information systems will increase significantly. The Company's plans
for the development and implementation of its billing systems rely, for the most
part, on the delivery of products and services by third party vendors.
Similarly, the Company is developing customer call centers to provision service
orders. Information systems are vital to the success of the call centers, and
the information systems for these call centers are largely being developed by
third party vendors. Failure of these vendors to deliver proposed products and
services in a timely and effective manner and at acceptable costs, failure of
the Company to adequately identify all of its information and processing needs,
failure of the Company's related processing or information systems, or the
failure of the Company to upgrade systems as necessary could have a material
adverse effect on the ability of the Company to reach its objectives, on its
financial condition and on its results of operations.
18
<PAGE> 22
DEPENDENCE ON A SMALL NUMBER OF MAJOR CUSTOMERS
The Company receives a significant portion of its revenues from a small
number of major customers, particularly the IXCs that service the Company's
markets. For the fiscal year ended June 30, 1996, the fiscal period ended
December 31, 1996 and the nine months ended September 30, 1997, approximately
60%, 40% and 24% of the Company's revenues, respectively, were attributable to
access services provided to four of the largest IXCs, including services
provided for the benefit of their customers. The Company is, and expects to
continue to be, dependent upon such customers, and the loss of any one of them
could have a material adverse effect on the Company's business, results of
operations and financial condition. Additionally, customers who account for
significant portions of the Company's revenues may have the ability to negotiate
prices for the Company's services that are more favorable to the customer and
that result in lower profit margins for the Company. The Federal
Telecommunications Act may also encourage IXCs to construct their own local
facilities, repackage unbundled network elements and/or resell the local
services of ACSI's competitors, which may materially adversely affect the
Company. Additionally, in the nine months ended September 30, 1997,
approximately 33% of the Company's revenues were generated by ISPs. See
"-- Competition," "Business -- Competition" and "-- Regulation."
DEPENDENCE UPON SUPPLIERS; SOLE AND LIMITED SOURCES OF SUPPLY
The Company relies on other companies to supply certain key components of
its network infrastructure, including telecommunications services, network
capacity and switching and networking equipment, which, in the quantities and
quality demanded by the Company, are available only from sole or limited
sources. The Company is also dependent upon ILECs to provide telecommunications
services and facilities to the Company and its customers. The Company has from
time to time experienced delays in receiving telecommunications services and
facilities, and there can be no assurance that the Company will be able to
obtain such services or facilities on the scale and within the time frames
required by the Company at an affordable cost, or at all. Any failure to obtain
such services or additional capacity on a timely basis at an affordable cost, or
at all, would have a material adverse effect on the Company's business,
financial condition and results of operations. The Company also is dependent on
its suppliers' ability to provide necessary products and components that comply
with various Internet and telecommunications standards, interoperate with
products and components from other vendors and function as intended when
installed as part of the network infrastructure. Any failure of the Company's
sole or limited source suppliers to provide products or components that comply
with Internet standards, interoperate with other products or components used by
the Company in its network infrastructure or by its customers or fulfill their
intended function as a part of the network infrastructure could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business."
DEPENDENCE UPON NETWORK INFRASTRUCTURE; RISK OF SYSTEM FAILURE; SECURITY RISKS
The Company's success in marketing its services to business and government
users requires that the Company provide superior reliability, capacity and
security via its network infrastructure. The Company's networks and networks
upon which it depends are subject to physical damage, power loss, capacity
limitations, software defects, breaches of security (by computer virus,
break-ins or otherwise) and other factors, certain of which may cause
interruptions in service or reduced capacity for the customers. Interruptions in
service, capacity limitations or security breaches could have a material adverse
effect on the Company's business, financial condition and results of operations.
DEPENDENCE ON RIGHTS-OF-WAY AND OTHER THIRD PARTY AGREEMENTS
The Company must obtain easements, rights-of-way, franchises and licenses
(collectively, "local approvals") from various private parties, actual and
potential competitors and local governments in order to construct and maintain
its fiber optic local networks. The Company has obtained the local approvals
necessary to construct and operate its local networks in the central business
districts of all of the markets in which the Company's local networks are
presently operating or are under construction. The Company does not yet have all
of the local approvals required to implement its local network business plan in
prospective new markets or to expand its existing markets, and there can be no
assurance that the Company will be able to obtain and
19
<PAGE> 23
maintain local approvals on acceptable terms or that ILECs, CLECs or other
competitors will not obtain similar local approvals that will allow them to
compete against the Company or enter a market before the Company or to expand
the Company's existing networks to compete effectively. Some of the agreements
for local approvals obtained by the Company may be short-term, or revocable at
will, and there can be no assurance that the Company will have continued access
to local approvals after their expiration. If any of these agreements were
terminated or could not be renewed and the Company was forced to remove its
fiber from the streets or abandon its local network in place, such termination
or non-renewal would be likely to have a material adverse effect on the
Company's business, results of operations and financial condition. Furthermore,
certain of the Company's pole attachment agreements with private entities are
contingent on CLECs being legally entitled to pole access. Certain utilities
have challenged the constitutionality of mandatory access to poles and other
facilities in ongoing litigation. If ongoing litigation or legislative activity
alters current requirements, the Company may be denied access or required to
renegotiate the rates and other terms for access in these contracts. In this
event, the Company may have to consider alternative means for building out its
local networks.
As a condition to granting local approvals to the Company, certain local
governments have required the Company to post performance bonds or letters of
credit and to pay ongoing fees based upon the gross revenues generated by, or
linear footage of, the applicable network. In many markets, ILECs are not
required to pay such fees or pay substantially less than those paid by the
Company which may put the Company at a competitive disadvantage in its markets.
In addition, as of September 30, 1997, the Company had posted approximately $8.3
million in performance bonds and letters of credit and expects to post
additional bonds or letters of credit in the future. As of September 30, 1997,
the Company had been required to pledge approximately $4.9 million in cash
collateral to obtain these bonds and letters of credit, and may be required to
pledge substantial collateral to obtain the bonds or letters of credit in the
future. See "Business -- Implementation of Integrated Network -- Rights-of-Way"
and "-- Regulation."
EFFECT OF REGULATION
As a common carrier, the Company is subject to substantial federal, state
and local regulation. The Company's local networks do not require authorization
from the Federal Communications Commission (the "FCC") for construction or
installation. However, the Company may file FCC tariffs stating its rates, terms
and conditions of service for access services, and must file tariffs covering
its international traffic. State regulatory agencies regulate intrastate
communications, while local authorities control the Company's access to and use
of municipal rights-of-way. The Federal Telecommunications Act preempted all
state and local legal requirements which prohibit or have the effect of
prohibiting any entity from providing any intrastate telecommunications service.
However, many states continue to require telecommunications carriers to obtain a
certificate, license, permit or similar approval before providing services.
Thus, the Company's ability to provide additional intrastate services is
dependent upon its receipt of requisite state regulatory approval. The inability
to obtain the approvals necessary to provide intrastate switched services could
have a material adverse effect on the Company's business, results of operations
and financial condition.
The Federal Telecommunications Act imposes a duty upon all ILECs to
negotiate in good faith with potential interconnectors such as the Company to
provide interconnection to the ILEC network, exchange local traffic, make
unbundled basic local network elements available and permit resale of most local
services. Some local interconnection agreements must be filed with state Public
Service Commissions ("PSC") for approval. In the event that negotiations with
the ILECs do not succeed, the Company has a right to seek PSC arbitration of any
unresolved issues.
The Federal Telecommunications Act also has increased local competition by
IXCs, CATVs and public utility companies, which may have a material adverse
effect on the Company. In addition, the Federal Telecommunications Act has
granted important regulatory relief to the ILECs, including providing ILECs
substantial new pricing flexibility, restoring the ability of RBOCs to provide
long distance services and allowing RBOCs to provide certain cable television
services. Moreover, the FCC recently has taken a number of actions intended
ultimately to reduce regulation of ILECs, restructure the manner in which ILECs
charge for interexchange access services, reduce interexchange access service
rate levels and reform the current
20
<PAGE> 24
methods used to fund universal service goals. These changes will tend to enhance
the competitive position of the ILECs, which may materially adversely affect the
Company. Furthermore, no assurance can be given that court decisions or changes
in current or future federal or state legislation or regulations would not
materially adversely affect the Company. See "-- Competition" and
"Business -- Regulation."
Internet-related information services are not currently subject to direct
regulation by the FCC or any other U.S. agency other than regulation applicable
to businesses generally. The FCC is considering whether additional regulations
should be applied to Internet services and whether Internet service providers
should pay interexchange access charges. Moreover, as discussed hereafter, the
Federal Telecommunications Act and similar State laws create civil and criminal
penalties for the knowing transmission of "indecent" material over the Internet.
Additionally, the Federal Telecommunications Act may permit telecommunications
companies, RBOCs or others to increase the scope or reduce the cost of their
Internet access services. These and other changes in the regulatory environment
relating to the telecommunications or Internet-related services industry could
have an adverse effect on the Company's Internet-related services business.
The Company cannot predict the effect that the Federal Telecommunications
Act or any future legislation, regulation or regulatory changes may have on its
business.
COMPETITION
The Company operates in a highly competitive environment for all of its
services. An increasing trend toward strategic business alliances in the
telecommunications industry may create significant new competition for ACSI.
- Dedicated and Switched Voice Services. The Company's competitors in this
market are predominantly ILECs, other CLECs and CATVs and may potentially
include microwave carriers, satellite carriers, teleports, public
utilities, wireless telecommunications providers, IXCs, integrated
communications providers and private networks built by large end-users.
With the passage of the Federal Telecommunications Act and the entry of
RBOCs into the long distance market, the Company believes that IXCs may
construct their own local facilities and/or resell local services in
order to compete with the bundled local and long distance services to be
offered by the ILECs as a result of the Federal Telecommunications Act.
Given that a substantial portion of the Company's revenues are billed to
IXCs for services provided for the benefit of their customers, such
action could have a material adverse effect on the Company. See
"Business -- Competition."
Currently, the Company does not have a significant market share in any
market. Most of the Company's actual and potential competitors have
substantially greater financial, technical and marketing resources than
the Company. In particular, ILECs have long-standing relationships with
their customers, have the potential to subsidize access services with
monopoly service revenue and benefit from certain existing federal, state
and local regulations that the Company believes, in certain respects,
favor ILECs over the Company. See "Business -- Regulation." For example,
the Interconnection Decisions issued by the FCC and the Federal
Telecommunications Act, which allow CLECs to interconnect with ILECs'
facilities, have been accompanied by increased pricing flexibility and
partially relaxed regulatory oversight of ILECs. The Company believes
that ILECs are offering and will continue to offer term and volume
discounts to customers, which will further increase competition for the
Company and other CLECs and which could significantly adversely affect
the Company's future dedicated services revenues. Moreover, some ILECs
impose reconfiguration charges and/or termination liabilities on
customers seeking to shift their traffic from ILEC facilities to CLEC
facilities, which may have an adverse effect on a CLEC's ability to
attract these customers and, in several instances, ILECs have delayed
converting customers who have requested conversion to the Company's local
networks. The Company may have to incur additional expense to acquire
customers if the Company has to reimburse their termination liabilities.
Although these problems have been encountered with several ILECs, the
Company has filed formal complaints with the FCC alleging that BellSouth
in particular has imposed reconfiguration charges in an unreasonable and
discriminatory manner and has failed to convert customers to ACSI's local
services on a timely basis.
21
<PAGE> 25
The Company expects that other CLECs may operate in most, if not all, of
the markets targeted by the Company and many of these markets may not be
able to support multiple CLECs. Additionally, delays in constructing or
expanding any network could adversely affect the Company's competitive
position in markets where another CAP or CLEC has a network under
construction or can provide services on an already-existing network.
There can be no assurance that the Company will be able to achieve or
maintain an adequate market share, maintain construction schedules or
compete effectively in any of its markets. See "Business -- Competition."
- Data Services. The market for data communications services, including IP
switching, is extremely competitive. There are no substantial barriers to
entry, and the Company expects that competition will intensify in the
future. The Company believes that its ability to compete successfully
depends on a number of factors, including: market presence; the ability
to execute a rapid expansion strategy; the capacity, reliability and
security of its network infrastructure; ease of access to and navigation
of the Internet; the pricing policies of its competitors and suppliers;
the timing of the introduction of new services by the Company and its
competitors; the Company's ability to support industry standards; and
industry and general economic trends. The Company's success in this
market will depend heavily upon its ability to provide high quality
Internet connectivity and value-added Internet services at competitive
prices. See "Business -- Competition."
- Internet Services. The market for Internet access services is extremely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will intensify in the future. The Company has
entered this market principally through the Cybergate Acquisition and
believes that its ability to compete successfully will depend upon a
number of factors, including: market presence; the capacity, reliability
and security of its network infrastructure; ease of access to and
navigation of the Internet; the pricing policies of its competitors and
suppliers; the timing of introductions of new products and services by
the Company and its competitors; the Company's ability to support
existing and emerging industry standards; and industry and general
economic trends.
The Company's current and prospective competitors include many large
companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company
competes or expects to compete directly or indirectly with the following
categories of companies: (1) other international, national and regional
commercial Internet service providers; (2) established on-line services
companies that currently offer or are expected to offer Internet access;
(3) computer hardware and software and other technology companies; (4)
IXCs; (5) RBOCs; (6) CATVs; and (7) nonprofit or educational Internet
service providers. The ability of these competitors or others to bundle
services and products with Internet connectivity services could place the
Company at a significant competitive disadvantage in this services
market.
IMPACT OF TECHNOLOGICAL CHANGE
The telecommunications industry is subject to rapid and significant
technological change that could materially affect the continued use of fiber
optic cable or the electronics utilized in the Company's networks. Future
technological changes, including changes related to the emerging wireline and
wireless transmission and switching technologies and Internet-related services
and technologies, could have a material adverse effect on the Company's
business, results of operations and financial condition.
The market for the Company's telecommunications services is characterized
by rapidly changing technology, evolving industry standards, emerging
competition and frequent new product and service introductions. There can be no
assurance that the Company will successfully identify new service opportunities
and develop and bring new services to market. The Company is also at risk from
fundamental changes in the way telecommunications services are marketed and
delivered. The Company's data communications service strategy assumes that
technology such as frame relay and ATM protocols, utilizing fiber optic or
copper-based telecommunications infrastructures, will continue to be the primary
protocols and transport infrastructure for data communications services. The
Company's pursuit of necessary technological advances may require
22
<PAGE> 26
substantial time and expense, and there can be no assurance that the Company
will succeed in adapting its telecommunications services business to alternate
access devices, conduits and protocols.
STRATEGIC INVESTMENTS; BUSINESS COMBINATIONS
The Company from time to time engages in discussions with (i) potential
business partners looking toward formation of business combinations or strategic
alliances that would expand the reach of the Company's networks or services and
(ii) potential strategic investors (i.e., investors in the same or related
business) who have expressed an interest in making an investment in or acquiring
the Company. In addition to providing additional growth capital, the Company
believes that an alliance with an appropriate strategic investor or business
partner could provide operating synergies to, and enhance the competitive
position of, both ACSI and such strategic investor/business partner within the
rapidly consolidating telecommunications industry. There can be no assurance
that any agreement with any potential strategic investor or business partner
will be reached on terms acceptable to the Company. An investment, business
combination or strategic alliance could constitute a Change of Control (as
defined in the Existing Indentures) requiring the Company to offer to purchase
all outstanding Existing Notes. In the event that such a Change of Control
occurs at a time when the Company does not have sufficient available funds to
purchase all Existing Notes tendered or at a time when the Company is prohibited
from purchasing the Existing Notes, an Event of Default (as defined in the
Existing Indentures) could occur under the relevant indenture. The Company
expects to actively pursue over the next several months one or more acquisitions
of companies engaged in business similar or related to the business of the
Company. If any such acquisition is consummated, it is likely to require the
issuance by the Company of capital stock in an amount that could be material.
There can be no assurance that the Company will identify any suitable candidate
for acquisition or that any such acquisition will be consummated. At this time,
however, the Company currently has no agreement, arrangement or understanding
with any potential strategic investor or potential business partner with respect
to any acquisition, business combination or strategic alliance.
POTENTIAL LIABILITY OF INTERNET ACCESS PROVIDERS
The law governing the liability of on-line services providers and Internet
access providers for participating in the hosting or transmission of
objectionable materials or information currently is unsettled. Under the terms
of the Federal Telecommunications Act, both civil and criminal penalties can be
imposed for the use of interactive computer services for the transmission of
certain indecent or obscene communications. However, this provision was recently
found to be unconstitutional by the U.S. Supreme Court in American Civil
Liberties Union v. Janet Reno. Nonetheless, many states have adopted or are
considering adopting similar requirements, and the constitutionality of such
state requirements remains unsettled at this time. In addition, several private
lawsuits have been filed seeking to hold Internet access providers accountable
for information which they transmit. In one such case (Religious Technology
Center v. NETCOM On-Line Communications Services, Inc. (907 F. Supp. 1361 (N.D.
Cal. 1995), the court ruled that an Internet access provider is not directly
liable for copies that are made and stored on its computer but may be held
liable as a contributing infringer where, with knowledge of the infringing
activity, the Internet access provider induces, causes or materially contributes
to another person's infringing conduct. Another court recently extended the
Netcom holding to operators of electronic bulletin boards (Sega Enterprises Ltd.
v. Maphia, 848 F. Supp. 923 (N.D. Cal. 1996)). While the outcome of these
activities is uncertain, the ultimate imposition of potential liability on
Internet access providers for information which they host, distribute or
transport could materially change the way they must conduct business. To avoid
undue exposure to such liability, Internet access providers could be compelled
to engage in burdensome investigation of subscriber materials or even
discontinue offering services altogether.
DEPENDENCE ON KEY PERSONNEL
The Company is currently managed by a small number of key management and
operating personnel whose efforts will largely determine the Company's success.
The success of the Company also depends upon its ability to hire and retain
qualified operating, marketing, financial, accounting and technical personnel.
23
<PAGE> 27
Competition for qualified personnel in the telecommunications industry is
intense and, accordingly, there can be no assurance that the Company will be
able to continue to hire or retain necessary personnel. The Company in
consultation with its advisors is considering whether to acquire key person life
insurance coverage although it has no such coverage at this time. The loss of
key management personnel would likely have a material adverse impact on the
Company. See "Management."
CONTROL BY CERTAIN STOCKHOLDERS AND MANAGEMENT
As of September 30, 1997, the Company's directors and executive officers
beneficially owned approximately 5.8% of the outstanding Common Stock. As of
September 30, 1997, the principal stockholders of the Company beneficially owned
approximately 64.5% of the outstanding Common Stock, including 38.2%, 21.8% and
8.4% of the outstanding Common Stock which is beneficially owned by The Huff
Alternative Income Fund, L.P. ("Huff"), the designees of which occupy three
positions on the Board of Directors, ING Equity Partners, L.P. I ("ING"), the
designees of which occupy two positions on the Board of Directors and affiliates
of First Analysis Corporation ("FAC"), a designee of which occupies one position
on the Board of Directors, respectively. In addition, at the date hereof Huff is
the beneficial owner of approximately 13% of the 14 3/4% Preferred Stock, which
shares have voting rights in certain circumstances. At the date hereof, ING
Baring (U.S.) Securities, Inc., which may be deemed an affiliate of ING, is the
beneficial owner of 10% of the 14 3/4% Preferred Stock issued in connection with
the Unit Offering. Accordingly, if they choose to act together, these persons
will be able to control the election of the Board of Directors and other matters
voted upon by the stockholders. A sale of Common Stock by one or more of the
principal stockholders to third parties could trigger the right of the holders
of the Notes and the Existing Notes to require the Company to repurchase the
Existing Notes (a "Change of Control Offer"). In the event that a Change of
Control Offer occurs at a time when the Company does not have sufficient
available funds to pay the Change of Control Purchase Price (as defined in the
Existing Indentures) for all Existing Notes tendered, or at a time when the
Company is prohibited from purchasing the Existing Notes, an Event of Default
(as defined in the relevant indenture) could occur under the relevant indenture.
In certain circumstances, in determining whether the approval of holders of the
required principal amount of 2007 Notes has been received, the 2007 Notes held
by W.R. Huff, on behalf of investment management accounts for which it acts as
investment advisor and over which it has sole dispositive power, shall be
disregarded. See "Management," "Principal Stockholders" and "Description of
Certain Indebtedness -- Existing Notes."
REGISTRATION RIGHTS
Holders of substantially all of the shares of Common Stock (i) outstanding
(other than shares issued in the Common Stock Offering) and (ii) issuable upon
exercise of outstanding options and warrants have either piggyback or demand
registration rights relating to those shares. Holders of a significant number of
outstanding shares of Common Stock and a significant number of shares issued or
issuable upon exercise of options and warrants have waived or agreed to waive
their rights to "piggyback" on prior Company offerings and/or to demand
registration of their shares until 180 days after April 15, 1997. The Company
has agreed to use its commercially reasonable efforts to register all shares as
to which piggyback and demand rights were waived on or before the 210th day
following April 15, 1997 (in which registration all security holders with
registration rights may have the right to include their shares). As a result,
the Company's ability to raise additional cash through a public offering of its
equity securities may be limited. There can be no assurance that persons with
piggyback and demand registration rights who have not waived or agreed to waive
those rights will not request the Company to file a registration statement for
their shares prior to 180 days after April 15, 1997 or that such security
holders will not seek damages from the Company for any alleged breach of such
security holders' registration rights in connection with past Company offerings.
Additionally, the Company has an obligation to register under the Securities Act
1,000,000 of the 1,030,000 shares of Common Stock issued in the Cybergate
Acquisition no later than 210 days after April 15, 1997, but in no event later
than December 31, 1997, and is required to register up to 150,000 additional
shares which may be issued in connection with the Cybergate Acquisition no later
than 60 days after such issuance. These shares will be freely transferable upon
such registration. The Company also has an obligation to register under the
Securities Act any shares issued to MCI in the MCI Transaction (see "Recent
Developments"), on the later of
24
<PAGE> 28
(i) April 15, 1998 and (ii) the 121st day following the effective date of a
demand registration statement filed for MCI (which the Company may be obligated
to file as early as seven months after April 15, 1997). MCI also has piggyback
rights in respect of such shares. Such shares will be freely transferable upon
any such registration.
LACK OF PUBLIC MARKET; EXCHANGE OFFER
The New Preferred Stock will be new securities for which there is currently
no market. The Old Preferred Stock is eligible for trading in the PORTAL Market.
However, ACSI does not intend to apply for listing of the New Preferred Stock or
the Old Preferred Stock on any securities exchange or to seek approval for
quotation through any automated quotation system. There can be no assurance as
to the development or liquidity of any market for the Preferred Stock. If an
active market does not develop, the market price and liquidity of the Preferred
Stock will be adversely affected. Many possible events could adversely affect
the development or liquidity of any market for such securities.If a market for
the Preferred Stock were to develop, the Preferred Stock could trade at prices
that may be higher or lower than its initial offering price depending upon many
factors, including prevailing interest rates, the Company's operating results,
and the market for similar securities. Historically, the market for high-yield
securities, such as the Preferred Stock, has been subject to disruptions that
have caused substantial volatility in the prices of such securities. There can
be no assurance that, if a market for the Preferred Stock were to develop, such
market will not be subject to similar disruptions. Although the Initial
Purchaser has informed the Company that it currently intends to make a market in
the Preferred Stock, it is not obligated to do so and any such market-making may
be discontinued at any time without notice. In addition, such market-making
activity may be limited during the Exchange Offer.
25
<PAGE> 29
USE OF PROCEEDS
There will be no proceeds to the Company from the Exchange Offer. The net
proceeds to the Company from the Junior Preferred Stock Offering were
approximately $145.7 million. The Company intends to continue to use the net
proceeds from the Junior Preferred Stock Offering, to fund sales, marketing and
product development costs incurred in connection with the Company's growth, to
expand voice and data networks and to fund negative operating cash flow. Pending
such uses, the Company has invested the net proceeds from the Junior Preferred
Stock Offering in marketable securities.
The Company has estimated that as of September 30, 1997, the total
remaining capital required for implementing integrated networks and its other
services and to fund negative cash flow through December 31, 1997 and December
31, 1998 was approximately $40.0 million and $144.0 million, respectively.
Management anticipates that the Company's current cash resources are sufficient
to fund the Company's continuing negative cash flow and required capital
expenditures into the first quarter of 2000. If during the first quarter of 2000
the Company is unable to obtain additional cash through the sale of debt or
equity securities or increases in existing or new credit facilities, the Company
will be unable to fund its operations.
The Company expects to actively pursue over the next several months one or
more acquisitions of companies engaged in business similar or related to the
business of the Company. If any such acquisition is consummated, it is likely to
require the issuance by the Company of capital stock in an amount that could be
material. There can be no assurance that the Company will identify any suitable
candidate for acquisition or that any such acquisition will be consummated. At
this time, however, the Company has no agreements, understandings or
arrangements for any such acquisitions or alliances. Future acquisitions or
alliances may require additional equity or debt financing, which the Company
will seek to obtain, as required, and may also require that the Company obtain
the consent of the holders of the Existing Notes and the holders of certain
other instruments.
26
<PAGE> 30
CAPITALIZATION
The following table sets forth the total cash and cash equivalents and
capitalization of the Company (i) as of September 30, 1997, and (ii) as adjusted
to give effect to the Junior Preferred Stock Offering and application of the
estimated net proceeds therefrom. The net proceeds of the Junior Preferred Stock
Offering were approximately $145.7 million. This table should be read in
conjunction with the Consolidated Financial Statements and related notes thereto
included in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
---------------------------------------
AS ADJUSTED FOR
THE JUNIOR PREFERRED
ACTUAL STOCK OFFERING(1)
-------------- --------------------
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents........................................... $ 149,874 $ 295,524
Restricted assets invested in Marketable Securities(2).............. 74,945 74,945
--------- ---------
Total cash and restricted assets.................................... $ 224,819 $ 370,469
========= =========
Long term debt
12 3/4% Senior Discount Notes due 2006............................ $ 121,805 $ 121,805
13% Senior Discount Notes due 2005................................ 77,690 77,690
13 3/4% Senior Notes due 2007..................................... 220,000 220,000
Notes payable(3).................................................. 30,012 30,012
Other long-term liabilities....................................... 267 267
--------- ---------
Total long-term debt...................................... 449,774 449,774
Redeemable stock and options........................................ 53,793 199,443
Stockholders' equity (deficit):
Common Stock, par value $0.01 per share, 75,000,000 shares
authorized, 36,386,323 shares issued and outstanding at
September 30, 1997(4)(5)....................................... 364 364
Additional paid-in capital........................................ 134,133 134,133
Accumulated deficit............................................... (162,080) (162,080)
--------- ---------
Total stockholders' equity (deficit)...................... (27,583) (27,583)
--------- ---------
Total capitalization...................................... $ 475,984 $ 621,634
========= =========
</TABLE>
- ---------------
(1) As adjusted to give effect to the Junior Preferred Stock Offering as if it
occurred on September 30, 1997. The net proceeds from the Junior Preferred
Stock Offering were approximately $145.7 million.
(2) Represents investments in Marketable Securities sufficient to make the first
five interest payments on the 2007 Notes. The Company placed approximately
$70 million of the net proceeds realized from the Debt Offering,
representing funds sufficient to pay the first five interest payments on the
2007 Notes, into the Escrow Account.
(3) Consists primarily of the AT&T Credit Facility totaling $31.2 million, of
which approximately $31.2 million had been drawn as of September 30, 1997.
(4) Excludes 8,060,344 and 11,028,005 shares reserved for issuance upon exercise
of options and warrants, respectively, outstanding at September 30, 1997, at
a weighted average exercise price of $5.23 and 500,000 shares issuable in
connection with the Company's Employee Stock Purchase Plan (as defined).
Also excludes 251,567 additional shares issuable upon exercise of the 2005
Warrants as a result of the Common Stock Offering. ACSI has also agreed to
issue warrants to purchase up to an aggregate of approximately 1.7 million
shares of Common Stock to MCI. Also excludes the 6,023,850 shares (subject
to an increase of 1,684,875 additional shares in the event the Company fails
to raise net proceeds of at least $50,000,000 through the issue and sale of
its qualified capital stock (other than preferred stock) on or before
December 31, 1998) reserved for issuance upon exercise of the 75,000
warrants issued in connection with the Unit Offering on July 10, 1997. See
"Summary -- Recent Developments."
(5) The aggregate proceeds from the exercise of all warrants and options
outstanding at September 30, 1997, would be approximately $99.9 million.
27
<PAGE> 31
UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED FINANCIAL DATA
The following Unaudited Pro Forma Condensed Consolidated Financial Data
consist of Unaudited Pro Forma Condensed Consolidated Statements of Operations
for the fiscal year ended June 30, 1996, for the fiscal period ended December
31, 1996 and for the nine months ended September 30, 1997 and Unaudited Pro
Forma Condensed Consolidated Balance Sheet as of December 31, 1996
(collectively, the "Pro Forma Statements"). The Unaudited Pro Forma Condensed
Consolidated Statements of Operations give effect to the Cybergate Acquisition
as if it occurred on July 1, 1995 and the Unaudited Pro Forma Condensed
Consolidated Balance Sheet gives effect to the Cybergate Acquisition as if it
occurred on December 31, 1996.
Management believes that, on the basis set forth herein, the Pro Forma
Statements reflect a reasonable estimate of the Cybergate Acquisition based on
currently available information. The pro forma financial data are presented for
informational purposes only and do not purport to represent what the Company's
financial position or results of operations would have been had the Cybergate
Acquisition in fact occurred on the dates assumed or that may result from future
operations. The pro forma data should be read in conjunction with the Company's
Consolidated Financial Statements and related notes thereto which are included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30, 1996 FISCAL PERIOD ENDED DECEMBER 31, 1996(1)
---------------------------------------------- ----------------------------------------------
THE THE
THE COMPANY THE COMPANY
COMPANY CYBERGATE ADJUSTMENTS PRO FORMA COMPANY CYBERGATE ADJUSTMENTS PRO FORMA
-------- --------- ----------- --------- -------- --------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues......................... $ 3,415 $ 3,723 $ -- $ 7,138 $ 6,990 $ 2,636 $ -- $ 9,626
Operating expenses:
Network development and
operations..................... 5,265 1,762 -- 7,027 8,703 1,136 -- 9,839
Selling, general and
administrative................. 13,464 1,378 100(2) 14,942 20,270 1,247 50(2) 21,567
Noncash stock and compensation... 2,736 -- -- 2,736 550 -- -- 550
Depreciation and amortization.... 3,078 372 872(3) 4,322 4,911 245 436(3) 5,592
-------- ------ ------- -------- -------- ------ ----- --------
Total operating expenses......... 24,543 3,512 972 29,027 34,434 2,628 486 (37,548)
-------- ------ ------- -------- -------- ------ ----- --------
Operating income (loss).......... (21,128) 211 (972) (21,889) (27,444) 8 (486) (27,922)
Non-operating income (expense)... (6,067) (27) (320)(4) (6,414) (7,633) (53) (160)(4) (7,846)
-------- ------ ------- -------- -------- ------ ----- --------
Income (loss) before minority
interest....................... (27,195) 184 (1,292) (28,303) (35,077) (45) (646) (35,768)
Minority interest................ 413 -- -- 413 160 -- -- 160
-------- ------ ------- -------- -------- ------ ----- --------
Net income (loss)................ (26,782) 184 (1,292) (27,890) (34,917) (45) (646) (35,608)
Preferred stock dividends and
accretion...................... (3,871) -- -- (3,871) (2,003) -- -- (2,003)
-------- ------ ------- -------- -------- ------ ----- --------
Net income (loss) to common
stockholders................... $(30,653) $ 184 $(1,292) $ (31,761) $(36,920) $ (45) $ (646) $ (37,611)
======== ====== ======= ======== ======== ====== ===== ========
Net loss per common
stockholder.................... $ (4.96) $ (4.40) $ (5.48) $ (4.84)
======== ======== ======== ========
Weighted average number of common
shares outstanding............. 6,185 1,030(5) 7,215 6,734 1,030(5) 7,764
</TABLE>
28
<PAGE> 32
<TABLE>
<CAPTION>
NINE-MONTH PERIOD ENDED SEPTEMBER 30,
1997
--------------------------------------
THE
COMPANY
THE PRO
COMPANY CYBERGATE(6) FORMA
-------- ------------ --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................................... $ 35,847 $218 $ 36,065
Operating expenses:
Network development and operations......................... 28,668 94 28,762
Selling, general and administrative........................ 47,975 94 48,069
Noncash stock and compensation............................. 1,324 -- 1,324
Depreciation and amortization.............................. 16,077 58 16,135
-------- ---- --------
Total operating expenses................................... 94,044 246 94,290
-------- ---- --------
Operating income (loss).................................... (58,197) (28) (58,225)
Non-operating income (expense)............................. (21,443) 3 (21,440)
-------- ---- --------
Income (loss) before minority interest..................... (79,640) (25) (79,665)
Minority interest.......................................... -- -- --
-------- ---- --------
Net income (loss).......................................... (79,640) (25) (79,665)
Preferred stock dividends and accretion.................... (3,584) -- (3,584)
-------- ---- --------
Net income (loss) to common stockholders................... $(83,224) $(25) $(83,249)
======== ==== ========
Net loss per common stockholder............................ $ (3.45) $ (3.44)
======== ========
Weighted average number of common shares outstanding....... 24,140 24,197
</TABLE>
- ---------------
(1) Subsequent to June 30, 1996, the Company changed its fiscal year-end from
June 30 to December 31. Accordingly, data for the fiscal period ended
December 31, 1996 is for the six months ended December 31, 1996.
(2) Represents expense related to a consulting agreement entered into by the
Company with a former shareholder of Cybergate.
(3) Reflects amortization of goodwill over a 10-year period and accounting
software over a three-year period.
(4) Reflects amortization of consent solicitation fees over the remaining terms
of the 2005 Notes and the 2006 Notes.
(5) Excludes adjustment for shares of Common Stock issuable if Cybergate meets
certain performance measures. Inclusion of such shares would be
anti-dilutive.
(6) Reflects Cybergate activity for the period from January 1, 1997, to January
17, 1997 (the date of acquisition).
29
<PAGE> 33
UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED FINANCIAL DATA -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------------------
THE
THE COMPANY
COMPANY CYBERGATE ADJUSTMENTS PRO FORMA
-------- --------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
ASSETS
Current assets:
Cash and cash equivalents................. $ 78,618 $ 60 $ (500)(1) $ 75,178
(3,000)(2)
Restricted cash........................... 2,342 -- -- 2,342
Accounts receivable....................... 2,429 127 -- 2,556
Other current assets...................... 1,203 51 -- 1,254
-------- ------ ------- --------
Total current assets................. 84,592 238 (3,500) 81,330
Networks, furniture and equipment, net......... 136,083 2,317 100(3) 138,500
Goodwill....................................... 8,385(1) 8,385
Deferred financing fees........................ 8,380 -- 3,000(2) 11,380
Other assets................................... 983 -- -- 983
-------- ------ ------- --------
Total assets......................... $230,038 $ 2,555 $ 7,985 $ 240,578
======== ====== ======= ========
LIABILITIES, REDEEMABLE STOCK, OPTIONS AND
WARRANTS, MINORITY INTEREST AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses..... $ 33,588 $ 348 $ -- $ 33,936
Notes payable -- current portion.......... 872 -- -- 872
Customer deposits and advanced billings... 0 338 -- 338
Other..................................... 4,132 -- -- 4,132
-------- ------ ------- --------
Total current liabilities................. 38,592 686 -- 39,278
Notes payable.................................. 209,538 306 100(3) 209,944
Advances due to affiliates..................... -- 551 -- 551
Dividends payable.............................. 6,946 -- -- 6,946
Other.......................................... 0 142 -- 142
-------- ------ ------- --------
Total liabilities.................... 255,076 1,685 100 256,861
Redeemable stock, options, and warrants........ 2,000 347 (347)(1) 2,000
Minority interest.............................. 0 -- -- 0
Stockholders' equity (deficit)................. (27,038) 523 8,232(1) (18,283)
-------- ------ ------- --------
Total liabilities, redeemable stock,
options and warrants, minority
interest and stockholders' equity
(deficit).......................... $230,038 $ 2,555 $ 7,985 $ 240,578
======== ====== ======= ========
</TABLE>
- ---------------
(1) Records the Cybergate Acquisition for a purchase price of $8,755,000
(1,030,000 shares of Common Stock at $8.50 per share, the per share closing
sales price of the Common Stock on January 17, 1997) plus estimated
transaction expenses of $500,000. Excludes 150,000 additional shares of
Common Stock which may be issued in 50,000 share increments (or a percentage
thereof) on March 1, 1998, 1999 and 2000 if Cybergate achieves certain
performance measures. In determining the cost of the identifiable assets and
liabilities acquired, it has been assumed that an independent appraisal will
result in fair values equal to the recorded book values as of the date of
the Cybergate Acquisition. In the opinion of management, due to the nature
of the assets and liabilities acquired, the fair values will approximate the
book values. The preliminary allocation of the purchase price results in
goodwill of approximately $8.4 million which will be amortized over 10
years.
(2) Records the payment of $3.0 million, including related transaction expenses
for solicitation fees payable to holders of the 2005 Notes and the 2006
Notes in order to obtain their consent to amend the indentures governing the
2005 Notes and the 2006 Notes. The amendments permit the Company to enter
into certain acquisition transactions, including the Cybergate Acquisition.
(3) Reflects the non-exclusive assignment to Cybergate of certain accounting
software for $100,000, payable over a three-year period.
30
<PAGE> 34
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below as of and for the
periods ended June 30, 1995 and 1996 and December 31, 1996 are derived from and
qualified by reference to the audited Consolidated Financial Statements of the
Company contained herein and the related notes thereto, and should be read in
conjunction therewith and in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations included elsewhere in
this Prospectus. The Company's Consolidated Financial Statements as of and for
the periods ended June 30, 1995 and June 30, 1996 and December 31, 1996 have
been audited by KPMG Peat Marwick LLP, independent auditors. Subsequent to June
30, 1996, the Company has changed its fiscal year-end from June 30 to December
31. Accordingly, all data for the fiscal period ended December 31, 1996 is for
the six months ended December 31, 1996. The consolidated financial data of the
Company as of and for the six months ended December 31, 1995 and as of and for
the nine months ended September 30, 1996 and September 30, 1997 have been
derived from the unaudited Consolidated Financial Statements of the Company
which, in the opinion of management, include all adjustments, consisting only of
normal recurring adjustments which the Company considers necessary for a fair
presentation of the results of operations and the financial condition for those
periods. The consolidated financial data for the fiscal period ended December
31, 1996 and the nine months ended September 30, 1997 are not necessarily
indicative of results for a twelve-month fiscal year.
<TABLE>
<CAPTION>
FISCAL
FISCAL YEAR SIX MONTHS PERIOD NINE MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
-------------------- ------------ ------------ ------------------------
1995 1996 1995 1996 1996 1997
-------- -------- ------------ ------------ --------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 389 $ 3,415 $ 989 $ 6,990 $ 5,239 $ 35,847
Operating expenses.......................... 14,797 24,543 7,966 34,434 28,535 94,044
-------- -------- -------- --------- --------- --------
Income (loss) from operations............... (14,408) (21,128) (6,977) (27,444) (23,296) (58,197)
Interest and other income................... 218 4,410 777 2,757 5,093 3,893
Interest and other expense.................. (170) (10,477) (2,835) (10,390) (13,653) (25,336)
Debt conversion expense..................... (385) -- -- -- -- --
-------- -------- -------- --------- --------- --------
Net income (loss) before minority
interest.................................. (14,746) (27,195) (9,035) (35,077) (31,856) (79,640)
Minority interest(1)........................ 48 413 156 160 353 --
-------- -------- -------- --------- --------- --------
Net income (loss)........................... (14,698) (26,782) (8,879) (34,917) (31,503) (79,640)
Preferred stock dividends and accretion..... (1,071) (3,871) (1,854) (2,003) (3,024) (3,584)
-------- -------- -------- --------- --------- --------
Net income (loss) to common stockholders.... $(15,769) $(30,653) $(10,734) $(36,920) $(34,527) $ (83,224)
======== ======== ======== ========= ========= ========
Net income (loss) per common share.......... $ (3.30) $ (4.96) $ (1.82) $ (5.48) $ (5.22) $ (3.45)
======== ======== ======== ========= ========= ========
Weighted average shares outstanding......... 4,772 6,185 5,901 6,734 6,614 24,140
OTHER DATA:
Deficiency in earnings to cover combined
fixed charges and preferred stock
dividends(2).............................. (16,353) (34,117) (11,652) (39,348) (38,302) (86,778)
EBITDA(3)................................... $ (7,443) $(14,901) $ (4,855) $(21,822) $(16,520) $ (40,796)
Depreciation and amortization............... 498 3,078 763 4,911 4,717 16,077
Capital expenditures........................ 15,303 60,856 17,657 64,574 64,933 103,851
BALANCE SHEET DATA (END OF PERIOD):
Cash and cash equivalents................... $ 20,351 $134,116 $ 57,348 $ 78,618 $102,819 $ 149,874
Total assets................................ 37,627 223,600 147,935 230,038 214,540 500,605
Long-term liabilities....................... 4,723 189,072 110,176 216,484 204,721 449,774
Redeemable stock, options and warrants...... 2,931 2,155 2,660 2,000 2,155 53,793
Stockholders' equity (deficit).............. 22,141 8,982 26,308 (27,038) (5,680) (27,583)
</TABLE>
- ---------------
(1) Minority interest represents a 7.25% ownership of AT&T Credit Corporation in
the Company's subsidiaries that operate its networks in Louisville, Fort
Worth, Greenville, Columbia and El Paso. See "Description of Certain
Indebtedness."
(2) For purposes of computing this amount earnings (loss) consists of earnings
(loss) before minority interest and fixed charges. Fixed charges consists of
interest expense (including amortization of debt issuance costs) and
one-third of rent expense which is deemed to be representative of interest
expense.
(3) EBITDA consists of net income (loss) before net interest, income taxes,
depreciation and amortization and noncash stock compensation and, in fiscal
year ended June 30, 1995, debt conversion expense of $385,000. It is a
measure commonly used in the telecommunications industry and is presented to
assist in understanding the Company's operating results. However, it is not
intended to represent cash flow or results of operations in accordance with
Generally Accepted Accounting Principles. Noncash compensation expense
associated with employee stock options was $6.4 million and $2.7 million in
fiscal years ended June 30, 1995 and 1996, respectively, $1.2 million and
$550,000 in the nine months ended December 31, 1995 and fiscal period ended
December 31, 1996, respectively and $1.7 million and $1.3 in the nine months
ended September 30, 1996 and 1997, respectively. See Note 6 of "Notes to
Consolidated Financial Statements."
31
<PAGE> 35
THE EXCHANGE OFFER
TERMS OF THE EXCHANGE OFFER
General
In connection with the sale of the Old Preferred Stock pursuant to a
Purchase Agreement dated as of October 6, 1997, between the Company and the
Initial Purchaser, the Initial Purchaser and its assignees became entitled to
the benefits of the Registration Rights Agreement.
Under the Registration Rights Agreement, the Company is obligated to (i)
file the Registration Statement of which this Prospectus is a part for a
registered exchange offer with respect to an issue of new preferred stock
identical in all material respects to the Old Preferred Stock within 45 days
after October 16, 1997, the date the Old Preferred Stock was issued (the "Issue
Date"), and (ii) use its best efforts to cause the Registration Statement to
become effective within 120 days after the Issue Date. The Exchange Offer being
made hereby if commenced and consummated within such applicable time periods
will satisfy those requirements under the Registration Rights Agreement. See
"Description of the Preferred Stock -- Exchange Offer; Registration Rights."
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal (which together constitute the Exchange Offer),
the Company will accept for exchange up to 150,000 shares of Old Preferred
Stock, having an aggregate Liquidation Preference of $150,000,000, validly
tendered and not withdrawn prior to 5:00 p.m., New York City time, on the
Expiration Date. The Company will issue one share of New Preferred Stock in
exchange for each share of Old Preferred Stock accepted in the Exchange Offer.
As of the date of this Prospectus, 150,000 shares of Old Preferred Stock,
having an aggregate Liquidation Preference of $150,000,000, were outstanding.
This Prospectus, together with the Letter of Transmittal, is being sent to all
registered holders as of December 23, 1997. The Company's obligation to accept
shares of Old Preferred Stock for exchange pursuant to the Exchange Offer is
subject to certain conditions as set forth herein under "-- Conditions."
The Company shall be deemed to have accepted validly tendered shares of Old
Preferred Stock 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 of shares of Old Preferred Stock for the purposes of receiving
the shares of New Preferred Stock from the Company and delivering the shares of
New Preferred Stock to such holders.
In the event the Exchange Offer is consummated, subject to certain limited
exceptions, the Company will not be required to register the Old Preferred
Stock. In such event, holders of Old Preferred Stock seeking liquidity in their
investment would have to rely on exemptions to registration requirements under
the U.S. securities laws. See "Risk Factors -- Consequences of Failure to
Exchange."
Expiration Date; Extensions; Amendments
The term "Expiration Date" shall mean January 22, 1998 (20 business days
following the commencement of the Exchange Offer), unless the Company, in its
sole discretion, extends the Exchange Offer, in which case the term "Expiration
Date" shall mean the latest date to which the Exchange Offer is extended. See
"-- Acceptance of Old Preferred Stock for Exchange; Delivery of New Preferred
Stock."
In order to extend the Expiration Date, the Company will notify the
Exchange Agent of any extension by oral or written notice and will mail to the
record holders of Old Preferred Stock an announcement thereof, each prior to
9:00 a.m., New York City time, on the next business day after the previously
scheduled Expiration Date. Such announcement may state that the Company is
extending the Exchange Offer for a specified period of time.
The Company reserves the right (i) to delay accepting any shares of Old
Preferred Stock, to extend the Exchange Offer or to terminate the Exchange Offer
and not accept shares of Old Preferred Stock not previously accepted if any of
the conditions set forth herein under "-- Conditions" shall have occurred and
shall not have been waived by the Company, 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 deemed by it to be advantageous to the
holders of the Old Preferred Stock. Any such delay in acceptance, extension,
termination or amendment will be followed as promptly as practicable by oral or
written notice thereof. If the
32
<PAGE> 36
Exchange Offer is amended in a manner determined by the Company to constitute a
material change, the Company will promptly disclose such amendment in a manner
reasonably calculated to inform the holders of the Old Preferred Stock of such
amendment and the Company will extend the Exchange Offer for a period of five to
10 business days, depending upon the significance of the amendment and the
manner of disclosure to holders of the Old Preferred Stock, if the Exchange
Offer would otherwise expire during such five to 10 business day period.
Without limiting the manner in which the Company may choose to make public
announcement of any delay, extension, amendment or termination 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 an appropriate news agency.
NO VOTE OF THE COMPANY'S SECURITY HOLDERS IS REQUIRED UNDER APPLICABLE LAW
TO EFFECT THE EXCHANGE OFFER AND NO SUCH VOTE (OR PROXY THEREFOR) IS BEING
SOUGHT HEREBY.
Holders of Old Preferred Stock do not have any appraisal or dissenters'
rights in connection with the Exchange Offer under the Delaware General
Corporation Law, the state in which the Company is incorporated.
DIVIDENDS ON THE NEW PREFERRED STOCK
Dividends on the New Preferred Stock will accrue from the date of issuance
of the Old Preferred Stock, are cumulative and will be payable quarterly, in
arrears, on January 15, April 15, July 15 and October 15 of each year commencing
January 15, 1998, at a rate per annum of 12 3/4% of the Liquidation Preference
thereof. Dividends will also accrue and cumulate on any accrued and unpaid
dividends.
PROCEDURES FOR TENDERING
To tender in the Exchange Offer, a holder must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, have the signatures thereon
guaranteed if required by the Letter of Transmittal and mail or otherwise
deliver such Letter of Transmittal or such facsimile, together with 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
shares of Old Preferred Stock must be received by the Exchange Agent along with
the Letter of Transmittal, (ii) a timely confirmation of a book-entry transfer
(a "Book-Entry Confirmation") of such shares of Old Preferred Stock, if such
procedure is available, into the Exchange Agent's account at The Depository
Trust Company (the "Book-Entry Transfer Facility") pursuant to the procedure for
book-entry transfer described below, must be received by the Exchange Agent
prior to the Expiration Date or (iii) the holder must comply with the guaranteed
delivery procedures described below. THE METHOD OF DELIVERY OF SHARES OF OLD
PREFERRED STOCK, LETTERS OF TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS IS AT
THE ELECTION AND RISK OF THE HOLDERS. IF SUCH DELIVERY IS BY MAIL, IT IS
RECOMMENDED THAT REGISTERED MAIL, PROPERLY INSURED, WITH RETURN RECEIPT
REQUESTED, BE USED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE
TIMELY DELIVERY. NO LETTERS OF TRANSMITTAL OR SHARES OF OLD PREFERRED STOCK
SHOULD BE SENT TO THE COMPANY. To be tendered effectively, the shares of Old
Preferred Stock, Letter of Transmittal and all other required documents must be
received by the Exchange Agent prior to 5:00 p.m., New York City time, on the
Expiration Date. Delivery of all documents must be made to the Exchange Agent at
its address set forth below. Holders may also request their respective brokers,
dealers, commercial banks, trust companies or nominees to effect such tender for
such holders.
The tender by a holder of Old Preferred Stock 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.
Only a holder of shares of Old Preferred Stock may tender such shares of
Old Preferred Stock in the Exchange Offer. The term "holder" with respect to the
Exchange Offer means any person in whose name shares of Old Preferred Stock are
registered on the books of the Company or any other person who has obtained a
properly completed stock power from the registered holder.
33
<PAGE> 37
Any beneficial owner whose shares of Old Preferred Stock 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 his behalf. If such beneficial
owner wishes to tender on his own behalf, such beneficial owner must, prior to
completing and executing the Letter of Transmittal and delivering his shares of
Old Preferred Stock, either make appropriate arrangements to register ownership
of the shares of Old Preferred Stock in such owner's name or obtain a properly
completed stock 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 any member firm of a registered national
securities exchange or of the National Association of Securities Dealers, Inc.
or a commercial bank or trust company having an office or correspondent in the
U.S. (an "Eligible Institution") unless the shares of Old Preferred Stock
tendered pursuant thereto are tendered (i) by a registered holder who has not
completed the box entitled "Special Issuance 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, such
guarantee must be by an Eligible Institution.
If the Letter of Transmittal is signed by a person other than the
registered holder of any shares of Old Preferred Stock listed therein, such
shares of Old Preferred Stock must be endorsed or accompanied by stock powers
and a proxy which authorizes such person to tender the shares of Old Preferred
Stock on behalf of the registered holder, in each case as the name of the
registered holder or holders appears on the certificates in respect of such
shares of Old Preferred Stock.
If the Letter of Transmittal or any shares of Old Preferred Stock stock
powers are signed by trustees, executors, administrators, guardians,
attorneys-in-fact, officers of corporations or others acting in a fiduciary or
representative capacity, such person 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) and withdrawal of the tendered shares of Old Preferred Stock 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
shares of Old Preferred Stock not properly tendered or any shares of Old
Preferred Stock which, if accepted by the Company, 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 shares of Old
Preferred Stock. 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 shares of Old Preferred Stock must be cured within
such time as the Company shall determine. None of the Company, the Exchange
Agent or any other person shall be under any duty to give notification of
defects or irregularities with respect to tenders of shares of Old Preferred
Stock, nor shall any of them incur any liability for failure to give such
notification. Tenders of shares of Old Preferred Stock will not be deemed to
have been made until such irregularities have been cured or waived. Any shares
of Old Preferred Stock 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 without cost to such holder by the Exchange Agent to the
tendering holders of shares of Old Preferred Stock, unless otherwise provided in
the Letter of Transmittal, as soon as practicable following the Expiration Date.
In addition, the Company reserves the right in its sole discretion, subject
to the provisions of the Certificate of Designation, to (i) purchase or make
offers for any shares of Old Preferred Stock that remain outstanding subsequent
to the Expiration Date or, as set forth under "-- Conditions," to terminate the
Exchange Offer in accordance with the terms of the Registration Rights Agreement
and (ii) to the extent permitted by applicable law, purchase shares of Old
Preferred Stock in the open market, in privately negotiated transactions or
otherwise. The terms of any such purchases or offers could differ from the terms
of the Exchange Offer.
By tendering, each holder will represent to the Company that: (i) it is not
an affiliate of the Company (as defined under Rule 405 of the Securities Act);
(ii) any shares of New Preferred Stock to be received by it were acquired in the
ordinary course of its business; and (iii) at the time of commencement of the
Exchange
34
<PAGE> 38
Offer, it was not engaged in, and did not intend to engage in, a distribution of
such shares of New Preferred Stock and had no arrangement or understanding with
any person to participate in the distribution (within the meaning of the
Securities Act) of the shares of New Preferred Stock. If a holder of shares of
Old Preferred Stock is an affiliate of the Company, and is engaged in or intends
to engage in a distribution of the shares of New Preferred Stock or has any
arrangement or understanding with respect to the distribution of the shares of
New Preferred Stock to be acquired pursuant to the Exchange Offer, such holder
could not rely on the applicable interpretations of the staff of the SEC and
must comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any secondary resale transaction. Each broker
or dealer that receives shares of New Preferred Stock for its own account in
exchange for shares of Old Preferred Stock, where such shares of Old Preferred
Stock were acquired by such broker or dealer as a result of market-making
activities, or other trading activities, must acknowledge that it will deliver a
prospectus in connection with any resale of such shares of New Preferred Stock.
See "Plan of Distribution."
ACCEPTANCE OF OLD PREFERRED STOCK FOR EXCHANGE; DELIVERY OF NEW PREFERRED STOCK
Upon satisfaction or waiver of all of the conditions to the Exchange Offer,
the Company will accept, promptly after the Expiration Date, all shares of Old
Preferred Stock properly tendered and will issue the shares of New Preferred
Stock promptly after acceptance of the shares of Old Preferred Stock. See
"-- Conditions" below. For purposes of the Exchange Offer, the Company shall be
deemed to have accepted validly tendered shares of Old Preferred Stock for
exchange when, as and if the Company has given oral or written notice thereof to
the Exchange Agent.
For each share of Old Preferred Stock accepted for exchange, the holder of
such Old Preferred Stock will receive a share of New Preferred Stock having a
Liquidation Preference equal to that of the surrendered share of Old Preferred
Stock. If (i) neither the Registration Statement of which this Prospectus is a
part (the "Exchange Offer Registration Statement") relating to the Exchange
Offer has been declared effective by February 13, 1998, or (ii) notwithstanding
that the Company has consummated or will consummate the Exchange Offer, the
Company is required to file a shelf registration statement (the "Shelf
Registration Statement") with respect to the Old Preferred Stock and such Shelf
Registration Statement is not declared effective by the applicable date
specified under "Description of the Preferred Stock -- Exchange Offer;
Registration Rights", then commencing on the date of such Registration Default
(as defined), Additional Dividends (as defined) will accrue on the Preferred
Stock owned by each holder affected by such Registration Default from and
including the date on which any Registration Default shall occur to but
excluding the date on which all Registration Defaults have been cured at a rate
per annum of 0.25% for each 90-day period that such Registration Default
continues; provided, that such rate shall in no event exceed 1.0% per annum.
Additional Dividends shall be paid, either in cash or, at the Company's option,
in additional shares of Preferred Stock, on each regular quarterly Dividend
Payment Date following the occurrence of such Registration Default through the
Dividend Payment Date next following the date when such Registration Default
shall have been cured. Following the cure of all Registration Defaults, the
accrual of Additional Dividends will cease. Upon the effectiveness of the
Exchange Offer Registration Statement or a Shelf Registration Statement,
Additional Dividends payable on the shares of Old Preferred Stock from the date
of such effectiveness will cease to accrue and all accrued and unpaid dividends
as of the occurrence of such effectiveness shall be paid on the next Dividend
Payment Date to the holders of the Old Preferred Stock exchanged for New
Preferred Stock.
In all cases, issuance of shares of New Preferred Stock for shares of Old
Preferred Stock that are accepted for exchange pursuant to the Exchange Offer
will be made only after timely receipt by the Exchange Agent of certificates for
such shares of Old Preferred Stock or a timely Book-Entry Confirmation of
transfer of such shares of Old Preferred Stock into the Exchange Agent's account
at the Book-Entry Transfer Facility, a properly completed and duly executed
Letter of Transmittal and all other required documents. If any tendered shares
of Old Preferred Stock are not accepted for any reason set forth in the terms
and conditions of the Exchange Offer or if certificates with respect to shares
of Old Preferred Stock are submitted for a greater number of shares than the
holder desires to exchange, such unaccepted or nonexchanged shares of Old
Preferred Stock will be returned without expense to the tendering holder thereof
(or, in the case of shares of Old Preferred Stock tendered by book-entry
transfer procedures described below, such nonexchanged shares
35
<PAGE> 39
of Old Preferred Stock will be credited to an account maintained with such
Book-Entry Transfer Facility) as promptly as practicable after the expiration or
termination of the Exchange Offer.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect
to the Old Preferred Stock at the Book-Entry Transfer Facility for purposes of
the Exchange Offer within two business days after the date of this Prospectus.
Any financial institution that is a participant in the Book-Entry Transfer
Facility's systems may make book-entry delivery of shares of Old Preferred Stock
by causing the Book-Entry Transfer Facility to transfer such shares of Old
Preferred Stock into the Exchange Agent's account at the Book-Entry Transfer
Facility in accordance with such Book-Entry Transfer Facility's procedures for
transfer. However, although delivery of shares of Old Preferred Stock may be
effected through book-entry transfer at the Book-Entry Transfer Facility, the
Letter of Transmittal or facsimile thereof with any required signature
guarantees and any other required documents must, in any case, be transmitted to
and received by the Exchange Agent at one of the addresses set forth below under
"-- Exchange Agent" on or prior to the Expiration Date or the guaranteed
delivery procedures described below must be complied with.
GUARANTEED DELIVERY PROCEDURES
If a registered holder of shares of Old Preferred Stock desires to tender
such shares of Old Preferred Stock, and the shares of Old Preferred Stock are
not immediately available, or time will not permit such holder's shares of Old
Preferred Stock or other required documents to reach the Exchange Agent before
the Expiration Date, or the procedures for book-entry transfer cannot be
completed on a timely basis, a tender may be effected if (i) the tender is made
through an Eligible Institution, (ii) prior to the Expiration Date, the Exchange
Agent received from such Eligible Institution a properly completed and duly
executed Letter of Transmittal (or a facsimile thereof) and Notice of Guaranteed
Delivery, substantially in the form provided by the Company (by facsimile
transmission, mail or hand delivery), setting forth the name and address of the
holder of Old Preferred Stock and the amount of Old Preferred Stock tendered,
stating that the tender is being made thereby and guaranteeing that within five
New York Stock Exchange ("NYSE") trading days after the date of execution of the
Notice of Guaranteed Delivery, the certificates for all physically tendered
shares of Old Preferred Stock, in proper form for transfer, or a Book-Entry
Confirmation, as the case may be, and any other documents required by the Letter
of Transmittal will be deposited by the Eligible Institution with the Exchange
Agent and (iii) the certificates for all physically tendered shares of Old
Preferred Stock, in proper form for transfer, or a Book-Entry Confirmation, as
the case may be, and all other documents required by the Letter of Transmittal
are received by the Exchange Agent within five NYSE trading days after the date
of execution of the Notice of Guaranteed Delivery.
WITHDRAWAL OF TENDERS
Tenders of shares of Old Preferred Stock may be withdrawn at any time prior
to 5:00 p.m., New York City time, on the Expiration Date.
For a withdrawal to be effective, a written notice of withdrawal must be
received by the Exchange Agent at one of the addresses set forth below under
"Exchange Agent." Any such notice of withdrawal must specify the name of the
person having tendered the shares of Old Preferred Stock to be withdrawn,
identify the shares of Old Preferred Stock to be withdrawn (including the number
of shares of such Old Preferred Stock) and (where certificates for shares of Old
Preferred Stock have been transmitted) specify the name in which such shares of
Old Preferred Stock are registered, if different from that of the withdrawing
holder. If certificates for shares of Old Preferred Stock 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. If shares of Old Preferred Stock has been tendered
pursuant to the procedure for book-entry transfer described above, any notice of
withdrawal must specify the name and number of the account at the Book-Entry
Transfer Facility to be credited with the withdrawn shares of Old Preferred
Stock and otherwise comply with the procedures of such facility. All questions
as to the validity, form and eligibility (including time of receipt) of such
notices will be determined by the Company, whose determination shall be final
and binding on all parties. Any shares of Old Preferred Stock so withdrawn
36
<PAGE> 40
will be deemed not to have been validly tendered for exchange for purposes of
the Exchange Offer. Any shares of Old Preferred Stock which have been tendered
for exchange but which are not exchanged for any reason will be returned to the
holder thereof without cost to such holder (or, in the case of shares of Old
Preferred Stock tendered by book-entry transfer into the Exchange Agent's
account at the Book-Entry Transfer Facility pursuant to the book-entry transfer
procedures described above, such shares of Old Preferred Stock will be credited
to an account maintained with such Book-Entry Transfer Facility for the shares
of Old Preferred Stock) as soon as practicable after withdrawal, rejection of
tender or termination of the Exchange Offer. Properly withdrawn shares of Old
Preferred Stock may be retendered by following one of the procedures described
under "-- Procedures for Tendering" above at any time on or prior to the
Expiration Date.
CONDITIONS
Notwithstanding any other term of the Exchange Offer, the Company will not
be required to accept for exchange, or to issue shares of New Preferred Stock in
exchange for, any shares of Old Preferred Stock and may terminate or amend the
Exchange Offer as provided herein before the acceptance of such shares of Old
Preferred Stock, if because of any change in law, or applicable interpretations
thereof by the Commission, the Company determines that it is not permitted to
effect the Exchange Offer, and the Company has no obligation to, and will not
knowingly, accept tenders of shares of Old Preferred Stock from "affiliates" of
the Company (within the meaning of Rule 405 under the Securities Act) or from
any other holder or holders who are not eligible to participate in the Exchange
Offer under applicable law or interpretations thereof by the Commission, or if
the shares of New Preferred Stock to be received by such holder or holders of
Old Preferred Stock in the Exchange Offer, upon receipt, will not be tradeable
by such holder without restriction under the Securities Act and the Exchange Act
and without material restrictions under the "blue sky" or securities laws of
substantially all of the states.
EXCHANGE AGENT
The Bank of New York has been appointed as Exchange Agent for the Exchange
Offer. Questions and requests for assistance and requests for additional copies
of this Prospectus or of the Letter of Transmittal should be directed to the
Exchange Agent addressed as follows:
<TABLE>
<S> <C>
By Mail: By Hand/Overnight Delivery:
Tender and Exchange Department Tender and Exchange Department
P.O. Box 11248 101 Barclay Street
Church Street Station Receive and Deliver Window
New York, New York 10206-1248 New York, New York 10286
</TABLE>
Facsimile Transmission:
(212) 815-6213
Confirm by Telephone:
(800) 507-9357
FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will be
borne by the Company. The principal solicitation for tenders pursuant to the
Exchange Offer is being made by mail; however, additional solicitations may be
made by telephone, telecopy or in person by officers and regular employees of
the Company.
The Company will not make any payments to brokers, dealers or other persons
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
the Exchange Agent for its reasonable out-of-pocket expenses in connection
therewith. The Company may also pay brokerage houses and other custodians,
nominees and fiduciaries the reasonable out-of-pocket expenses incurred by them
in forwarding copies of the Prospectus and related
37
<PAGE> 41
documents to the beneficial owners of the Old Preferred Stock, and in handling
or forwarding tenders for exchange.
The expenses to be incurred in connection with the Exchange Offer will be
paid by the Company, including fees and expenses of the Exchange Agent and
Trustee (as hereinafter defined) and accounting, legal, printing and related
fees and expenses.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Old Preferred Stock pursuant to the Exchange Offer. If, however, certificates
representing shares of New Preferred Stock or Old Preferred Stock not tendered
or accepted for exchange are to be delivered to, or are to be registered or
issued in the name of, any person other than the registered holder of the shares
of Old Preferred Stock tendered, or if tendered shares of Old Preferred Stock
are registered in the name of any person other than the person signing the
Letter of Transmittal and any transfer taxes are payable, or if a transfer tax
is imposed for any reason other than the exchange of shares of Old Preferred
Stock 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 Preferred Stock will be recorded in the Company's accounting
records at the same carrying value as the Old Preferred Stock 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 upon the consummation of
the Exchange Offer. The expenses of the Exchange Offer will be amortized by the
Company over the term of the New Preferred Stock in accordance with generally
accepted accounting principles.
38
<PAGE> 42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis contains certain statements of a
forward-looking nature relating to future events or the future financial
performance of the Company. Holders of Old Preferred Stock are cautioned that
such statements are only predictions and that actual events or results may
differ materially. In evaluating such statements, holders of Old Preferred Stock
should specifically consider the various factors identified in this Prospectus,
including the matters set forth under the caption "Risk Factors," which could
cause actual results to differ materially from those indicated by such
forward-looking statements. The following discussion should be read in
conjunction with the consolidated financial statements and the related notes
thereto included elsewhere or incorporated by reference in this Prospectus.
OVERVIEW
ACSI is a provider of integrated local voice and data communications
services to commercial customers primarily in mid-sized metropolitan markets in
the southern United States. The Company is a rapidly growing CLEC, supplying
businesses with advanced telecommunications services on its digital SONET-based
fiber optic local networks and through resale of incumbent local exchange
carrier services. To date, the Company has derived the majority of its revenues
from the sale of dedicated services, generally at a discount to the price of the
ILECs. The Company's dedicated services include special access, switched
transport and private line services.
As a supplement to its dedicated services, the Company introduced local
switched voice services in two of its markets and began offering local switched
voice services in two additional markets using its own facilities before March
31, 1997. The Company's local switched services include: local exchange services
(dial tone), advanced ISDN and enhanced voice services. In late 1996, the
Company also deployed ACSINet, a coast-to-coast, leased broadband data
communications network through which the Company offers frame relay, ATM and
Internet access services to both ISPs and local businesses. As of September 30,
1997, the Company had ACSINet data POPs in 44 markets, including all but one of
the markets in which the Company has operational local networks. Additionally,
primarily through the Cybergate Acquisition, the Company has begun providing
Internet services. The Cybergate Acquisition provides a foundation to support
the Company's Internet service offerings to ISPs in existing ACSI markets and to
end-users in targeted ACSI markets.
As of September 30, 1997, the Company had 32 operational local networks. In
an attempt to improve financial performance and conserve capital, the Company is
reassessing the optimum number of local networks needed to achieve its
objectives.
The Company provides dedicated services to IXCs and to those business and
government end-users whose volumes of voice and data traffic are large enough to
warrant paying a fixed monthly charge for a specific capacity requirement rather
than a usage-based variable charge. These monthly charges vary according to the
capacity of each circuit, the volume of individual circuits ordered by the
customer, the mileage of the circuits, the need for any ancillary services and
the term of the service contract, but are typically less than the rates charged
by the ILECs for similar services, volumes and terms. For the fiscal period
ended December 31, 1996, 40% of the Company's revenues were generated by four of
the largest IXCs. As of September 30, 1997, the Company had long-term operating
leases for nine Lucent 5ESS switches. The use of operating leases, rather than
the acquisition of such equipment, reduces the Company's capital requirements
but negatively impacts its EBITDA. The Company has long-term operating leases
for 9 voice and 40 data switches totaling $20.8 million at interest rates
ranging from 7% to 11% over terms ranging from 3 to 7 years, with annual
payments increasing over the term of each lease. The Company has successfully
negotiated approximately $19 million in additional long term operating leases
for an estimated 8 voice and 20 data switches with interest rates and payment
structures similar to the existing operating leases.
Beginning in the fiscal quarter ended December 31, 1996, the Company began
providing and plans to continue to provide, local switched voice services, such
as local dial tone, termination of local calling, Centrex services, PBX
trunking, switched access and enhanced voice services, initially to existing and
new corporate customers in buildings already connected to the Company's local
networks. Revenues from the Company's local switched voice services will be
generated from fixed and usage-based charges billed directly to the end
39
<PAGE> 43
user at rates below those charged by ILECs for similar services. The Company
began generating revenues from its local switched voice services beginning in
the three months ending March 31, 1997.
In December 1996, the Company began providing high-speed data services to
ISPs and corporate, institutional and government customers. ACSI's data services
revenues are generated from either flat rate or usage-based recurring charges
based on network access speed and the data throughput rate requested by the
end-user as well as from non-recurring charges for installation and
provisioning. Principally through the Cybergate Acquisition, ACSI has begun to
offer direct Internet access to commercial and consumer end-users as well as
provide private label Internet services for the Company's strategic distribution
partners throughout all of the Company's markets. Revenues from the Company's
Internet services will be generated from usage-based variable rates charged
directly to the end-user by the Company.
The Company believes that integration of its SONET-based fiber optic local
networks and its coast-to-coast, leased broadband data communications network
will provide a platform for the provision of a wide variety of voice, high-speed
data and other communications services at a reduced cost. While the Company may
offer its services to customers that are not directly connected to its
integrated network through resale of the ILEC's network, the Company believes
that it can gradually migrate many of these off-net customers to higher margin
on-net accounts as it increases penetration of all its services within a given
building. As a result, the capital investment of connecting additional buildings
and customers to ACSI's integrated network should become more cost-effective.
Over time, the Company believes it can increase its market share of all of its
service offerings as a result of the reliability and quality of its integrated
network, prompt customer service, competitive pricing, cross marketing/bundling
synergies and new service offerings throughout the markets it serves.
ACSI is operating its coast-to-coast, leased broadband data communications
network via high bandwidth (DS-3) longhaul circuits pursuant to multi-year
operating leases with various IXCs. Network connectivity within each node will
be via DS-3 bandwidth, enabling the transparent migration of longhaul circuits
to DS-3 capacity as needed. Ultimately, the platform technology is capable of
upgrading the backbone to higher bandwidths without further modification.
Initially, the Company expects to experience negative cash flow from
operations in each of its operating local networks. The Company estimates that
because of the reduced operating costs associated with its smaller local
networks and its single point of service sales force, it can achieve operating
cash flow breakeven (i.e., positive EBITDA before overhead allocations) on
dedicated access services provided on its local networks within ten to 15 months
from the start of those services. Thereafter, the Company anticipates that its
profit margins will increase as each local network is expanded to connect
additional customers directly to its network backbone and as off-net customers
migrate to on-net status (thus allowing the Company to retain the portion of
customer charges previously paid out to the ILEC for resale of ILEC facilities).
The Company will also experience initial negative cash flow from operations as
its data, local switched voice and Internet services are introduced and until
networks providing those services reach operating cash flow breakeven.
CAPITAL EXPENDITURES; OPERATING CASH FLOW
As of September 30, 1997, the Company was operating 32 digital fiber optic
networks. The costs associated with the initial construction and operation of a
network may vary greatly, primarily due to market variations in geographic and
demographic characteristics, and the types of construction technologies which
can be used to deploy the network. Management estimates that construction of the
initial one-to-three mile fiber optic backbone and installation of related
network transmission equipment for dedicated services for each market will
generally cost between $3.5 million and $6.0 million depending on the size of
the market served. Including planned expansion routes, total capital
expenditures per network are estimated to average $6.0 million. In addition to
capital expenditure requirements, the Company incurs sales and marketing
(including sales commissions) and operating expenses and other expenses such as
property taxes and, in certain markets, franchise fees. Prior to the completion
of network construction, certain of these expenses, to the extent they are
related to pre-service construction, are capitalized. These additional
capitalized expenses, estimated by management to be between approximately
$500,000 and $1.0 million per network, are amortized over the
40
<PAGE> 44
anticipated life of the network. These costs vary depending on the size of the
market, the length of time required to build-out the network and the rate of
growth of the customer base.
As the Company develops, introduces and rolls out its high-speed data,
enhanced voice messaging and local switched services in each of its target
markets, additional capital expenditures and net operating costs will be
incurred. The amount of these costs will vary, based on the number of customers
served and the actual services provided to the customers.
Although as of September 30, 1997, the Company was generating revenues from
32 of its fiber optic networks, on a consolidated basis, it is still incurring
negative cash flows due, in part, to the funding requirements for the networks
the Company has under construction or development and, to the roll-out of its
new data and switched voice services. The Company expects it will continue to
incur a negative cash flow for at least two years. The Company anticipates that
without an infusion of additional cash it will exhaust its cash resources during
the first quarter of 2000. The Company currently expects to begin generating
positive cash flow from operations in the year 2000. However, there can be no
assurance that the Company's networks or any of its other services will ever
provide a revenue base adequate to sustain profitability or to generate positive
cash flow.
RESULTS OF OPERATIONS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE AND NINE
MONTH PERIODS ENDED SEPTEMBER 30, 1996.
Revenues
The Company reported an increase in revenues to $16.1 million for the three
months ended September 30, 1997 compared with revenues of $2.8 million for the
three months ended September 30, 1996. For the nine months ended September 30,
1997, revenues increased to $35.8 million compared with $5.2 million for the
same period of 1996. The increase in revenues is due to an increase in the
networks in operation and expanded service offerings in each market. The 1997
revenues continue to be derived from significant growth in dedicated services,
data services, Internet services and local switched voice services. For 1996,
substantially all of the revenues were derived from the provision of dedicated
services.
OTHER NETWORK INFORMATION IS AS FOLLOWS:
<TABLE>
<CAPTION>
NETWORK NETWORK VOICE
ROUTE FIBER BUILDINGS GRADE FULL TIME
AS OF THE PERIOD ENDED: MILES MILES CONNECTED EQUIVALENTS EMPLOYEES
-------------------------------- ------- ------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
March 31, 1996.................. 200 9,466 133 125,208 142
June 30, 1996................... 386 28,476 216 137,431 199
March 31, 1997.................. 908 75,867 858 554,883 502
June 30, 1997................... 957 82,693 1,083 886,375 559
September 30, 1997.............. 977 85,976 1,239 989,285 669
</TABLE>
The terms "Voice Grade Equivalents ('VGEs')" or "Voice Grade Equivalent
Circuits" are commonly used measures of telephone service equivalent to one
telephone line (64 kilobits of bandwidth) actually billed to a customer.
Total Operating Expenses
Network development and operating expenses for the three months ended
September 30, 1997 increased to $10.6 million from $3.7 million for the same
period of 1996. The increase is due to significant increases in personnel,
network development and non-payroll operating expenses. Related personnel costs
increased to $4.0 million in the quarter ended September 30, 1997, from
approximately $2.8 million in the quarter ended September 30, 1996. Other
operating expenses, which include expenses such as contract labor and legal
expenses, travel expenses, rent, utilities, charges and taxes increased to $6.6
million for the quarter ended September 30, 1997 from approximately $0.9 million
for the quarter ended September 30, 1996.
41
<PAGE> 45
For the nine months ended September 30, 1997, network development and
operating expenses increased to $28.7 million from $6.1 million for the nine
months ended September 30, 1996. This increase is due to significant increases
in personnel, network development and non-payroll operating expenses. Related
personnel costs increased to $10.5 million for the nine months ended September
30, 1997, from approximately $5.8 million for the same period of 1996. Other
operating expenses, increased to $18.2 million for the nine months ended
September 30, 1997 from approximately $0.3 million for the nine months ended
September 30, 1996.
For the three months ended September 30, 1997, selling, general and
administrative expenses increased to $18.2 million from $5.7 million for the
same period of 1996. Related personnel costs increased to $7.6 million for the
quarter ended September 30, 1997 from $1.5 million for the quarter ended
September 30, 1996. Corresponding operating costs increased to $10.6 million for
the quarter ended September 30, 1997 from $4.2 million for the quarter ended
September 30, 1996. This increase reflected costs associated with the Company's
efforts to significantly expand its national and local city sales and its
marketing and administrative staffs, as well as increased legal and other
consulting expenses associated with its aggressive programs for obtaining
regulatory approvals and certifications and providing quality network services.
In the nine months ended September 30, 1997, selling, general and
administrative expenses increased to $48.0 million from $16.1 million for the
nine months ended September 30, 1996. Related personnel costs increased to $19.7
million for the nine months ended September 30, 1997 from $3.2 million for the
nine months ended September 30, 1996. Corresponding operating costs increased to
$28.3 million for the nine months ended September 30, 1997 from $12.9 million
for the same period of 1996.
Depreciation and amortization expenses increased to $6.6 million for the
three months ended September 30, 1997 from $2.4 million for the three months
ended September 30, 1996. For the nine months ended September 30, 1997,
depreciation and amortization increased to $16.1 million from $4.7 million for
the same period of 1996. As of September 30, 1997, the Company increased its
capital assets to $250.4 million compared to $144.4 million at December 31, 1996
and $101.9 million as of September 30, 1996. Non-cash stock compensation expense
increased to $0.5 million for the quarter ended September 30, 1997 from $0.2
million for the quarter ended September 30, 1996. For the nine months ended
September 30, 1997, non-cash compensation expense decreased to $1.3 million from
$1.7 for the same period of 1996.
Interest and Other Expenses
Interest and other income increased to $2.8 million for the three months
ended September 30, 1997 compared with $1.5 million for the same period of 1996.
For the nine months ended September 30, 1997 interest and other income decreased
to $3.9 million from $5.1 million for the same period ended 1996. Interest and
other expense increased to $12.9 million from $6.0 million for the quarters
ended September 30, 1997 and 1996, respectively. For the nine months ended
September 30, 1997 and 1996, interest and other expense increased to $25.3
million from $13.7 million, respectively. The increase in interest and other
income for the quarter reflects the increase in earnings from the proceeds
received from the 2007 Notes and the 14 3/4% Preferred Stock which have been
invested. The increase in interest and other expenses reflected the accrual of
interest related to the 2005, 2006 and 2007 Notes and the Company's increased
borrowings under AT&T Credit Facility. Payments of principal and interest on the
AT&T Credit Facility began in the first quarter 1997. Payments of interest on
the 2005 Notes, 2006 Notes and the 2007 Notes will not begin until May 2001,
October 2001 and January 1998, respectively.
FISCAL PERIOD ENDED DECEMBER 31, 1996 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
1995
Revenues
During the fiscal period ended December 31, 1996, the Company recorded
revenues of $7.0 million as compared to revenues of $988,877 during the six
months ended December 31, 1995. Four of the largest IXCs accounted for
approximately $2.8 million, or 40%, of revenues for the fiscal period ended
December 31, 1996.
42
<PAGE> 46
Other network information is as follows:
<TABLE>
<CAPTION>
NETWORKS VOICE
IN ROUTE FIBER BUILDINGS GRADE FULL TIME
AS OF THE PERIOD ENDED: OPERATION MILES MILES CONNECTED EQUIVALENTS EMPLOYEES
- ------------------------------- --------- ----- ------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1995.............. 9 136 5,957 100 82,055 111
December 31, 1996.............. 21 697 48,792 595 384,134 322
</TABLE>
Total Operating Expenses
Network development and operating expenses for the fiscal period ended
December 31, 1996 increased to $8.7 million from $2.9 million in the six months
ended December 31, 1995, reflecting significant increases in personnel, network
development and non-payroll operating expenses. Related personnel costs
increased to $3.9 million in the fiscal period ended December 31, 1996, from
approximately $1.5 million in the six months ended December 31, 1995. Other
operating expenses related to the development of prospective new markets, which
include expenses such as contract labor and legal expenses and certain franchise
fees, travel expenses, rent, utilities, charges and taxes increased to $4.8
million in the fiscal period ended December 31, 1996 from approximately $1.4
million in the six months ended December 31, 1995.
In the fiscal period ended December 31, 1996, selling, general and
administrative expenses increased to $20.3 million from $3.1 million in the six
months ended December 31, 1995. Related personnel costs increased to $6.6
million in the fiscal period ended December 31, 1996 from $1.5 million in the
six months ended December 31, 1995, and corresponding operating costs increased
to $13.7 million in the fiscal period ended December 31, 1996 from $1.6 million
in the six months ended December 31, 1995. This increase reflected costs
associated with the Company's efforts in the rapid expansion of its services
offered, network deployment and geographic coverage as well as significantly
increasing its national and local city sales, marketing and administrative
staffs and increased legal and other consulting expenses associated with its
programs for obtaining regulatory approvals and certifications and providing
quality network services.
Depreciation and amortization expenses increased to $4.9 million in the
fiscal period ended December 31, 1996 from $762,657 in the six months ended
December 31, 1995. The Company increased its capital assets to $144.4 million as
of December 31, 1996, from the $32.6 million in capital assets as of December
31, 1995. Non-cash stock compensation expense decreased to $549,645 for the
fiscal period ended December 31, 1996 from $1.2 million for the six months ended
December 31, 1995. This expense reflects the Company's accrual of non-cash costs
for options granted to key executives, employees and others arising from the
difference between the exercise price and the valuation prices used by the
Company to record such costs and from the vesting of those options. Certain of
these options had put rights and other factors that required variable plan
accounting in both 1996 and 1995 but, on or about June 30, 1995, the Company
renegotiated contracts with certain of its officers, establishing a limit of
$2.5 million on the Company's "put right" obligations with respect to those
contracts. Between July 1, 1995 and June 30, 1996, the limit was further reduced
to $2.0 million.
During the fiscal period ended December 31, 1996, the Company incurred a
net operating loss of $27.4 million and generated negative cash flow from
operations of $6.7 million, compared to a net operating loss of $7.0 million and
negative cash flow from operations of $4.8 million in the six months ended
December 31, 1995.
Interest and Other Expenses
Interest and other income increased to $2.8 million for the fiscal period
ended December 31, 1996 from $777,504 in the six months ended December 31, 1995.
Interest and other expense increased to $10.4 million in the fiscal period ended
December 31, 1996 from $2.8 million in the six months ended December 31, 1995.
The increase in interest and other income reflects the significant increase in
available funds from the Company's sale of its 9% Series B Preferred Stock in
June and November 1995, the 2005 Notes in November 1995 and the 2006 Notes in
March 1996. The increase in interest and other expenses reflected the accrual of
interest related to the 2005 Notes and 2006 Notes and the Company's increased
borrowings under the AT&T Credit Facility. Payments of principal and interest on
the AT&T Credit Facility will begin in calendar 1997,
43
<PAGE> 47
payments of interest on the 2005 Notes will not begin until November 2000 and
payments of interest on the 2006 Notes will not begin until October 2001.
AT&T Credit Corporation's minority interest in certain of the Company's
operating subsidiaries reduced operating losses by approximately $160,370 for
the fiscal period ended December 31, 1996, and by $155,861 for the six month
period ended December 31, 1995.
FISCAL YEAR ENDED JUNE 30, 1996 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1995
Revenues
During the fiscal year ended June 30, 1996 ("fiscal 1996"), the Company
recorded revenues of $3.4 million as compared to revenues of $388,887 during the
fiscal year ended June 30, 1995 ("fiscal 1995"). Four of the largest IXCs
accounted for approximately $2.1 million, or 60%, of revenues for fiscal 1996 as
compared to fiscal 1995 when three of the largest IXCs accounted for
approximately $331,000, or 85% of revenues for fiscal 1995, reflecting the
Company's increased sales to end-users during fiscal 1996.
Total Operating Expenses
Network development and operations expenses for fiscal 1996 increased to
$5.3 million from $3.3 million in fiscal 1995, reflecting significant increases
in personnel, network development and non-payroll operating expenses. These
increased costs were associated with developing and establishing centralized
engineering, circuit provisioning and network management functions, constructing
and initially operating the Company's competitive access networks and performing
market feasibility, engineering, rights-of-way and regulatory evaluations in
additional target cities. Related personnel costs increased to $4.5 million in
fiscal 1996 from approximately $1.3 million in fiscal 1995. Other operating
expenses related to the development of prospective new markets, which include
expenses such as contract labor and legal expenses and certain franchise fees,
travel expenses, rent, utilities, charges and taxes, decreased to $800,212 in
fiscal 1996 from approximately $1.9 million in fiscal 1995.
In fiscal 1996, selling, general and administrative expenses increased to
$13.5 million from $4.6 million in fiscal 1995. Related personnel costs
increased to $3.2 million in fiscal 1996 from $2.0 million in fiscal 1995, and
corresponding operating costs increased to $10.2 million in fiscal 1996 from
$2.2 million in fiscal 1995. This increase reflected costs associated with the
Company's efforts in expanding its national and local city sales, marketing and
administrative staffs, as well as increased legal and other consulting expenses
associated with its aggressive programs for obtaining regulatory approvals and
certifications and providing quality network services.
Depreciation and amortization expenses increased to $3.1 million in fiscal
1996 from $497,811 in fiscal 1995. During fiscal 1996 the Company increased its
capital assets to approximately $80.2 million, representing an increase from
$15.9 million at the end of fiscal 1995. Non-cash stock compensation expense
decreased to $2.7 million for fiscal 1996 from $6.4 million for fiscal 1995.
This expense reflects the Company's accrual of non-cash costs for options and
warrants granted to key executives, employees and others arising from the
difference between the exercise price and the valuation prices used by the
Company to record such costs and from the vesting of those options and warrants.
Certain of these options had put rights and other factors that required variable
plan accounting in fiscal 1994 and fiscal 1995 but, at the end of fiscal 1995,
the Company renegotiated contracts with certain of its officers, establishing a
limit of $2.5 million on the Company's put right obligations with respect to
those contracts. During fiscal 1996, the limit was further reduced to $2.0
million.
Interest and Other Expenses
Interest and other income increased to $4.4 million for fiscal 1996 from
$217,525 in fiscal 1995. Interest expense and other costs increased to $10.5
million in fiscal 1996 from $170,095 in fiscal 1995. These increases in interest
income and expenses reflected the significant increase in available funds from
the Company's sale of its 9% Series B Preferred Stock in June and November 1995
and the 2005 Notes in November 1995. The increase in interest and other expenses
reflected the accrual of interest related to the 2005 Notes and the
44
<PAGE> 48
Company's increased borrowings under the AT&T Credit Facility. Payments of
principal and interest on the AT&T Credit Facility will begin in calendar 1997,
payments of interest on the 2005 Notes do not begin until November 2000 and
payments of interest of the 2006 Notes do not begin until October 2001.
Debt conversion expense in fiscal 1995 totaled $385,000, reflecting
expenses incurred in connection with the conversion of certain of the Company's
debt to equity in September 1994. AT&T Credit Corporation's minority interest in
the Company's operating subsidiaries for which it provided funding, reduced
operating losses by approximately $412,606 for fiscal 1996, and by $48,055 for
fiscal 1995.
LIQUIDITY AND CAPITAL RESOURCES
To date, the Company has funded the construction of its local networks and
its operations with external financing. Prior to November 1995, the primary
sources of funds used to finance the building of existing networks and the
completion of new targeted networks were two preferred stock private offerings
completed in October 1994 and June 1995, through which the Company raised an
aggregate of approximately $39.6 million before related expenses, and the AT&T
Credit Facility, through which the Company has financing commitments for $31.2
million. On November 14, 1995, the Company completed a private offering of the
2005 Notes and the 2005 Warrants from which the Company received approximately
$96.1 million in net proceeds. The 2005 Notes will accrue to an aggregate
principal amount of $190.0 million by November 1, 2000, after which cash
interest will accrue and be payable on a semi-annual basis. The Company also
received net proceeds of approximately $4.7 million from the private sale of an
additional 50,000 shares of its preferred stock to a principal stockholder and
the exercise by that stockholder of warrants to purchase 214,286 shares of
Common Stock acquired in the Company's June 1995 preferred stock private
placement. On March 21, 1996, the Company completed a private offering of the
2006 Notes from which the Company received net proceeds of approximately $61.8
million. The 2006 Notes will accrue to an aggregate principal amount of $120.0
million by April 1, 2001, after which cash interest will accrue and be payable
on a semi-annual basis. On April 15, 1997, the Company completed the Common
Stock Offering. The Company completed the sale of an additional 660,000 shares
on May 14, 1997 upon exercise of the underwriters' over-allotment option. The
Company received net proceeds of approximately $40.0 million from the sale of
these 8,660,000 shares. On July 10, 1997, the Company completed the Unit
Offering from which the Company received net proceeds of approximately $67
million. The Company used a portion of these funds to pay ordinary course trade
accounts payable that were more than 60 days overdue, thereby curing an Event of
Default under each of the indentures relating to the 2005 Notes and the 2006
Notes. On July 23, 1997, the Company completed the sale of the 2007 Notes. Of
the total net proceeds of $208.0 million, the Company placed $70.0 million
representing funds sufficient to pay the first five semi-annual interest
payments on the 2007 Notes into an escrow account for the benefit of the holders
thereof.
In addition, the Company in the past has considered and expects to continue
to consider potential acquisitions or other strategic arrangements that may fit
the Company's strategic plan. Although the Company has had discussions
concerning such potential acquisitions or arrangements, to date, no agreements
have been reached with regard to any particular transaction. Any such
acquisitions or strategic arrangements that the Company might consider are
likely to require additional equity or debt financing, which the Company will
seek to obtain as required. The Company's expectations of required future
capital expenditures are based on the Company's current estimates and the
current state and federal regulatory environment. There can be no assurance that
actual expenditures will not be significantly higher or lower. In addition,
there can be no assurance that the Company will be able to meet its strategic
objectives or that such funds, if available at all, will be available on a
timely basis or on terms that are acceptable to the Company.
Management anticipates that the Company's current cash resources are
sufficient to fund the Company's continuing negative cash flow and required
capital expenditures into the first quarter of 2000. Without an infusion of
additional cash, the Company will exhaust its cash resources during the first
quarter of 2000. To meet its additional remaining capital requirements and to
successfully implement its growth strategy, ACSI will be required to sell
additional equity securities, increase its existing credit facility, enter into
additional credit facilities or sell additional debt securities, certain of
which would require the consent of the Company's debtholders. Furthermore,
before incurring additional indebtedness, the Company may be required to seek
45
<PAGE> 49
additional equity financing to maintain balance sheet and liquidity ratios
required under certain of its debt instruments and, as a result of the
registration rights of certain of the Company's security holders, the Company's
ability to raise capital through a public offering of equity securities may be
limited. Accordingly, there can be no assurance that the Company will be able to
obtain the additional financing necessary to satisfy its cash requirements or to
successfully implement its growth strategy, in which event the Company will be
forced to curtail its planned network expansion and may be unable to fund its
ongoing operations.
Preferred Stock. In October 1994, the Company completed the private
placement of 186,664 shares of its 9% Series A Convertible Preferred Stock, par
value $1.00 per share (which was later exchanged for Series A-1 Preferred Stock
that was converted into 7,466,560 shares of Common Stock simultaneous with the
completion of the Common Stock Offering) with accompanying warrants to purchase
an aggregate of 2,674,506 shares of Common Stock, for an aggregate consideration
of $16.8 million (before deduction of estimated offering expenses), including
the conversion of $4.3 million of outstanding debt. Of the warrants sold in
October 1994, warrants to acquire 1,491,222 shares of Common Stock were
exercised by a principal stockholder for an aggregate exercise price of
approximately $100,000. See "Principal Stockholders."
In June 1995, the Company completed a private placement of 227,500 shares
of its Series B Preferred Stock with accompanying warrants to purchase an
aggregate of 1,584,303 shares of Common Stock, for an aggregate consideration of
$22.8 million. In addition, in November 1995, the Company completed a private
placement of 50,000 shares of its Series B Preferred Stock together with the
exercise of accompanying warrants to purchase 214,286 shares of Common Stock to
a principal stockholder for an aggregate consideration of $4.7 million. The
Series B Preferred Stock was converted into an aggregate of 9,910,704 shares of
Common Stock simultaneous with the completion of the April Offering.
In July, 1997 the Company issued the 14 3/4% Preferred Stock. Dividends on
the Preferred Stock accrue from the date of issuance, are cumulative and are
payable quarterly in arrears commencing September 30, 1997, at a rate per annum
of 14 3/4% of the liquidation preference per share. Dividends on the 14 3/4%
Preferred Stock will be paid, at the Company's option, either in cash or by the
issuance of additional shares of 14 3/4% Preferred Stock; provided, however,
that after June 30, 2002, to the extent and for so long as the Company is not
precluded from paying cash dividends on the 14 3/4% Preferred Stock by the terms
of any then outstanding indebtedness or any other agreement or instrument to
which the Company is then subject, the Company shall pay dividends on the
14 3/4% Preferred Stock in cash.
In October 1997, the Company issued the Preferred Stock. Dividends on the
Preferred Stock accrue from the date of issuance, are cumulative and are payable
quarterly in arrears commencing January 15, 1998, at a rate per annum of 12 3/4%
of the liquidation preference per share. Dividends on the Preferred Stock will
be paid, at the Company's option, either in cash or by the issuance of
additional shares of Preferred Stock; provided, however, that after October 15,
2002, to the extent and for so long as the Company is not precluded from paying
cash dividends on the Preferred Stock by the terms of any agreement or
instrument governing any of its then outstanding indebtedness, the Company shall
pay dividends on the 12 3/4% Preferred Stock in cash.
AT&T Credit Facility. In October 1994, the Company entered into the AT&T
Credit Facility pursuant to which AT&T Credit Corporation has agreed to provide
up to $31.2 million in financing for the development and construction of fiber
optic local networks by five of the Company's subsidiaries. In connection with
each loan made under the AT&T Credit Facility, AT&T Credit Corporation purchased
7.25% of the capital stock of the funded subsidiary, and ACSI pledged the other
shares and the assets of the subsidiary to AT&T Credit Corporation as security
for the loan. During fiscal 1995, the Company's subsidiaries in Louisville, Fort
Worth, Greenville and Columbia entered into loan agreements under the AT&T
Credit Facility providing for AT&T Credit Corporation funding of up to $19.8
million in the aggregate, and, in September 1995, the Company's subsidiary in El
Paso entered into a loan agreement under the AT&T Credit Facility providing for
up to $5.5 million of AT&T Credit Corporation funding. As of September 30, 1997,
an aggregate of $31.2 million had been borrowed under these agreements.
Principal amounts payable on the AT&T Credit Facility during 1997 are
approximately $872,000.
46
<PAGE> 50
The Company has entered into negotiations with AT&T Capital Corporation to
roll-up the five existing loan agreements comprising the AT&T Credit Facility
into one loan agreement to be entered into with the Company, and to be secured
by the existing assets of the Company (including the stock, but not the assets,
of certain of the Company's subsidiaries) (the "New AT&T Facility"). The Company
expects the New AT&T Facility to otherwise be on terms substantially similar to
those of the existing AT&T Credit Facility. The maximum aggregate amount of
credit available under the proposed New AT&T Facility will not exceed $35
million, which is the maximum amount of credit the Company is allowed to borrow
in its Secured Credit Facility (as defined in the Existing Indentures and in the
Indenture (as defined herein) with respect to the Notes). AT&T Credit
Corporation has issued to each of the Company's Subsidiaries that are parties to
the AT&T Credit Facility a waiver through December 31, 1997, of compliance by
such subsidiaries with certain covenants contained therein. Such covenants are
not expected to be included in the New AT&T Facility. The Company has agreed
with the Initial Purchaser that, after the date of expiration of such waiver (as
the same may be extended), upon the receipt of a demand for payment under the
AT&T Credit Facility, the Company will repay the AT&T Credit Facility in full
and will maintain cash and cash equivalents in an aggregate amount sufficient
for such purpose, unless, on or prior to such demand for payment, the New AT&T
Facility shall have become effective and the Company shall be in compliance with
all covenants contained therein.
On June 11, 1997, the Company notified the trustee under each of the
indentures relating to the 2005 Notes and the 2006 Notes that, as of June 10,
1997, it had approximately $13.0 million in the aggregate of ordinary course
trade accounts payable that were more than 60 days overdue. As of June 30, 1997,
the Company had approximately $17.4 million in the aggregate of ordinary course
trade accounts payable that were more than 60 days overdue. These overdue
amounts constituted Indebtedness of the Company, as that term is defined in each
of the indentures relating to the 2005 Notes and the 2006 Notes. The incurrence
by the Company of such Indebtedness is not permitted under each such indenture
and, therefore, constituted an Event of Default (as defined in the indentures
relating to the 2005 Notes and the 2006 Notes) under each such indenture. The
Company used a portion of the proceeds of the Unit Offering to pay in full all
ordinary course trade accounts payable that were more than 60 days overdue to
cure such Event of Default.
EFFECTS OF NEW ACCOUNTING STANDARDS
During early 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, Accounting for EPS, which will become effective December 15, 1997,
and will thereafter require the Company to disclose basic earnings (loss) per
share in addition to the common stock equivalent disclosure information already
required. Early adoption of SFAS No. 128 is not permitted.
While the Company does not know precisely the impact of adopting SFAS No.
128, the Company does not expect that the adoption of SFAS No. 128 will have a
material effect on the Company's consolidated financial statements.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 129 (FAS 129), "Disclosure of Information
about Capital Structure." The Company is required to adopt the provisions of
this Statement for fiscal years ending after December 15, 1997. This Statement
continues the previous requirement to disclose certain information about an
entity's capital structure found in APB Opinions No. 10, "Omnibus
Opinion -- 1966," No. 15, "Earnings per Share," and FASB Statement No. 47,
"Disclosure of Long-Term Obligations," for entities that were subject to the
requirements of those standards. As the Company has been subject to the
requirements of each of those standards, adoption of FAS No. 129 will have no
impact on the Company's financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (FAS No. 130), "Reporting Comprehensive
Income." FAS No. 130 established standards for the reporting and display of
comprehensive income and its components in the financial statements. The Company
is required to adopt the provisions of the Statement for fiscal years beginning
after December 15, 1997. Earlier application is permitted; however, upon
adoption the Company will be required to reclassify previously reported annual
and interim financial statements. The Company believes that the disclosure of
comprehensive income in accordance with the provisions of FAS No. 130 will not
impact the manner of presentation of its financial statements as currently and
previously reported.
47
<PAGE> 51
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (FAS No. 131), "Disclosure about Segments
of an Enterprise and Related Information." FAS No. 131 requires the Company to
present certain information about operating segments and related information,
including geographic and major customer data, in its annual financial statements
and in condensed financial statements for interim periods. The Company is
required to adopt the provisions of the Statement for fiscal years beginning
after December 15, 1997. Earlier application is permitted; however, upon
adoption the Company will be required to restate previously reported annual
segment and related information in accordance with the provisions of FAS No.
131. The Company has not completed its analysis of the impact on the financial
statements that will be caused by the adoption of this Statement.
48
<PAGE> 52
BUSINESS
INDUSTRY OVERVIEW
The continuing deregulation of the telecommunications industry and
technological change have resulted in an increasingly information-intensive
business environment. Regulatory, technological, marketing and competitive
trends have expanded substantially the Company's opportunities in the converging
voice and data communications services markets. Regulatory initiatives, such as
the Federal Telecommunications Act, are expected to expand opportunities in the
local telecommunications services market, the size of which is estimated to be
approximately $100 billion in 1997. Technological advances, including rapid
growth of the Internet, the increased use of packet switching technology for
voice communications and the growth of multimedia applications, are expected to
result in substantial growth in the high-speed data services market to
approximately $10 billion by 2000 compared to $1 billion in 1995.
Dedicated Services. Competition in the local exchange services market
began in the mid-1980s. In New York City, Chicago and Washington, D.C., newly
formed companies provided dedicated non-switched services by installing fiber
optic facilities connecting POPs of IXCs within a metropolitan area and, in some
cases, connecting business and government end-users with IXCs. Most of the early
CAPs operated limited networks in the central business districts of major cities
in the U.S. where the highest concentration of voice and data traffic, including
IXC traffic, is typically found. CAPs used the substantial capacity and
economies of scale inherent in fiber optic cable to offer customers service that
was generally less expensive and of higher quality than could be obtained from
the ILECs due, in part, to antiquated copper-based facilities used in many ILEC
networks.
Local Switched Voice Services. Initially, CAPs could compete effectively
only for special access and private line services to customers in buildings
directly connected to their separate networks, but the FCC Interconnection
Decisions in 1992 and 1993 allowed CAPs to increase the number of customers and
markets serviced significantly without physically expanding their networks.
Those Interconnection Decisions also enabled CAPs to provide interstate switched
access services in competition with ILECs, which has encouraged the development
of the competitive interstate switched access market. The Company believes that
competition in this market will be further enhanced because the Federal
Telecommunications Act requires (i) removal of state and local entry barriers,
(ii) ILECs to provide interconnections to their facilities, and (iii) access to
rights-of-way. In addition, to the extent that ILECs begin to compete with IXCs
for long distance services, IXCs may have a competitive incentive to move access
business away from ILECs to CLECs, and CLEC market share may increase.
Data Communications Services. The Company believes that high-speed data
communications services represent one of the fastest growing segments of the
telecommunications services market, due in part to the continuing proliferation
of computers and the increasing need to interconnect these computers via local
and wide area networks, the dramatic growth of the Internet and the emergence of
multimedia applications. Together, these applications have spawned numerous
network technologies and communications protocols to support legacy, current and
emerging needs. The domestic network infrastructure currently supporting both
voice and data transport requirements, which focuses on IP switching and framed
relay services, is being strained by the increasing demand for high-bandwidth
transport at both the local and national levels. The Company believes that the
increasing volume and complexity of high-speed applications will further strain
the domestic network infrastructure and create an opportunity for ACSI to
provide a single high-quality ATM-based network capable of consistently
supporting diverse data communications needs.
- Internet Access Services. Businesses are increasingly using the Internet
to transmit e-mail, engage in commercial transactions (e.g., electronic
commerce) and develop internal communications networks, or "intranets."
Increasing business utilization of the Internet has added to the demand
for higher-speed access (i.e., services connecting users to the
Internet), applications (such as "Web browsers"), increased port capacity
and secure network facilities. In addition, this has resulted in
significant demand for local and interexchange communications network
services, applications software and systems integration services.
49
<PAGE> 53
- Frame Relay. Frame relay service is a fast-packet transport solution
targeted at LAN-to-LAN and legacy networks. Frame relay service is
designed to meet fluctuating, or periodic, data transfer requirements by
offering shared virtual bandwidth connectivity at high speed. Frame relay
services offer low cost data transmission with generally minimal delay,
few errors and high speed performance.
- ATM. ATM is a high bandwidth service providing virtual networking for
voice, data and multimedia traffic. The ability to combine all three
media provides opportunities to reduce costs associated with running
three separate networks. The major benefits of ATM include providing
shared access to trunk bandwidth for multiple applications and
application types, minimizing the number of wide area connections needed
and supporting user access speeds of at least 1.5 mbps (T-1). The Company
expects the growth in demand for frame relay services to slow and the
demand for ATM services to increase.
Internet Services. An increasing number of businesses and individuals have
access to the Internet through their personal computers and the use of the
modem. Individuals or businesses can connect to the Internet via a modem by
calling an ISP's local POP. ISPs connect users to the Internet via leased or
owned high-speed dedicated data lines. ISPs also help users install and
configure connectivity software and Internet access services. An ISP may offer a
commercial user Internet services at various speeds, depending on a customer's
needs, via direct connections or leased local lines to a local POP.
COMPANY STRATEGY
The Company's objective is to become a full service alternative to the ILEC
for business, government and institutional end-users in its markets by offering
superior products with excellent customer service at competitive prices. In
order to achieve this objective, the Company seeks to:
- Leverage Existing Infrastructure. The Company believes that its
integrated telecommunications networks, both its local fiber networks and
ACSINet, are capable of providing a broad range of voice and data
communications services to its customers. The Company is focusing its
efforts on improving penetration in the markets it already serves by
continuing to offer additional services. The Company believes that
providing switched local voice services permits it to increase the
traffic and revenue associated with its networks. The Company also
recently began providing calling-card, teleconferencing and other long
distance services. In markets in which it does have operational networks,
the Company's decision to pursue a resale strategy would position the
Company as a full-service provider, capable of providing its customers
with a one-stop-shopping alternative to the ILEC. In markets in which it
does not currently have an operational network, this resale strategy
positions the Company to eventually construct networks in those markets,
which networks would benefit immediately from an existing customer base.
- Develop Direct and Indirect Sales Channels to Commercial End-Users. The
Company has divided its sales and marketing efforts into three different
channels: direct sales to end-users, sales to IXCs and ISPs and sales of
private-label services through alternative distribution channels.
Direct Sales. The Company's local sales force continues to focus on the
commercial end-users in each of the markets it serves. The Company
believes that its local, customer-oriented, single point-of-service sales
structure facilitates greater customer care in both the sales and
customer service processes and helps the Company differentiate itself as
a customer-focused telecommunications services provider. The Company's
major account sales force targets large national accounts. As of
September 30, 1997, the Company's sales force in this area was made up of
178 sales people, which represents an increase of 123 sales people since
December 31, 1996, and is expected to increase to 210 sales people by the
end of 1997 or during 1998.
Sales to IXCs and ISPs. The Company sells dedicated services to long
distance carriers and ISPs who use the Company's products and services to
provide local access for their own products. For example, the Company
recently entered into an agreement with MCImetro in which, subject to
certain conditions, MCI has agreed to name ACSI as its preferred local
provider for dedicated and transport services in 21 ACSI markets for at
least a five-year period. See "Recent Developments".
50
<PAGE> 54
Sales Through Alternative Distribution Channels. As of September 30,
1997, the Company had executed over 63 sales agency agreements and is
actively recruiting additional telecommunications sales agents to market
the Company's services. In addition, the Company intends to expand
distribution of its services by contracting with IXCs, utilities, CATVs,
RBOCs, other ILECs and cellular and other wireless communication
providers to resell the Company's products and services under their own
private labels. The Company is presently recruiting a dedicated sales
force to serve in the support of sales through these and other
alternative distribution channels.
- Market the Company's Services Under the ACSI Brand Name. The Company is
establishing the ACSI brand name by marketing and packaging its broad
array of communications services directly to end-users. In markets in
which it has local networks established, both switched services and data
services are marketed under the ACSI brand name; in markets in which the
Company has no network installed, it resells local switched services
under the ACSI brand name. In both types of markets, the Company also
pursues opportunities to bundle its services together to strengthen the
ACSI identity as a full-service provider of telecommunications services.
- Provide Superior Customer Service. The Company is developing and
implementing an integrated customer care strategy that is intended to
provide a heightened level of responsive customer service across its full
range of existing and planned products and services. This strategy
comprises infrastructure, training, performance monitoring and
image/brand recognition and will serve to leverage the Company's
operational support systems, other information/financial systems and
customer care organizations. The Company has made significant capital
investments in its integrated network management platform which monitors
and manages all voice and data network elements. The Company expects to
have completed customer care and billing systems by the end of 1998,
which are intended to improve the Company's provision of integrated
customer service on a cost efficient basis. These and other quality
management and improvement programs, when implemented, are expected to
enable the Company to differentiate itself in the marketplace by
providing a level of customer care and customer service that is of a
higher quality than that which is available in today's market.
- Expand Resale of Local Exchange Voice Services. Management believes that
the Company can successfully enter new markets with lower capital
investment by acting as a reseller of either local switched voice or data
services. This strategy is intended to allow the Company to build brand
name awareness and develop a customer base without incurring the initial
capital costs typically incurred by facilities-based entrants. This
strategy also enables the Company to make capital decisions based on
where its customers are most highly concentrated. Once the Company has
established a customer base, the Company plans to invest in extending its
network infrastructure in those markets that it already serves.
- Accelerate Financial Return on Incremental Expenditures. The Company is
pursuing opportunities that accelerate the return on the Company's
invested capital. The Company believes that it will achieve an earlier
return on its investment by focusing on new customer application in
existing markets rather than continuing to increase the number of new
networks built. For this reason, the Company has modified its earlier
goal of constructing 50 local networks by the end of 1998, is now
evaluating additional markets in which it may construct local networks
and is establishing a presence in additional markets through resale of
switched services and data POPs. The Company plans to redeploy into
customer applications in existing markets the capital that was scheduled
to be used to develop those additional networks. While management
continues to believe in the long-term return on capital afforded by the
constructed networks, it believes that the investment in customer
applications will have a more immediate return. As part of this strategy,
the Company has also implemented a shift in its incentive-based
compensation for a number of its key executives, toward revenue and
EBITDA and away from new network development and growth.
ACSI SERVICES
The Company currently provides, or is actively implementing plans to
provide, a wide range of local telecommunications services including dedicated
and private line, high-speed data services, including IP
51
<PAGE> 55
switching and managed services, local switched voice services and Internet
services. The Company's SONET-based fiber optic local networks are designed to
support this wide range of enhanced communications services, provide increased
network reliability and reduce costs for its customers.
Dedicated Services. During 1996, dedicated and private line services for
IXCs and other carriers generated a substantial portion of the Company's
revenues, with the remaining revenues generated from business and government
end-users. The Company's dedicated services provide high capacity non-switched
interconnections: (i) between POPs of the same IXC; (ii) between POPs of
different IXCs; (iii) between large business and government end-users and their
selected IXCs; (iv) between an IXC POP and an ILEC central office or between two
ILEC central offices; and (v) between different locations of business or
government end-users.
- Special access services. Special access services provide a link between
an end-user location and the POP of its IXC, or links between IXC POPs,
thus bypassing the facilities of the ILEC. These services, which may be
ordered by either the long distance customer or directly by its IXC,
typically provide the customer better reliability, shorter installation
intervals, and lower costs than similar services offered by the ILEC.
Customer charges are based on the number of channel terminations, fixed
and mileage-sensitive transport charges, and costs for any services
required to multiplex circuits.
- Switched transport services. Switched transport services are offered to
IXCs that have large volumes of long distance traffic aggregated by a
ILEC switch at a central office where the CAP has collocated its network.
The Company provides dedicated facilities for transporting these
aggregated volumes of long distance traffic from the ILEC central office
to its POP or between ILEC central offices.
- Private line services. Private line services provide dedicated
facilities between two end-user locations in the same metropolitan area
(e.g., a central banking facility and a branch office or a manufacturing
facility and its remote data processing center) and are priced like
special access services (channel termination charges plus transport and
any associated multiplexing charges). The Company expects the demand for
private line service to increase in conjunction with higher bandwidth
customer applications.
Local Switched Voice Services. As of September 30, 1997, the Company is
offering local switched voice services using its own facilities in Columbus,
Georgia; Montgomery, Alabama; Birmingham, Alabama; Ft. Worth, Texas; Louisville,
Kentucky; Little Rock, Arkansas; Albuquerque, New Mexico; Tucson, Arizona; and
New Orleans, Louisiana. In April 1997, the Company began providing local
switched services on a resale basis in 15 markets. As of September 30, 1997, the
Company is offering local switched services on a resale basis in 32 markets and
plans to expand further the number of markets in which it is reselling local
switched services throughout 1997 and the first quarter of 1998. As an adjunct
to its local switched services, the Company anticipates providing calling card
and other interLATA services by the end of the fourth quarter of 1997.
The Company's local switched voice services include telephone exchange
service, including optional enhanced services such as call waiting, caller ID
and three-way conference calling; switching traffic between ACSI's switch and a
business customer's PBX and routing local, intraLATA and interLATA phone calls
according to the customers' specific requirements; providing local dial tone
services with functionality such as free internal communications, call
forwarding, call transfer, conference call and speed dialing; ISDN data
services; and origination and termination of long distance traffic between a
customer premise and interexchange carrier via shared trunks utilizing the
Company's local switch.
During the first quarter of 1997, the Company began generating revenues
from its enhanced voice services that are currently being offered to small and
mid-sized business and government end-users in a limited number of its local
network markets. The Company's goal is to expand its enhanced voice service
offerings and customer base. The Company's enhanced voice services include its
First Line and First Line Plus messaging products and services under the brand
names Virtualine and Virtualine 800, including basic voice messaging, follow-me
call routing, virtual calling card services, fax services, e-mail and paging
notification services, and automated attendant services.
52
<PAGE> 56
High-Speed Data Services. ACSINet, the Company's coast-to-coast, leased
broadband data communications network, supports the following Company services:
- ACSINet Internet Access Service. The Company provides public Internet
connectivity and IP transport for the business and reseller communities.
This service is targeted to local and regional ISPs and corporate
Internet users requiring dedicated access. The service operates over the
ACSINet DS3 (45 Mbps) backbone, a fully-meshed, coast-to-coast network
with Internet connectivity at multiple network access points (NAPs) to
ensure continuous availability to the Internet.
- Managed Services. These services include design, installation,
maintenance, hardware (such as switches, routers and modems),
configuration management (such as maintaining consistent versions of the
router software and deploying consistent configurations) and overall
network management for a customer's network. The Company's managed
services are designed to eliminate many of the timing, coordination and
inter-operability issues that arise in installations requiring multiple
vendors.
- Frame Relay. Frame relay service is provided to end-users with
LAN-to-LAN and legacy networks, allowing them to share virtual bandwidth
connectivity at high speed. Frame relay services offer low cost data
transmission with generally minimal delay, few errors and high speed
performance. As users' requirements expand into multimedia applications,
which require higher bandwidth, frame relay offers a natural migration
path to ATM.
- ATM. The Company's ATM services include native speed LAN connectivity,
diagnostic imaging, video-conferencing and other high-bandwidth
applications.
Internet Services. Principally through the Cybergate Acquisition, the
Company has begun to offer high-speed data communications services, including
computer network connections and related infrastructure services, to allow both
commercial and residential customers to have access to the Internet through
their personal computers and the use of a modem.
IMPLEMENTATION OF INTEGRATED NETWORK
The Company has developed an integrated communications network consisting
of SONET-based fiber optic local networks, a coast-to-coast, leased broadband
data communications network and local central office switching facilities.
Local Network Development. Digital fiber optic telecommunications networks
generally offer faster and more accurate transmissions for all data and voice
communications than analog telecommunications systems or digital transmission
systems using copper wire, which continues to be used in varying degrees by the
ILECs. Fiber optic networks also generally require less maintenance than copper
wire or microwave facilities of comparable transmission capacity, thereby
decreasing operating costs. Because ACSI is employing the latest digital
transmission technology in its local networks, these SONET-based fiber optic
networks will have substantial additional capacity, and further increases in
capacity can be achieved through a change in electronics. The Company believes
it will be able to use its local CLEC networks to provide a wide range of
telecommunications services with only incremental facilities costs. Key elements
of the Company's local network development plan include: (i) thoroughly
analyzing potentially favorable markets for development; (ii) seeking
authorizations from public and private entities for rights-of-way; and (iii)
efficiently implementing construction plans in a timely manner, thereby allowing
the Company to gain a competitive position in the chosen market.
- Site Selection. Before deciding to enter a market, the Company conducts
a detailed feasibility study to determine the potential size of the
market, existing competition within the market, the Company's ability to
obtain municipal authorizations, including franchises and access to
rights-of-way, and the relative ease of market entry from a local and
state regulatory standpoint. The rights-of-way assessment, done by
independent telecommunications consultants, determines whether another
CAP/CLEC network is under construction or ready to construct in the
target market, the availability of economical rights-of-way, the local
utility's receptiveness to allow use of its rights-of-way, the topology
of the city, concentrations of commercial real estate, and the local city
permit and franchise requirements. The market or end-user survey, also
done by independent telecommunications consul-
53
<PAGE> 57
tants, identifies the significant commercial and government end-users in
the target service areas. Individual telephone and/or face-to-face
interviews are then conducted with potential end-users, focusing on those
anticipated to have the largest business volume. The interviews determine
the end-user's receptiveness to using a competitor to the ILEC, the
telecommunications requirements of such end-user, current pricing by the
ILEC and other relevant information. This "bottom up" sizing of the
target service areas provides an estimate of the prospective business by
building and by customer.
- Rights-of-Way. As part of its due diligence on a market during its site
selection process, the Company seeks municipal authorizations (such as
franchises, licenses, or permits) to construct and operate its network
within the public rights-of-way. The duration of this approval process
can vary from less than three months to several years, depending on the
specific legal, administrative, and political factors existing in that
market. The initial term of these municipal approvals, once granted, may
range from as few as five years to as many as 25 years, and such
approvals typically may be renewed for additional terms. See "Risk
Factors -- Dependence on Rights-of-Way and Other Third Party Agreements"
and "-- Effect of Regulation."
Concurrently with its seeking municipal authorizations, the Company
initiates discussions with electric or gas utilities, CATVs and other
private providers of rights-of-way and/or facilities that may be used by
the Company for installation of its network. These discussions are
intended to result in agreements that allow the Company to make use of
those parties' fiber optic cables (such as indefeasible rights of use),
underground conduits, distribution poles, transmission towers, and
building entrances. The Company's ability to enter into such agreements
can have a material impact on the Company's capital costs for network
construction and the speed with which the Company can construct its
networks. Additionally, obtaining such agreements facilitates the
Company's ability to expand efficiently beyond the central business
district to serve additional end-users in its markets. The term of such
agreements is typically ten to 25 years, with renewal terms of five to 15
years. The Company believes that the experience of members of its senior
management team in negotiating such agreements gives it a competitive
advantage over other CLECs that have less experience in successfully
negotiating such agreements.
- Implementation of Local Network Construction. The Company initially
builds a one- to three-mile SONET-based fiber loop in the central
business district or a discrete area outside of the central business
district of a given target market. This network provides the users with
lower costs, fiber optic clarity, diversity of access, and fault tolerant
reliability of service, with automatic stand-by and rerouting in the
event of operator, system or network failure. The Company's networks are
then expanded into suburban business areas and other ILEC central offices
to serve additional customers. These expansions may be in excess of 100
route miles. The Company utilizes outside contractors to construct its
networks.
The Company, through outside consultants, prepares preliminary and final
engineering studies for the initial portions of its local networks prior
to obtaining municipal authorizations required to begin network
construction. This process enables the Company to initiate network
construction activities immediately upon receipt of municipal
authorizations. Outside plant construction of a typical downtown network
will take from four to six months, depending on various factors. The
Company also coordinates collocation with the ILEC's downtown central
office and interconnections with selected IXC POPs with other
construction milestones, reducing overall network development costs and
allowing the Company to initiate operations at an earlier date.
Following completion of its initial network and the commencement of
network operations, the Company's local staff, in consultation with
personnel at the Company's headquarters, designs expansion routes that
will enable the Company to reach additional end-users and to interconnect
with additional ILEC central offices outside the central business
district or the targeted construction area. Construction of these
expansion routes is typically done under agreements with third party
rights-of-way providers as described above, but in some instances the
Company constructs its own new facilities (typically by trenching or
directional boring) where third party facilities (whether aerial or
underground) do not exist or are not available for use by the Company.
The Company also constructs lateral
54
<PAGE> 58
network facilities from its fiber optic backbone to provide on-network
service to its customers. In some instances, the Company will design and
construct some or substantially all of its routes outside the central
business district concurrently with the construction of the downtown
network, increasing the speed of overall network construction and, in the
Company's opinion, creating a competitive advantage over other CLECs that
may have entered or are seeking to enter the market. To the extent
possible, the Company engages the third party right-of-way provider to
install ACSI's cable in or on the third party's facilities, usually at a
lower cost and with greater speed than that obtained by using outside
contractors.
The Company's network management center in Annapolis Junction, Maryland
monitors all of the Company's networks from one central location.
Centralized electronic monitoring and control of the Company's networks
allows the Company to avoid duplication of this function in each city.
This consolidated operations center also helps to reduce the Company's
per customer monitoring and customer service costs, such that they are
lower than would be available if monitored on a single-city basis. The
Company also plans to use this facility to monitor the performance of
data and switched voice services. During 1996, the Company performed
various network management services for other telecommunications service
providers and plans to continue to offer these services on a limited
basis.
A critical element of the Company's local network development plan is
integrating the Company's local networks with ACSINet, its coast-to-coast leased
broadband data communications network.
Implementation of Local Switched Voice and High-Speed Data Services. Where
technically feasible and economically practicable, the Company intends to deploy
a hubbed switching strategy by using Company-owned or leased switch capacity in
a large, centrally located market to provide services within that market and to
serve several other markets located within the same geographical area via remote
switching modules. By aggregating switched traffic from multiple small markets
through a central hub switch, the Company also expects to realize reduced
operating expenses associated with switch engineering and maintenance.
The Company is implementing local switched services through a combination
of facilities-based services and resale of ILEC services. As of September 30,
1997, the Company has installed central office switching facilities in Columbus,
Georgia; Montgomery, Alabama; Birmingham, Alabama; Ft. Worth, Texas; Louisville,
Kentucky; Little Rock, Arkansas; Albuquerque, New Mexico; Tucson, Arizona; and
New Orleans, Louisiana. The Company expects to have switches installed in a
total of 16 markets by the end of December 1997. Toward this end, the Company
had long-term lease commitments for nine initial switches as of September 30,
1997. As of September 30, 1997, the Company is offering local switched services
on a resale basis in 32 markets and plans to expand further the number of
markets in which it is reselling local switched services throughout 1997 and the
first quarter of 1998.
In December 1996, the Company deployed ACSINet, a coast-to-coast, leased
broadband data communications backbone network via leased inter-city fiber
connections on which customers' high-speed data and multimedia traffic may be
transported at a high-quality level on a cost-effective basis. ACSI believes its
ATM-based high bandwidth network will be capable of simultaneously supporting IP
switching, frame relay and multimedia applications. This technology will allow
network customers to migrate transparently from lower speed services to high
bandwidth services, as their data communications requirements expand.
COMPETITION
Dedicated Services. The Company operates in a highly competitive
environment and has no significant market share in any market in which it
operates. The Company provides dedicated services to large business and
government end-users. In each of the metropolitan areas to be served by the
Company's networks, the Company's dedicated services will compete principally
with the dedicated services offered by the ILEC. The ILECs, as the historical
monopoly providers of local access and other services, have long-standing
relationships with their customers and have financial and technical resources
substantially greater than those of the Company. The ILECs also offer certain
services that the Company cannot currently provide without first obtaining
requisite regulatory approvals. See "-- Regulation."
Competition for dedicated services is based on price, quality, network
reliability, customer service, service features and responsiveness to the
customer's needs. The Company believes that its management expertise, coupled
with its highly reliable, state-of-the-art digital networks, which offer
significant transmission capacity
55
<PAGE> 59
at competitive prices, will allow it to compete effectively with the ILECs,
which may have not yet fully deployed fiber optic networks in many of the
Company's target markets. The Company currently prices its services at a modest
discount compared to the prices of the ILEC while providing what the Company
believes is a higher level of customer service. The Company's fiber optic
networks will provide both diverse access routing and redundant electronics,
design features not widely deployed by the ILEC's networks (which were
originally designed in tree and branch or star configurations).
Other potential competitors of the Company include CATVs, public utilities,
IXCs, wireless telecommunications providers, microwave carriers, satellite
carriers, teleports, private networks built by large end-users, and other CLECs.
With the passage of the Federal Telecommunications Act and the entry of RBOCs
into the long distance market, the Company believes that IXCs may be motivated
to construct their own local facilities and/or resell the local services of
ACSI's competitors. For example, AT&T has announced its intention to offer local
services and has filed for state certification in markets which include, among
others, several of the Company's markets. See "Risk Factors -- Competition."
Other CLECs or CATVs currently are competitors in various markets in which the
Company has networks in operation or under construction. Based on management's
experience at other CLECs, it is believed the initial market entrant with an
operational fiber optic CLEC network generally enjoys a competitive advantage
over other CLECs that later enter the market. The Company expects that there
will be other CLECs operating in most, if not all, of its target markets and
that some of these CLECs may have networks in place and operating before the
Company's network is operational. While it is generally believed within the CLEC
industry that being the first market entrant to offer services typically
enhances that CLEC's competitive advantage relative to CLECs that enter the
market at a later time, the Company recognizes that in some instances it may
have other competitive advantages (such as a superior right-of-way arrangement
or large customer commitments) that it believes outweigh another CLEC's
first-to-market advantage; in these instances, the Company may elect to enter a
market where an established CLEC already exists.
High-Speed Data Services. The Company's competitors for high-speed data
services include major IXCs, other CLECs, and various providers of niche
services (e.g., Internet access providers, router management services and
systems integrators). In general, none of these competitors currently offers a
comprehensive solution for a customer's potential data service requirements, a
core premise of the Company's data strategy. The Company intends to pursue
arrangements with other data service providers to leverage each entity's
strengths in a given market or segment of the service chain by bundling elements
of complete data solutions (i.e., bundle its local access and frame relay
services with an IXC's longhaul transport services). The interconnectivity of
the Company's markets will create additional competitive advantages over other
data service providers that must obtain local access from the ILEC or another
CLEC in each market or that cannot obtain intercity transport rates on as
favorable terms as the Company.
There is significant competition for Internet access and related services
in the United States, with few barriers to entry. The Company expects that
competition will increase as existing services and network providers and new
entrants compete for customers. ACSI's current and future competitors include
telecommunications companies, including the RBOCs, IXCs, CLECs and CATVs, and
other Internet access providers, such as UUNET Technologies, Inc., Advanced
Network & Services, Inc., BBN Corporation, NETCOM On-Line Communications
Services, Inc. and PSINet Inc. Many of these competitors have greater financial,
technical, marketing and human resources, more extensive infrastructure and
stronger customer and strategic relationships than ACSI. The Company believes
that it will have a competitive advantage in offering Internet access services
to those ISPs and commercial customers in markets where ACSI has local fiber
optic network facilities relative to other Internet access providers that must
purchase local loop access from the ILEC, ACSI or another CLEC in that market.
Additionally, ACSI believes that customers with operations in multiple locations
served by ACSI local fiber optic networks will find single-source Internet
access services from ACSI more cost effective.
All of the seven original RBOCs offer at least some basic frame relay
service. The Company believes that most IXCs offer substantial domestic and
international frame relay service, generally positioned to provide significant
savings over traditional private lines. Other frame relay service providers
include WorldCom, Inc. and Intermedia Communications. A number of companies,
primarily CLECs, have announced plans to offer
56
<PAGE> 60
frame relay service. ATM offerings are only beginning to emerge. ATM service is
currently being offered by most of the original RBOCs, WorldCom, Inc., AT&T,
MCI, Sprint and WilTel, Inc. A number of other data communications providers,
CLECs and facilities-based CATVs have announced their intentions to offer ATM
services in the future.
A number of equipment vendors, systems integrators and Internet access and
service providers offer components of managed services. The Company believes
that it will have a competitive advantage over those managed services providers
that do not have local loop facilities.
Local Switched Voice Services. In all of the markets where the Company is
currently operating or plans to operate, the ILEC currently is a de facto
monopoly provider of local switched voice services, including enhanced voice
services. The Company expects that the Federal Telecommunications Act will
enable CLECs, CATVs, electric utilities, cellular and wireless providers, and
others to offer local switched voice services in competition with the ILECs in
the Company's target markets. The Company believes that its strategy to leverage
its basic network infrastructure into higher margin service offerings, migrating
to local switched voice services, will allow it to procure a profitable share of
the market. The Company's ability to cross-market services will create
opportunities to increase margins by migrating customers from off-network to
on-network status. As the number of end-users in a given off-network building
increases for all service offerings, the economics improve to the point where
the capital costs of connecting the building to ACSI's network are more than
covered by the increased margins represented by retaining the portion of
customer revenue paid out to the ILEC.
Competition for enhanced voice services primarily consists of basic voice
mail services offered by ILECs and cellular providers in connection with their
core offerings and customer premise-based voice mail platforms. The voice mail
offerings of the ILECs typically have limited features and flexibility compared
to the services contemplated by the Company; thus, the Company believes its
enhanced voice messaging services and focused sales efforts should be able to
penetrate effectively those segments of the small and mid-sized business market
that require more features and/or flexibility than services offered by the
ILECs. Customer premise-based platform voice mail offerings typically require a
relatively large up front capital investment and recurring maintenance costs and
are generally marketed to large companies rather than the small and mid-sized
end-users targeted by the Company.
Internet Services. The market for Internet access services is extremely
competitive. There are no substantial barriers to entry, and the Company expects
that competition will intensify in the future. The Company has entered this
market principally through the Cybergate Acquisition and believes that its
ability to compete successfully will depend upon a number of factors, including
market presence; the capacity, reliability and security of its network
infrastructure; ease of access to and navigation of the Internet; the pricing
policies of its competitors and suppliers; the timing of introductions of new
products and services by the Company and its competitors; the Company's ability
to support existing and emerging industry standards; and industry and general
economic trends.
The Company's current and prospective competitors include many large
companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company expects
to compete directly or indirectly with the following categories of companies:
(1) other international, national and regional commercial Internet service
providers; (2) established on-line services companies that currently offer or
are expected to offer Internet access; (3) computer hardware and software and
other technology companies; (4) IXCs; (5) RBOCs; (6) CATVs; and (7) nonprofit or
educational Internet service providers. The ability of these competitors or
others to bundle services and products with Internet connectivity services could
place the Company at a significant competitive disadvantage in this services
market.
REGULATION
Overview
The Company's services are subject to federal, state and local regulation.
The FCC exercises jurisdiction over all facilities and services of
telecommunications common carriers to the extent those facilities are used to
provide, originate or terminate interstate or international communications.
State regulatory commissions
57
<PAGE> 61
retain jurisdiction over the Company's facilities and services to the extent
they are used to originate or terminate intrastate communications. Local
governments may require the Company to obtain licenses or franchises regulating
use of public rights-of-way necessary to install and operate its networks.
Federal Regulation
The Federal Telecommunications Act. On February 1, 1996, the U.S. Congress
enacted comprehensive telecommunications reform legislation, which the President
signed into law as the Federal Telecommunications Act on February 8, 1996. The
Company believes that this legislation is likely to enhance competition in the
local telecommunications marketplace because it (i) removes state and local
entry barriers, (ii) requires ILECs to provide interconnections to their
facilities, (iii) facilitates the end-users' choice to switch service providers
from ILECs to CLECs such as the Company and (iv) requires access to
rights-of-way. The legislation also will tend to enhance the competitive
position of the ILECs and increase local competition by IXCs, CATVs and public
utility companies.
The Federal Telecommunications Act requires all telecommunications carriers
(including ILECs and CLECs (such as the Company)): (i) not to prohibit or unduly
restrict resale of their services; (ii) to provide dialing parity and
nondiscriminatory access to telephone numbers, operator services, directory
assistance and directory listings; (iii) to afford access to poles, ducts,
conduits and rights-of-way; and (iv) to establish reciprocal compensation
arrangements for the transport and termination of telecommunications. It also
requires ILECs to provide interconnection (a) for the transmission and routing
of telephone exchange service and exchange access, (b) at any technically
feasible point within the ILEC's network, (c) that is at least equal in quality
to that provided by the ILEC to itself, its affiliates or any other party to
which the ILEC provides interconnection, and (d) at rates, terms and conditions
that are just, reasonable and nondiscriminatory. ILECs also are required under
the new law to provide nondiscriminatory access to network elements on an
unbundled basis at any technically feasible point, to offer their local
telephone services for resale at wholesale rates, and to facilitate collocation
of equipment necessary for competitors to interconnect with or access the
unbundled network elements.
In addition, the Federal Telecommunications Act requires RBOCs to comply
with certain safeguards and offer interconnections that satisfy a prescribed
14-point checklist before the RBOCs are permitted to provide in-region interLATA
(i.e. long distance) services. Other requirements apply when RBOCs manufacture
telecommunications equipment. These safeguards are designed to ensure that the
RBOCs' competitors have access to local exchange and exchange access services on
nondiscriminatory terms and that subscribers of regulated non-competitive RBOC
services do not subsidize their provision of competitive services. The
safeguards also are intended to promote competition by preventing RBOCs from
using their market power in local exchange services to obtain an
anti-competitive advantage in the provision of other services. On December 24,
1996, the FCC adopted a number of procedures to provide greater protection
against cross-subsidization and clarified the use of the prevailing price method
for transaction valuation.
Moreover, the Federal Telecommunications Act also granted important legally
binding relief. ILECs were given substantial new pricing flexibility; RBOCs have
regained the ability to provide long distance services and have obtained new
rights to provide certain cable TV services; IXCs are permitted to construct
their own local facilities and/or resell local services; and state laws can no
longer require CATVs to obtain a franchise before offering telecommunications
services nor permit CATVs' franchise fees to be based on their
telecommunications revenues. In addition, under the Federal Telecommunications
Act all utility holding companies are permitted to diversify into
telecommunications services. See "Risk Factors -- Competition." Three RBOCs,
Ameritech, Southwestern Bell ("SBC") and BellSouth, have filed applications with
the FCC for authority to provide in-region interLATA service in selected states.
The Ameritech and SBC applications have been denied by the FCC while the
BellSouth application for authority to provide long distance services to
consumers in South Carolina and Louisiana are under consideration. Other RBOCs
have begun the process to provide in-region interLATA service by filing with
state commissions notice of their intent to file at the FCC. On July 2, 1997,
SBC filed suit in U.S. District Court in Wichita Falls, Texas challenging the
constitutionality of the provision of the Federal Telecommunications Act
governing RBOC entry into in-region long distance markets. The denial of
Ameritech's application also is the subject of appeals and petitions for
rehearing.
58
<PAGE> 62
FCC Rules Implementing the Local Competition Provisions of the Federal
Telecommunications Act. On August 8, 1996, the FCC released a First Report and
Order, a Second Report and Order and a Memorandum Opinion and Order in its CC
Docket 96-98 (combined, the "Interconnection Orders") that established a
framework of minimum, national rules enabling state Public Service Commissions
("PSCs") and the FCC to begin implementing many of the local competition
provisions of the Federal Telecommunications Act. In its Interconnection Orders,
the FCC prescribed certain minimum points of interconnection necessary to permit
competing carriers to choose the most efficient points at which to interconnect
with the ILECs' networks. The FCC also adopted a minimum list of unbundled
network elements that ILECs must make available to competitors upon request and
a methodology for states to use in establishing rates for interconnection and
the purchase of unbundled network elements. The FCC also adopted a methodology
for states to use when applying the Federal Telecommunications Act's "avoided
cost standard" for setting wholesale prices with respect to retail services.
The following summarizes the key issues addressed in the Interconnection
Orders.
- Interconnection. ILECs are required to provide interconnection for
telephone exchange or exchange access service, or both, to any requesting
telecommunications carrier at any technically feasible point. The
interconnection must be at least equal in quality to that provided by the
ILEC to itself or its affiliates and must be provided on rates, terms and
conditions that are just, reasonable and nondiscriminatory.
- Access to Unbundled Elements. ILECs are required to provide requesting
telecommunications carriers with nondiscriminatory access to network
elements on an unbundled basis at any technically feasible point on
rates, terms, and conditions that are just, reasonable and
nondiscriminatory. At a minimum, ILECs must unbundle and provide access
to network interface devices, local loops, local and tandem switches
(including all software features provided by such switches), interoffice
transmission facilities, signaling and call-related database facilities,
operations support systems and information and operator and directory
assistance facilities. Further, ILECs may not impose restrictions,
limitations or requirements upon the use of any unbundled network
elements by other carriers.
- Methods of Obtaining Interconnection and Access to Unbundled
Elements. ILECs are required to provide physical collocation of
equipment necessary for interconnection or access to unbundled network
elements at the ILEC's premises, except that the ILEC may provide virtual
collocation if it demonstrates to the PSC that physical collocation is
not practical for technical reasons or because of space limitations.
- Pricing Methodologies. New entrants were required to pay for
interconnection and unbundled elements at rates based on the ILEC's Total
Element Long-Run Incremental Cost ("TELRIC") of providing a particular
network element plus a reasonable share of forward-looking joint and
common costs, and may include a reasonable profit. However, as discussed
below, these rules were first stayed, and later vacated, by the U.S.
Court of Appeals for the Eighth Circuit.
- Access Charges for Unbundled Switching and Access Charge Reform. IXCs
which order unbundled switching elements temporarily were required to pay
an access charge to an ILEC when the ILEC provides exchange access
service. Access charges also must be paid when an IXC originates or
terminates interexchange traffic to a customer to which it provides local
services by reselling ILEC exchange services. However, a series of access
charge reforms were announced by the FCC on May 7, 1997. See "-- Other
Regulation -- Access Charges" below.
- Resale Pricing. ILECs are required to offer for resale any
telecommunications service that the carrier provides at retail to
subscribers who are not telecommunications carriers. PSCs were required
to identify which marketing, billing, collection and other costs will be
avoided or that are avoidable by ILECs when they provide services on a
wholesale basis and to calculate the portion of the retail rates for
those services that is attributable to the avoided and avoidable costs.
However, as discussed below, the specific federal pricing requirements
were stayed, and later vacated, by the U.S. Court of Appeals for the
Eighth Circuit.
59
<PAGE> 63
- Transport and Termination Charges. The FCC rules required that LEC
charges for transport and termination of local traffic delivered to them
by competing LECs must be cost-based and should be based on the LECs'
TELRIC cost of providing that service. However, as discussed below, the
FCC's pricing and costing rules were first stayed, and later vacated, by
the U.S. Court of Appeals for the Eighth Circuit.
- Access to Rights-of-Way. The FCC established procedures and guidelines
designed to facilitate the negotiation and mutual provision of
nondiscriminatory access by telecommunications carriers and utilities to
their poles, ducts, conduits, and rights-of-way. Expedited dispute
resolution procedures are set forth should good faith negotiations fail.
- Universal Service Reform. All telecommunications carriers, including the
Company, are required to contribute funding for universal service
support, on an equitable and nondiscriminatory basis, in an amount
sufficient to preserve and advance universal service pursuant to a
specific or predictable universal service funding mechanism. The Company
cannot at this time predict the level of its mandatory contribution, but
the Company believes that it will likely be a significant expenditure. On
May 8, 1997, the FCC released an order implementing these requirements by
reforming its existing access charge and universal service rules. See
"-- Other Regulation -- Universal Service Reform" below.
Most provisions of the Interconnection Orders were appealed. Numerous
appeals were consolidated for consideration by the U.S. Court of Appeals for the
Eighth Circuit (captioned Iowa Utilities Board v. FCC). The Court of Appeals
thereupon stayed the effectiveness of most of the pricing and costing provisions
of FCC rules adopted in the Interconnection Orders. On July 18, 1997, the Court
of Appeals released its decision regarding issues raised in the consolidated
appeals of the Interconnection Orders. The Interconnection Orders were upheld in
part and reversed in part. A non-exclusive list of decisions rendered include
that:
- The FCC exceeded its jurisdiction in establishing rules governing the
prices that ILECs may charge competitors for interconnection, unbundled
access and resale. The Court ruled that the authority to establish prices
for local communications facilities and services is reserved to the
States and, thus, vacated the FCC's pricing rules (except as they apply
to CMRS providers).
- The FCC's "pick and choose" rule, which allows competitors to select
terms of previously approved interconnection agreements for their own
use, conflicts with the purposes of the Federal Telecommunications Act,
and also was vacated.
- The FCC lacks authority to hear formal complaints which involve the
review and/or enforcement of certain terms of local interconnection
agreements approved by State commissions.
- The FCC lacks authority to require interconnection agreements which were
negotiated before the enactment of the Federal Telecommunications Act to
be submitted for State commission approval.
- The FCC may not adopt a blanket requirement that State interconnection
rules must be consistent with the FCC's regulations.
- The FCC correctly concluded that ILEC operations support systems,
operator services and vertical switching features qualify as network
elements that are subject to the unbundling requirements of the Federal
Telecommunications Act.
- The FCC's definition of "technically feasible" was upheld for purposes of
deciding where ILECs must permit interconnection by competitors, but the
FCC's use of this term to determine what elements must be unbundled was
rejected.
- The FCC erred in deciding that ILECs could be required by competitors to
provide interconnection and unbundled network elements at levels of
quality which exceed those levels at which ILECs provide such services to
themselves.
- The FCC cannot require ILECs to recombine network elements for
competitors, but competitors may recombine such network elements
themselves as necessary to provide telecommunications services.
- Claims that the unbundling rules effected an unconstitutional taking were
not decided because they were either raised by parties which lacked
standing or were not ripe for review.
60
<PAGE> 64
- FCC rules and policies regarding the ILECs' duty to provide for physical
collocation of equipment were upheld.
- The FCC's rules requiring ILECs to allow the resale of promotional prices
lasting more than 90 days were upheld.
The Interconnection Orders, and resulting local interconnection rules, were
vacated in part consistent with these decisions. A companion appeal (captioned
Competitive Telecommunications Association v. FCC) was decided on June 27, 1997.
In the latter case, the court upheld the FCC's decision that the term
"interconnection" as used in the Federal Telecommunications Act relates to
physical access, and does not include transmission and routing services as well.
On reconsideration, the Eighth Circuit upheld its prior decision as to
recombination of network elements. Various parties have filed petitions for
certiorari to the U.S. Supreme Court seeking reversal of the Eighth Circuit
decisions on recombination rules, "pick and choose" rules and the FCC's
jurisdiction to set prices for local communications facilities and services. The
Company cannot predict whether the Eighth Circuit decisions will stand, or what
actions the FCC may or may not take in response to these appellate decisions.
Notably, the FCC recently made the use of forward looking, economic costs for
the pricing of local interconnection, transport and termination and unbundled
network elements, a temporary condition of its approval of the merger of Bell
Atlantic and NYNEX. Similarly, the FCC indicated in its denial of Ameritech's
application for in-region long distance authority that an RBOC's use of such
forward looking, economic costs is relevant to the issue of whether it has
satisfied the conditions necessary for approval of such an application, although
that ruling has been appealed.
Other Regulation. In general, the FCC has a policy of encouraging the
entry of new competitors, such as the Company, in the telecommunications
industry and preventing anti-competitive practices. Therefore, the FCC has
established different levels of regulation for dominant carriers and nondominant
carriers. For domestic common carrier telecommunications regulation, large ILECs
such as GTE and the RBOCs are currently considered dominant carriers, while
CLECs such as the Company are considered nondominant carriers.
- Tariffs. As a nondominant carrier, the Company may install and operate
facilities for the transmission of domestic interstate communications
without prior FCC authorization. Services of nondominant carriers have
been subject to relatively limited regulation by the FCC, primarily
consisting of the filing of tariffs and periodic reports. With the
exception of informational tariffs for operator-assisted services and
interexchanges 10xxx-2x digital services, the FCC has ruled that
interexchange carriers must cancel their tariffs for domestic, interstate
interexchange services. However, the FCC's interexchange de-tariffing
order was recently stayed by order of the U.S. Court of Appeals for D.C.
Tariffs are still required to be filed for international services. On
June 19, 1997, the FCC issued an order granting petitions filed by
Hyperion and Time-Warner to provide CLECs the option to cease filing
tariffs for interstate interexchange access services and has proposed to
make the withdrawal of CLEC access service tariffs mandatory. However,
nondominant carriers like the Company must offer interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remain subject
to FCC complaint procedures.
Pursuant to these FCC requirements, the Company has filed and maintains
tariffs for its interstate services with the FCC. All of the interstate
access and retail "basic" services (as defined by the FCC) provided by
the Company are described therein. "Enhanced" services (as defined by the
FCC) need not be tariffed. The Company believes that its enhanced voice
and Internet services are "enhanced" services which need not be tariffed.
The Company has not yet decided whether it will elect to cease filing
interstate interexchange access tariffs.
Nondomestic carriers such as the Company also are required to obtain FCC
authorization pursuant to Section 214 of the Communications Act before
providing international communications services. The Company obtained
authority from the FCC to provide voice and data communications services
between the United States and all foreign points.
- ILEC Price Cap Regulation Reform. In 1991, the FCC replaced traditional
rate of return regulation for large ILECs with price cap regulation.
Under price caps, ILECs can only raise prices for certain services, by a
small percentage each year. In addition, there are constraints on the
pricing of ILEC
61
<PAGE> 65
services that are competitive with those of CLECs. On September 14, 1995,
the FCC proposed a three-stage plan that would substantially reduce ILEC
price cap regulation as local markets become increasingly competitive and
ultimately would result in granting ILECs nondominant status. Adoption of
the FCC's proposal to reduce significantly its regulation of ILEC pricing
would significantly enhance the ability of ILECs to compete against the
Company and could have a material adverse effect on the Company. The FCC
released an order on December 24, 1996 which adopted certain of these
proposals, including the elimination of the lower service band index
limits on price reductions within the access service category. The FCC's
December 1996 order also eased the requirements necessary for the
introduction of new services. On May 7, 1997, the FCC took further action
in its CC Docket No. 94-1 updating and reforming its price cap plan for
ILECs. The changes require price cap LECs to reduce their price cap
indices by 6.5 percent annually, less an adjustment for inflation. The
FCC also eliminated rules that require ILECs earning more than certain
specified rates of return to "share" portions of the excess with their
access customers during the next year in the form of lower access rates.
These actions could have a significant impact on the interstate access
prices charged by the ILECs with which the Company competes.
- Access Charges. Over the past few years, the FCC has granted ILECs
significant flexibility in pricing their interstate special and switched
access services. Under this pricing scheme, ILECs may establish pricing
zones based on access traffic density and charge different prices for
each zone. The Company anticipates that this pricing flexibility will
result in ILECs lowering their prices in high traffic density areas, the
probable area of competition with the Company. The Company also
anticipates that the FCC will grant ILECs increasing pricing flexibility
as the number of interconnections and competitors increases. On May 7,
1997, the FCC took action in its CC Docket No. 96-262 to reform the
current interstate access charge system. The FCC adopted an order which
makes various reforms to the existing rate structure for interstate
access that are designed to move access charges, over time, to more
economically efficient rate levels and structures. The following is a
nonexclusive list of actions announced by the FCC:
Subscriber Line Charge ("SLC"). The maximum permitted amount which an
ILEC may charge for SLC's on certain lines was increased. Specifically,
the ceiling was increased significantly for second and additional
residential lines, and for multi-line business customers. SLC ceiling
increases began in July 1997 and will be phased-in over a two-year
period.
Presubscribed Interchange Carrier Charge ("PICC"). The FCC created a new
PICC access charge rate element. The PICC is a flat-rated, per-line
charge that is recovered by LECs from IXCs. The charge is designed to
recover common line revenues not recovered through SLCs. Effective
January 1, 1998, the maximum permitted PICC charge will be $0.53 per
month for primary residential lines and $1.50 per month for second and
additional residential lines. The initial maximum PICC for multi-line
business will be $2.75. The ceilings will be permitted to increase over
time.
Carrier Common Line Charge ("CCL"). As the ceilings on the SLCs and
PICCs increase, the per-minute CCL charge will be eliminated. Until then,
the CCL will be assessed on originating minutes of use. Thus, ILECs will
charge lower rates for terminating then originating access. In addition,
Long Term Support ("LTS") payments for universal service will be
eliminated from the CCL charge.
Local Switching. Effective January 1, 1998, ILECs subject to price-cap
regulation will be required to move non-traffic-sensitive ("NTS") costs
of local switching associated with line ports to common line and recover
them through the common line charge discussed above. Local switching
costs attributable to dedicated trunk ports must be moved to the trunking
basket and recovered through flat-rate monthly charges.
Transport. The "unitary" rate structure option for tandem-switched
transport will be eliminated effective July 1, 1998. For price cap LECs,
additional rate structure charges will become effective on January 1,
1998, which will alter the recovery of certain NTS costs of
tandem-switching and multiplexing and the minutes-of-use assumption
employed to determine tandem-switched transport prices. Also effective
January 1, 1998, certain costs currently recovered through Transport
Interconnection Charge ("TIC") will be reassigned to specified facilities
charges. The reassignment of tandem
62
<PAGE> 66
costs currently recovered through the TIC to the tandem switching charge
will be phased in evenly over a three-year period. Residual TIC charges
will be recovered in part through the PICC, and price cap reductions will
be targeted at the per-minute residual TIC until it is eliminated.
In other actions, the FCC clarified that incumbent LECs may not assess
interstate access charges on the purchasers of unbundled network elements
or information services providers (including ISPs). Further regulatory
actions affecting ISPs are being considered in a notice of inquiry
released December 24, 1996. The FCC also decided not to adopt any
regulations governing the provision of terminating access by CLECs. ILECs
also were ordered to adjust their access charge rate levels to reflect
contributions to and receipts from the new universal service funding
mechanisms.
The FCC also announced that it will, in a subsequent Report and Order to
be issued during summer 1997, provide detailed rules for implementing a
market-based approach to further access charge reform. That process will
give incumbent LECs progressively greater flexibility in setting rates as
competition develops, gradually replacing regulation with competition as
the primary means of setting prices. The FCC also adopted a "prescriptive
safeguard" to bring access rates to competitive levels in the absence of
competition. For all services then still subject to price caps and not
deregulated in response to competition, the FCC required incumbent LECs
subject to price caps to file Total Service Long Run Incremental Cost
("TSLRIC") costs studies no later than February 8, 2001.
This series of decisions is likely to have a significant impact on the
operations, expenses, pricing and revenue of the Company. On June 18, 1997, the
FCC denied petitions filed by several ILECs asking the FCC to stay the
effectiveness of its access charge reform decision. Various parties have sought
reconsideration or approval of the FCC's access charge rulings and all or part
of the order ultimately could be set aside or revised.
Universal Service Reform. On May 8, 1997, the FCC released an order in its
CC Docket No. 96-45, which reforms the current system of intrastate universal
service support and implements the universal services provisions of the Federal
Telecommunications Act. The FCC established a set of policies and rules that
ensure that low-income consumers and consumers that live in rural, insular and
high cost areas received a defined set of local telecommunications services at
affordable rates. This is accomplished in part through expansion of direct
consumers subsidy programs and in part by ensuring that rural, small and high
cost LECs continue to receive universal service subsidy support. The FCC also
created new programs to subsidize connection of eligible schools, libraries and
rural health care providers to telecommunications networks. These programs will
be funded by assessment of eligible revenues of nearly all providers of
intrastate telecommunications carriers, including competitive LECs such as the
Company.
The Company, like other telecommunications carriers that provide intrastate
telecommunications services, will be required to contribute a portion of its
end-user telecommunications revenues to fund universal service programs.
However, the Company also is eligible to qualify as a recipient of universal
service support if it elects to service areas designated for universal service
support over its own network. The eligibility criteria established by the FCC
provide that carriers must be a common carrier, and offer and advertise,
throughout a designated service area, all of the services supported by universal
service subsidies. Such carriers must provide the support services, at least in
part, over their own facilities or through use of unbundled network elements
purchased from incumbent LECs. The FCC's decisions in CC Docket No. 96-45 could
have a significant impact on future operations of the Company.
State Regulation
The Company believes that most, if not all, states in which it proposes to
operate will require a certification or other authorization to offer intrastate
services. Many of the states in which the Company operates or intends to operate
are in the process of addressing issues relating to the regulation of CLECs.
Some states may require authorization to provide enhanced services.
In some states, existing state statutes, regulations or regulatory policy
may preclude some or all forms of local service competition. The Federal
Telecommunications Act contains provisions that prohibit states and localities
from adopting or imposing any legal requirement that may prohibit, or have the
effect of prohibiting, the ability of any entity to provide any interstate or
intrastate telecommunications service. The FCC is required to preempt any such
state or local requirements to the extent necessary to enforce the Federal
63
<PAGE> 67
Telecommunications Act's open market entry requirements. States and localities
may, however, continue to regulate the provision of intrastate
telecommunications services, and, presumably, require carriers to obtain
certificates or licenses before providing service.
Some states in which the Company operates are considering legislation which
could impede efforts by new entrants in the local services market to compete
effectively with ILECs. The Arkansas legislature, for example, recently enacted
legislation which curtails the ability of the state PSC to make available
additional network elements to CLECs or authorize CLECs to receive universal
service funding. On March 25, 1997, the Company filed a petition for Declaratory
Ruling with the FCC asking it to preempt portions of the Arkansas statute.
As of September 30, 1997 the Company had obtained intrastate authority for
the provision of dedicated services and a full range of local switched services
in Alabama, Arizona, Arkansas, Colorado, the District of Columbia, Florida,
Georgia, Kansas, Kentucky, Louisiana, Maryland, Mississippi, Missouri, Nevada,
New Mexico, Oklahoma, South Carolina, Tennessee, Texas and Virginia. In
addition, the Company has obtained PSC certification to provide interLATA
services in a majority of these states and is seeking such certification in
other states. There can be no assurances that the Company will receive the
authorizations it may seek in the future to the extent it expands into other
states or seeks additional services from the above-named PSCs. See "Risk
Factors -- Rapid Expansion of Operations." In most states, the Company is
required to file tariffs setting forth the terms, conditions and prices for
services that are classified as intrastate.
The Company believes that, as the degree of intrastate competition
increases, the states will offer the ILECs increasing pricing flexibility. This
flexibility may present the ILECs with an opportunity to subsidize services that
compete with the Company's services with revenues generated from non-competitive
services, thereby allowing ILECs to offer competitive services at prices below
the cost of providing the service. The Company cannot predict the extent to
which this may occur or its impact on the Company's business.
Local Interconnection. The Federal Telecommunications Act imposes a duty
upon all ILECs to negotiate in good faith with potential interconnectors to
provide interconnection to the ILEC network, exchange local traffic, make
unbundled basic local network elements available, and permit resale of most
local services. In the event that negotiations do not succeed, the Company has a
right to seek state PSC arbitration of any unresolved issues. The state PSC must
conclude the arbitration within nine months of the date upon which the ILEC
received the Company's initial request for interconnection. The Company has
negotiated or arbitrated interconnection arrangements with each of the
following: BellSouth (North Carolina, South Carolina, Georgia, Florida, Alabama,
Mississippi, Louisiana, Tennessee and Kentucky), Southwestern Bell (Texas,
Arkansas, Kansas, Missouri and Oklahoma), US West (Arizona, New Mexico and
Colorado), Bell Atlantic (Maryland, Virginia and the District of Columbia), GTE
(Texas, Kentucky and Florida) and Sprint/ Central Telephone (Nevada).
Arbitration decisions involving interconnection arrangements in several states
have been challenged in lawsuits filed in U.S. District Court by the affected
ILECs.
The Company has experienced some difficulty in obtaining timely ILEC
implementation of local interconnection agreements. Delays encountered in
unbundled loop installation have caused the Company to file complaints against
BellSouth with the FCC and Georgia PSC. The Company is considering the
possibility of filing similar actions against other ILECs.
Local Government Authorizations. The Company is required to obtain street
use and construction permits and licenses and/or franchises to install and
expand its fiber optic networks using municipal rights-of-way. In some
municipalities where the Company has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenues or on a per linear foot basis, as well as post
performance bonds or letters of credit. There can be no assurance that the
Company will not be required to post similar bonds in the future, nor is there
any assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, the ILECs do not pay such
franchise fees or pay fees that are substantially less than those required to be
paid by the Company. To the extent that competitors do not pay the same level of
fees as the Company, the Company could be at a competitive disadvantage.
However, the Federal Telecommunications Act provides that any compensation
extracted by states and localities for use of public rights-of-way must be "fair
and reasonable," applied on a "competitively neutral and nondiscriminatory
basis" and be "publicly disclosed" by such government entity. Termination of
64
<PAGE> 68
the existing franchise or license agreements prior to their expiration dates
could have a materially adverse effect on the Company.
EMPLOYEES
As of September 30, 1997, the Company employed a total of 669 individuals
full time. The Company believes that its future success will depend on its
continued ability to attract and retain highly skilled and qualified employees.
None of the Company's employees is subject to a collective bargaining agreement.
The Company believes that its relations with its employees are good.
LEGAL PROCEEDINGS
ACSI's former Chief Financial Officer, Harry J. D'Andrea, has initiated
litigation against the Company in the Circuit Court of Maryland for Anne Arundel
County. The lawsuit alleges four different counts: breach of contract; breach of
the covenant of good faith and fair dealing; negligent misrepresentation; and
specific performance. D'Andrea seeks damages in excess of $5,000,000, and the
right to exercise options to purchase 100,000 shares of ACSI common stock at
$4.25 per share. The Company received a copy of the Complaint on April 8, 1997.
The Company believes it has meritorious defenses to this complaint and intends
to defend this lawsuit vigorously.
A Houston, Texas based company named "American Communication Services,
Inc." has initiated litigation against the Company in the District Court of
Travis County, Texas, contending that the Company's use of the "American
Communications Services, Inc." name in the State of Texas violates Texas law.
The Company intends to litigate the matter vigorously if an out of court
resolution cannot be reached.
Additionally, the Company and its subsidiaries are currently parties to
routine litigation incidental to their business, none of which, individually or
in the aggregate, are expected to have a material adverse effect on the Company.
The Company and its subsidiaries are parties to various court appeals and
regulatory arbitration proceedings relating to certain of the Company's
interconnection agreements and continue to participate in regulatory proceedings
before the FCC and state regulatory agencies concerning the authorization of
services and the adoption of new regulations. See "-- Regulation."
PROPERTIES
The Company leases 23,925 and 6,619 square feet of office space in
Annapolis Junction, Maryland for its corporate headquarters and network
management center for $29,506 and $8,522, respectively per month as of September
30, 1997 subject to periodic increases in specified amounts. The primary lease
expires in 2002 with an option to renew for two additional five year periods.
The secondary lease is currently on a month-to-month term. Additional office
space of 16,561 square feet is leased in Laurel, Maryland for corporate offices
and local network operations. The leases expire in 2006 and 1997. The Company
leases 3,063 square feet of corporate office space in Rosemont, Illinois under a
lease which expires in 2000. The Company leases a 1,358 square foot field office
in Lombard, Illinois which houses its local network development operations. This
lease expires in 1999.
As of September 30, 1997, the Company's various operating subsidiaries have
leased facilities for their offices and network nodes. The aggregate monthly
rent on these properties is approximately $265,000. The various leases expire on
dates ranging from December, 1997, to April, 2007. Most leases include renewal
options. Additional office space and equipment rooms will be leased as
additional networks are constructed and the Company's operations are expanded.
The Company believes that its insurance coverage on these properties is
adequate and in compliance with the related leases.
65
<PAGE> 69
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information as of the date of this
Prospectus regarding the directors and executive officers of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION AND OFFICES HELD
- ---------------------------------------- --- -------------------------------------------------
<S> <C> <C>
Anthony J. Pompliano.................... 58 Chairman of the Board of Directors
Jack E. Reich........................... 47 President and Chief Executive Officer and
Director
Riley M. Murphy......................... 41 Executive Vice President -- Legal and Regulatory
Affairs, General Counsel and Secretary
David L. Piazza......................... 42 Chief Financial Officer
George M. Middlemas(1).................. 51 Director
Edwin M. Banks(2)....................... 35 Director
Christopher L. Rafferty(1).............. 49 Director
Benjamin P. Giess....................... 35 Director
Olivier L. Trouveroy(1)(2).............. 42 Director
Peter C. Bentz.......................... 32 Director
</TABLE>
- ---------------
(1) Member of Compensation Committee
(2) Member of Audit Committee
Anthony J. Pompliano, Chairman of the Board of Directors, has more than 30
years of experience in the telecommunications industry. Mr. Pompliano was
elected a director of the Company in November 1993. He was co-founder and
President of Metropolitan Fiber Systems, the predecessor organization to MFS
Communications, a publicly-traded CLEC that was acquired by WorldCom, Inc. in
December 1996. Mr. Pompliano served as President, CEO and Vice Chairman of MFS
Communications from April 1988 until March 1991. He joined ACSI in August 1993
after the expiration of his non-competition agreement with MFS Communications.
Before his association with MFS Communications and its predecessor, he was Vice
President -- Operations and Sales for MCI Telecommunications International from
1981 to 1987, and prior thereto, was Vice President -- National Operations for
Western Union International, Inc. from 1960 to 1981.
Jack E. Reich, President and Chief Executive Officer, had 22 years of
telecommunications industry and management experience before joining ACSI in
December 1996. Mr. Reich was elected to the Board of Directors in October 1997.
For two and one-half years prior to joining ACSI, Mr. Reich was employed by
Ameritech, Inc. as President of its Custom Business Service Organization, where
Mr. Reich was responsible for full business marketing to Ameritech's largest
customers for telecommunications services, advanced data services, electronic
commerce and managed services/outsource initiatives. Prior to that, he served as
President of MCI's Multinational Accounts organization and also served as MCI's
Vice President of Products Marketing. Mr. Reich has also held sales and
marketing positions at AT&T and ROLM Corp. Mr. Reich has a B.S. degree from St.
Louis University and an MBA from the University of Chicago.
Riley M. Murphy, Executive Vice President -- Legal and Regulatory Affairs
and Secretary, had twelve years of experience in the private practice of
telecommunications regulatory law for interexchange, cellular, paging and other
competitive telecommunication services prior to joining the Company. Since
February 1995, she has served as an officer and director of The Association for
Local Telecommunications Services. Ms. Murphy joined ACSI on a full-time basis
in April 1994 and was senior counsel to Locke Purnell Rain Harrell, a
Dallas-based law firm through December 1994. From 1987 to 1992, Ms. Murphy was a
partner of Wirpel and Murphy, a telecommunications law firm she co-founded, and
from 1992 to 1993 she was a sole practitioner. She holds a B.A. degree from the
University of Colorado and a J.D. from the Catholic University of America and is
admitted to practice law in the District of Columbia and Louisiana.
66
<PAGE> 70
David L. Piazza, Chief Financial Officer, joined the Company on March 24,
1997. For ten years prior to joining the Company, Mr. Piazza was employed by MFS
Communications in a variety of finance and senior management positions, most
recently as the Senior Vice President and Chief Financial Officer of MFS
Telecom, Inc., a subsidiary of MFS Communications. Prior to his employment with
MFS Communications, Mr. Piazza was employed by AT&T for four years in its
finance and support divisions. Mr. Piazza received his B.S. degree in
Accountancy from the University of Illinois and holds a CPA.
George M. Middlemas, Director, was elected a director of the Company in
December 1993. Mr. Middlemas is a general partner of Apex Management
Partnership, which is the general partner of Apex Investment Fund I, L.P. and
Apex Investment Fund II, L.P., both of which are venture capital funds, and
affiliates of First Analysis Corporation, a principal stockholder of the
Company. See "Principal Stockholders." From March 1991 to December 1991, Mr.
Middlemas acted as an independent consultant providing fund raising and other
advisory services. From 1985 until March 1991, Mr. Middlemas was a Senior Vice
President and Principal of Inco Venture Capital Management, a venture capital
firm. He also serves on the Board of Directors of PureCycle Corporation,
Security Dynamics Technologies, Inc. and several privately held companies.
Edwin M. Banks, Director, was elected a director of the Company in October
1994. Since 1988, Mr. Banks has been employed by W. R. Huff Asset Management
Co., L.L.C. and currently serves as a portfolio manager concentrating in the
healthcare, communications, food and food services industries. From 1985 until
he joined W.R. Huff Asset Management Co., L.L.C., Mr. Banks was employed by
Merrill Lynch & Company. Mr. Banks received his B.A. degree from Rutgers College
and his MBA degree from Rutgers University. Mr. Banks also serves as a director
of Magellan Health Services.
Christopher L. Rafferty, Director, was elected a director of the Company in
October 1994. Mr. Rafferty has been employed by WRH Partners, L.L.C., the
general partner of Huff since June 1994. From January 1993 to February 1994, Mr.
Rafferty was Vice President -- Acquisitions for Windsor Pet Care, Inc., a
venture capital-backed firm focusing on consolidating the pet care services
industry. From October 1990 to January 1993, Mr. Rafferty was a consultant
specializing in merchant banking, leveraged acquisitions and venture capital
transactions. From June 1987 to the time he started his consulting business, Mr.
Rafferty was a Managing Director of Chase Manhattan Capital Corporation, the
merchant banking and private equity investment affiliate of Chase Manhattan
Corporation. Mr. Rafferty received his undergraduate degree from Stanford
University and his law degree from Georgetown University.
Benjamin P. Giess, Director, was elected a director of the Company in June
1995. Since 1992, Mr. Giess has been employed by ING and its predecessors and
affiliates and currently serves as a Partner responsible for originating,
structuring and managing equity and debt investments. From 1991 to 1992, Mr.
Giess worked in the Corporate Finance Group of ING Capital. From 1990 to 1991,
Mr. Giess was employed by the Corporate Finance Group of General Electric
Capital Corporation where he worked in the media and entertainment group. Prior
to attending business school, from 1986 to 1988, Mr. Giess was the Credit
Department Manager of the Boston Branch of ABN Amro North America, Inc. From
1984 to 1986, Mr. Giess was employed at the Shawmut Bank of Boston. Mr. Giess
also serves as a director of Matthews Studio Equipment Group, CMI Holding Corp.
and TransCare Corporation. Mr. Giess received his undergraduate degree from
Dartmouth College and his MBA from the Wharton School of the University of
Pennsylvania.
Olivier L. Trouveroy, Director, was elected a director of the Company in
June 1995. Since 1992, Mr. Trouveroy has been employed by ING and its
predecessors and affiliates and currently serves as a Managing Partner
responsible for originating, structuring and managing equity and debt
investments. From 1990 to 1992, Mr. Trouveroy was a Managing Director in the
Corporate Finance Group ("CFG") of General Electric Capital Corporation in
charge of CFG's office in Paris, France. From 1984 to 1990, Mr. Trouveroy held
various positions in the Mergers and Acquisitions department of Drexel Burnham
Lambert in New York, most recently as a First Vice President. Mr. Trouveroy also
serves as a director of AccessLine Technologies, Inc., Cost Plus, Inc. and
TransCare Corporation. Mr. Trouveroy holds B.S. and Masters degrees in Economics
from the University of Louvain in Belgium, as well as an MBA from the University
of Chicago.
67
<PAGE> 71
Peter C. Bentz, Director, was elected a director of the Company in June
1995. Since 1992, Mr. Bentz has been employed by W. R. Huff Asset Management
Co., L.L.C. as a research analyst specializing in telecommunications, media and
healthcare. Mr. Bentz received his Bachelor of Science degree from Boston
College in 1987 and his MBA from the Wharton School of the University of
Pennsylvania in 1992.
The Board is comprised of seven members who were elected by the holders of
the Company's Common Stock. All directors of the Company hold office until the
next annual meeting of stockholders and until their successors are duly elected
and qualified.
68
<PAGE> 72
EXECUTIVE COMPENSATION
The following table provides a summary of compensation for the fiscal
period ended December 31, 1996 and for each of the three fiscal years ended June
30, 1996, 1995 and 1994, with respect to the Company's Chief Executive Officer,
and the other five most highly compensated officers of the Company during the
fiscal year ended June 30, 1996 whose annual salary and bonus during such fiscal
year exceeded $100,000 (collectively, the "Named Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
--------------------------------------- NUMBER OF
OTHER SECURITIES
NAME AND PRINCIPAL POSITION ON ANNUAL UNDERLYING ALL OTHER
DECEMBER 31, 1996 YEAR SALARY BONUS COMPENSATION(1) OPTIONS(2) COMPENSATION
- --------------------------------------------- ---- -------- -------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Anthony J. Pompliano......................... 1996* $124,167 $ 75,000(3) $ -- -- $ 2,574(4)
Executive Chairman of the Board 1996 239,583 175,000(3) -- -- 6,187(4)
of Directors 1995 219,500 175,000(3) -- 500,000 6,977(4)
1994 110,000 -- 25,000(5) 1,349,899 61,507(6)
Jack E. Reich(7)............................. 1996* 20,883 -- -- 1,200,000
President and Chief Executive
Officer -- Communications Services
Riley M. Murphy.............................. 1996* 91,250 -- -- -- --
Executive Vice President -- Legal 1996 162,499 81,500(8) 37,004(10) 50,000 3,536(4)
and Regulatory Affairs, General 1995 150,000 81,500(9) -- 250,001(12) 9,783(4)
Counsel and Secretary 1994 37,500 -- 48,620(11) --
Robert H. Ottman(13)......................... 1996* 90,667 -- -- -- --
Executive Vice President/Network 1996 170,000 50,000(3) 100,000(10) -- --
Services and Technical Support 1995 28,333 -- -- 250,000 --
Richard A. Kozak(14)......................... 1996* 129,167 137,500(3) -- 83,334(15) 2,700(4)
President and Chief Executive 1996 232,885 200,000(3) -- -- 5,400(4)
Officer -- Corporate Services and 1995 184,378 175,000(3) -- 399,999(15) 3,750(4)
Acting Chief Financial Officer 1994 87,500 -- 39,728(5) 899,932 --
George M. Tronsrue, III(16).................. 1996* 100,000 -- -- -- 2,400(4)
President and Chief Operating 1996 191,128 54,116(17) -- 50,000 4,800(4)
Officer -- Strategy and Technology 1995 150,000 135,417(17) 68,800(10) 350,001(12) --
Development 1994 53,827 50,000 -- --
</TABLE>
- ---------------
(*) Subsequent to June 30, 1996, the Company changed its fiscal year-end to
December 31. Information is for the six months ended December 31, 1996.
(1) Excludes perquisites and other personal benefits that in the aggregate do
not exceed 10% of the Named Officers' total annual salary and bonus.
(2) See information provided in "Option Grants in Fiscal Year Ended June 30,
1996 and Fiscal Period Ended December 31, 1996" and "December 31, 1996
Option Values."
(3) Represents cash bonuses received for attainment of certain performance
goals.
(4) Represents payments received for medical or disability insurance in excess
of that provided to other employees and/or car allowances and, for Ms.
Murphy, includes payments of $6,423 of premiums in connection with
professional liability insurance for the period prior to her employment
with the Company.
(5) Consists of amounts paid to Messrs. Pompliano and Kozak as consultants for
services rendered prior to their employment by the Company in August 1993
and November 1993, respectively.
(6) Consists of $20,000 received as compensation in connection with the
Company's November 1993 sale of 400,000 shares of Common Stock and $41,507
received as compensation in connection with the Company's June 1994
issuance of $4,300,720 principal amount of 15% convertible notes.
(7) Mr. Reich commenced employment with the Company in December 1996.
(8) Represents an installment of a $244,500 cash bonus, $81,500 of which was
paid in January 1997.
(9) This payment represents the first installment of a $244,500 cash bonus.
(10) Includes $65,000, $100,000 and $37,004 paid to Messrs. Tronsrue and Ottman
and Ms. Murphy, respectively, in connection with relocation and moving
expenses relating to the relocation of the Company's headquarters to
Annapolis Junction, Maryland.
(11) Consists of $43,620 received for performing legal services for the Company
as outside counsel and a $5,000 for relocation expenses.
(12) 150,000 of these options were originally granted in the fiscal year ended
June 30, 1994 at an exercise price of $2.50 per share and such exercise
price was subsequently reduced to $2.25 per share in connection with the
Company's October 1994 offering of preferred stock.
(13) Mr. Ottman commenced employment with the Company in May 1995 and his
employment was terminated in February 1997.
(14) Mr. Kozak served as the Company's President and Chief Executive Officer
during fiscal year 1996. He became Acting Chief Financial Officer in
December 1996 upon the resignation of the Company's previous Chief
Financial Officer. In connection with the Company's December 1996
management reorganization, Mr. Kozak became President and Chief Executive
Officer -- Corporate Services. Effective February 2, 1997, Mr. Kozak's
employment with the Company was terminated.
(15) In connection with the settlement of the dispute relating to the
termination of Mr. Kozak's employment, all of the options granted in fiscal
period ended December 31, 1996 and options to purchase 83,333 shares
granted in fiscal year ended June 30, 1995 were canceled. See "Certain
Transactions."
(16) Mr. Tronsrue served as Chief Operating Officer during fiscal year 1996,
until November 1996 when he became President and Chief Operating
Officer -- Strategy and Technology Development. Effective September 3,
1997, Mr. Tronsrue resigned from such position. The Company and Mr.
Tronsrue have entered into a separation agreement.
(17) Represents an installment of a $244,500 bonus, $54,116 of which was due on
February 24, 1997.
69
<PAGE> 73
OPTION GRANTS IN FISCAL YEAR ENDED JUNE 30, 1996 AND FISCAL PERIOD ENDED
DECEMBER 31, 1996
The following table contains information concerning the grant of stock
options to the Named Officers during the fiscal year ended June 30, 1996 and the
fiscal period ended December 31, 1996.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS(1)
-----------------------------------------
NUMBER OF % OF TOTAL MARKET PRICE
SECURITIES OPTIONS OF UNDERLYING
UNDERLYING GRANTED TO EXERCISE OR SECURITIES ON
OPTIONS EMPLOYEES BASE PRICE DATE OF EXPIRATION
NAME GRANTED IN PERIOD (PER/SHARE) GRANT DATE
- -------------------------------- ---------- ---------- ----------- ------------- --------
<S> <C> <C> <C> <C> <C>
Anthony J. Pompliano............ -- -- -- -- --
Jack E. Reich................... 200,000 13.95% $ 9.375 $11.625 12/1/02
200,000 13.95 9.375 11.625 12/1/03
200,000 13.95 9.375 11.625 12/1/04
200,000 13.95 9.375 11.625 12/1/05
400,000 27.9 9.375 11.625 12/31/07
Riley M. Murphy................. 25,000(2) 2.2 3.40 3.875 3/30/03
25,000(3) 2.2 3.40 3.875 3/30/04
Robert H. Ottman................ -- -- -- -- --
Richard A. Kozak................ 83,334 5.8 15.00 11.75 11/15/04(4)
George M. Tronsrue, III......... 25,000(2) 2.2 3.40 3.875 2/22/03
25,000(3) 2.2 3.40 3.875 2/22/04
</TABLE>
- ---------------
(1) Mr. Tronsrue and Ms. Murphy were granted options in fiscal year ended June
30, 1996, and Messrs. Reich and Kozak were granted options in the fiscal
period ended December 31, 1996.
(2) These options were granted on July 6, 1995, with an exercise price of $3.40.
Ms. Murphy's options will vest on March 31, 1998 provided, that she does not
voluntarily terminate her employment with the Company or is not terminated
for cause prior to the applicable vesting date. Due to Mr. Tronsrue's
resignation effective as of September 3, 1997, these options were cancelled.
(3) These options were granted on July 6, 1995, with an exercise price of $3.40.
Ms. Murphy's options will vest on March 31, 1999 provided, that she does not
voluntarily terminate her employment with the Company or is not terminated
for cause prior to the vesting date. Due to Mr. Tronsrue's resignation
effective as of September 3, 1997, these options were cancelled.
(4) These options were canceled in connection with the settlement of the dispute
relating to the termination of Mr. Kozak's employment. See "Certain
Transactions."
DECEMBER 31, 1996 OPTION VALUES
The following table sets forth the value of unexercised options held by the
Named Officers as of December 31, 1996. None of the Named Officers exercised
options during the fiscal year ended June 30, 1996 or the fiscal period ended
December 31, 1996.
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED OPTIONS AT DECEMBER 31,
OPTIONS AT DECEMBER 31, 1996 1996(1)
----------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Anthony J. Pompliano..................... 1,599,899 250,000 $15,455,253 $ 1,987,500
Jack E. Reich............................ -- 1,200,000 -- 1,650,000
Riley M. Murphy.......................... 137,501 162,501 1,168,759 1,323,759
Robert H. Ottman......................... 100,000 150,000(2) 775,000 1,162,500
Richard A. Kozak......................... 1,133,265 250,000(3) 10,824,326 970,825
George M. Tronsrue, III.................. 250,000 150,000(4) 2,125,000 1,217,500
</TABLE>
- ---------------
(1) Represents the difference between the per share exercise price of the
unexercised options and $10.75, the last sale price on December 31, 1996, as
reported by the Nasdaq Stock Market.
(2) The vesting of options to purchase 75,000 of these shares was accelerated in
connection with the termination of Mr. Ottman's employment in February 1997.
(3) Of these, options to purchase 166,667 shares were canceled and the vesting
of options to purchase an additional 83,333 shares was accelerated in
connection with the settlement of the dispute relating to the termination of
Mr. Kozak's employment. See "Certain Transactions."
(4) Of Mr. Tronsrue's unexercisable options, 50,000 vested in February, 1997,
and the remainder have been cancelled due to Mr. Tronsrue's resignation
effective as of September 3, 1997.
70
<PAGE> 74
DIRECTORS' COMPENSATION
Members of the Board do not receive cash compensation for acting as members
of the Board or Committees of the Board, other than reimbursement for reasonable
out-of-pocket expenses incurred in connection with their attendance at meetings
of the Board and its committees. Directors who also serve as executive officers
receive cash compensation for acting in their capacity as executive officers.
See "-- Summary Compensation Table." From time to time the Board has granted
options to purchase shares of Common Stock to members of the Board who are not
also officers of the Company in consideration for their service as directors.
However, other than "formula grants" under the Company's 1994 Stock Option Plan,
no formal arrangement exists. For the fiscal period ended December 31, 1996, no
directors were granted options.
EMPLOYMENT AGREEMENTS
Anthony J. Pompliano. The Company is party to an employment agreement with
Anthony J. Pompliano, its Chairman, which terminates on August 23, 1998. Under
the terms of the agreement, as amended, Mr. Pompliano is entitled to an annual
base salary of $275,000 and a cash bonus of up to $200,000 for each of the 1997
and 1998 fiscal years based upon the Company's achievement of certain
performance goals for the relevant fiscal year. Under this employment agreement,
Mr. Pompliano has been granted options to purchase an aggregate of 1,849,899
shares of the Company's Common Stock at exercise prices ranging from $.875 per
share to $2.80 per share. 1,662,399 of these options are currently vested. Mr.
Pompliano has the right to obtain a 30-day loan from the Company for the purpose
of paying the aggregate exercise price of the options granted to him.
Mr. Pompliano has the right, for 90 days after termination of his
employment (unless he is terminated by the Company "for cause" or he voluntarily
resigns), to sell to the Company up to $1.0 million in then market value of
shares of Common Stock issued or issuable pursuant to the options granted to Mr.
Pompliano under his employment agreement, at a price equal to the
publicly-traded price of the Common Stock, less the exercise price of the
options with respect to unexercised options; provided, however, this right
cannot be exercised unless at least 5,000,000 shares of Common Stock are owned
by non-affiliates of the Company at the time of his request and the market value
of the outstanding Common Stock is at least $300 million. Mr. Pompliano's
employment agreement also contains non-compete, non-solicitation and
confidentiality provisions.
Jack E. Reich. The Company is party to an employment agreement with Jack
E. Reich, its President and Chief Executive Officer, which terminates on
December 31, 2000, extendable for one year by mutual agreement. Under the terms
of this agreement, Mr. Reich is entitled to a minimum annual base salary of
$250,000, a cash bonus of $100,000 in 1997 and annual bonuses of between
$150,000 and $350,000 based on the Company's achievement of certain performance
goals. Under this employment agreement, Mr. Reich was granted an option to
purchase 1,200,000 shares of Common Stock at an exercise price $9.375 per share.
These options vest in installments between December 1997 and December 2001,
subject to Mr. Reich's continued employment. Mr. Reich's employment agreement
also contains non-compete, non-solicitation and confidentiality provisions.
Riley M. Murphy. The Company is party to an employment agreement with
Riley M. Murphy, its Executive Vice President for Legal and Regulatory Affairs,
which terminates on March 31, 1999. This agreement, as amended, calls for an
annual salary of $200,000 and a guaranteed bonus of $244,500, payable in annual
installments through January 1997. Under this employment agreement, Ms. Murphy
was granted options to purchase an aggregate of 300,002 shares of Common Stock
at prices ranging from $2.25 per share to $3.40 per share. Ms. Murphy's
employment agreement also contains non-compete, non-solicitation and
confidentiality provisions.
The shares of Common Stock underlying the stock options held by Messrs.
Pompliano and Reich and Ms. Murphy which are discussed above are the subject of
a registration rights agreement with the Company, pursuant to which these
executive officers have been granted certain demand and piggyback registration
rights with respect to the shares of Common Stock underlying these options.
71
<PAGE> 75
1994 STOCK OPTION PLAN
On November 15, 1994, the Board adopted and on December 16, 1994,
stockholders approved the 1994 Stock Option Plan. On January 26, 1996, November
15, 1996, and June 25, 1997 the Company's stockholders approved amendments to
the 1994 Stock Option Plan (the "1994 Plan"). The 1994 Plan will terminate no
later than November 15, 2004, ten years after adoption by the Board of Directors
and after such termination no additional options may be granted. The 1994 Plan
is administered by the Compensation Committee which makes discretionary grants
("discretionary grants") of options to employees (including employees who are
officers and directors of the Company), directors who are not employees of the
Company ("Outside Directors") and consultants. The 1994 Plan also provides for
formula grants of options to Outside Directors ("formula grants"). Under the
1994 Plan, 5,000,000 shares of Common Stock have been reserved for discretionary
and formula grants. As of December 31, 1996, 845,350 discretionary and 20,000
formula options had been granted under the 1994 Plan.
Options granted pursuant to discretionary grants may be nonqualified
options or incentive options within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended. The selection of participants, allotment of
shares, determination of price and other conditions of purchase of such options
will be determined by the Compensation Committee, in its sole discretion.
Options granted pursuant to discretionary grants are exercisable for a period of
up to ten years, except that incentive options granted to optionees who, at the
time the option is granted, own stock representing greater than 10% of the
voting power of all classes of stock of the Company or any parent or subsidiary,
are exercisable for a period of up to five years. The per-share exercise price
of incentive options granted pursuant to discretionary grants must be no less
than 100% of the fair market value of the Common Stock on the date of grant,
except that the per share exercise price of incentive options granted to
optionees who, at the time the option is granted, own stock representing greater
than 10% of the voting power of all classes of stock of the Company or any
parent or subsidiary, must be no less than 110% of the fair market value of the
Common Stock. The per share exercise price of nonqualified stock options granted
pursuant to discretionary grants must be no less than 85% of the fair market
value of the Common Stock on the date of grant. To the extent options are
granted at less than fair market value, the Company incurs a non-cash cost for
financial reporting purposes.
Under the formula grants, each Outside Director will be granted
automatically a nonqualified option to purchase 50,000 shares (subject to
adjustment as provided in the 1994 Plan). Each such director may decline such
grant. Each option granted pursuant to a formula grant will vest and become
exercisable as to 10,000 shares on the date such option is granted (the "Grant
Date"), as to 10,000 shares on the date of the first annual meeting of
stockholders held at least eight months after the Grant Date (the "First Annual
Meeting") and as to 10,000 shares on the date of each of the next three annual
meetings of stockholders held after the First Annual Meeting, provided that the
option will only vest on the relevant annual meeting of stockholders date if the
Outside Director is re-elected to the Board at such meeting. Each such option
shall have a term of five years from the relevant vesting date. The exercise
price per share of Common Stock for options granted pursuant to a formula grant
shall be 100% of the fair market value as determined under the terms of the 1994
Plan.
Generally, all options granted under the 1994 Plan are nontransferable,
other than by will or by the laws of descent and distribution, and may be
exercised during the optionee's lifetime, only by the optionee, or in the event
of the optionee's legal incapacity to do so, by the optionee's guardian or legal
representative. On June 25, 1997, the Company's stockholders approved the
Company's adoption of an amendment to the 1994 Plan authorizing the inclusion of
a provision in stock option agreements relating to options granted to Outside
Directors which permits the transfer by such Outside Director of the options
granted pursuant to such stock option agreement.
As of December 31, 1996, there were 322 employees eligible to participate
and approximately 107 actual participants in the 1994 Plan. During the fiscal
year ended June 30 and the fiscal period ended December 31, 1996 there were no
grants of options pursuant to the 1994 Plan to any director or executive officer
of the Company, including the Named Officers. There were grants of options
pursuant to the 1994 Plan to all other
72
<PAGE> 76
employees as a group to acquire an aggregate of 595,309 shares of Common Stock,
at an average exercise price of $5.41 per share, during the fiscal year ended
June 30, 1996 and the fiscal period ended December 31, 1996.
EMPLOYEE STOCK PURCHASE PLAN
On November 15, 1996, the Company's stockholders approved the Company's
adoption of an Employee Stock Purchase Plan (the "Stock Purchase Plan"). The
Stock Purchase Plan is intended to qualify as an "employee stock purchase plan"
under Section 423 of the Code. All regular full-time employees of the Company
(including officers), and all other employees whose customary employment is for
more than 20 hours per week, who in either case have been employed by the
Company for at least three months are eligible to participate in the Stock
Purchase Plan. Directors who are not employees are not eligible. A maximum of
500,000 shares of the Company's Common Stock are reserved for offering under the
Stock Purchase Plan and available for purchase thereunder, subject to
anti-dilution adjustments in the event of certain changes in the capital
structure of the Company.
Under the Stock Purchase Plan, offerings will be made at the commencement
of each offering period ("Offer Period"). During each Offer Period, deductions
are to be made from the pay of participants (in accordance with their
authorizations) and credited to their accounts under the Stock Purchase Plan.
Payroll deductions may be from 1% to 15% (in whole percentage increments) of a
participant's regular base pay. Participants may not make direct cash payments
to their accounts.
The price per share at which shares of Common Stock are to be purchased
pursuant to the Stock Purchase Plan for any Offer Period is the lesser of (a)
85% of the fair market value of Common Stock on the commencement of the Offer
Period or (b) 85% of the fair market value of Common Stock on the last business
day of an Offer Period. On the last business day of each Offer Period, amounts
credited to the accounts of participants who have been neither terminated from
the employ of the Company nor withdrawn from the Stock Purchase Plan for such
Offer Period are used to purchase shares of Common Stock in accordance with the
elections of such participants. Any amounts remaining in the accounts of
participants at the end of any Offer Period are refunded to the participants.
Only amounts credited to the accounts of participants may be applied to the
purchase of shares of Common Stock under the Stock Purchase Plan.
If for any Offer Period the number of shares of Common Stock available for
Stock Purchase Plan purposes shall be insufficient, the Board of Directors of
the Company is authorized to apportion the remaining available shares pro rata
among participating employees on the basis of their payroll deductions in effect
for such Offer Period.
The Company makes no cash contributions to the Stock Purchase Plan, but
bears the expenses of its administration. The Stock Purchase Plan is
administered by the Compensation Committee, which has authority to establish and
change the number and duration of the Offer Periods during the term of the Stock
Purchase Plan, and to make rulings and interpretations thereunder.
The Stock Purchase Plan will terminate when all available shares have been
purchased, or earlier in the discretion of the Compensation Committee. The first
Offer Period commenced on December 2, 1996 and ended on June 30, 1997. New Offer
Periods will commence on each July 1 and January 1 thereafter until the Stock
Purchase Plan is terminated. At December 31, 1996, there were approximately 272
employees (including officers and directors) who were eligible to participate in
the Stock Purchase Plan.
73
<PAGE> 77
CERTAIN TRANSACTIONS
In June 1995, the Company completed a private placement of its Series B
Preferred Stock, of which ING purchased an aggregate of 100,000 shares of Series
B Preferred Stock, warrants to purchase 428,571 shares of Common Stock at an
exercise price of $0.01 per share and a warrant to purchase 100,000 shares of
Common Stock at an exercise price of $2.50 per share. Huff and certain of its
affiliates purchased an aggregate of 100,975 shares of the Series B Preferred
Stock, warrants to purchase 432,749 shares of Common Stock at an exercise price
of $0.01 per share, a warrant to purchase 100,000 shares of Common Stock at an
exercise price of $1.79 per share and a warrant to purchase 100,000 shares at an
exercise price of $2.50 per share. Apex and certain of its affiliates purchased
an aggregate of 21,000 shares of the Series B Preferred Stock and warrants to
purchase an aggregate of 90,000 shares of Common Stock at an exercise price of
$0.01 per share. The price per unit in the June 1995 private placement was $100.
Pursuant to the Series B Purchase Agreement, in November 1995, ING purchased
50,000 additional shares of the Series B Preferred Stock and exercised a warrant
entitling ING to purchase 214,286 shares of Common Stock at an exercise price of
$0.01 per share. In connection with these private placements, the Company
entered into the registration rights agreement dated June 26, 1995, among the
holders of the Series B Preferred Stock, certain holders of Common Stock and
certain holders of options or warrants convertible into Common Stock (the
"Equity Registration Rights Agreement") wherein the parties were granted
piggyback registration rights with respect to any registration statements (other
than Registration Statements filed on Forms S-4 or S-8) filed by the Company
with the Commission at any time prior to the sixth anniversary of the Equity
Registration Rights Agreement, and certain demand registration rights following
the occurrence of, among other things, a qualifying offering. The Common Stock
Offering was a qualifying offering. Huff and certain of its affiliates purchased
an aggregate of 10,000 Units in the Unit Offering, acquiring thereby 10,000
shares of Preferred Stock and 10,000 Warrants. ING Baring (U.S.) Securities,
Inc., which may be deemed an affiliate of ING, purchased 7,500 Units in the Unit
Offering, acquiring thereby 7,500 shares of Preferred Stock and 7,500 Warrants.
The Company has in place policies and procedures that enable it to comply with
the covenants in the Existing Indentures and in the Indenture regarding
transactions with affiliates.
The initial purchasers in the Debt Offering have informed the Company that
W.R. Huff Asset Management Co., L.L.C. (an affiliate of Huff) on behalf of
investment management accounts for which W.R. Huff acts as investment advisor
and over which it has sole dispositive power, purchased $50 million of the 2007
Notes in the Debt Offering, for which the Company paid W.R. Huff, on behalf of
such accounts, a fee of $750,000 with respect to such purchase.
The Company was party to an employment agreement with Richard A. Kozak,
which was terminated effective February 2, 1997. Each of the parties initially
claimed the termination was the result of a breach of the employment agreement
by the other party. In settlement of their dispute and related litigation
concerning Mr. Kozak's termination, the parties agreed, among other things, that
Mr. Kozak would (i) receive $300,000 in cash, payable by the Company in three
equal installments on April 1, July 1 and October 1, 1997, (ii) forfeit 166,667
of his unvested options, and (iii) execute a 180-day Lock-Up Agreement for all
but 150,000 of the shares underlying his vested options and 80,000 other shares
he holds. Also, Mr. Kozak's rights to have his shares of Common Stock registered
under the Securities Act terminated upon completion of the Common Stock
Offering. The Company has agreed to accelerate the vesting of Mr. Kozak's
remaining 83,333 options which had not vested at the time of his termination.
Mr. Kozak has also agreed to certain non-compete, non-solicitation and
confidentiality provisions expiring on December 31, 1997. Under his employment
agreement, Mr. Kozak had been granted stock options to purchase an aggregate of
1,383,265 shares of the Company's Common Stock at exercise prices ranging from
$0.875 per share to $15.00 per share, of which options to purchase 1,133,265
shares had vested as of his termination. In January 1997, Mr. Kozak exercised
options to purchase 100,000 of these shares.
74
<PAGE> 78
PRINCIPAL STOCKHOLDERS
The following table sets forth as of September 30, 1997, certain
information regarding the beneficial ownership of the Company's Common Stock
outstanding (assuming the exercise of options and warrants exercisable on or
within 60 days of such date) by (i) each person who is known to the Company to
own 5% or more of the Common Stock, (ii) each director of the Company, (iii) the
Chief Executive Officer and each of the Named Officers and (iv) all executive
officers and directors of the Company as a group.
Unless otherwise indicated, the named persons exercise sole voting and
investment power over the shares that are shown as beneficially owned by them.
<TABLE>
<CAPTION>
NUMBER PERCENTAGE
NAME OF BENEFICIAL OWNER(1) OF SHARES OF TOTAL(2)
------------------------------------------------------------- ------------ -----------
<S> <C> <C>
Anthony J. Pompliano(3)...................................... 1,662,499 4.4%
Jack E. Reich................................................ -- --
Riley M. Murphy(4)........................................... 193,752 *
George M. Middlemas(5)....................................... 1,748,147 4.6
Christopher L. Rafferty(6)................................... 8,000 *
Edwin M. Banks(6)............................................ -- --
Peter C. Bentz(6)............................................ -- --
Olivier L. Trouveroy(7)...................................... -- --
Benjamin P. Giess(7)......................................... -- --
Richard A. Kozak(8).......................................... 649,932 1.8
Robert H. Ottman(9).......................................... 175,000 *
George M. Tronsrue, III(10).................................. 300,000 *
The Huff Alternative Income Fund, L.P.(11)................... 15,090,140 38.2
ING Equity Partners, L.P. I(12).............................. 7,946,828 21.8
First Analysis Corporation(13).)............................. 3,156,420 8.4
All executive officers and directors as a group (10
persons)................................................... 2,220,800 5.8
</TABLE>
- ---------------
<TABLE>
<C> <S>
* Less than one percent.
(1) The addresses of all officers and directors listed above are in the care of the Company.
(2) The percentage of total outstanding for each stockholder is calculated by dividing (i) the number of shares of
Common Stock deemed to be beneficially owned by such stockholder as of September 30, 1997 by (ii) the sum of
(A) the number of shares of Common Stock outstanding as of September 30, 1997 plus (B) the number of shares of
Common Stock issuable upon the exercise of options or warrants held by such stockholder which were exercisable
as of September 30, 1997 or will become exercisable within 60 days after September 30, 1997 ("currently
exercisable").
(3) Includes currently exercisable options to purchase 1,662,399 shares.
(4) Includes currently exercisable options to purchase 193,752 shares.
(5) Includes currently exercisable options to purchase 20,000 shares. Also includes 788,905 shares of Common Stock
owned by Apex II and 278,973 shares of Common Stock currently owned by Apex I. Mr. Middlemas is a general
partner of Apex Management Partnership which is the general partner of Apex I and Apex II. Mr. Middlemas
disclaims beneficial ownership of the shares owned by Apex I and Apex II, except to the extent of his ownership
in the general partner of Apex I and in the general partner of Apex II.
(6) Messrs. Banks and Bentz are employees of W.R. Huff Asset Management Co., L.L.C., an affiliate of Huff. Mr.
Rafferty is an employee of WRH Partners, L.L.C., the general partner of Huff. William R. Huff is the President
of the General Manager of WRH Partners, L.L.C. Messrs. Huff, Rafferty, Bentz and Banks disclaim beneficial
ownership of all shares held by Huff.
(7) Mr. Trouveroy is a Managing Partner of ING and Mr. Giess is a Partner of ING. Messrs. Trouveroy and Giess
disclaim beneficial ownership of all shares held by ING.
(8) Includes currently exercisable options to purchase 1,041,598 shares. Mr. Kozak's employment was terminated
effective February 2, 1997. See "Certain Transactions."
(9) Includes currently exercisable options to purchase 175,000 shares. Mr. Ottman's employment with the Company was
terminated in February 1997.
(10) Includes currently exercisable options to purchase 300,000 shares.
(11) Includes currently exercisable warrants to purchase 200,000 shares. The address for Huff is 1776 On the Green,
67 Park Place, Morristown, NJ 07960.
(12) Includes currently exercisable warrants to purchase 100,000 shares. The address for ING is 135 East 57th
Street, 16th Floor, New York, NY 10022.
(13) Includes 1,034,465 shares of Common Stock currently owned by Apex II. Includes 103,800 and 175,173 shares of
Common Stock owned by Apex I. Includes 359,214 and 732,213 shares of Common Stock owned by The Productivity
Fund II, L.P. ("Productivity"). Includes 714,293 shares of Common Stock owned by Environmental Private Equity
Fund II, L.P. ("EPEF"). FAC is an ultimate general partner of Apex I, Apex II, Productivity and EPEF and may be
deemed to be the beneficial owner of the shares owned by them. FAC disclaims beneficial ownership of these
shares. F. Oliver Niklan, Jr. is the president of FAC and therefor may be deemed to be the beneficial owner of
the shares that may be deemed beneficially owned by FAC. Mr. Niklan disclaims beneficial ownership of these
shares. The address for First Analysis Corporation is 233 South Wacker Drive, Suite 9600, Chicago, IL 60093.
</TABLE>
75
<PAGE> 79
DESCRIPTION OF CERTAIN INDEBTEDNESS
AT&T CREDIT FACILITY
In October 1994, the Company entered into the AT&T Credit Facility pursuant
to which AT&T Credit Corporation has agreed to provide up to $31.2 million in
financing for the development and construction of fiber optic networks by the
Company's subsidiaries. Pursuant to the AT&T Credit Facility, during fiscal 1995
the Company's subsidiaries in Louisville, Fort Worth, Greenville and Columbia
entered into loan agreements with AT&T Credit Corporation providing for up to
$19.8 million in loans secured by the assets of such subsidiaries, and in
September 1995, the Company's subsidiary in El Paso entered into a separate loan
agreement with AT&T Credit Corporation pursuant to the AT&T Credit Facility
providing for up to an aggregate of approximately $5.5 million in loans secured
by its assets. During 1996, the existing loan agreements were amended to
increase the aggregate credit available under such agreements to the $31.2
million credit availability under the AT&T Credit Facility. As of September 30,
1997, outstanding borrowings under the AT&T Credit Facility totaled
approximately $31.2 million. Interest rates applicable to the loans range from
11.93% to 14.47%.
The loans under the AT&T Credit Facility are secured by all of the assets
of the respective borrowing subsidiary, including its installed fiber optic
system and other equipment. The principal of borrowed amounts is payable in 28
consecutive quarterly installments, beginning with the ninth quarter after the
date of the loan. The principal of borrowed amounts may be prepaid in certain
circumstances, and must be prepaid along with a premium in other circumstances.
Interest is due quarterly. At the borrowing subsidiary's option, the interest
rate may be fixed or variable. The borrowing subsidiary has a one-time option to
convert all variable rate loans to fixed rate loans. Upon certain events of
default, additional interest ranging from 2% to 4% will become payable. Interest
may generally be deferred so long as it would not cause the outstanding
principal balance to exceed the commitment amounts for Capital Loans and for
Equipment Loans (as defined in the loan documents). In addition, the AT&T Credit
Facility includes covenants, some of which impose certain restrictions on the
Company and its subsidiaries including restrictions on the declaration or
payment of dividends, the conduct of certain activities, certain capital
expenditures, the creation of additional liens or indebtedness, the disposition
of assets, transactions with affiliates, and extraordinary corporate
transactions. The AT&T Credit Facility imposes restrictions on the ability of
those subsidiaries of ACSI that incur indebtedness thereunder to transfer funds
to ACSI in the form of dividends or other distributions. The AT&T Credit
Facility also imposes restrictions on the ability of such subsidiaries to raise
capital by incurring additional indebtedness. These factors could limit ACSI's
ability to meet its obligations with respect to the Notes.
Pursuant to the AT&T Credit Facility, the Company had contributed
approximately $26.4 million in capital to its subsidiaries through September 30,
1997, and AT&T Credit Corporation received 7.25% of the outstanding capital
stock of each of the Company's operating subsidiaries for which it provided
financing. The Company was required to pledge its interest in the respective
subsidiaries to AT&T Credit Corporation as a condition to each loan. Under
certain circumstances, this pledge agreement also restricts the Company's
ability to pay dividends on its capital stock.
The Company has entered into negotiations with AT&T Credit Corporation to
roll-up the five existing loan agreements comprising the AT&T Credit Facility
into the New AT&T Credit Facility (to be secured by the existing assets of the
Company including the stock, but not the assets, of certain of the Company's
subsidiaries), which the Company expects will otherwise be on terms
substantially similar to those of the existing AT&T Credit Facility. The maximum
aggregate amount of credit available under the proposed New AT&T Facility will
not exceed $35 million, which is the maximum amount of credit the Company is
allowed to borrow in its Secured Credit Facility (as defined in the Existing
Indentures and in the Indenture with respect to the Notes). AT&T Credit
Corporation has issued to each of the Company's Subsidiaries that are parties to
the AT&T Credit Facility a waiver through December 31, 1997, of compliance by
such subsidiaries with certain covenants contained therein. Such covenants are
not expected to be included in the New AT&T Facility. The Company has agreed
with the initial purchaser in the Junior Preferred Stock Offering that, after
the date of expiration of such waiver (as the same may be extended), upon the
receipt of a demand for
76
<PAGE> 80
payment under the AT&T Credit Facility, the Company will repay the AT&T Credit
Facility in full and will maintain cash and cash equivalents in an aggregate
amount sufficient for such purpose, unless, on or prior to such demand for
payment, the New AT&T Facility shall have become effective and the Company shall
be in compliance with all covenants contained therein.
THE EXISTING NOTES
The terms of the Existing Notes include those stated in the applicable
Existing Indenture and those made a part of the applicable Existing Indenture by
reference to the Trust Indenture Act of 1939, as in effect on the date of that
Existing Indenture. The terms of the Existing Indentures are substantially
similar. The following summaries of certain provisions of the Existing
Indentures do not purport to be complete and are subject to, and are qualified
in their entirety by reference to, all of the provisions of the applicable
Existing Indenture.
The Existing Notes are general unsubordinated and unsecured senior
obligations of ACSI and rank pari passu with all other unsubordinated and
unsecured indebtedness of ACSI. As a holding company that conducts virtually all
of its business through subsidiaries, ACSI currently has no source of operating
cash flow other than from dividends and distributions from its subsidiaries.
ACSI's subsidiaries have no obligation to pay amounts due on the Existing Notes
and do not guarantee the Existing Notes. Therefore, the Existing Notes will be
effectively subordinated to all liabilities of ACSI's subsidiaries, including
trade payables. Any rights of ACSI and its creditors, including the holders of
the Existing Notes, to participate in the assets of any of ACSI's subsidiaries
upon any liquidation or reorganization of any such subsidiary are subject to the
prior claims of that subsidiary's creditors (including trade creditors).
Upon a Change of Control (as defined in the Existing Indentures), each
holder of the Existing Notes will have the right to require ACSI to repurchase
all or any part of such holder's Existing Notes at 101% of the respective
Accreted Value (as defined in the Existing Indentures) or principal amount, as
the case may be, thereof, or, in the case of any such repurchase on or after
November 1, 2000 in the case of the 2005 Notes, on or after April 1, 2001 in the
case of the 2006 Notes and on or after January 15, 2002 in the case of the 2007
Notes, 101% of the respective principal amount thereof, plus accrued and unpaid
interest, if any, thereon, to the date of repurchase. A Change of Control would
occur if, among other things, any person or group, other than Mr. Pompliano, Mr.
Kozak, certain affiliates of First Analysis Corporation, ING or Huff, acquires
more than 35% of the total voting power of the Company.
Each of the Existing Indentures contains certain covenants which, among
other things, restrict the ability of ACSI and certain of its subsidiaries to
incur additional indebtedness, pay dividends or make distributions in respect of
ACSI's capital stock or make certain other restricted payments, create
restrictions on the ability of certain subsidiaries to make distributions on
their 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.
On June 11, 1997, the Company notified the trustee under each of the
indentures relating to the 2005 Notes and the 2006 Notes that, as of June 10,
1997, it had approximately $13.0 million in the aggregate of ordinary course
trade accounts payable that were more than 60 days overdue. As of June 30, 1997,
the Company had approximately $17.4 million in the aggregate of ordinary course
trade accounts payable that were more than 60 days overdue. These overdue
amounts constituted Indebtedness of the Company, as that term is defined in each
of the indentures relating to the 2005 Notes and the 2006 Notes. The incurrence
by the Company of such Indebtedness is not currently permitted under each such
indenture and, therefore, constituted an Event of Default (as defined in the
indentures relating to the 2005 Notes and 2006 Notes) under each such indenture.
The Company used a portion of the proceeds of the Unit Offering to pay in full
all ordinary course trade accounts payable that were more than 60 days overdue
to cure such Event of Default.
The 2005 Notes
The 2005 Notes mature on November 1, 2005. The yield on the 2005 Notes
equals 13% per annum, computed on a semi-annual bond equivalent basis and
calculated from November 9, 1995. The 2005 Notes will accrete at a rate of 13%,
compounded semi-annually, to an aggregate principal amount of $190,000,000 by
November 1, 2000. Cash interest will not accrue on the 2005 Notes prior to
November 1, 2000. Thereafter,
77
<PAGE> 81
interest on the 2005 Notes will accrue at the rate of 13% per annum and will be
payable in cash semi-annually on May 1 and November 1, commencing May 1, 2001.
The 2005 Notes will be redeemable, at the option of ACSI at any time, in whole
or in part, on or after November 1, 2000, at 110%, 106 2/3% and 103 1/3% of the
principal amount for the twelve months following November 1, 2000, 2001 and
2002, respectively, plus accrued and unpaid interest, if any, to the date of
redemption.
The 2006 Notes
The 2006 Notes mature on April 1, 2006. The yield on the 2006 Notes equals
12 3/4% per annum, computed on a semi-annual bond equivalent basis and
calculated from March 21, 1996. The 2006 Notes will accrete at a rate of
12 3/4%, compounded semi-annually, to an aggregate principal amount of
$120,000,000 by April 1, 2001. Cash interest will not accrue on the 2006 Notes
prior to April 1, 2001. Thereafter, interest on the 2006 Notes will accrue at
the rate of 12 3/4% per annum and will be payable in cash semi-annually on April
1 and October 1, commencing October 1, 2001. The 2006 Notes will be redeemable,
at the option of ACSI at any time, in whole or in part, on or after April 1,
2001 at 106 3/8%, 104 1/4% and 102 1/8% of the principal amount for the twelve
months following April 1, 2001, 2002 and 2003, respectively, plus accrued and
unpaid interest, if any, thereon, to the date of repurchase.
The 2007 Notes
The 2007 Notes mature on July 15, 2007. The 2007 Notes bear interest at a
rate of 13 3/4% per annum from July 23, 1997 payable semi-annually in cash on
January 15, and July 15, commencing January 15, 1998. The Company placed
approximately $70.0 million of the proceeds from the sale of the 2007 Notes,
representing funds sufficient to pay the first five semi-annual interest
payments on the 2007 Notes, into an escrow account to held by the escrow agent
for the benefit of the holders of the 2007 Notes. The 2007 Notes are redeemable,
at the option of the ACSI, in whole or in part, on or after July 15, 2002 at
106.875%, 105.156%, 103.438%, 101.719% and 100% of their principal amount for
the twelve months following July 15, 2002, 2003, 2004, 2005 and 2006,
respectively, plus accrued and unpaid interest, if any, thereon, to the date of
repurchase. In addition, at any time on or prior to July 15, 2000, the Company
may, at its option, redeem up to 35% of the aggregate principal amount at
maturity of the 2007 Notes with the net cash proceeds of one or more Equity
Offerings (as defined in the 2007 Indenture), at a redemption price equal to
113.75% of the principal amount thereof; provided, however, that after giving
effect to any such redemption, at least $143.0 million aggregate principal
amount of the 2007 Notes remains outstanding.
78
<PAGE> 82
DESCRIPTION OF THE PREFERRED STOCK
The following summary of certain provisions of both the Old Preferred Stock
and the New Preferred Stock does not purport to be complete and is subject to,
and is qualified in its entirety by reference to, all the provisions of the
Certificate of Designation relating thereto, copies of which may be obtained
from the Company upon request. The definitions of certain specialized terms used
in the following summary are defined in the Certificate of Designation. Certain
capitalized terms used in this summary are defined under "-- Certain
Definitions" below.
GENERAL
At the consummation of the Exchange Offer, the Company will issue up to
150,000 shares of New Preferred Stock which has been designated as "12 3/4%
Junior Redeemable Preferred Stock due 2009." Such shares, when issued and when
holders of Old Preferred Stock have validly tendered their shares for such New
Preferred Stock will be fully paid and nonassessable and the holders thereof
will not have any subscription or preemptive rights in connection therewith. The
Company has also reserved up to 550,000 additional shares of the Preferred Stock
for issuance to pay dividends on the Preferred Stock in additional shares of
Preferred Stock in accordance with the provisions of the Certificate of
Designation for the Preferred Stock (the "Certificate of Designation"), which
will govern the New Preferred Stock and which governs the Old Preferred Stock.
The Preferred Stock, whenever issued, will have a Liquidation Preference of
$1,000 per share.
RANKING
All claims of the holders of the New Preferred Stock, including without
limitation, claims with respect to dividend payments, redemption payments,
mandatory repurchase payments or rights upon liquidation, winding-up or
dissolution, shall rank junior to the claims of the holders of any debt of the
Company and all other creditors of the Company.
The New Preferred Stock will, with respect to dividend rights and rights on
liquidation, winding-up and dissolution, rank (i) senior to all classes of
common stock and to each other class of capital stock or series of
preferred stock established hereafter by the Board of Directors the terms of
which do not expressly provide that it ranks senior to, or on a parity with, the
New Preferred Stock as to dividend rights and rights on liquidation, winding-up
and dissolution of the Company (collectively referred to, together with all
classes of common stock of the Company, as "Junior Stock"); (ii) subject to
certain conditions, on a parity with each other class of capital stock or series
of preferred stock established hereafter by the Board of Directors, the terms of
which expressly provide that such class or series will rank on a parity with the
New Preferred Stock as to dividend rights and rights on liquidation, winding-up
and dissolution (collectively referred to as "Parity Stock"); and (iii) junior
to the 14 3/4% Preferred Stock and any future Senior Stock (as defined).
While any shares of Preferred Stock are outstanding, the Company may not
authorize, create or increase the authorized amount of any class or series of
stock that ranks senior to the Preferred Stock with respect to the payment of
dividends or amounts upon liquidation, dissolution or winding up (other than any
shares of 14 3/4% Preferred Stock issued as dividends thereon, including as
Additional Dividends (as defined in the terms of the 14 3/4% Certificate))
without the consent of the holders of at least 66 2/3% of the outstanding shares
of Preferred Stock (any such class or series of stock, together with the 14 3/4%
Preferred Stock, being referred to herein as "Senior Stock"). However, without
the consent of any holder of Preferred Stock, the Company may create additional
classes of stock, increase the authorized number of shares of preferred stock or
issue series of a stock that ranks junior to or on parity with the Preferred
Stock with respect, in each case, to the payment of dividends and amounts upon
liquidation, dissolution and winding up. See "-- Voting Rights."
The holders of the 14 3/4% Preferred Stock, subject to the terms of the
Certificate of Designation for the 14 3/4% Preferred Stock (the "14 3/4%
Certificate"), are entitled to receive a liquidation preference of $1,000 per
share, plus an amount equal to all accrued and unpaid dividends, and the Company
may voluntarily redeem the 14 3/4% Preferred Stock at any time on or after
January 1, 2003 at certain redemption prices, plus an amount equal to all
accrued and unpaid dividends.
79
<PAGE> 83
DIVIDENDS
Holders of the outstanding shares of New Preferred Stock will be entitled
to receive, when, as and if declared by the Board of Directors of the Company,
out of funds legally available therefor, dividends on the New Preferred Stock at
a rate per annum equal to 12 3/4% of the Liquidation Preference thereof, payable
quarterly (each such quarterly period being herein called a "Dividend Period").
Dividends will also accrue and cumulate on any accrued and unpaid dividends. All
dividends will be cumulative, whether or not earned or declared, on a daily
basis from the date of issuance and will be payable quarterly (each such
quarterly period being herein called a "Dividend Period") in arrears on January
15, April 15, July 15 and October 15 of each year (each a "Dividend Payment
Date"), commencing on January 15, 1998, to holders of record on the January 1,
April 1, July 1 and October 1 immediately preceding the relevant Dividend
Payment Date.
Dividends on the New Preferred Stock may be paid, at the Company's option,
on any Dividend Payment Date, either in cash or by the issuance of additional
shares of New Preferred Stock (and, at the Company's option, payment of cash in
lieu of fractional shares) having an aggregate Liquidation Preference equal to
the amount of such dividends, and the issuance of such additional shares of New
Preferred Stock will constitute "payment" of the related dividend for all
purposes of the Certificate of Designation; provided, however, that after
October 15, 2002, to the extent and for so long as the Company is not precluded
from paying cash dividends on the New Preferred Stock by the terms of any
agreement or instrument governing any of its then outstanding indebtedness, the
Company shall pay dividends in cash.
In the event that dividends on the Preferred Stock are in arrears and
unpaid (either in cash or by the issuance of additional shares of Preferred
Stock) for six or more quarterly dividend periods (whether or not consecutive),
whether before or after October 15, 2002, or the Company shall fail to pay
dividends in cash for six or more quarterly dividend periods (whether or not
consecutive) beginning October 15, 2002, holders of the Preferred Stock will be
entitled to certain voting rights. See "-- Voting Rights." The Certificate of
Designation provides that the Company will take all actions required or
permitted under the Delaware General Corporation Law (the "DGCL") to permit the
payment of dividends on the Preferred Stock, including, without limitation,
through the revaluation of its assets in accordance with the DGCL, to make or
keep funds legally available for the payment of dividends.
Dividends on account of arrears for any past Dividend Period and dividends
in connection with any optional redemption may be declared and paid at any time,
without reference to any regular Dividend Payment Date, to holders of record of
Preferred Stock on such date, not more than forty-five (45) days prior to the
payment thereof, as may be fixed by the Board of Directors of the Company.
No dividend whatsoever shall be declared or paid upon, or any sum set apart
for the payment of dividends upon, any outstanding share of Preferred Stock with
respect to any dividend period unless all dividends for all preceding dividend
periods have been declared and paid, or declared and a sufficient sum set apart
for the payment of such dividend, upon all outstanding shares of Senior Stock.
No full dividends may be declared or paid or funds set apart for the payment of
dividends on any Parity Stock for any period unless full cumulative dividends
shall have been or contemporaneously are declared and paid (or are deemed
declared and paid) in full or declared and, if payable in cash, a sum in cash
sufficient for such payment set apart for such payment on the Preferred Stock.
If full dividends are not so paid, the Preferred Stock will share dividends pro
rata with the Parity Stock. So long as any Preferred Stock is outstanding and
unless and until full cumulative dividends have been paid (or are deemed paid)
in full on the Preferred Stock: (i) no dividend (other than a dividend payable
solely in shares of additional Junior Stock) shall be declared or paid upon, or
any sum set apart for the payment of dividends upon, any shares of Junior Stock;
(ii) no other distribution shall be declared or made upon, or any sum set apart
for the payment of any distribution upon, any shares of Junior Stock, other than
a distribution consisting solely of Junior Stock; (iii) no shares of Parity
Stock or Junior Stock or warrants, rights, calls or options to purchase such
Parity Stock or Junior Stock shall be purchased, redeemed or otherwise acquired
or retired for value (excluding an exchange for shares of other Junior Stock) by
the Company or any of its Subsidiaries, other than certain repurchase
obligations with respect to such warrants, rights, calls or options in existence
on the Issue Date of the Preferred Stock; and (iv) no monies shall be paid into
or set apart or made available for a sinking or other like fund for the
purchase, redemption or other
80
<PAGE> 84
acquisition or retirement for value of any shares of Parity Stock or Junior
Stock by the Company or any of its Subsidiaries. Holders of the Preferred Stock
will not be entitled to any dividends, whether payable in cash, property or
stock, in excess of the full cumulative dividends as herein described.
The indentures relating to the Existing Notes and the AT&T Credit Facility
contain, and future credit agreements or other agreements relating to
indebtedness of the Company or its subsidiaries may contain, restrictions on the
ability of the Company to pay dividends on the Preferred Stock (other than
solely in additional shares of Preferred Stock). See "Risk Factors -- Holding
Company Structure; Source of Payments in Respect of Preferred Stock."
CHANGE OF CONTROL
Upon the occurrence of a Change of Control (as defined below), the Company
will be required to make an offer (the "Change of Control Offer") to each holder
of shares of Preferred Stock to repurchase all or any part (but not, in the case
of any holder requiring the Company to purchase less than all of the shares of
Preferred Stock held by such holder, any fractional shares) of such holder's
Preferred Stock at a purchase price in cash equal to 101% of the aggregate
Liquidation Preference thereof plus, without duplication, accumulated and unpaid
dividends and Additional Dividends, if any, thereon to the date of purchase (the
"Change of Control Payment").
The Change of Control Offer must be commenced within 30 days following a
Change of Control, must remain open for at least 30 and not more than 40 days
(unless otherwise required by applicable law) and must comply with the
requirements of Rule 14e-1 under the Exchange Act and any other securities laws
and regulations thereunder to the extent such laws and regulations are
applicable in connection with the repurchase of the Preferred Stock as a result
of a Change of Control.
The Change of Control provisions described above will be applicable whether
or not any other provisions of the Certificate of Designation are applicable.
Except as described above with respect to a Change of Control, the Certificate
of Designation does not contain provisions that permit the holders of the
Preferred Stock to require that the Company repurchase or redeem the Preferred
Stock in the event of a takeover, recapitalization or similar transaction.
The Company will not be required to make a Change of Control Offer to the
holders of Preferred Stock upon a Change of Control if either (a) a third party
makes the Change of Control Offer described above in the manner, at the times
and otherwise in compliance with the requirements set forth in the Certificate
of Designation, and purchases all shares of Preferred Stock validly tendered and
not withdrawn under such Change of Control Offer or (b) the date at which such
Change of Control Offer would otherwise be required to be made is prior to the
later of (i) the Stated Maturity (as defined in the indentures relating to the
Existing Notes) of the last to mature of the Existing Notes and (ii) the
retirement of all of the outstanding 14 3/4% Preferred Stock.
The Company does not currently have adequate financial resources to effect
a repurchase of the Preferred Stock upon the occurrence of a Change of Control
and there can be no assurance that the Company will have such resources in the
future.
If the date at which a Change of Control Offer otherwise would be required
to be made is prior to the later of (i) the Stated Maturity (as defined in the
indentures relating to the Existing Notes) of the last to mature of the Existing
Notes and (ii) the retirement of all of the outstanding 14 3/4% Preferred Stock,
then, in lieu of any such Change of Control Offer, holders of two-thirds of the
Preferred Stock will be entitled to designate an Independent Financial Advisor
(as defined below) to determine, within 20 days of such designation, in the
opinion of such firm, the appropriate dividend rate that the Preferred Stock
should bear so that, after such reset, the Preferred Stock would have a market
value of 101% of the Liquidation Preference. If, for any reason and within 5
days of the designation of an Independent Financial Advisor by the holders, such
Independent Financial Advisor is unacceptable to the Company, the Company shall
designate a second Independent Financial Advisor to determine, within 15 days of
such designation, in its opinion, such an appropriate reset dividend rate for
the Preferred Stock. In the event that the two Independent Financial
81
<PAGE> 85
Advisors cannot agree, within 25 days of the designation of an Independent
Financial Advisor by the holders of two-thirds of the Preferred Stock, on the
appropriate reset dividend rate, the two Independent Financial Advisors shall,
within 10 days of such 25th day, designate a third Independent Financial
Advisor, which, within 15 days of designation, will determine, in its opinion,
such an appropriate reset rate which is between the two rates selected by the
first two Independent Financial Advisors; provided, however, that the reset rate
shall in no event be less than 12 3/4% per annum or greater than 15 1/4% per
annum. The reasonable fees and expenses, including reasonable fees and expenses
of legal counsel, if any, and customary indemnification, of each of the three
above-referenced Independent Financial Advisors shall be borne by the Company.
Upon the determination of the reset rate, the Preferred Stock shall accrue and
cumulate dividends at the reset rate as of the date of occurrence of the Change
of Control.
A "Change of Control" shall be deemed to occur if (i) the sale, conveyance,
transfer or lease of all or substantially all of the assets of the Company to
any "person" or "group" (within the meaning of Sections 13(d)(3) and 14(d)(2) of
the Exchange Act or any successor provisions 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 (as defined below) or any subsidiary of the Company)
shall have occurred; (ii) any "person" or "group" as aforesaid, other than any
Permitted Holder, 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 and/or warrants or options 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 (together with any new directors whose
election or appointment by such board or whose nomination for election by the
shareholders 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 then in office; provided, however, that no Change of Control shall
occur if the "person" or "group" in the case of clause (i) above is a Strategic
Investor or the "beneficial owner" of voting power in excess of 50% of the
voting power of the Company in the case of clause (ii) above is a Strategic
Investor and such Strategic Investor beneficially owns in excess of 50% of the
voting power of the Company.
"Independent Financial Advisor" means a United States investment banking
firm of national standing in the United States which does not, and whose
directors, officers and employees or affiliates do not, have a direct or
indirect financial interest in the Company.
"Permitted Holders" means The Huff Alternative Income Fund, L.P., ING
Equity Partners, L.P.I., Apex Investment Fund I, L.P., Apex Investment Fund II,
L.P., The Productivity Fund II, L.P. and Anthony J. Pompliano and the respective
affiliates (other than the Company and its subsidiaries) of each of the
foregoing.
"Strategic Investor" means a publicly traded company (i) whose principal
business is operating a public utility company and/or a cable and/or telephone
and/or telecommunications system in the United States or which, after the
consummation of the relevant transaction, is or will be delivering its own
services over the networks or systems of the Company and any business reasonably
related to the foregoing, or creating, developing or marketing communications
related network equipment, software or other devices for use in transmitting
voice, video or data, (ii) which has, or the parent of which has, a Total Equity
Market Capitalization in excess of $1.0 billion and (iii) whose senior unsecured
debt securities are rated (or carry an implied rating) by Moody's Investors
Service, Inc. (or any successor to the rating agency business thereof) or
Standard & Poor's Corporation (or any successor to the rating agency business
thereof) as Baa- or BBB-, respectively, or better, on a pro forma basis assuming
the consummation of any transaction with the Company, provided that if such
securities are rated by both such rating agencies, the lowest rating of the two
shall govern for purposes of this definition.
"Total Equity Market Capitalization" of any person means, as of any day of
determination, the sum of (1) the product of (A) the aggregate number of
outstanding primary shares of common stock of such person on such day (which
shall not include any options or warrants on, or securities convertible or
exchangeable into
82
<PAGE> 86
or exercisable for, shares of common stock of such person) multiplied by (B) the
average closing price of such common stock over the 20 consecutive trading days
immediately preceding such day, plus (2) the liquidation value of any
outstanding shares of preferred stock of such person on such day.
OPTIONAL REDEMPTION
The Preferred Stock may be redeemed, in whole or in part, at the option of
the Company, at any time after October 15, 2003, at the redemption prices
(expressed in percentages of an amount equal to the sum of (i) the Liquidation
Preference thereof and (ii) the liquidation preference of any accrued and unpaid
dividends to the date of redemption payable in Preferred Stock) set forth below,
plus, without duplication, an amount in cash equal to all accrued and unpaid
cash dividends to the redemption date (including an amount in cash equal to a
prorated dividend for the period from the Dividend Payment Date immediately
prior to the redemption date to the redemption date), if redeemed during the
12-month period beginning on October 15 of each of the years set forth below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
-------------------------------------------------------- ----------
<S> <C>
2003.................................................... 106.375%
2004.................................................... 104.781
2005.................................................... 103.188
2006.................................................... 101.594
2007 and thereafter..................................... 100.000%
</TABLE>
Notwithstanding the foregoing, the Company will have the option, on or
prior to October 15, 2000, to redeem up to 35% of the outstanding Preferred
Stock at a price of 112.75% (expressed as a percentage of an amount equal to the
sum of (i) the Liquidation Preference thereof and (ii) the liquidation
preference of any accrued and unpaid dividends to the date of redemption payable
in Preferred Stock), plus, without duplication, accrued and unpaid cash
dividends to the date of redemption, with the proceeds of (i) one or more public
common equity offerings generating cash proceeds to the Company of at least $25
million or (ii) the sale of capital stock generating cash proceeds to the
Company of at least $25 million to a company which has, or whose parent has, a
Total Equity Market Capitalization of at least $1.0 billion on a consolidated
basis (an "Eligible Equity Investor"); provided that at least 65% of the
Preferred Stock initially issued remains outstanding after any such redemption.
In the event of a redemption of only a portion of the then outstanding
shares of the Preferred Stock, the Company shall effect such redemption on a pro
rata basis, except that the Company may redeem such shares held by holders of
fewer than ten shares (or shares held by holders who would hold less than ten
shares as a result of such redemption), as may be determined by the Company.
The AT&T Credit Facility, the indentures relating to the Existing Notes and
the 14 3/4% Certificate restrict the ability of the Company to redeem the
Preferred Stock. See "Description of Certain Indebtedness" and "Description of
Capital Stock."
MANDATORY REDEMPTION
The Company will be required to redeem (subject to the legal availability
of funds therefor) all outstanding shares of the Preferred Stock on October 15,
2009, at a price equal to 100% of the Liquidation Preference thereof, plus,
without duplication, all accrued and unpaid dividends to the date of redemption.
Future agreements of the Company may restrict or prohibit the Company from
redeeming the Preferred Stock.
PROCEDURE FOR REDEMPTION
On and after any redemption date, unless the Company defaults in the
payment of the applicable redemption price, dividends will cease to accumulate
on shares of Preferred Stock called for redemption and all rights of holders of
such shares will terminate except for the right to receive the redemption price,
without interest; provided, however, that if a notice of redemption shall have
been given as provided in the succeeding
83
<PAGE> 87
sentence and the funds necessary for redemption (including an amount in respect
of all dividends that will accrue to the redemption date) shall have been
segregated and irrevocably set apart by the Company, in trust for the benefit of
the holders of the shares called for redemption, then dividends shall cease to
accumulate on the redemption date on the shares to be redeemed and, at the close
of business on the day or when such funds are segregated and set apart, the
holders of the shares to be redeemed shall cease to be stockholders of the
Company and shall be entitled only to receive the redemption price for such
shares. The Company will send a written notice of redemption by first-class mail
to each holder of record of shares of Preferred Stock, not fewer than 30 days
nor more than 60 days prior to the date fixed for such redemption at its
registered address. Shares of Preferred Stock issued and reacquired will, upon
compliance with the applicable requirements of Delaware law, have the status of
authorized but unissued shares of preferred stock of the Company undesignated as
to series and may, with any and all other authorized but unissued shares of
preferred stock of the Company, be designated or redesignated and issued or
reissued, as the case may be, as part of any series of preferred stock of the
Company, except that any issuance or reissuance of shares of Preferred Stock
must be in compliance with the Certificate of Designation.
LIQUIDATION RIGHTS
Upon any voluntary or involuntary liquidation, dissolution or winding-up of
the Company, holders of the Preferred Stock will be entitled to be paid, out of
the assets of the Company available for distribution to stockholders, after
payment to the holders of any then outstanding Senior Stock (including, without
limitation, the 14 3/4% Preferred Stock), the full amount of the liquidation
preference and accrued and unpaid dividends to which they are entitled, the
Liquidation Preference per share of Preferred Stock, plus, without duplication,
an amount in cash equal to all accrued and unpaid dividends thereon to the date
fixed for liquidation, dissolution or winding-up (including an amount equal to a
prorated dividend for the period from the last Dividend Payment Date to the date
fixed for liquidation, dissolution or winding-up and including an amount equal
to the redemption premium that would have been payable had the Preferred Stock
been the subject of an optional redemption on such date), before any
distribution is made on any Junior Stock, including, without limitation, Common
Stock of the Company. If, upon any voluntary or involuntary liquidation,
dissolution or winding-up of the Company, the amounts payable with respect to
the Preferred Stock and all other Parity Stock are not paid in full, the holders
of the Preferred Stock and the Parity Stock will share equally and ratably in
any distribution of assets of the Company in proportion to the full liquidation
preference to which each is entitled. After payment of the full amount of the
Liquidation Preference and accrued and unpaid dividends to which they are
entitled, the holders of Preferred Stock will not be entitled to any further
participation in any distribution of assets of the Company. However, neither the
sale, conveyance, exchange or transfer (for cash, shares of stock, securities or
other consideration) of all or substantially all of the property or assets of
the Company, nor the consolidation or merger of the Company with one or more
entities, shall be deemed to be a liquidation, dissolution or winding-up of the
Company.
VOTING RIGHTS
The holders of Preferred Stock, except as otherwise required under Delaware
law or as set forth below, shall not be entitled or permitted to vote on any
matter required or permitted to be voted upon by the stockholders of the
Company.
The Certificate of Designation provides that if (i) the Company fails to
pay cash dividends on the Preferred Stock for six or more Dividend Periods
(whether or not consecutive) beginning October 15, 2002, or (ii) the Company
fails to pay dividends, either in cash or by the issuance of additional shares
of Preferred Stock, for six or more Dividend Periods (whether or not
consecutive), whether before or after October 15, 2002, or (iii) the Company
fails to comply with the Change of Control covenant contained in the Certificate
of Designation, or (iv) the Company fails to comply with any other covenant
contained in the Certificate of Designation and such failure continues for 30
consecutive days after receipt of written notice of such failure from the
holders of at least 25% of the shares of Preferred Stock then outstanding, or
(v) there occurs a default under any mortgage, indenture or instrument under
which there may be issued, or by which there may be secured or evidenced, any
Indebtedness for money borrowed by the Company or any of its Subsidiaries (or
84
<PAGE> 88
the payment of which is guaranteed by the Company or any of its Subsidiaries)
whether such Indebtedness or Guarantee now exists, or is created after the Issue
Date, which default (x) is caused by a failure to pay principal of or premium,
if any, or interest on such Indebtedness prior to the expiration of the grace
period provided in such Indebtedness on the date of such default (a "Payment
Default") or (y) results in the acceleration of such Indebtedness prior to its
express maturity and, in each case, the principal amount of any such
Indebtedness, together with the principal amount of any other such Indebtedness
under which there has been a Payment Default or the maturity of which has been
so accelerated, aggregates $10.0 million or more, at any time, in each case,
after a 60-day period during which such Payment Default shall not have been
cured or such acceleration rescinded or (vi) the Company fails to redeem all of
the outstanding Preferred Stock on October 15, 2009, then the holders of a
majority of the then outstanding shares of Preferred Stock, voting as a class,
shall be entitled to elect the lesser of (a) such number of directors as will
constitute 25% of the number of members of the Company's Board of Directors and
(b) two directors to the Company's Board of Directors, and the Company shall
take such action as may be required to cause the total number of directors of
the Company to be increased by such number. Such voting rights will continue
until such time as, in the case of a dividend default, all dividends in arrears
on the Preferred Stock are paid in full, in the case of a failure to comply with
a covenant set forth in the Certificate of Designation (including the Change of
Control covenant), such failure is remedied or waived by the holders of a
majority of the then outstanding shares of Preferred Stock, and, in all other
cases, any failure or default giving rise to such voting rights is remedied or
waived by the holders of at least two-thirds of the shares of Preferred Stock
then outstanding, at which time the term of any directors elected pursuant to
the provisions of this paragraph shall terminate. The foregoing voting rights
provided for in the Certificate of Designation will be the holder's exclusive
remedy at law or in equity.
The Certificate of Designation also provides that the Company will not
authorize any series of preferred stock that ranks senior to the Preferred
Stock, without the affirmative vote or consent of holders of at least two-thirds
of the shares of Preferred Stock then outstanding, voting or consenting, as the
case may be, as one class. In addition, the Certificate of Designation provides
that without the affirmative vote or consent of the holders of at least
two-thirds of the then outstanding shares of Preferred Stock, voting or
consenting, as the case may be, as one class, the Company may not amend the
terms of the Preferred Stock (other than the covenants described herein under
"Certain Covenants," which may be amended with the affirmative vote or consent
of the holders of a majority of the then outstanding shares of Preferred Stock,
voting or consenting, as the case may be, as one class; provided, however, that,
during the pending of any Change of Control Offer, the consent of every holder
of Preferred Stock shall be necessary to modify any Change of Control Offer
required under the covenant entitled "-- Change of Control"). The Certificate of
Designation also provides that, except as set forth above, (a) the creation,
authorization or issuance of any shares of Junior Stock, Parity Stock or Senior
Stock or (b) the increase or decrease in the amount of authorized Capital Stock
of any class, including any preferred stock, shall not require the consent of
the holders of Preferred Stock and shall not be deemed to affect adversely the
rights, preferences, privileges or voting rights of shares of Preferred Stock.
CERTAIN COVENANTS
The sole remedy to holders of Preferred Stock in the event of the Company's
failure to comply with any of the covenants described below and the continuation
of such failure to for 30 consecutive days after receipt of written notice
thereof from the holders of 25% of the Preferred Stock then outstanding, will be
the voting rights described above and such breach by the Company will not cause
any action taken by the Company to be invalid or unauthorized under its charter
documents.
Incurrence of Indebtedness and Issuance of Disqualified Stock or Preferred
Stock
The Certificate of Designation provides that the Company will not, and will
not permit any of its Subsidiaries to directly or indirectly, create, incur,
issue, assume, guarantee or otherwise become directly or indirectly liable for
the payment of (collectively, "incur" and, correlatively, "incurred" and
"incurrence") any Indebtedness (including, without limitation, Acquired
Indebtedness) and that the Company will not issue any Disqualified Stock and
will not permit any of its Subsidiaries to issue any shares of Subsidiary
Preferred Stock;
85
<PAGE> 89
provided that the Company may incur Indebtedness (including Acquired
Indebtedness) or issue shares of Disqualified Stock or Subsidiary Preferred
Stock if the Company's Consolidated Leverage Ratio as of the last day of the
Company's most recently ended fiscal quarter for which internal financial
statements are available immediately preceding the date on which such
Indebtedness is incurred, or such Disqualified Stock or Subsidiary Preferred
Stock is issued, as the case may be, would have been (a) greater than zero and
less than 5.5 to 1.0, if such incurrence or issuance is on or prior to December
31, 1999, and (b) greater than zero and less than 5.0 to 1.0, if such incurrence
or issuance is after December 31, 1999, determined on a pro forma basis
(including pro forma application of the net proceeds therefrom) as if such
Indebtedness had been incurred, or such Disqualified Stock had been issued, as
the case may be, at the beginning of such fiscal quarter.
The foregoing limitation will not apply to:
(a) the incurrence of Indebtedness by the Company or any Subsidiary
pursuant to Credit Agreement(s); provided that the aggregate principal
amount of such Credit Agreement(s) at any one time outstanding under this
clause (a) does not exceed $100.0 million for the Company and all of its
Subsidiaries;
(b) the Existing Indebtedness (including all amounts that accrue
thereon);
(c) the incurrence of Vendor Debt by the Company or any Subsidiary;
provided that the aggregate principal amount of such Vendor Debt does not
exceed 80% of the purchase price or cost of the construction, acquisition
or improvement of the applicable Telecommunications Related Assets financed
therewith (or 100% of the total cost of the Telecommunications Related
Assets financed therewith if such Vendor Debt was extended for the purchase
of tangible physical assets and was so financed by the vendor thereof or an
affiliate of such vendor);
(d) the incurrence by the Company or any of its Restricted
Subsidiaries of Refinancing Indebtedness with respect to Indebtedness
permitted pursuant to clause (b) of this paragraph;
(e) the incurrence of Indebtedness by the Company not to exceed, at
any one time outstanding, 2.0 times the sum of (i) the net cash proceeds
received by the Company from the issuance and sale of the Preferred Stock
and the issuance and sale of any other class or series of its Capital Stock
(other than Disqualified Stock) from and after September 30, 1997 plus (ii)
the fair market value at the time of issuance of Capital Stock (other than
Disqualified Stock) issued in connection with any acquisition of a
Telecommunications Company, in each case to a Person other than a
Subsidiary of the Company; and
(f) the incurrence by the Company of Indebtedness (in addition to
Indebtedness permitted by any other clause of this paragraph) in an
aggregate principal amount (or accreted value, as applicable) at any time
outstanding not to exceed $100.0 million;
For purposes of this covenant, the Certificate of Designation provides
that, in the event that the Company proposes to incur Indebtedness pursuant to
clause (e) above, the Company shall, simultaneously with the incurrence of such
Indebtedness, deliver to the Transfer Agent a resolution of the Board of
Directors set forth in an Officers' Certificate stating that the sale or sales
of Capital Stock forming the basis for the incurrence of such Indebtedness (i)
constitutes an investment in the Company and (ii) has not been made for the
purpose of circumventing this covenant. The Certificate of Designation will also
provide that, in the event that the Company rescinds, reverses or unwinds such
sale of Capital Stock or otherwise returns or refunds all or any portion of the
net cash proceeds of such sale of Capital Stock (whether by dividend,
distribution or otherwise) within 270 days of the date of the incurrence of such
Indebtedness, such Indebtedness will be deemed to be incurred on the date of,
and immediately after giving effect to, such rescission, reversal, unwinding,
return or refund.
For purposes of determining compliance with this covenant, in the event
that an item of Indebtedness, Disqualified Stock, or Subsidiary Preferred Stock
meets the criteria of more than one of the categories described in clauses (a)
through (f) above or is entitled to be incurred pursuant to the first paragraph
of this covenant, the Company shall, in its sole discretion, classify such item
in any manner that complies with this covenant and such item will be treated as
having been incurred pursuant to only one of such clauses or
86
<PAGE> 90
pursuant to the first paragraph herein. Accrual of interest or dividends, the
accretion of accreted value or liquidation preference and the payment of
interest or dividends in the form or additional Indebtedness or shares of
Capital Stock will not be deemed to be an incurrence of Indebtedness for
purposes of this covenant.
Dividend and Other Payment Restrictions Affecting Subsidiaries
The Certificate of Designation provides that the Company will not, and will
not permit any of its Restricted Subsidiaries to, directly or indirectly, create
or otherwise cause or suffer to exist or become effective any encumbrance or
restriction on the ability of any Restricted Subsidiary to:
(i)(a) pay dividends or make any other distributions to the Company or
any of its Restricted Subsidiaries on its Capital Stock or (b) pay any
indebtedness owed to the Company or any of its Restricted Subsidiaries,
(ii) make loans or advances to the Company or any of its Restricted
Subsidiaries,
(iii) transfer any of its properties or assets to the Company or any
of its Subsidiaries,
except for such encumbrances or restrictions existing under or by reason of:
(a) Existing Indebtedness as in effect on the Issue Date;
(b) any Credit Agreement creating or evidencing Indebtedness permitted
by clause (a) under the "Incurrence of Indebtedness and Issuance of
Disqualified Stock on Preferred Stock" covenant described above and any
amendments, modifications, restatement, renewals, increases, supplements,
refundings, replacements or refinancings thereof;
(c) 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;
(d) the Certificate of Designation, the Old Preferred Stock or the New
Preferred Stock;
(e) applicable law;
(f) customary provisions restricting subletting or assignment of any
lease of the Company or any Restricted Subsidiary or customary provisions
in certain agreements that restrict the assignment of such agreement or any
rights thereunder;
(g) purchase money obligations or Vendor Debt for property acquired in
the ordinary course of business that impose restrictions of the nature
described in clause (iii) above on the property so acquired;
(h) 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 issued by such Restricted Subsidiary in connection with
or in anticipation of its acquisition), provided that the EBITDA of such
Restricted Subsidiary is not taken into account in determining whether such
acquisition is permitted by the terms of the Indenture;
(i) 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;
(j) 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; and
(k) Refinancing Indebtedness; provided that such encumbrances or
restrictions are not materially more restrictive than those contained in
the documentation governing the Indebtedness being extended, refinanced,
renewed, replaced, defeased or refunded.
87
<PAGE> 91
Merger, Consolidation or Sale of Assets
The Company will not, in any transaction or series of transactions,
consolidate with, or merge with or into, any other Person (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 the Preferred
Stock shall be converted into or exchanged for, and shall become shares of,
such Surviving Entity, successor, transferee or resulting Person, having in
respect of such Surviving Entity the same powers, preferences and relative
participating, optional and other special rights and qualifications,
limitations or restrictions thereon, that the Preferred Stock had with
respect to the Company immediately prior to such transaction;
(ii) immediately after giving effect to such transaction or series of
related 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 related transactions), no
Voting Rights Triggering Event shall have occurred or resulted therefrom;
and
(iii) immediately after giving effect to such transaction or series of
related 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 related transactions), the
Company (or the Surviving Entity, if the Company is not continuing) would
(A) be permitted to incur $1.00 of additional Indebtedness pursuant to the
first paragraph of "-- Incurrence of Indebtedness and Issuance of
Disqualified Stock or Preferred Stock" or (B) have a Total Equity Market
Capitalization of at least $1.0 billion and total Indebtedness, net of cash
and cash equivalents (as presented on the Company's consolidated balance
sheet), in an amount less than 40% of its Total Market Capitalization.
Reports
The Certificate of Designation 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 SEC the annual reports,
quarterly reports and other documents which the Company would have been required
to file with the SEC 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 SEC 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 SEC), within
30 days of each Required Filing Date, (i) transmit by mail to all holders of the
Preferred Stock, as their names and addresses appear on the records of the
Transfer Agent and to any Persons that request such reports in writing, without
cost to such holders or Persons, and (ii) file with the Transfer Agent copies of
the annual reports, quarterly reports and other documents (without exhibits)
which the Company has filed or would have filed with the SEC 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 SEC if
the SEC does not permit such filing. In addition to the foregoing, commencing
with the unaudited information for the fiscal quarter ended September 30, 1997,
the Company will file with the SEC and will thereafter transmit by mail to
holders of the Preferred Stock and file with the Transfer Agent within the same
time periods as set forth in the second next preceding sentence, unaudited
information, on an aggregate Fiber Network basis (before headquarter
allocations) segmented by the calendar year in which each such Fiber Network
became operational, setting forth the investment in plant, property and
equipment to date, revenue, EBITDA, EBIT, access lines, fiber miles, route
miles, buildings
88
<PAGE> 92
connected and voice grade equivalents; provided, however, that the Company will
provide such unaudited information with respect to (i) all Fiber Networks that
were initially operational at any time prior to December 31, 1995 (all such
Fiber Networks shall be deemed to have become operational in calendar year 1995)
and (ii) all Fiber Networks that were initially operational in each succeeding
calendar year (including all or any portion of the then current year); and
provided, further, that the Company need no longer comply with the information
requirements of this sentence after four consecutive fiscal quarters for which
the ratio of EBITDA of the Company to Consolidated Interest Expense (other than
dividends or distributions with respect to preferred stock or Disqualified Stock
of the Company) of the Company is greater than 1.0 or after the occurrence of a
Change of Control.
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Certificate of Designation. Reference is made to the Certificate of Designation
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.
"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,
further, that neither the Company nor any of its Restricted Subsidiaries shall
be deemed to be Affiliates of each other; and provided, further, that any lender
under the Secured Credit Facility and its Affiliates shall not be deemed to be
Affiliates of the Company or any Restricted Subsidiary solely as a result of the
existence of the Secured Credit Facility or their holdings of Capital Stock of
the Company or any Restricted Subsidiary acquired in connection with the Secured
Credit Facility. 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 shall be deemed to be
control.
"Annualized Pro Forma EBITDA" means with respect to any Person, such
Person's Pro Forma EBITDA for the latest fiscal quarter for which internal
financial statements are then available multiplied by four.
"Asset Sale" means, with respect to any Person, any transfer, conveyance,
sale, lease or other disposition (including, without limitation, by way of
consolidation or merger, but excluding by means of any Sale and Leaseback
Transaction or by the granting of a Lien permitted under the definition of
"Permitted Liens") by such Person or any of its Restricted Subsidiaries to any
Person other than the Company or a Restricted Subsidiary of the Company, in one
transaction, or a series of related transactions (each hereinafter referred to
as a "Disposition"), of Property or assets of such Person or any of its
Restricted Subsidiaries, the Fair Market Value of which exceeds $2 million,
other than (i) a Disposition of Property in the ordinary course of business
consistent with industry practice and (ii) a Disposition by the Company in
connection with a transaction permitted under "-- Merger, Consolidation, Sale of
Assets."
"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
89
<PAGE> 93
such lease without penalty or upon payment of a penalty (in which case the
rental payments shall include such penalty).
"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 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 and
certificates of deposit of any commercial bank organized in the United States
having capital and surplus in excess of $500 million with a maturity date not
more than one year from the date of acquisition, (iii) repurchase obligations
with a term of not more than seven days for underlying securities of the types
described in clause (i) above entered into with any bank meeting the
qualifications specified in clause (ii) above, (iv) direct obligations issued by
any state of the United States of America or any political subdivision of any
such state or any public instrumentality thereof maturing, or subject to tender
at the option of the holder thereof within ninety days after the date of
acquisition thereof and, at the time of acquisition, having a rating of A or
better from Standard & Poor's Ratings Group ('Standard & Poor's") or A-2 or
better from Moody's Investors Service, Inc. ("Moody's"), (v) commercial paper
issued by the parent corporation of any commercial bank organized in 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
Standard & Poor's or Moody's and in each case maturing within ninety 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).
"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, (y) all accrued interest
and (z) all commissions, discounts and other fees and charges owed with respect
to letters of credit, bankers' acceptances or similar facilities) paid or
accrued, or scheduled to be paid or accrued, during such period; (ii) dividends
or distributions with respect to preferred stock or Disqualified Stock of such
Person (and of its Restricted Subsidiaries if paid to a Person other than such
Person or its Restricted Subsidiaries) declared and payable in cash; (iii) the
portion of any rental obligation of such Person or its Restricted Subsidiaries
in respect of any Capital Lease Obligation allocable to interest expense in
accordance with GAAP; (iv) the portion of any rental obligation of such Person
or its Restricted Subsidiaries in respect of any Sale and Leaseback Transaction
allocable to interest expense (determined as if such were treated as a Capital
Lease Obligation); and (v) to the extent any Indebtedness of any other Person is
Guaranteed by such Person or any of its Restricted Subsidiaries, the aggregate
amount of interest paid, 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
90
<PAGE> 94
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.
"Consolidated Leverage Ratio" means, for any Person, as of any date, the
ratio of (i) the sum of the aggregate outstanding amount of all Indebtedness of
a Person and its Subsidiaries determined on a consolidated basis in accordance
with GAAP to (ii) Annualized Pro Forma EBITDA.
"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, (ii) any net income of any Person
other than such Person and its Restricted Subsidiaries, except to the extent of
the amount of dividends or other distributions actually paid to such Person or
its Restricted Subsidiaries by such other Person during such period; (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; (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); and (viii) the
cumulative effect of changes in accounting principles.
"Consolidated Net Worth" means, with respect to any Person as of any date,
the sum of (i) the consolidated equity of the common stockholders of such Person
and its consolidated Subsidiaries as of such date plus (ii) the respective
amounts reported on such Person's balance sheet as of such date with respect to
any series of preferred stock (other than Disqualified Stock) that by its terms
is not entitled to the payment of dividends unless such dividends may be
declared and paid only out of net earnings in respect of the year of such
declaration and payment, but only to the extent of any cash received by such
Person upon issuance of such preferred stock, less (x) all write-ups (other than
write-ups resulting from foreign currency translations and write-ups of tangible
assets of a going concern business made within 12 months after the acquisition
of such business) subsequent to the Issue Date in the book value of any asset
owned by such Person or a consolidated Subsidiary of such Person, (y) all
investments as of such date in unconsolidated Subsidiaries and in Persons that
are not Subsidiaries (except, in each case, Permitted Investments) and (z) all
unamortized debt discount and expense and unamortized deferred charges as of
such date, all of the foregoing determined in accordance with GAAP.
"Credit Agreement" means, with respect to any Person, any agreement entered
into by and among such Person and one or more commercial banks or financial
institutions, providing for senior term or revolving credit borrowings of a type
similar to credit agreements typically entered into by commercial banks and
financial institutions, including any related notes, Guarantees, collateral
documents, instruments and agreements executed in connection therewith, as such
credit agreement and related agreements may be amended, extended, refinanced,
renewed, restated, replaced or refunded from time to time.
"Disqualified Stock" means any Capital Stock (other than the 14 3/4%
Preferred 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 mandatory redemption date of the Preferred Stock.
"EBIT" means the amount calculated in the same manner as EBITDA, but not
including clauses (iii) and (iv) of the definition thereof.
91
<PAGE> 95
"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, (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 non-cash 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 Preferred Stock
and the Certificate of Designation.
"Exchange Rate Obligation" means, with respect to any Person, any currency
swap agreements, forward exchange rate agreements, foreign currency futures or
options, exchange rate collar agreements, exchange rate insurance and other
agreements or arrangements, or combination thereof, designed to provide
protection against fluctuations in currency exchange rates.
"Existing Indebtedness" means Indebtedness outstanding on the date of
initial issuance of the Preferred Stock, including the Existing Notes and the
AT&T Credit Facility.
"Fair Market Value" means, with respect to any asset or Property, the sale
value that would 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.
"Fiber Network" means a digital fiber optic telecommunications network
wholly owned by the Company that serves a Metropolitan Area.
"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 Certificate of Designation 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).
"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 obligations of such Person for money
borrowed, (ii) any obligation of such Person evidenced by bonds, debentures,
notes, Guarantees or other similar instruments, including, without limitation,
any such obligations incurred in connection with acquisition of Property, assets
or businesses, excluding trade accounts payable made in the ordinary course of
business, (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 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 60 days overdue or which are
being contested in good faith), (v) any Capital Lease Obligation of such Person,
(vi) the maximum fixed redemption or repurchase price of Disqualified Stock of
such Person and, to the extent held by other Persons, the maximum fixed
redemption or repurchase price of Disqualified Stock of such Person's Restricted
Subsidiaries, at the time of determination, (vii) the notional amount of any
Interest Hedging Obligations or Exchange Rate Obligations of such Person at the
time of determination, (viii) any Attributable Indebtedness with respect to any
Sale and Leaseback Transaction to which such Person is a party and (ix) any
obligation of the type referred to in clauses (i) through (viii) of this
definition of another Person and all dividends and distributions of another
Person the payment of which, in either case, such Person has
92
<PAGE> 96
Guaranteed or is responsible or liable for, 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
Certificate of Designation; 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 the 2005 Notes or 2006
Notes outstanding at any date, the amount of such 2005 Notes or 2006 Notes shall
be the Accreted Value (as defined in the relevant indenture) thereof as of such
date unless cash interest has commenced to accrue pursuant to the relevant
indenture, in which case the amount of the 2005 Notes or 2006 Notes outstanding
will be determined pursuant to the relevant indenture and will not include any
accrued and unpaid cash interest which would otherwise be included in Accreted
Value because of clause (iii) of the definition thereof in the relevant
indenture.
"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 Subsidiaries'
exposure to fluctuations in interest rates.
"Investment" in any Person means any direct, indirect or contingent (i)
advance or loan to, Guarantee of any Indebtedness of, extension of credit or
capital contribution to such Person, (ii) the acquisition of any shares of
Capital Stock, bonds, notes, debentures or other securities of such Person, or
(iii) the 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 commercially reasonable
extensions of trade credit. The amount of any 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 other than cash,
such Property shall be valued at its Fair Market Value at the time of such
transfer.
"Issue Date" means the date of initial issuance of the Preferred Stock.
"Lien" means, with respect to any Property or other asset, any mortgage or
deed or 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 kind or 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).
"Metropolitan Area" means the 31 metropolitan areas in which the Company,
as of June 30, 1997, has a Fiber Network and other metropolitan areas deemed in
the reasonable business judgment of the management of the Company to provide an
opportunity for the building and operation of such a Fiber Network with the
reasonable potential to produce financial results for the Company at least
substantially comparable to the metropolitan areas in which the Company has such
operational Fiber Networks.
"Net Income" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain or loss,
together with any related provision for taxes on such gain or loss, realized in
connection with (a) any Asset Sale (including, without limitation, dispositions
pursuant to Sale and Leaseback Transactions) or (b) the disposition of any
securities by such Person or any of its Subsidiaries or the extinguishment of
any Indebtedness of such Person or any of its Subsidiaries and (c) any
extraordinary or nonrecurring gain or loss, together with any related provision
for taxes on such extraordinary or nonrecurring gain or loss.
93
<PAGE> 97
"New Preferred Stock" means the 12 3/4% Junior Redeemable Preferred Stock
due 2009 authorized by the Certificate of Designation that may be issued
pursuant to the Exchange Offer pursuant to the Registration Rights Agreement.
"Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"Officers' Certificate" means a certificate signed by the Chairman of the
Board, a Vice Chairman of the Board, the President 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 and
delivered to the Transfer Agent, which shall comply with the Indenture.
"Permitted Liens" means (i) Liens on Property or assets of a Person
existing at the time such Person is merged into or consolidated with the Company
or any 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 Subsidiaries other than the
Property or assets subject to the Liens prior to such merger or consolidation;
(ii) Liens on Telecommunications Related Assets existing during the time of the
construction thereof; (iii) Liens incurred or deposits made to secure the
performance of tenders, bids, leases, 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;
(iv) Liens existing as of the Issue Date; (v) Liens to secure borrowings
permitted under clause (a) of the second paragraph of "-- Incurrence of
Indebtedness and Issuance of Disqualified Stock or Preferred Stock" (including
any such liens arising in connection with the Secured Credit Facility); (vi) 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; (vii) 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); (viii) easements, rights-
of-way, licenses and other similar restrictions on the use of Properties or
minor imperfections of title that, in the aggregate, are not material in amount
and do not in any case materially detract from the Properties subject thereto or
interfere with the ordinary conduct of the business of the Company or its
Subsidiaries; (ix) any Lien to secure obligations under workmen's compensation
laws or similar legislation, including any Lien with respect to judgments which
are not currently dischargeable; (x) 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); (xi) any
interest or title of a lessor in Property subject to a Capital Lease Obligation;
(xii) Liens to secure any Vendor Debt; 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; (xiii) Liens in favor of the Company or
any Restricted Subsidiary; (xiv) Liens on Property or assets of a Person
existing prior to the time such Person is acquired by the Company as a result of
(a) Investments by the Company or a Restricted Subsidiary in or in respect of a
Person to the extent the consideration for such Investment consists of shares of
Qualified Stock of the Company or (b) Investments in certain joint venture
entities; provided that such Liens were in existence prior to the contemplation
of such Investment and do not secure any Property or assets of the Company or
any of its Subsidiaries other than the Property or assets subject to the Liens
prior to such Investment; (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; (xvi) Liens on
the escrow account for the 2007 Notes and all funds and securities therein
securing only the 2007 Notes equally and ratably and (xvii) 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 (i) through
(v) and (xii), provided that such Liens do not extend to any other Property or
assets and the principal amount of the Indebtedness secured by such Liens is not
increased.
"Person" means any individual, corporation, partnership, joint venture,
trust, unincorporated organization or government or any agency or political
subdivision thereof.
94
<PAGE> 98
"Pro Forma EBITDA" means, for any Person, for any period, the EBITDA of
such Person as determined on a consolidated basis in accordance with GAAP
consistently applied, after giving effect to the following: (i) if, during or
after such period, such Person or any of its Subsidiaries shall have made any
Asset Sale, Pro Forma EBITDA for such Person and its Subsidiaries for such
period shall be reduced by an amount equal to the Pro Forma EBIDTA (if positive)
directly attributable to the assets which are the subject of such Asset Sale for
the period or increased by an amount equal to the Pro Forma EBITDA (if negative)
directly attributable thereto for such period and (ii) if, during or after such
period, such Person or any of its Subsidiaries completes an acquisition of any
Person or business which immediately after such acquisition is a Subsidiary of
such Person, Pro Forma EBITDA shall be computed so as to give pro forma effect
to such Asset Sale or the acquisition of such Person or business, as the case
may be, as if such acquisition had been completed as of the beginning of such
period, and (iii) if, during or after such period, such Person or any of its
Subsidiaries incurs any Indebtedness (including without limitation, any Acquired
Indebtedness) or issues any Disqualified Stock, Pro Forma EBITDA shall be
computed so as to give pro forma effect (including pro forma application of the
proceeds therefrom) thereto as if such Indebtedness or Disqualified Stock had
been incurred as of the beginning of such period.
"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.
"Qualified Stock" of any Person means a class of Capital Stock other than
Disqualified Stock.
"Refinancing Indebtedness" means Indebtedness issued in exchange for, or
the proceeds of which are used to refinance, repurchase, replace, refund or
defease other Indebtedness.
"Restricted Subsidiary" means 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.
"Secured Credit Facility" means the AT&T Credit Facility as in effect on
the Issue Date and additional secured credit agreements to which the Company is
or becomes a party, in an aggregate amount not to exceed $35 million, and all
related amendments, notes, collateral documents, guarantees, instruments and
other agreements executed in connection therewith, as the same may be amended,
modified, supplemented, restated, renewed, extended, refinanced, substituted or
replaced from time to time.
"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.
"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.
"Subsidiary Preferred Stock" means Capital Stock of a Subsidiary of any
class or classes (however designated) that ranks prior, as to the payment of
dividends or as to the distribution of assets upon any voluntary or involuntary
liquidation, dissolution or winding up of such a Subsidiary, to shares of
Capital Stock of any other class of such a Subsidiary.
"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)
95
<PAGE> 99
above or (iii) evaluating, participating or pursuing any other activity or
opportunity that is related to those specified in (i) or (ii) above.
"Telecommunications Company" means any Person substantially all of the
assets of which consist of Telecommunications Assets.
"Telecommunications Related Assets" means all assets, rights (contractual
or otherwise) and properties, whether tangible or intangible, used or intended
for use in connection with a Telecommunications Business.
"Telecommunications Service Market" means a network built by the Company to
service a market.
"Total Equity Market Capitalization" of any person means, as of any day of
determination, the sum of (1) the product of (A) the aggregate number of
outstanding primary shares of common stock of such person on such day (which
shall not include any options or warrants on, or securities convertible or
exchangeable into or exercisable for, shares of common stock of such person)
multiplied by (B) the average closing price of such common stock over the 20
consecutive trading days immediately preceding such day, plus (2) the
liquidation value of any outstanding shares of preferred stock of such person on
such day.
"Total Market Capitalization" of any person means, as of any day of
determination, the sum of (1) the consolidated Indebtedness of such Person and
its Subsidiaries on such day, plus (2) the product of (i) the aggregate number
of outstanding primary shares of common stock of such Person on such day (which
shall not include any options or warrants on, or securities convertible or
exchangeable into, shares of common stock of such Person) and (ii) the average
closing price of such common stock over the 20 consecutive trading days
immediately preceding such day, plus (3) the liquidation value of any
outstanding shares of preferred stock of such Person on such day, less (4) cash
and cash equivalents as presented on such Person's consolidated balance sheet on
such date. If no such closing price exists with respect to shares of any such
class, the value of such shares for purposes of clause (2) of the preceding
sentence shall be determined by the Company's Board of Directors in good faith
and evidenced by a resolution of the Board of Directors.
"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 each of the
indentures governing the Existing Notes.
"Vendor Debt" means any purchase money Indebtedness of the Company or any
Subsidiary incurred in connection with the acquisition of Telecommunications
Related 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.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (i) the sum of the
products obtained by multiplying (a) the amount of each then remaining
installment, sinking fund, serial maturity or other required payments of
principal, including payment at final maturity, in respect thereof, by (b) the
number of years (calculated to the nearest one-twelfth) that will elapse between
such date and the making of such payment, by (ii) the then outstanding principal
amount of such Indebtedness.
"Wholly Owned Subsidiary" of any Person means a Subsidiary of such Person
all of the outstanding Capital Stock or other ownership interests (other than
directors' qualifying shares) of which shall at the time be owned by such Person
or by one or more Wholly Owned Subsidiaries of such Person or a combination
thereof.
TRANSFER AGENT AND REGISTRAR
The Bank of New York will be the transfer agent and registrar for the
Preferred Stock.
96
<PAGE> 100
EXCHANGE OFFER; REGISTRATION RIGHTS
The Company entered into the Registration Rights Agreement concurrently
with the issuance of the Old Preferred Stock. Pursuant to the Registration
Rights Agreement, the Company agreed to file with the Commission no later than
45 days after the date of issuance of the Preferred Stock, the Exchange Offer
Registration Statement on the appropriate form under the Securities Act with
respect to the New Preferred Stock. Upon the effectiveness of the Exchange Offer
Registration Statement, the Company will offer to the holders of Transfer
Restricted Securities pursuant to the Exchange Offer who are able to make
certain representations the opportunity to exchange their Transfer Restricted
Securities for New Preferred Stock. If (i) the Company is not required to file
the Exchange Offer Registration Statement or permitted to consummate the
Exchange Offer because the Exchange Offer is not permitted by applicable law or
Commission policy or (ii) any holder of Transfer Restricted Securities notifies
the Company prior to the 20th day following consummation of the Exchange Offer
that (A) it is prohibited by law or Commission policy from participating in the
Exchange Offer or (B) that it may not resell the New Preferred Stock acquired by
it in the Exchange Offer to the public without delivering a prospectus and the
prospectus contained in the Exchange Offer Registration Statement is not
appropriate or available for such resales, the Company will file with the
Commission a Shelf Registration Statement to cover resales of the Preferred
Stock by the holders thereof who satisfy certain conditions relating to the
provision of information in connection with the Shelf Registration Statement.
The Company will use its best efforts to cause the applicable registration
statement to be declared effective as promptly as possible by the Commission.
For purposes of the foregoing, "Transfer Restricted Securities" means each share
of Preferred Stock until (i) the date on which such Preferred Stock has been
exchanged by a person other than a broker-dealer for New Preferred Stock in the
Exchange Offer, (ii) following the exchange by a broker-dealer in the Exchange
Offer of Preferred Stock for New Preferred Stock or New Exchange Debentures the
date on which such New preferred Stock are sold to a purchaser who receives from
such broker-dealer on or prior to the date of such sale a copy of the prospectus
contained in the Exchange Offer Registration Statement, (iii) the date on which
such Preferred Stock has been effectively registered under the Securities Act
and disposed of in accordance with the Shelf Registration Statement or (iv) the
date on which such Preferred Stock is distributed to the public pursuant to Rule
144A under the Act.
The Registration Rights Agreement provides that (i) the Company will file
an Exchange Offer Registration Statement with the Commission on or prior to 45
days after the Closing Date, (ii) the Company will use its best efforts to have
the Exchange Offer Registration Statement declared effective by the Commission
on or prior to 120 days after the Closing Date, (iii) unless the Exchange Offer
would not be permitted by applicable law or Commission policy, the Company will
commence the Exchange Offer and use its best efforts to issue on or prior to 30
business days after the date on which the Exchange Offer Registration Statement
was declared effective by the Commission, shares of New Preferred Stock in
exchange for all Preferred Stock tendered prior thereto in the Exchange Offer
and (iv) if obligated to file the Shelf Registration Statement, the Company will
use its best efforts to file the Shelf Registration Statement with the
Commission on or prior to 30 days after such filing obligation arises (and in
any event within 90 days after the Closing Date) and to cause the Shelf
Registration to be declared effective by the Commission (1) in the case of a
Shelf Registration Statement filed pursuant to clause (i) of the fourth sentence
of the preceding paragraph, 120 days after the date the Company becomes
obligated to file such Shelf Registration Statement and (2) in the case of a
Shelf Registration Statement filed pursuant to clause (ii) of the fourth
sentence of the preceding paragraph, 150 days after the date on which the
Company receives the notice specified in clause (ii) of the fourth sentence of
the preceding paragraph. If (a) the Company fails to file any of the
Registration Statements required by the Registration Rights Agreement on or
before the date specified for such filing, (b) any of such Registration
Statements is not declared effective by the Commission on or prior to the date
specified for such effectiveness (the "Effectiveness Target Date"), or (c) the
Company fails to consummate the Exchange Offer within 30 business days following
the Effectiveness Target Date with respect to the Exchange Offer Registration
Statement, or (d) the Shelf Registration Statement or the Exchange Offer
Registration Statement is declared effective but thereafter ceases to be
effective or usable in connection with resales of Transfer Restricted Securities
during the periods specified in the Registration Rights Agreement (each such
event referred to in clauses (a) through (d) above a "Registration Default"),
then additional dividends ("Additional Dividends") will accrue on the Preferred
Stock from and including the date on which
97
<PAGE> 101
any Registration Default shall occur to but excluding the date on which all
Registration Defaults have been cured at a rate per annum of 0.25% for each
90-day period that such Registration Default continues; provided, that such rate
shall in no event exceed 1.0% per annum. Additional Dividends shall be paid,
either in cash or, at the Company's option, in additional shares of Preferred
Stock, on each regular quarterly Dividend Payment Date following the occurrence
of such Registration Default through the Dividend Payment Date next following
the date when such Registration Default shall have been cured. Following the
cure of all Registration Defaults, the accrual of Additional Dividends will
cease.
The Registration Rights Agreement also provides that the Company (i) shall
pay, as applicable, certain reasonable expenses incident to the Shelf
Registration Statement and (ii) will indemnify certain holders of the Preferred
Stock against certain liabilities, including liabilities under the Securities
Act.
Holders of the Old Preferred Stock will be required to make certain
representations to the Company (as described above) and will be required to
deliver information to be used in connection with the Shelf Registration
Statement in order to have their Preferred Stock included in the Shelf
Registration Statement. A holder who sells Preferred Stock 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
purchasers, 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 a
holder (including certain indemnification obligations).
For so long as the Preferred Stock is outstanding, the Company will
continue to provide to holders of the Preferred Stock and to prospective
purchasers of the Preferred Stock the information required by Rule 144A(d)(4)
under the Securities Act. The Company will provide a copy of the Registration
Rights Agreement to prospective purchasers of Preferred Stock identified to the
Company upon request.
The foregoing description of the Registration Rights Agreement is a summary
only, does not purport to be complete and is qualified in its entirety by
reference to all provisions of the Registration Rights Agreement.
BOOK-ENTRY, DELIVERY AND FORM
The certificates representing the shares of New Preferred Stock will be
issued in fully registered form without interest coupons. Shares of New
Preferred Stock will be represented by one or more permanent global securities
in definitive, fully registered form (each a "Global Security") and will be
deposited with the Transfer Agent as custodian for, and registered in the name
of, Cede & Co., as nominee of The Depository Trust Company (the "Depositary")
(such nominee being referred to herein as the "Global Security Holder")
Except in the limited circumstances described below regarding "Certificated
Securities," owners of beneficial interests in a Global Security will not be
entitled to receive physical delivery of Certificated Securities (as defined
below).
The Depositary is a limited-purpose trust company that was created to hold
securities for its participating organizations (collectively, the "Participants"
or the "Depositary's Participants") and to facilitate the clearance and
settlement of transactions in such securities between Participants through
electronic book-entry changes in accounts of its Participants. The Depositary's
Participants include securities brokers and dealers (including the Initial
Purchaser), banks and trust companies, clearing corporations and certain other
organizations. Access to the Depositary's system is also available to other
entities such as banks, brokers, dealers and trust companies (collectively, the
"Indirect Participants" or the "Depositary's Indirect Participants") that clear
through or maintain a custodial relationship with a Participant, either directly
or indirectly. Persons who are not Participants may beneficially own securities
held by or on behalf of the Depositary only through the Depositary's
Participants or the Depositary's Indirect Participants.
The Company expects that pursuant to procedures established by the
Depositary (i) upon deposit of the Global Security, the Depositary will credit
the accounts of Participants designated by the Initial Purchaser with the
appropriate number of shares of the Global Security and (ii) ownership of the
Preferred Stock evidenced by the Global Security will be shown on, and the
transfer of ownership thereof will be effected only through, records maintained
by the Depositary (with respect to the interests of the Depositary's
Participants),
98
<PAGE> 102
the Depositary's Participants and the Depositary's Indirect Participants.
Prospective purchasers are advised that the laws of some states require that
certain persons take physical delivery in definitive form of securities that
they own. Consequently, the ability to transfer Preferred Stock evidenced by the
Global Security will be limited to such extent. For certain other restrictions
on the transferability of the Preferred Stock see "Notice to Investors."
So long as the Global Security Holder is the registered owner of any
Preferred Stock the Global Security Holder will be considered the sole holder
under the Certificate of Designation of any Preferred Stock evidenced by the
Global Security. Beneficial Owners of Preferred Stock evidenced by the Global
Security will not be considered the owners or holders thereof under the
Certificate of Designation for any purpose. Neither the Company nor the Transfer
Agent will have any responsibility or liability for any aspect of the records of
the Depositary or for maintaining, supervising or reviewing any records of the
Depositary relating to the Preferred Stock.
Payments in respect of dividends and redemption payments and Additional
Dividends, if any, on any Preferred Stock registered in the name of the Global
Security Holder on the applicable record date will be payable by the Company to
or at the direction of the Global Security Holder in its capacity as the
registered holder under the Certificate of Designation. Under the terms of the
Certificate of Designation, the Company and the Transfer Agent may treat the
persons in whose names Preferred Stock, including the Global Security, are
registered as the owners thereof for the purpose of receiving such payments.
Consequently, neither the Company nor the Transfer Agent has or will have any
responsibility or liability for the payment of such amounts to beneficial owners
of Preferred Stock. The Company believes, however, that it is currently the
policy of the Depositary to immediately credit the accounts of the relevant
Participants with such payments, in amounts proportionate to their respective
holdings of beneficial interests in the relevant security as shown on the
records of the Depositary. Payments by the Depositary's Participants and the
Depositary's Indirect Participants to the Beneficial Owners of Preferred Stock
will be governed by standing instructions and customary practice and will be the
responsibility of the Depositary's Participants or the Depositary's Indirect
Participants.
CERTIFICATED SECURITIES
Subject to certain conditions, any person having a beneficial interest in
the Global Security may, upon request to the Transfer Agent, exchange such
beneficial interest for Preferred Stock in the form of Certificated Securities.
Upon any such issuance, the Transfer Agent is required to register such
Certificated Securities in the name of, and cause the same to be delivered to,
such person or persons (or the nominee of any thereof). In addition, if (i) the
Company notifies the Transfer Agent in writing that the Depositary is no longer
willing or able to act as a depositary and the Company is unable to locate a
qualified successor within 90 days or (ii) the Company, at its option, notifies
the Transfer Agent in writing that it elects to cause the issuance of Preferred
Stock in the form of Certificated Securities under the Certificate of
Designation, then, upon surrender by the Global Security Holder of its Global
Security, Preferred Stock in such form will be issued to each person that the
Global Security Holder and the Depositary identify as being the Beneficial Owner
of the related Preferred Stock.
Neither the Company nor the Transfer Agent will be liable for any delay by
the Global Security Holder or the Depositary in identifying the Beneficial
Owners of Preferred Stock and the Company and the Transfer Agent may
conclusively rely on, and will be protected in relying on, instructions from the
Global Security Holder or the Depositary for all purposes.
99
<PAGE> 103
DESCRIPTION OF CAPITAL STOCK
ACSI's authorized capital stock consists of 76,500,000 shares of capital
stock, consisting of 75,000,000 shares of Common Stock, par value $.01 per
share, and 1,500,000 shares of preferred stock, par value $1.00 per share. On
June 30, 1997, there were 35,926,902 shares of Common Stock issued and
outstanding and held of record by approximately 292 persons. Prior to the Common
Stock Offering the Company had designated 186,664 shares (of which 183,754
remain outstanding) of its authorized Preferred Stock as 9% Series A-1
Convertible Preferred Stock, 100,000 shares as its 9% Series B-1 Convertible
Preferred Stock, 102,500 shares as its 9% Series B-2 Convertible Preferred
Stock, 25,000 shares as its 9% Series B-3 Convertible Preferred Stock, and
50,000 shares as its 9% Series B-4 Convertible Preferred Stock. Upon completion
of the Common Stock Offering, the 461,254 issued and outstanding shares of
preferred stock were converted into 17,260,864 shares of Common Stock and became
authorized but unissued shares of preferred stock. As of July 10, 1997, the
Company had 1,500,000 shares of preferred stock that were authorized and 75,000
shares issued of its 14 3/4% Preferred Stock.
PREFERRED STOCK
The authorized but unissued preferred stock may be issued by the Board of
Directors of the Company from time to time in one or more series with such
preferences, terms and rights as the Board of Directors may determine without
further action by the stockholders of the Company. Accordingly, the Board of
Directors has the power to fix the dividend rate and to establish the
provisions, if any, relating to dividends, voting rights, redemption rates,
sinking funds, liquidation preferences and conversion rights for any series of
preferred stock issued in the future.
It is not possible to state the actual effect of the authorization of any
particular series of preferred stock upon the rights of holders of the Common
Stock until the Board of Directors determines the specific rights of the holder
of preferred stock of any further series. The issuance of preferred stock may
have the effect of delaying, deferring or preventing a change in control of the
Company without further action by the stockholders.
Dividends on the 14 3/4% Preferred Stock will accrue from July 10, 1997,
are cumulative and will be payable quarterly in arrears, commencing September
30, 1997, out of funds legally available therefor, at a rate per annum of
14 3/4% of the liquidation preference per share. Dividends will also accrue and
cumulate on any accrued and unpaid dividends. The liquidation preference of the
14 3/4% Preferred Stock is $1,000 per share. Dividends may be paid, at the
Company's option, on any dividend payment date either in cash or by the issuance
of additional shares of 14 3/4% Preferred Stock (and, at the Company's option,
payment of cash in lieu of fractional shares); provided, however, that after
June 30, 2002, to the extent and for so long as the Company is not precluded
from paying cash dividends on the 14 3/4% Preferred Stock by the terms of any
then outstanding indebtedness or any other agreement or instrument to which the
Company is subject, the Company shall pay dividends in cash. The 14 3/4%
Preferred Stock will be redeemable at the Company's option, in whole or in part,
at any time on or after January 1, 2003, at the redemption prices set forth in
the 14 3/4% Certificate, plus, without duplication, accrued and unpaid dividends
to the date of redemption. In addition, prior to June 30, 2000, the Company may,
at its option, redeem up to an aggregate of 30% of the shares of 14 3/4%
Preferred Stock at a redemption price of 114.75% (expressed as a percentage of
an amount equal to the sum of (i) the liquidation preference thereof and (ii)
the liquidation preference of any accrued and unpaid dividends to the date of
redemption payable in 14 3/4% Preferred Stock), plus, without duplication,
accrued and unpaid dividends to the date of redemption, with the net proceeds of
(i) one or more public common equity offerings generating cash proceeds of at
least $25 million or (ii) the sale of capital stock generating cash proceeds of
at least $25 million to an Eligible Equity Investor (as defined in the 14 3/4%
Certificate); provided that after any such redemption at least 70% of the
14 3/4% Preferred Stock initially issued remains outstanding. The Company is
required to redeem all the 14 3/4% Preferred Stock outstanding on June 30, 2008
at a redemption price equal to 100.00% of the liquidation preference thereof,
plus, without duplication, accrued and unpaid dividends to the date of
redemption.
No full dividends may be declared or paid or funds set apart for the
payment of dividends on any other class of capital stock or series of preferred
stock established hereafter by the Board of Directors of the Company ranking on
a parity with the 14 3/4% Preferred Stock (except dividends on parity stock
payable in
100
<PAGE> 104
additional shares of parity stock) for any period unless full cumulative
dividends shall have been or contemporaneously are declared and paid (or are
deemed declared and paid) in full or declared and, if payable in cash, a sum in
cash sufficient for such payment set apart for such payment on the 14 3/4%
Preferred Stock. If full dividends are not so paid, the 14 3/4% Preferred Stock
will share dividends pro rata with such parity stock. No dividends may be paid
or set apart for such payment on any class of capital stock or series of
preferred stock ranking junior to the 14 3/4% Preferred Stock (except dividends
on junior stock payable in additional shares of junior stock) and no junior
stock or parity stock may be repurchased, redeemed or otherwise retired nor may
funds be set apart for payment with respect thereto, if full cumulative
dividends have not been paid in full (or deemed paid) on the 14 3/4% Preferred
Stock.
Dividends on the Preferred Stock will accrue from October 16, 1997, are
cumulative and will be payable quarterly in arrears, commencing January 15,
1998, out of funds legally available therefor, at a rate per annum of 12 3/4% of
the liquidation preference per share. Dividends will also accrue and cumulate on
any accrued and unpaid dividends. The liquidation preference of the Preferred
Stock is $1,000 per share. Dividends may be paid, at the Company's option, on
any dividend payment date either in cash or by the issuance of additional shares
of Preferred Stock (and, at the Company's option, payment of cash in lieu of
fractional shares); provided, however, that after October 15, 2002, to the
extent and for so long as the Company is not precluded from paying cash
dividends on the Preferred Stock by the terms of any agreement or instrument
governing any of its then outstanding indebtedness, the Company shall pay
dividends in cash. The Preferred Stock will be redeemable at the Company's
option, in whole or in part, at any time on or after October 15, 2003, at the
redemption prices set forth in the Certificate of Designation, plus, without
duplication, accrued and unpaid dividends to the date of redemption. In
addition, prior to October 15, 2000, the Company may, at its option, redeem up
to an aggregate of 35% of the shares of Preferred Stock at a redemption price of
112.75% (expressed as a percentage of an amount equal to the sum of (i) the
liquidation preference thereof and (ii) the liquidation preference of any
accrued and unpaid dividends to the date of redemption payable in Preferred
Stock), plus, without duplication, accrued and unpaid dividends to the date of
redemption, with the net proceeds of (i) one or more public common equity
offerings generating cash proceeds of at least $25 million or (ii) the sale of
capital stock generating cash proceeds of at least $25 million to an Eligible
Equity Investor (as defined in the Certificate of Designation); provided that
after any such redemption at least 65% of the Preferred Stock initially issued
remains outstanding. The Company is required to redeem all the Preferred Stock
outstanding on October 15, 2009 at a redemption price equal to 100.00% of the
liquidation preference thereof, plus, without duplication, accrued and unpaid
dividends to the date of redemption.
COMMON STOCK
ACSI is authorized to issue 75,000,000 shares of Common Stock. Under the
Company's By-Laws, at least a majority of the issued and outstanding voting
securities of the Company present at a duly called stockholders' meeting
constitutes a quorum. Generally, if a quorum is present the affirmative vote of
the majority of the voting securities represented at the meeting constitutes an
act of the stockholders.
Subject to the rights of holders of the peffered stock, certain covenants
contained in the Indentures which restrict the Company's ability to declare
dividends on its Common Stock, and the restrictions on dividends contained in an
agreement between the Company and AT&T Credit Corporation, holders of the
Company's Common Stock are entitled to receive dividends, on a pro rata basis,
as may from time to time be declared by the Board of Directors. The holders of
Common Stock are entitled to one vote per share on every question submitted to
them at a meeting of shareholders. In the event of liquidation, dissolution or
winding up, the holders of Common Stock are, subject to the liquidation
preference of the holders of preffered stock, entitled to share ratably in all
assets of the Company available for distribution to stockholders along with the
holders of the preffered stock, any other series or class of preferred stock
entitled to a share of the remaining assets of the Company pro rata based on the
number of shares of Common Stock held by each (assuming full conversion of all
such preferred stock or such other series or class of preferred stock). The
holders of the Company's Common Stock do not have pre-emptive rights or
cumulative voting rights with respect to the election of directors.
101
<PAGE> 105
ANTI-TAKEOVER STATUTE
Section 203 of the DGCL prohibits certain transactions between a Delaware
corporation and an interested stockholder, which is defined therein as a person
who, together with any affiliates and/or associates of such person, beneficially
owns, directly or indirectly, 15% or more of the outstanding voting shares of a
Delaware corporation. This provision prohibits certain business combinations
(defined broadly to include mergers, consolidations, sales or other dispositions
of assets having an aggregate value in excess of 10% of the consolidated assets
of the corporation, and certain transactions that would increase the interested
stockholder's proportionate share ownership in the corporation) between an
interested stockholder and a corporation for a period of three years following
the time the interested stockholder acquired its stock unless (i) the business
combination is approved by the corporation's Board of Directors prior to the
date the interested stockholder acquired shares, (ii) the interested stockholder
acquired at least 85% of the voting stock of the corporation in the transaction
in which it becomes an interested stockholder or (iii) the business combination
is approved by a majority of the Board of Directors and by the affirmative vote
of 66 2/3% of the votes entitled to be cast by disinterested stockholders at an
annual or special meeting. The Charter and By-laws do not exclude the Company
from the restrictions imposed under Section 203 of the DGCL.
LIMITATION OF LIABILITY OF DIRECTORS
The Charter 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 174 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 Amended and Restated Certificate of Incorporation and the By-laws
provide that directors and officers of the Company (as well as agents and
employees of the Company at the discretion of the Board) shall, to the fullest
extent authorized by the DGCL or any other applicable laws then in effect, 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 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
102
<PAGE> 106
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 Delaware 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
Delaware Court of Chancery or such other court shall deem proper.
Section 145 further provides that to the extent a director, officer,
employee or agent 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 any person who is a or was a director, officer, employee or agent of
the corporation against any liability asserted against him in any such capacity,
or arising out of his status as such, whether or not the corporation would have
the power to indemnify him against such liabilities under Section 145.
There has not been in the past and there is not presently pending any
litigation or proceeding involving a director, officer, employee or agent of the
Company which could give rise to an indemnification obligation on the part of
the Company. In addition, except as described herein, the Board of Directors is
not aware of any threatened litigation or proceeding which may result in a claim
for indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the Company has
been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Company of expenses incurred or paid
by a director, officer or controlling person of the Company 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
Company will, unless in the opinion of 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.
The foregoing summary of certain material provisions of ACSI's Charter and
By-laws is qualified in its entirety by reference to the complete text of those
documents.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar of ACSI's Common Stock is The Bank of New
York, 101 Barclay Street, New York, New York 10286.
103
<PAGE> 107
U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE EXCHANGE OFFER
The following is a general discussion of the material U.S. Federal income
tax consequences of the Exchange Offer to holders of Old Preferred Stock. This
summary is based upon current provisions of the Internal Revenue Code of 1986,
as amended, regulations of the Treasury Department, administrative rulings and
pronouncements of the Internal Revenue Service and judicial decisions currently
in effect, all of which are subject to change, possibly with retroactive effect.
The discussion does not deal with all aspects of U.S. Federal income taxation
that may be relevant to particular investors in light of their personal
investment circumstances, nor does it address considerations applicable to
investors subject to special treatment under the U.S. Federal income tax laws.
In addition, the discussion does not consider the effect of any foreign, state,
local, gift, estate or other tax laws that may be applicable to a particular
investor. EACH POTENTIAL INVESTOR SHOULD CONSULT ITS TAX ADVISOR REGARDING THE
PARTICULAR TAX CONSEQUENCES OF PURCHASING, HOLDING AND DISPOSING OF THE OLD
PREFERRED STOCK AND THE NEW PREFERRED STOCK INCLUDING THE APPLICABILITY AND
EFFECT OF STATE, LOCAL AND FOREIGN TAX LAWS.
The exchange of Old Preferred Stock for New Preferred Stock pursuant to the
Exchange Offer will not constitute a taxable exchange. As a result, a holder (i)
will not recognize taxable gain or loss as a result of exchanging Old Preferred
Stock for New Preferred Stock pursuant to the Exchange Offer; (ii) the holding
period of the New Preferred Stock will include the holding period of the Old
Preferred Stock exchanged therefor; and (iii) the adjusted tax basis of the New
Preferred Stock will be the same as the adjusted tax basis of the Old Preferred
Stock exchanged therefor immediately before the exchange.
PLAN OF DISTRIBUTION
Each broker-dealer that receives New Preferred Stock 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 Preferred Stock. This
Prospectus, as it may be amended or supplemented from time to time, may be used
by a broker-dealer in connection with resales of New Preferred Stock received in
exchange for Preferred Stock where such Preferred Stock was acquired as a result
of market-making activities or other trading activities. The Company has agreed
that, starting on the Expiration Date and ending on the close of business 180
days after 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 , 1998 (90 days after the date of this
Prospectus), all dealers effecting transactions in the New Preferred Stock may
be required to deliver a prospectus.
The Company will not receive any proceeds from any sale of New Preferred
Stock by broker-dealers. New Preferred Stock 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 Preferred Stock 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
Preferred Stock. Any broker-dealer that resells New Preferred Stock that was
received by it for its own account pursuant to the Exchange Offer and any broker
or dealer that participates in a distribution of such New Preferred Stock may be
deemed to be an "underwriter" within the meaning of the Securities Act and any
profit of any such resale of New Preferred Stock 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, 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 after the Expiration Date, the Company will
promptly send 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 has agreed to pay all expenses
incident to the Exchange Offer (including the expenses of one counsel for the
holders of the Preferred Stock) other than
104
<PAGE> 108
commissions or concessions of any brokers or dealers and will indemnify the
holders of the New Preferred Stock (including any broker-dealers) against
certain liabilities, including liabilities under the Securities Act.
LEGAL MATTERS
Certain legal matters with respect to the New Preferred Stock will be
passed upon for the Company by Riley M. Murphy, Annapolis Junction, Maryland.
EXPERTS
The consolidated financial statements of American Communications Services,
Inc. as of June 30, 1995 and 1996 and December 31, 1996, and for the years ended
June 30, 1995 and 1996 and six months ended December 31, 1996, have been
included herein and in the registration statement in reliance upon the report of
KPMG Peat Marwick LLP, independent certified public accountants, appearing
elsewhere herein, and upon the authority of said firm as experts in accounting
and auditing.
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS
On April 21, 1995, pursuant to authorization of its Board of Directors and
approval of its Audit Committee, the Company dismissed the firm of Coopers &
Lybrand L.L.P. ("Coopers & Lybrand") as its auditors and retained KPMG Peat
Marwick LLP ("KPMG Peat Marwick"). Coopers & Lybrand's report for each of the
fiscal years ended June 30, 1993, and June 30, 1994, indicated uncertainties as
to the Company's ability to continue as a going concern. However, Coopers &
Lybrand's report for these years did not contain an adverse opinion or a
disclaimer of opinion and was not qualified or modified as to audit scope or
accounting principles.
During the fiscal years ended June 30, 1993, and June 30, 1994, and the
subsequent interim periods immediately preceding the change in accountants,
there were no disagreements with Coopers & Lybrand on any matter of accounting
principles or practice, financial statement disclosure, or auditing scope or
procedure, which if not resolved to the satisfaction of Coopers & Lybrand would
have caused them to make reference to the subject matter of the disagreement in
connection with their reports on the Company's financial statements. During the
fiscal years ended June 30, 1993, and June 30, 1994, and the subsequent interim
periods immediately preceding the change in accountants, there were no
reportable events (as that term is used in Regulation S-K, Item 304(a)(1)(v)(A)
through (D) of the Exchange Act), except that at the March 30, 1994, meeting of
the Audit Committee at which representatives of Coopers & Lybrand were present,
Coopers & Lybrand communicated to the Audit Committee that through approximately
August 1993, documentation of equity or other non-cash transactions and controls
over cash were less than adequate. This matter was then discussed. The Company
has authorized Coopers & Lybrand to respond fully to the inquiries of KPMG Peat
Marwick concerning such reportable events.
105
<PAGE> 109
GLOSSARY
ACCESS CHARGES -- The fees paid by IXCs to LECs for originating and
terminating long distance calls on their local networks.
ATM (ASYNCHRONOUS TRANSFER MODE) -- A recently commercialized switching and
transmission technology that is one of a general class of packet technologies
that relay traffic by way of an address contained within the first five bits of
a standard fifty-three bit-long packet or cell. ATM switching was specifically
developed to allow switching and transmission of mixed voice, data and video
(sometimes referred to as "multi-media" information) at varying rates. The ATM
format can be used by many different information systems, including LANs.
BROADBAND -- Broadband communications systems can transmit large quantities
of voice, data and video by way of digital or analog signals. Examples of
broadband communication systems include DS-3 fiber optic systems, which can
transmit 672 simultaneous voice conversations, or a broadcast television station
that transmits high resolution audio and video signals into the home. Broadband
connectivity is also an essential element for interactive multimedia
applications.
CAP (COMPETITIVE ACCESS PROVIDER) -- 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. CAPs are also referred to in the industry as
alternative local telecommunications service providers (ALTs) and metropolitan
area network providers (MANs) and were formerly referred to as alternative
access vendors (AAVs).
CATVS -- Cable television service providers.
CENTRAL OFFICES -- The switching centers or central switching facilities of
the LECs.
CENTREX -- Centrex is a service that offers features similar to those of a
Private Branch Exchange (PBX), except the equipment is located at the carrier's
premises and not at the premises of the 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.
CLEC (COMPETITIVE LOCAL EXCHANGE CARRIER) -- a CAP that also provides
Switch Local Services such as local dial tone and centrex.
CO-CARRIER STATUS -- A relationship between a CLEC and an ILEC that affords
the same access and rights to the other's network, and provides access and
services on an equal basis.
COLLOCATION -- The ability of a CAP such as the Company to connect its
network to the LEC's central offices. Physical collocation occurs when a CAP
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 CAP to connect its network to the LEC's central offices at
competitive prices, even though the CAP'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 generally offered by CAPs, including the Company.
DIGITAL -- A method of storing, processing and transmitting information
through the use of distinct electronic or optical pulses that represent the
binary code digits 0 and 1. Digital transmission and switching technologies
employ a sequence of these pulses to represent information as opposed to the
continuously variable analog signal. Digital transmission and switching
technologies offer a threefold improvement in speed and capacity over analog
techniques, allowing much more efficient and cost-effective transmission of
voice, video and data.
DS-0, DS-1, DS-3 -- Standard telecommunications industry digital signal
formats, which are distinguishable by bit rate (the number of binary digits (0
and 1) transmitted per second). DS-0 service has a bit
106
<PAGE> 110
rate of 64 kilobits per second. DS-1 service has a bit rate of 1.544 megabits
per second and DS-3 service has a bit rate of 45 megabits per second.
EBITDA -- Net income (loss) before net interest, income taxes, depreciation
and amortization.
FCC -- Federal Communications Commission.
FIBER MILES -- The number of route miles installed (excluding pending
installations) along a telecommunications path multiplied by the number of
fibers along that path. See the definition of "Route Miles" below.
FIBER OPTICS -- Fiber optic cable is the medium of choice for the
telecommunications and cable industries. Fiber is immune to electrical
interference and environmental factors that affect copper wiring and satellite
transmission. Fiber optic technology involves sending laser light pulses across
glass strands in order to transmit digital information. A strand of fiber optic
cable is as thick as a human hair yet has significantly greater bandwidth
capacity than copper cable, which is many times greater in size.
FIBER OPTIC RING NETWORK -- Most CAPs have built their networks in ring
configurations in order to ensure that, if one segment of a network is damaged
or cut, the traffic is simply re-routed and sent to its destination in the
opposite direction. The Company uses a "self-healing" optical fiber ring
architecture in its networks.
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.
ILEC (INCUMBENT LOCAL EXCHANGE CARRIER) -- An incumbent carrier providing
local exchange 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 CAP, long distance carrier or
end-user seeking such interconnection for the provision of interstate special
access and switched access transport services.
INTERNET PROTOCOL (IP) -- A compilation of network- and transport-level
protocols that allow computers with different architectures and operating system
software to communicate with other computers on the Internet.
ISDN (INTEGRATED SERVICES DIGITAL NETWORK) -- An internationally agreed
upon standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission line.
ISDN permits video-conferencing over a single line, for example, and also
supports a multitude of value-added networking capabilities, reducing costs for
end-users and results in more efficient use of available facilities. ISDN
combines standards for highly flexible customers to network signaling with both
voice and data within a common facility.
ISP -- An Internet service provider provides customers with access to the
Internet by linking its network directly or through other ISPs to the Internet
backbone network.
IXC (INTEREXCHANGE CARRIERS) -- See Long Distance Carrier.
LANS (LOCAL AREA NETWORKS) -- The interconnection of computers for the
purpose of sharing files, programs and various devices such as work stations,
printers and high-speed modems. LANs may include dedicated computers or file
servers that provide a centralized source of shared files and programs.
LATAS (LOCAL ACCESS AND TRANSPORT AREAS) -- The geographically defined
areas in which LECs are authorized by the MFJ to provide local switched
services.
LEC (LOCAL EXCHANGE CARRIER) -- A company providing local telephone
services.
LOCAL EXCHANGE AREAS -- A geographic area determined by the appropriate
state regulatory authority in which local calls generally are transmitted
without toll charges to the calling or called party.
LONG DISTANCE CARRIERS OR IXCS (INTEREXCHANGE CARRIERS) -- Long distance
carriers provide services between local exchanges on an interstate or intrastate
basis. A long distance carrier may offer services over its
107
<PAGE> 111
own or another carrier's facilities. Long distance carriers include, among
others, AT&T, MCI, Sprint, WorldCom and LCI, as well as resellers of long
distance capacity.
NAP -- Network Access Points are points where the national ISPs
interconnect their networks, allowing a multitude of local and regional ISPs to
exchange data and access the Internet globally.
NODE -- An individual point of origination and termination of data on the
network transported using frame relay or similar technology.
OFF-NET -- A customer that is not physically connected to one of the
Company's networks but who is accessed through interconnection with a LEC
network.
ON-NET -- A customer that is physically connected to one of the Company's
networks.
PBX (PRIVATE BRANCH EXCHANGE) -- A switching system within an office
building which allows calls from outside to be routed directly to the individual
instead of through a central number. This PBX also allows for calling within an
office by way of four digit extensions. Centrex is a service which can simulate
this service from an outside switching source, thereby eliminating the need for
a large capital expenditure on a PBX.
PCS (PERSONAL COMMUNICATIONS SERVICE) -- A type of wireless telephone
system that uses light, inexpensive handheld sets and communicates via low power
antennas.
POPS (POINTS OF PRESENCE) -- Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.
PRIVATE LINE -- A private, dedicated telecommunications connection between
end-user locations (excluding long distance carrier POPs).
RBOCS (REGIONAL BELL OPERATING COMPANIES) -- The seven local telephone
companies established by the MFJ. These RBOCs are prohibited from providing
interLATA services and from manufacturing telecommunications equipment.
ROUTE MILES -- The number of miles of the telecommunications path in which
fiber optic cables are installed as it would appear on a network map.
SONET (SYNCHRONOUS OPTICAL NETWORK) -- A self-healing fiber optic ring that
constitutes a local network.
SPECIAL ACCESS SERVICES -- The lease of private, dedicated
telecommunications lines or "circuits" along the network of a ILEC or a CAP
(such as the Company), whose lines or circuit 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 an end-user 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 IXC POPs.
SWITCHED TRAFFIC -- Telecommunications traffic along a switched network.
VGE (VOICE GRADE EQUIVALENT CIRCUITS) -- A measure of service equivalent to
one telephone line (64 kilobits of bandwidth) actually billed to a customer.
108
<PAGE> 112
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report.......................................................... F-2
Consolidated Balance Sheets as of June 30, 1995 and 1996 and December 31, 1996........ F-3
Consolidated Statements of Operations for the Years Ended June 30, 1995 and 1996 and
for the Six Months Ended December 31, 1996.......................................... F-5
Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended June 30,
1995 and 1996 and for the Six Months Ended December 31, 1996........................ F-6
Consolidated Statements of Cash Flows for the Years Ended June 30, 1995 and 1996 and
for the Six Months Ended December 31, 1996.......................................... F-7
Notes to Consolidated Financial Statements............................................ F-8
Condensed Consolidated Balance Sheets (Unaudited) as of December 31, 1996 and
September 30, 1997.................................................................. F-22
Condensed Consolidated Statements of Operations (Unaudited) for the Three and Nine
Months Ended September 30, 1996 and 1997............................................ F-23
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended
September 30, 1996 and 1997......................................................... F-24
Notes to Unaudited Condensed Consolidated Interim Financial Statements................ F-25
</TABLE>
F-1
<PAGE> 113
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND STOCKHOLDERS
AMERICAN COMMUNICATIONS SERVICES, INC.:
We have audited the accompanying consolidated balance sheets of American
Communications Services, Inc. and subsidiaries as of June 30, 1995 and 1996 and
December 31, 1996, and the related consolidated statements of operations,
stockholders' equity (deficit), and cash flows for the years ended June 30, 1995
and 1996 and the six months ended December 31, 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 audit 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 American
Communications Services, Inc. and subsidiaries as of June 30, 1995 and 1996 and
December 31, 1996, and the results of their operations and their cash flows for
the years ended June 30, 1995 and 1996 and for the six months ended December 31,
1996 in conformity with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
--------------------------------------
KPMG PEAT MARWICK LLP
Washington, D.C.
February 14, 1997
F-2
<PAGE> 114
AMERICAN COMMUNICATIONS SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1995 AND 1996 AND DECEMBER 31, 1996
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1995 1996 1996
----------- ------------ ------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (note 1).............. $20,350,791 $134,115,981 $ 78,618,544
Restricted cash (note 1)........................ 752,000 2,342,152 2,342,152
Trade accounts receivable, net of allowance for
doubtful accounts of $8,600, $189,500, and
$432,400 at June 30, 1995, June 30, 1996 and
December 31, 1996, respectively.............. 350,436 735,260 2,429,077
Other current assets............................ 92,325 1,003,465 1,202,711
----------- ------------ ------------
Total current assets.............................. 21,545,552 138,196,858 84,592,484
Networks, equipment and furniture, gross (note
2).............................................. 15,897,562 80,147,964 144,403,123
Less: accumulated depreciation and amortization... (330,272) (3,408,698) (8,320,372)
----------- ------------ ------------
15,567,290 76,739,266 136,082,751
Deferred financing fees, net of accumulated
amortization of $64,458, $732,775 and
$1,070,670, at June 30, 1995, June 30, 1996 and
December 31, 1996, respectively................. 292,113 8,334,183 8,380,283
Other assets...................................... 222,010 329,584 982,649
----------- ------------ ------------
Total assets...................................... $37,626,965 $223,599,891 $230,038,167
=========== ============ ============
LIABILITIES, REDEEMABLE STOCK, OPTIONS AND
WARRANTS, MINORITY INTEREST AND STOCKHOLDERS'
EQUITY
Current liabilities:
Notes payable -- current portion (note 4)....... $ 146,083 $ 252,809 $ 872,031
Accounts payable................................ 3,843,167 21,317,346 33,587,407
Accrued financing fees.......................... 1,542,255 -- --
Accrued employee costs.......................... 836,509 774,262 2,057,187
Other accrued liabilities....................... 1,269,484 886,692 2,074,945
----------- ------------ ------------
Total current liabilities......................... 7,637,498 23,231,109 38,591,570
Long term liabilities:
Notes payable, less current portion (notes 4 and
6)........................................... 3,652,085 184,129,361 209,538,226
Dividends payable (note 3)...................... 1,070,985 4,942,313 6,945,943
----------- ------------ ------------
Total liabilities................................. 12,360,568 212,302,783 255,075,739
----------- ------------ ------------
Redeemable stock, options and warrants (notes 6, 9
and 11)......................................... 2,930,778 2,155,025 2,000,000
----------- ------------ ------------
Minority interest (note 4)........................ 194,402 160,270 --
----------- ------------ ------------
Stockholders' equity (deficit) (notes 3, 4, 5 and
6):
Preferred stock, $1.00 par value, 186,664 shares
designated as 9% Series A-1 Convertible
Preferred Stock authorized, issued and
outstanding at June 30, 1995, June 30, 1996
and December 31, 1996, respectively,
convertible into 7,466,560 shares of common
stock (notes 3 and 4)........................ 186,664 186,664 186,664
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 115
AMERICAN COMMUNICATIONS SERVICES, INC.
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1995 1996 1996
----------- ------------ ------------
<S> <C> <C> <C>
Preferred stock, $1.00 par value, 277,500 shares
authorized and designated as 9% Series B
Convertible Preferred Stock; 227,500, 277,500
and 277,500 shares issued and outstanding at
June 30, 1995, June 30, 1996 and December 31,
1996, respectively, convertible into
9,910,704 shares of common stock (notes 3 and
5)........................................... 227,500 277,500 277,500
Common stock, $.01 par value, 75,000,000 shares
authorized, 5,744,782, 6,645,691 and
6,784,996 shares issued and outstanding at
June 30, 1995, June 30, 1996 and December 31,
1996, respectively (note 5).................. 56,827 65,837 67,850
Additional paid-in capital................... 42,411,448 55,975,078 54,870,194
Accumulated deficit.......................... (20,741,222) (47,523,266) (82,439,780)
----------- ------------ ------------
Total stockholders' equity (deficit).............. 22,141,217 8,981,813 (27,037,572)
----------- ------------ ------------
Commitments and contingencies (notes 1, 4, 6, 7,
8, and 9).......................................
Total liabilities, redeemable stock, options and
warrants, minority interest and stockholders'
equity (deficit)................................ $37,626,965 $223,599,891 $230,038,167
=========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 116
AMERICAN COMMUNICATIONS SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE SIX
----------------------------- MONTHS ENDED
JUNE 30, JUNE 30, DECEMBER 31,
1995 1996 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues (note 1)................................ $ 388,887 $ 3,415,137 $ 6,990,452
Operating expenses:
Network development and operations............. 3,282,183 5,264,570 8,703,057
Selling, general and administrative............ 4,597,615 13,463,775 20,269,991
Noncash stock compensation (note 6)............ 6,419,412 2,735,845 549,645
Depreciation and amortization.................. 497,811 3,078,426 4,911,674
------------ ------------ ------------
Total operating expenses......................... 14,797,021 24,542,616 34,434,367
Non-operating income (expenses):
Interest and other income...................... 217,525 4,409,733 2,757,461
Interest and other expense (note 4)............ (170,095) (10,476,904) (10,390,330)
Debt conversion expense (note 4)............... (385,000) -- --
------------ ------------ ------------
Loss before minority interest.................... (14,745,704) (27,194,650) (35,076,784)
Minority interest................................ 48,055 412,606 160,270
------------ ------------ ------------
Net loss......................................... (14,697,649) (26,782,044) (34,916,514)
Preferred stock dividends and accretion (note
3)............................................. (1,070,985) (3,871,328) (2,003,630)
------------ ------------ ------------
Net loss to common stockholders.................. $(15,768,634) $(30,653,372) $(36,920,144)
============ ============ ============
Net loss per common share........................ $ (3.30) $ (4.96) $ (5.48)
============ ============ ============
Average number of common shares outstanding...... 4,771,689 6,185,459 6,733,759
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 117
AMERICAN COMMUNICATIONS SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED JUNE 30, 1995 AND 1996 AND THE SIX MONTHS ENDED DECEMBER 31,
1996
<TABLE>
<CAPTION>
SERIES A-1 SERIES B COMMON
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK STOCK
--------------------- ------------------- ------------------- ---------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES
------ ----------- ------- -------- ------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at June 30, 1994........................ 1,700 $ 1,700,000 -- $ -- -- $ -- 2,755,005
Preferred Stock exchange (note 12)............... (1,700) (1,700,000) -- -- -- -- 548,387
Set par value for common stock (note 5).......... -- -- -- -- -- -- --
Acquisition of Piedmont Teleport, Inc. (note
13)............................................. -- -- -- -- -- -- 62,000
Write-off of note receivable for common stock.... -- -- -- -- -- -- --
Series A Preferred private placement, net of
related costs (note 3).......................... -- -- 186,664 186,664 -- -- --
Series B Preferred private placement, net of
related costs (note 3).......................... -- -- -- -- 227,500 227,500 --
Issuance of put right obligations (notes 6 and
9).............................................. -- -- -- -- -- -- --
Cancelation of put right obligation (note 9)..... -- -- -- -- -- -- --
Warrant and stock option exercises and stock
grant (note 6).................................. -- -- -- -- -- -- 2,379,390
Establish limitation on common stock put right
obligation (note 6)............................. -- -- -- -- -- -- --
Series A Preferred Stock dividends accrued (note
3).............................................. -- -- -- -- -- -- --
Net loss......................................... -- -- -- -- -- -- --
------ ----------- ------- -------- ------- -------- ---------
Balances at June 30, 1995........................ -- $ -- 186,664 $186,664 227,500 $227,500 5,744,782
Issuance of Series B-4 Preferred Stock (note
3).............................................. -- -- -- -- 50,000 50,000 --
Issuance of detachable warrants (notes 4 and
6).............................................. -- -- -- -- -- -- --
Warrants and stock options exercised (note 6).... -- -- -- -- -- -- 900,909
Series A and B Preferred Stock dividends accrued
(note 3)........................................ -- -- -- -- -- -- --
Cancelation of and adjustments to put right
obligations (note 6)............................ -- -- -- -- -- -- --
Stock compensation expense....................... -- -- -- -- -- -- --
Net loss......................................... -- -- -- -- -- -- --
------ ----------- ------- -------- ------- -------- ---------
Balances at June 30, 1996........................ -- $ -- 186,664 $186,664 277,500 $277,500 6,645,691
Warrants and stock options exercised (note 6).... -- -- -- -- -- -- 139,305
Series A and B Preferred Stock dividends accrued
(note 3)........................................ -- -- -- -- -- -- --
Accretion of consulting agreement credit to
exercise price of warrants (note 9)............. -- -- -- -- -- -- --
Cancelation of and adjustments to put right
obligations (note 6)............................ -- -- -- -- -- -- --
Stock compensation expense....................... -- -- -- -- -- -- --
Net loss......................................... -- -- -- -- -- -- --
------ ----------- ------- -------- ------- -------- ---------
Balances at December 31, 1996.................... -- $ -- 186,664 $186,664 277,500 $277,500 6,784,996
====== =========== ======= ======== ======= ======== =========
<CAPTION>
NOTES
RECEIVABLE TOTAL
ADDITIONAL ON SALE OF STOCKHOLDERS'
PAID-IN COMMON ACCUMULATED EQUITY
AMOUNT CAPITAL STOCK DEFICIT (DEFICIT)
------- ----------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balances at June 30, 1994........................ $ -- $ 1,080,566 $ (2,750) $ (6,043,573) $ (3,265,757)
Preferred Stock exchange (note 12)............... -- 1,700,000 -- -- --
Set par value for common stock (note 5).......... 33,033 (33,033) -- -- --
Acquisition of Piedmont Teleport, Inc. (note
13)............................................. -- -- -- -- --
Write-off of note receivable for common stock.... -- (2,750) 2,750 -- --
Series A Preferred private placement, net of
related costs (note 3).......................... -- 15,009,461 -- -- 15,196,125
Series B Preferred private placement, net of
related costs (note 3).......................... -- 20,434,000 -- -- 20,661,500
Issuance of put right obligations (notes 6 and
9).............................................. -- (53,303) -- -- (53,303)
Cancelation of put right obligation (note 9)..... -- 487,500 -- -- 487,500
Warrant and stock option exercises and stock
grant (note 6).................................. 23,794 349,030 -- -- 372,824
Establish limitation on common stock put right
obligation (note 6)............................. -- 4,510,962 -- -- 4,510,962
Series A Preferred Stock dividends accrued (note
3).............................................. -- (1,070,985) -- -- (1,070,985)
Net loss......................................... -- -- -- (14,697,649) (14,697,649)
------- ----------- ------- ------------ ------------
Balances at June 30, 1995........................ $56,827 $42,411,448 $ -- $(20,741,222) $ 22,141,217
Issuance of Series B-4 Preferred Stock (note
3).............................................. -- 4,950,000 -- -- 5,000,000
Issuance of detachable warrants (notes 4 and
6).............................................. -- 8,684,000 -- -- 8,684,000
Warrants and stock options exercised (note 6).... 9,010 289,360 -- -- 298,370
Series A and B Preferred Stock dividends accrued
(note 3)........................................ -- (3,871,328) -- -- (3,871,328)
Cancelation of and adjustments to put right
obligations (note 6)............................ -- 775,753 -- -- 775,753
Stock compensation expense....................... -- 2,735,845 -- -- 2,735,845
Net loss......................................... -- -- -- (26,782,044) (26,782,044)
------- ----------- ------- ------------ ------------
Balances at June 30, 1996........................ $65,837 $55,975,078 $ -- $(47,523,266) $ 8,981,813
Warrants and stock options exercised (note 6).... 1,393 175,945 -- -- 177,338
Series A and B Preferred Stock dividends accrued
(note 3)........................................ -- (2,003,630) -- -- (2,003,630)
Accretion of consulting agreement credit to
exercise price of warrants (note 9)............. -- 18,750 -- -- 18,750
Cancelation of and adjustments to put right
obligations (note 6)............................ 620 154,405 -- -- 155,025
Stock compensation expense....................... -- 549,646 -- -- 549,646
Net loss......................................... -- -- -- (34,916,514) (34,916,514)
------- ----------- ------- ------------ ------------
Balances at December 31, 1996.................... $67,850 $54,870,194 $ -- $(82,439,780) $ (27,037,572)
======= =========== ======= ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 118
AMERICAN COMMUNICATIONS SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE SIX
------------------------------ MONTHS ENDED
JUNE 30, JUNE 30, DECEMBER 31,
1995 1996 1996
------------ ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss............................................................. $(14,697,649) $ (26,782,044) $(34,916,514)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization...................................... 497,811 3,078,426 4,911,674
Interest deferral and accretion.................................... -- 10,447,687 10,041,189
Amortization of deferred financing fees............................ 323,900 668,317 334,671
Provision for doubtful accounts...................................... 8,570 180,940 242,915
Loss from impairment of assets....................................... -- -- 318,737
Loss attributed to minority interest................................. (48,055) (412,606) (160,270)
Noncash compensation, consultants and other expenses................. 6,419,412 2,735,845 549,645
Accretion of consulting agreement credit to exercise price of
warrants........................................................... -- -- 18,750
Noncash debt conversion expense...................................... 385,000 -- --
Changes in operating assets and liabilities:
Trade accounts receivable.......................................... (359,007) (565,764) (1,936,732)
Restricted cash related to operating activities.................... 200,000 -- --
Other current assets............................................... (92,325) (911,140) (199,246)
Other assets....................................................... (26,545) (107,574) (653,065)
Accounts payable................................................... 3,170,885 17,474,179 12,270,061
Accrued financing fees............................................. 1,542,255 (1,542,255) --
Accrued employee costs............................................. 719,333 (62,247) 1,282,925
Other accrued liabilities.......................................... 1,055,673 (382,792) 1,188,253
------------ ------------- ------------
Net cash (used in) provided by operating activities.................. (900,742) 3,818,972 (6,707,007)
------------ ------------- ------------
Cash flows from investing activities:
Purchase of net assets of Piedmont Teleport, Inc................... (19,135) -- --
Purchase of equipment and furniture................................ (306,454) (2,966,987) (1,827,119)
Restricted cash related to network activities...................... (752,000) (1,590,152) --
Network development costs.......................................... (14,996,303) (57,889,227) (62,746,777)
------------ ------------- ------------
Net cash used in investing activities................................ (16,073,892) (62,446,366) (64,573,896)
------------ ------------- ------------
Cash flows from financing activities:
Issuance of notes payable.......................................... 3,510,349 166,888,210 16,329,923
Payment of deferred financing fees................................. (310,175) (8,710,387) (380,771)
Warrant and stock option exercises................................. 372,824 298,370 177,338
Issuances of Series A Preferred Stock, net of offering costs and
conversion of bridge financing................................... 10,962,046 -- --
Issuances of Series B Preferred Stock, net of offering costs....... 20,661,500 5,000,000 --
Issuance of warrants with 2005 Notes............................... -- 8,684,000 --
Issuance of notes payable--stockholders............................ 250,000 -- --
Proceeds from sale of minority interest in subsidiaries............ 242,457 378,474 --
Payment of equipment financing..................................... -- -- (343,024)
Payments of notes payable--stockholders............................ (481,692) (146,083) --
Payments of bridge notes........................................... (1,000,000) -- --
Payments of secured note........................................... (75,000) -- --
Payments of secured convertible notes.............................. (77,281) -- --
------------ ------------- ------------
Net cash provided by financing activities............................ 34,055,028 172,392,584 15,783,466
------------ ------------- ------------
Net (decrease) increase in cash and cash equivalents................. 17,080,394 113,765,190 (55,497,437)
Cash and cash equivalents, beginning of year......................... $ 3,270,397 $ 20,350,791 $134,115,981
------------ ------------- ------------
Cash and cash equivalents, end of year............................... $ 20,350,791 $ 134,115,981 $78,618,544
============ ============= ============
Supplemental disclosure of cash flow information--interest paid on
all debt obligations............................................... $ 219,554 $ 29,217 $ 14,470
============ ============= ============
Supplemental disclosure of noncash investing and financing
activities:
Equipment financing................................................ $ -- $ 343,024 --
============ ============= ============
Dividends declared in connection with Series A Preferred Stock..... $ 1,070,985 $ 3,871,328 $ 2,003,630
============ ============= ============
Bridge financing, secured convertible notes, and notes
payable--stockholders converted to equity in connection with
Offerings.......................................................... $ 4,080,079 $ -- $ --
============ ============= ============
Cancellation of and adjustments to put right obligations............. $ (487,500) $ (775,753) $ (155,025)
============ ============= ============
Write off of note receivable from sale of common stock............... $ 2,750 $ -- $ --
============ ============= ============
Preferred stock exchange............................................. $ 1,700,000 $ -- $ --
============ ============= ============
Purchase of Piedmont Teleport, Inc. for common stock and related put
right obligation................................................... $ 192,303 $ -- $ --
============ ============= ============
Negotiation of right-of-way agreement for option discount............ $ 201,000 $ -- $ --
============ ============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 119
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1995 AND 1996 AND DECEMBER 31, 1996
(1) BASIS OF PRESENTATION AND RELATED MATTERS
Fiscal Year
Effective December 31, 1996, the Company changed its fiscal year from a
twelve-month period ending June 30 to a twelve-month period ending December 31.
The consolidated statements of operations, stockholders' equity (deficit) and
cash flows are presented for the twelve month period ended June 30, 1995, the
twelve month period ended June 30, 1996 and the six month period ended December
31, 1996.
The Unaudited Condensed Consolidated Statement of Operations information
for the six months ended December 31, 1995 is as follows:
<TABLE>
<S> <C>
Revenues....................................................... $ 988,877
Operating expenses............................................. 7,966,463
Non-operating expenses......................................... 2,057,410
-----------
Loss before minority interest.................................. (9,034,996)
Minority interest.............................................. 155,861
-----------
Net loss....................................................... (8,879,135)
Preferred stock dividends and accretion........................ (1,854,495)
-----------
Net loss to common stockholders................................ (10,733,630)
-----------
Net loss per common share...................................... (1.82)
Average number of common shares outstanding.................... 5,900,606
===========
</TABLE>
Organization
The consolidated financial statements include the accounts of American
Communications Services, Inc. and its majority-owned subsidiaries (ACSI or the
Company). As discussed in note 4 to the consolidated financial statements, all
of the Company's subsidiaries are wholly owned with the exception of the
Louisville, Fort Worth, El Paso, Greenville, and Columbia subsidiaries, in which
the Company has a 92.75% controlling ownership interest. All material
intercompany accounts and transactions have been eliminated in consolidation.
Business and Operating Environment
ACSI constructs and operates digital fiber optic networks and offers local
telecommunications services to long distance companies and business and
government end-users in selected target markets, principally in the southern
United States. The Company provides nonswitched dedicated services, including
special access, switched transport and private line services. In addition to
these dedicated services, the Company is developing and has begun offering high
speed data services to business, government and other communications carriers,
including Internet service providers. The Company has also begun offering, on a
limited basis, enhanced voice messaging services and plans to begin offering
local switched voice services in the future. The Company is a competitive local
exchange carrier and is referred to as a competitive access provider with
respect to provision of dedicated services.
To date, the Company has funded the construction of its networks and its
operations with external financing. Prior to November 1995, the primary sources
of funds were two Preferred Stock private offerings completed in October 1994
and June 1995 (see note 3), and a credit facility from AT&T Credit Corporation
(see note 4). During the fiscal year ended June 30, 1996, the Company raised
additional funds through an additional sale of Preferred Stock (see note 3), two
private offerings of Senior Notes, one of which included detachable warrants and
further borrowings under the AT&T Credit Corporation Credit Facility (see note
4).
F-8
<PAGE> 120
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has never been profitable, has never generated positive cash
flow from consolidated operations and, since its inception has incurred
significant net operating losses and negative cash flow. In accordance with the
terms of its debt facilities the Company has also deferred payment of most of
its interest charges. The Company's continued development, construction,
expansion, operation and potential acquisition of local networks, as well as the
further development of new services, including local switched voices and high-
speed data services, will require substantial capital expenditures. The
Company's ability to fund these expenditures is dependent upon the Company's
raising substantial financing. To meet its remaining capital requirements and to
fund operations and cash flow deficiencies, ACSI will be required to sell
additional equity securities, increase its existing credit facility, acquire
additional credit facilities or sell additional debt securities, certain of
which would require the consent of the Company's debtholders. Before incurring
additional indebtedness, the Company may be required to seek additional equity
financing to maintain balance sheet and liquidity ratios under certain of its
debt instruments. There can be no assurance that the Company will be able to
obtain the additional financing necessary to satisfy its cash requirements or to
successfully implement its growth strategy. Failure to raise sufficient capital
could compel the Company to delay or abandon some or all of its plans or
expenditures, which could have a material adverse effect on its business,
results of operations and financial condition.
Cash Equivalents and Restricted Cash
Pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities", the Company's short and long-term debt securities and
marketable equity securities are accounted for at market value. The fair market
value of short- and long-term investments is determined based on quoted market
prices for those investments. The Company's marketable securities have been
classified as available for sale and are recorded at current market value with
an offsetting adjustment to stockholders' equity (deficit).
The Company's investments consist of commercial paper, U.S. Government
Securities and money market instruments, all with original maturities of 90 days
or less. The fair market value of such securities approximates amortized cost.
At June 30, 1995 and 1996 and December 31, 1996, cash equivalents consists of
government securities and overnight investments.
The Company has provided performance bonds and letters of credit in various
cities in connection with its operations, resulting in a restriction of cash
amounting to $752,000, $2,342,000 and $2,342,000 at June 30, 1995, June 30, 1996
and December 31, 1996, respectively. The face amount of all bonds and letters of
credits was approximately $6,200,000 as of December 31, 1996.
Networks, Equipment and Furniture
Networks, equipment and furniture are stated at cost less accumulated
depreciation and amortization. Costs capitalized during the network development
stage include expenses associated with network engineering, design and
construction, negotiation of rights-of-way, obtaining legal and regulatory
authorizations and the amount of interest costs associated with the network
development.
Provision for depreciation of networks, equipment and furniture is computed
using the straight-line method over the estimated useful lives of the assets
beginning in the month a network is substantially complete and available for use
and equipment and furniture are acquired.
F-9
<PAGE> 121
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The estimated useful lives of the Company's principal classes of assets are
as follows:
<TABLE>
<S> <C>
Networks:
Fiber optic cables and installation costs............ 20 years
Telecommunications equipment......................... 3-7 years
Interconnection and collocation costs................ 3-10 years
Leasehold improvements................................. Life of lease
Furniture and fixtures................................. 5 years
Capitalized network development costs.................. 3-20 years
</TABLE>
The Company adopted the provisions of SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" on
January 1, 1996. This statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. Adoption of this statement did not have a material impact on the Company's
financial position, results of operations, or liquidity.
Deferred Financing Fees
Deferred financing fees include commitment fees and other costs related to
certain debt financing transactions and are being amortized using the effective
interest method over the initial term of the related debt.
Revenue Recognition
Revenue is recognized as services are provided. Billings to customers for
services in advance of providing such services are deferred and recognized as
revenue when earned. The Company also enters into managed services agreements
with certain customers. Under such agreements the Company provides use of
Company owned equipment, collocation and network access services. Revenue is
recognized on a monthly basis as these services are provided to the customer.
Earnings (Loss) Per Common Share
The computation of earnings (loss) per common share is based upon the
weighted average number of common shares outstanding. The effect of including
common stock options and warrants as common stock equivalents would be
anti-dilutive and is excluded from the calculation of loss per common share.
Income Taxes
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carryforwards and tax credit carryforwards for which income tax benefits are
expected to be realized in future years. A valuation allowance is established to
reduce deferred tax assets if it is more likely than not that all, or some
portion, of such deferred tax assets will not be realized. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date.
F-10
<PAGE> 122
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reclassifications
Certain reclassifications have been made to the June 30, 1995 and 1996
consolidated financial statements to conform to the December 31, 1996
presentation. Such reclassifications had no effect on net loss or total
stockholders' equity (deficit).
Stock Option Plan
Prior to July 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees", and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
July 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock Based
Compensation", which permits entities to recognize as expense over the vesting
period the fair value of all stock based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosure for employee stock option grants as if the fair-
value based method defined in SFAS No. 123 had been applied. The Company has
elected to continue to apply the provisions of APB Opinion No. 25 and provide
the pro forma disclosure provisions of SFAS No. 123.
Use of Estimates
The preparation of the consolidated 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 dates of the consolidated
financial statements and the reported amounts of revenue and expenses during the
reporting period. Actual results may differ from those estimates.
Concentration of Credit Risk
The Company receives a significant portion of its revenues from a small
number of major customers, particularly the long distance telecommunications
companies that service the Company's markets. For the years ended June 30, 1995
and June 30, 1996 and the six months ended December 31, 1996 approximately 85%,
60% and 40% of the Company's revenues were attributable to services provided to
three, four and four of the largest long distance telecommunications companies,
respectively. The loss of any one of these customers could have an adverse
material impact on the Company's revenues.
The Company provides managed services to certain Internet service
providers. Such companies operate in a highly competitive and uncertain
environment. Approximately 19% of the Company's revenues for the six months
ended December 31, 1996 were attributed to these companies. At December 31,
1996, the Company had trade accounts receivable of $923,000 from Internet
service providers. The Company also has approximately $4.5 million in equipment
dedicated to providing service to these companies. The Company believes that, if
necessary, this equipment could be redeployed throughout the Company's data
network.
F-11
<PAGE> 123
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) NETWORKS, EQUIPMENT AND FURNITURE
Networks, equipment and furniture consists of the following:
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1995 1996 1996
----------- ----------- ------------
<S> <C> <C> <C>
Networks and telecommunications equipment.......... $15,570,450 $76,853,865 $139,129,495
Furniture and fixtures............................. 188,534 1,982,910 3,334,147
Computer software.................................. 56,485 948,848 1,558,384
Leasehold improvements............................. 82,093 362,341 381,097
----------- ----------- ------------
15,897,562 80,147,964 144,403,123
Less -- accumulated depreciation and
amortization..................................... 330,272 3,408,698 8,320,372
----------- ----------- ------------
Total, net of accumulated depreciation and
amortization..................................... $15,567,290 $76,739,266 $136,082,751
=========== =========== ============
</TABLE>
For the years ended June 30, 1995 and 1996, the Company capitalized
interest of approximately $536,000 and $3,051,000, respectively. For the six
months ended December 31, 1996, the Company capitalized interest of
approximately $2,268,000.
(3) PRIVATE PLACEMENTS
In October 1994, the Company completed a private placement of its 9% Series
A Convertible Preferred Stock, $1.00 par value (the "Series A Preferred Stock").
There were 138,889 shares issued for cash at $90 per share resulting in proceeds
of $10,962,046, net of placement agent commissions and related placement fees
and costs.
In addition, bridge financing was converted and several other obligations
were retired with proceeds of the offering. See note 4 to the consolidated
financial statements. Further, as discussed in note 6 to the consolidated
financial statements, certain parties obtained warrants to purchase shares of
the Company's common stock. In June 1995, the Series A Preferred Stock was
exchanged for an identical number of 9% Series A-1 Convertible Preferred Stock,
$1.00 par value (the "Series A-1 Preferred Stock").
In June 1995, the Company completed a private placement of its 9% Series
B-1 Convertible Preferred Stock (the "Series B-1 Preferred"), 9% Series B-2
Convertible Preferred Stock (the "Series B-2 Preferred") and 9% Series B-3
Convertible Preferred Stock (the "Series B-3 Preferred"), each having a par
value of $1.00 per share. There were 227,500 shares issued for cash at $100 per
share with proceeds of $20,661,500, net of placement agent commissions and
related placement fees and costs. In November 1995, 50,000 shares of 9% Series
B-4 Convertible Preferred Stock (the "Series B-4 Preferred") were issued for
cash of $100 per share resulting in proceeds of $5,000,000. The Series B-1
Preferred, the Series B-2 Preferred, the Series B-3 Preferred and the Series B-4
Preferred are hereafter collectively referred to as the "Series B Preferred
Stock." The Series A-1 Preferred Stock and the Series B Preferred Stock are
hereafter collectively referred to as the "Preferred Stock." Further, as
discussed in note 6 to the consolidated financial statements, certain parties
obtained warrants to purchase shares of the Company's common stock.
The Company's Preferred Stock and common stock vote as a single class
(except with respect to the election of directors and certain other transactions
and matters) with the common stock entitled to one vote per share and the
Preferred Stock entitled to one vote for each share of common stock into which
it is convertible. At December 31, 1996, the outstanding Series A-1 Preferred
Stock was convertible into 7,466,560 shares of common stock and the outstanding
Series B Preferred Stock was convertible into 9,910,704 shares of common stock.
Pursuant to the Company's certificate of incorporation, the board of
directors is currently comprised of seven directors. The holders of common stock
are entitled to elect four directors and the holders of the
F-12
<PAGE> 124
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Preferred Stock are entitled to elect three directors. In addition, certain
transactions and matters require the consent of the holders of at least 75% of
the shares of Preferred Stock voting as a separate class.
Certain holders of the Company's Preferred Stock and common stock have
entered into a Voting Rights Agreement pursuant to which such stockholders have
agreed to vote their shares of Preferred Stock and common stock for the election
of directors designated by the majority Preferred stockholders.
In connection with its Series A-1 and Series B Preferred Stock, the Company
has recorded approximately $1,071,000, $4,942,000 and $6,946,000 as of June 30,
1995, June 30, 1996 and December 31, 1996, respectively, as a reduction in
additional paid-in capital, for the payment of anticipated dividends. The
Company's certificate of incorporation requires the Company to accrue dividends,
on a quarterly basis, at an annual rate of 9% of the face value of the Series
A-1 and B Preferred Stock.
Although the Board of Directors of the Company has not taken any formal
action as of December 31, 1996, as a condition of the aforementioned provisions
of the certificate of incorporation, the dividends have been deemed declared and
properly reflected in the accompanying consolidated financial statements.
Pursuant to the Company's certificate of incorporation, dividends accrued shall
be paid cumulatively, beginning January 1, 1998, or earlier upon conversion.
Upon a voluntary conversion on or before December 31, 1997, the Company shall,
in lieu of accrued and unpaid dividends, issue promissory notes to the holders
of the Preferred Stock. The Company expects to issue promissory notes to the
holders on January 1, 1998 for dividends accrued, if conversion has not
occurred, subject to restrictions included in the Senior Discount Note
Indentures. Conversion may occur at any time at the holder's option or
automatically, upon a certain qualifying issuance of common stock. As of
December 31, 1996, no conversions had occurred.
(4) DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1995 1996 1996
---------- ------------ ------------
<S> <C> <C> <C>
Notes payable -- stockholders at 10-15%, maturing
September 15, 1995............................... $ 146,083 -- --
AT&T Credit Corporation equipment and working
capital financing facility....................... 3,652,085 $ 14,971,122 $ 30,183,264
2006 Senior Discount notes, interest at 12 3/4%,
maturing April 1, 2006........................... -- 66,635,887 70,824,922
2005 Senior Discount notes, interest at 13%,
maturing November 1, 2005........................ -- 102,432,137 109,402,071
Secured equipment note payable, interest of 9.98%,
payable in 36 equal monthly installments of
$2,766, including interest commencing March 1,
1996............................................. -- 343,024 --
---------- ------------ ------------
Total long-term debt............................... 3,798,168 184,382,170 210,410,257
Less current portion............................... 146,083 252,809 872,031
---------- ------------ ------------
$3,652,085 $184,129,361 $209,538,226
========== ============ ============
</TABLE>
F-13
<PAGE> 125
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Principal payments for each of the years from 1997 to 2001 and thereafter
are due as follows at December 31, 1996:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
-------------------------------------------------------
<S> <C>
1997................................................... $ 872,031
1998................................................... 1,190,150
1999................................................... 2,124,721
2000................................................... 3,250,483
2001................................................... 4,618,260
Thereafter............................................. 198,354,612
------------
$210,410,257
============
</TABLE>
Notes Payable -- Stockholders
At June 30, 1995, the Company had a total of $146,083 in notes payable to
stockholders which matured and were repaid on September 14, 1995.
AT&T Credit Corporation Equipment and Working Capital Financing Facility
In October 1994, the Company entered into the AT&T Credit Facility pursuant
to which AT&T Credit Corporation has agreed to provide financing for the
development and construction of fiber optic networks by certain of the Company's
subsidiaries. In accordance with the terms of the facility, the Company is
obligated to use at least 10% of the borrowed funds for purchases of equipment
manufactured by AT&T or its affiliates. Pursuant to the AT&T Credit Facility,
during fiscal 1995 the Company's subsidiaries in Louisville, Fort Worth,
Greenville and Columbia entered into loan agreements with AT&T Credit
Corporation providing for up to $19.8 million in loans collateralized by the
assets of such subsidiaries. As of June 30, 1995, an aggregate of approximately
$3.7 million had been borrowed under these agreements. Subsequent to June 30,
1995, the Company's subsidiary in E1 Paso entered into a separate loan agreement
with AT&T Credit Corporation pursuant to the AT&T Credit Facility providing for
up to an aggregate of approximately $5.5 million in loans collateralized by its
assets. During the fiscal year ended June 30, 1996, the existing loan agreements
were amended to increase the aggregate credit available under such agreements to
$31.2 million. As of June 30, 1996 and December 31, 1996, outstanding borrowings
under the AT&T Credit Facility totaled approximately $15 million and $30
million, respectively, including accrued interest of approximately $1.4 million
and $2.7 million, respectively. Interest rates currently applicable to the loans
range from 11.93% to 14.47%.
The loans under the AT&T Credit Facility are collateralized by all of the
assets of the respective borrowing subsidiary, including its installed fiber
optic system and other equipment. The principal is payable in 28 consecutive
quarterly installments, beginning with the ninth quarter after the date of the
loan. The principal may be prepaid in certain circumstances, and must be prepaid
along with a premium in other circumstances. Interest is due quarterly. At the
borrowing subsidiary's option, the interest rate may be fixed or variable. The
borrowing subsidiary has a one-time option to convert all variable rate loans to
fixed rate loans. Upon certain events of default, additional interest ranging
from 2% to 4% will become payable. Interest may generally be deferred so long as
it would not cause the outstanding principal balance to exceed the commitment
amounts for Capital Loans and for Equipment Loans (as defined in the loan
documents). To date, the Company has elected to defer all interest due under the
loans. In addition, the AT&T Credit Facility includes covenants, some of which
impose certain restrictions on the Company and its restricted subsidiaries
including restrictions on the declaration or payment of dividends, the conduct
of certain activities, certain capital expenditures, the creation of additional
liens or indebtedness, the disposition of assets, transactions with affiliates
and extraordinary corporate transactions. The AT&T Credit Facility imposes
restrictions on the ability of those subsidiaries of ACSI that incur
indebtedness thereunder to transfer funds to ACSI in the form of dividends or
F-14
<PAGE> 126
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
other distributions. The AT&T Credit Facility also imposes restrictions on the
ability of such subsidiaries to raise capital by incurring additional
indebtedness. These restrictions could limit ACSI's ability to meet its
obligations with respect to the 2005 and 2006 Senior Discount Notes.
Pursuant to the AT&T Credit Facility, AT&T Credit Corporation purchased
7.25% of the outstanding capital stock of each of the Company's operating
subsidiaries for which it provided financing. The Company was required to pledge
its interest in these subsidiaries to AT&T Credit Corporation as a condition to
each loan. Under certain circumstances, this pledge agreement also restricts the
Company's ability to pay dividends on its capital stock.
2005 Senior Discount Notes and 2006 Senior Discount Notes
On November 14, 1995, the Company completed an offering of 190,000 Units
(the "Units") consisting of $190,000,000 principal amount of 13% Senior Discount
Notes due 2005 (the "2005 Notes") and warrants to purchase 2,432,000 shares of
the Company's common stock at a price of $7.15 per share (the "Warrants"). The
2005 Notes will accrete at a rate of 13% compounded semi-annually to an
aggregate principal amount of $190,000,000 by November 1, 2000. Thereafter,
interest on the 2005 Notes will accrue at the annual rate of 13% and will be
payable in cash semi-annually. The Company received net proceeds of
approximately $96,105,000 from the sale of the Units. The value ascribed to the
Warrants was $8,684,000.
On March 21, 1996, the Company completed an offering of $120,000,000 of
12 3/4% Senior Discount Notes due 2006 (the "2006 Notes") resulting in net
proceeds of approximately $61,800,000. The 2006 Notes will accrete at a rate of
12 3/4% compounded semi-annually, to an aggregate principal amount of
$120,000,000 by April 1, 2001. Thereafter, interest on the 2006 Notes will
accrue at the annual rate of 12 3/4% and will be payable in cash semi-annually
on April 1 and October 1, commencing on October 1, 2001. The 2006 Notes will
mature on April 1, 2006.
The 2005 Notes and 2006 Notes (collectively the "Notes") are general,
unsubordinated and unsecured obligations of the Company. The Company's
subsidiaries have no obligation to pay amounts due on the Notes and do not
guarantee the notes. Therefore, the Notes are effectively subordinated to all
liabilities of ACSI's subsidiaries, including trade payables. 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 subsidiaries will be subject to the prior claims of
that subsidiary's creditors.
The Notes are subject to certain covenants which, among other things,
restrict the ability of ACSI and certain of its subsidiaries to incur additional
indebtedness, pay dividends or make distributions.
Debt Conversion
On June 28, 1994, the Company issued a total of $4,300,720 principal of its
15 percent convertible bridge notes due December 31, 1994, including $1,300,720
issued to then existing stockholders. During 1995, the holders of $3,300,720 of
these convertible bridge notes converted the notes plus accrued interest thereon
of $35,754 into 37,073 shares of Series A Preferred Stock. The remaining
$1,000,000 principal amount was retired by cash payment from the proceeds of the
Series A Preferred Stock private offering (see note 3). The Company recorded
noncash debt conversion expense of $231,000 associated with the related
unamortized financing fees.
At June 30, 1994, the Company had outstanding loans from affiliates with an
aggregate principal balance of $606,640, which were notes secured by certain
assets of the Company. These loans bore interest at 15% per annum and had a
scheduled maturity date of December 31, 1994.
In October 1994, the holders of $529,359 principal amount of these notes,
plus accrued interest thereon of $29,368, converted the notes into 7,924 shares
of Series A Preferred Stock. The remaining principal on the
F-15
<PAGE> 127
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
secured convertible notes of $77,281 was retired by a cash payment from the
proceeds of the Series A Preferred Stock private offering (see note 3). The
Company recorded noncash debt conversion expense of $154,000 equal to the
premium to induce conversion.
In August 1994, the Company borrowed $250,000, at a rate of 15% per annum
from an affiliate that was payable on demand. In October 1994, this note was
converted into 2,778 shares of Series A Preferred Stock.
(5) STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock
In fiscal 1995, the Company established a par value of $.01 for its issued
and outstanding common stock.
Preferred Stock
Pursuant to the Series B Preferred Stock offerings, as described in note 3,
four classes of Series B Preferred Stock have been designated and issued. The
composition of the Series B Preferred Stock at December 31, 1996 is as follows:
<TABLE>
<S> <C>
Preferred Stock, $1.00 par value, 100,000 shares designated as 9% Series
B-1 Convertible Preferred Stock authorized, issued and outstanding...... $100,000
Preferred Stock, $1.00 par value, 102,500 shares designated as 9% Series
B-2 Convertible Preferred Stock authorized, issued and outstanding...... 102,500
Preferred Stock, $1.00 par value, 25,000 shares designated as 9% Series
B-3 Convertible Preferred Stock authorized, issued and outstanding...... 25,000
Preferred Stock, $1.00 par value, 50,000 shares designated as 9% Series
B-4 Convertible Preferred Stock authorized, issued and outstanding...... 50,000
--------
Total..................................................................... $277,500
========
</TABLE>
(6) STOCK OPTIONS AND STOCK PURCHASE WARRANTS
The Company has a stock option plan which provides for the granting of
options to officers, employees, directors and consultants of the Company to
purchase shares of its common stock within prescribed periods.
In 1994, the Company entered into employment agreements with five executive
officers. Pursuant to the agreements, as amended, such officers have been
granted options to purchase an aggregate of 4,149,834 shares of common stock of
the Company at exercise prices ranging from $.875 to $3.40 per share. The
options vest at various dates as specified in the employment agreements with
4,069,834 of the options vesting on specific dates ranging from November 1, 1993
to November 4, 2001, and 80,000 of such options which vested upon the occurrence
of certain specified performance milestones. When the employment of these
individuals with the Company terminates, these individuals have the right to
sell certain of their shares to the Company (the put right) for a price equal to
fair market value. On June 26, 1995, the employment agreements were amended to
limit the purchase price paid by the Company pursuant to the put right to a
maximum of $2,500,000, which amount is subject to further reductions based on
the employees' sales of stock. During the year ended June 30, 1996, the limit
was further reduced to $2,000,000.
The Company has also issued 500,000 options to a supplier to purchase stock
at 90% of the fair value at the date of exercise. Such options give the supplier
the right to sell the stock acquired back to the Company at fair value under
certain circumstances. None of the options have been exercised to date and they
expire in December, 1997.
The Company applies APB Opinion 25 and related Interpretations in
accounting for its plans. Accordingly, compensation cost has been recognized for
its stock option plans based on the intrinsic value of the option at the date of
grant. The compensation cost that has been charged against income was
F-16
<PAGE> 128
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
approximately $6.4 million, $2.7 million and $550,000 for the years ended June
30, 1995 and June 30, 1996 and for the six months ended December 31, 1996,
respectively. Had compensation cost for the Company's plan been determined based
on the fair value at the grant dates consistent with the method of FASB
Statement 123 for all options granted after June 30, 1995, and the intrinsic
value for all options granted prior to July 1, 1995, the Company's net loss and
loss per share would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
SIX
YEAR ENDED MONTHS ENDED
JUNE 30, DECEMBER 31,
1996 1996
------------ ------------
<S> <C> <C> <C>
Net loss As reported:......... $(26,782,044) $(34,916,514)
Pro forma:........... (27,533,636) (36,828,677)
Loss per common share As reported:......... (4.96) (5.48)
Pro forma:........... (5.08) (5.77)
</TABLE>
Pro forma net loss reflects compensation cost under SFAS No. 123 only for
options granted for the year ended June 30, 1996 and for the six months ended
December 31, 1996. Therefore, the full impact of calculating compensation cost
for stock options under SFAS No. 123 is not reflected in the pro forma net loss
amounts presented above because compensation cost is reflected over the vesting
period and compensation cost under SFAS No. 123 for options granted prior to
July 1, 1995 is not considered.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the year ended June 30, 1996 and the six months
ended December 31, 1996, respectively: dividend yield of 0% for both periods;
expected volatility of 50% and 50%, risk-free interest rates of 5.97% and 6.4%
and expected lives of 4.74 and 4.37 years.
A summary of the status of the Company's stock options as of June 30, 1995,
June 30, 1996 and December 31, 1996 and changes during the period ending on
those dates is presented below:
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
----------------------------------------- ------------------
JUNE 30, 1995 JUNE 30, 1996 DECEMBER 31, 1996
------------------- ------------------ ------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
(000) PRICE (000) PRICE (000) PRICE
------ --------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year......... 859 $2.22 5,042 $ 1.72 6,095 $ 2.21
Granted.................................. 4,283 1.64 1,228 4.30 1,433 9.45
Exercised................................ -- -- (105) 2.46 (48) 2.02
Forfeited................................ (100) 2.51 (70) 3.57 (23) 3.54
----- ----- -----
Outstanding at end of year............... 5,042 1.72 6,095 2.21 7,457 3.60
Options exercisable at year-end.......... 2,387 3,461 4,140
Weighted-average fair value of options
granted during the year................ $1.16 $3.35 $5.95
</TABLE>
F-17
<PAGE> 129
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about fixed stock options at
December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------------
WEIGHTED- OPTIONS EXERCISABLE
AVERAGE WEIGHTED- -----------------------
NUMBER REMAINING AVERAGE NUMBER WEIGHTED-
RANGE EXERCISABLE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE AVERAGE
EXERCISE PRICE AT 12/31/96 LIFE PRICE AT 12/31/96 PRICE
----------------------- ----------- ----------- --------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.875 to 2.25......... 4,038,777 2.2 years $ 1.46 3,596,275 $ 1.35
2.80 to 4.78........... 1,672,974 3.4 3.31 496,058 3.21
6.00 to 9.375.......... 1,662,000 4.7 8.53 47,500 6.00
15.00.................. 83,334 4.9 15.00 -- --
--------- -------- ----- --------- -----
$0.875 to 15.00........ 7,457,085 3.1 3.60 4,139,833 1.64
</TABLE>
During fiscal years ended June 30, 1995 and 1996, in connection with the
Series A-1 and Series B Preferred Stock private placements and related bridge
note conversions, warrants for 4,367,078 shares of common stock were issued at
prices ranging from $.01 to $3.10. In fiscal 1996, as part of the issuance of
the 2005 Notes, detachable warrants to purchase 2,432,000 shares of the
Company's common stock at a price of $7.15 per share were issued. These warrants
include certain anti-dilution provisions.
At December 31, 1996, unexercised warrants outstanding are as follows:
<TABLE>
<CAPTION>
NUMBER PRICE PER SHARE
--------- ---------------
<S> <C> <C>
Series A and Series B Preferred Stock placements... 1,474,836 $0.01-3.10
2005 Senior Discount Notes offering................ 2,432,000 7.15
Other.............................................. 865,000 0.01-9.68
--------- -----------
Total.............................................. 4,771,836 $0.01-9.68
========= ===========
</TABLE>
The gross proceeds that would be received by the Company on the exercise of
all outstanding options and warrants is approximately $53,400,000.
(7) COMMITMENTS AND CONTINGENCIES
Certain Agreements
The Company has signed nonexclusive license agreements with various utility
and inter-exchange carrier companies, including an affiliate of one of the
country's three largest long distance carriers, to install and maintain fiber
cable systems for the Company's use for periods up to 15 years or more, upon
exercising of extensions available to the parties. Under these agreements, the
Company has use of these rights-of-way for its telecommunications systems, and
may be entitled to certain payments for providing telecommunications service,
subject to its satisfactory performance of certain agreed upon requirements.
Retirement Plan
On February 1, 1996, the Company began sponsoring the American
Communications Services, Inc. 401(k) Plan (the "Plan"), a defined contribution
plan. All individuals employed on February 1, 1996 were eligible to participate.
Participation to all other employees is available after three months of
full-time equivalent service. The Company contributions under the Plan are
discretionary and may be as much as 6% of an employee's gross compensation
subject to certain limits. Total expense under the Plan amounted to
approximately $30,000 and $95,000 for the year ended June 30, 1996 and for the
six months ended December 31, 1996, respectively.
F-18
<PAGE> 130
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Legal Proceedings
On July 24, 1996, the Company was named as a codefendant in a lawsuit
arising from a personal injury sustained during the construction of one of its
networks. At the time of the incident giving rise to the lawsuit, the plaintiff
was an employee of a subcontractor hired by the Company's general contractor for
the construction project. The lawsuit seeks recovery from the Company and the
general contractor of at least $25 million plus punitive damages. The Company,
the general contractor, and the Company's insurance carrier have begun
investigations into the facts surrounding the incident and intend to defend
against this suit vigorously. In addition, the Company is a party to certain
litigation and regulatory proceedings arising in the ordinary course of
business.
In the opinion of management, based upon the advice of counsel, the
ultimate disposition of these matters will not have a material adverse effect on
the Company's consolidated financial position or results of operations.
(8) LEASES
The Company is obligated under various noncancelable operating leases for
office and node space as well as office furniture. The minimum future lease
obligations under these noncancelable operating leases as of December 31, 1996
are approximately as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
-------------------------------------------------------- -----------
<S> <C>
1997.................................................... $ 3,980,000
1998.................................................... 4,320,000
1999.................................................... 4,560,000
2000.................................................... 4,051,000
2001.................................................... 3,078,000
Thereafter.............................................. 13,640,000
-----------
$33,629,000
===========
</TABLE>
Rent expense for the years ended June 30, 1995 and June 30, 1996 and for
the six months ended December 31, 1996 was approximately $200,000, $1,166,000
and $1,700,000, respectively.
(9) RELATED-PARTY TRANSACTIONS
In October 1993, the Company executed a financial consulting and advisory
agreement with a related party for a period of six months. In consideration, the
related party received warrants to purchase 300,000 shares of ACSI common stock
exercisable at $.875 per share if a future equity financing was successfully
completed. The related party had the right to resell the shares to ACSI for
$2.50 per share two years from the date of the agreement. At June 30, 1994, the
Company provided an accrual of $487,500 for this redemption privilege at the
redemption price net of the exercise price. In June 1995, the Company's
obligations to repurchase the shares were assumed by a stockholder of the
Company. Accordingly, as of June 30, 1995, the $487,500 share value has been
transferred from redeemable stock, options, and warrants to additional paid-in-
capital.
On June 16, 1994, the Company entered into a financial consulting agreement
for capital raising activities with an entity controlled by significant
stockholders of the Company. Under this agreement, the Company paid $153,750 for
consulting services rendered through the date of the agreement relating to
placement of the Convertible Bridge Notes. Additionally, the Company agreed to
pay a $7,500 monthly consulting fee for a two year period beginning on the
closing date of the first private placement. During the six months ended
December 31, 1996 and the years ended June 30, 1996 and 1995, the Company paid
$22,500, $90,000 and $67,500 under this arrangement, respectively.
F-19
<PAGE> 131
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective July 1, 1994, the Company engaged SGC Advisory Services, Inc.
("SGC") as a financial and business consultant for three years. SGC is an
affiliate of a former director of the Company. Pursuant to the agreement, the
Company will compensate SGC as follows: (1) a monthly fee of $5,000; and (2)
options to purchase up to 50,000 shares of the Company's Common Stock which vest
on July 1, 1997, and are exercisable on or before July 1, 1999. At the end of
each month of the term of the agreement, SGC earns a credit against the exercise
price of those options equal to 1/36th of the exercise price. The shares issued
upon exercise of the options will be priced at $2.25 per share and the shares
issued will have piggy back registration rights.
(10) INCOME TAXES
Temporary differences and carryforwards that give rise to deferred tax
assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER
JUNE 30, JUNE 30, 31,
1995 1996 1996
---------- ----------- -----------
<S> <C> <C> <C>
Deferred tax assets:
Capitalized start-up and other costs... $4,163,941 $ 3,733,898 $ 3,972,981
Stock options--noncash compensation.... 2,768,488 3,848,128 4,085,146
Net operating loss carryforwards....... 1,149,755 12,181,162 31,310,726
Other accrued liabilities.............. 454,391 496,634 964,786
---------- ----------- -----------
Total gross deferred assets.............. 8,536,575 20,259,822 40,333,639
Less: valuation allowance.............. 8,291,380 18,304,754 31,990,518
---------- ----------- -----------
Net deferred tax assets.................. 245,195 1,955,068 8,343,121
Deferred tax liabilities--fixed assets
depreciation and amortization.......... 245,195 1,955,068 8,343,121
---------- ----------- -----------
Net deferred tax assets (liabilities).... -- -- --
========== =========== ===========
</TABLE>
The valuation allowance for deferred tax assets as of July 1, 1994 was
$2,375,327. The net change in the total valuation allowance for the years ended
June 30, 1995 and June 30, 1996 and for the six months ended December 31, 1996
was an increase of $5,916,053, $10,013,374 and $13,685,764, respectively. The
valuation allowances at June 30, 1996 and December 31, 1996 are a result of the
uncertainty regarding the ultimate realization of the tax benefits related to
the deferred tax assets. The utilization of the tax benefits associated with net
operating losses of approximately $80,000,000 at December 31, 1996 is dependent
upon the Company's ability to generate future taxable income. The net operating
loss carryforward period expires commencing in 2008 through the year 2012.
Further, as a result of certain financing and capital transactions, an annual
limitation on the future utilization of the net operating loss carryforward may
have occurred.
No income tax provision has been provided for the years ended June 30, 1995
and June 30, 1996 and the six months ended December 31, 1996 as the
aforementioned deferred tax assets have provided no tax benefit.
(11) ACQUISITION
On September 12, 1994 the Company executed a Stock Purchase Agreement with
Piedmont Teleport, Inc. under which the Company acquired certain assets,
liabilities, and certain right-of-way agreements for $20,000 in cash and the
issuance of 62,000 shares of the Company's common stock. The Company accounted
for the acquisition as a purchase and, accordingly, the purchase price was
allocated to the assets acquired and liabilities assumed based upon their
estimated fair values at September 12, 1994. The seller had the right to put
these shares back to the Company on November 1, 1996 for a price of $2.50 per
share. Accordingly, this obligation was recorded as redeemable stock until
November 1996 at which time it was reclassed to additional paid in capital.
F-20
<PAGE> 132
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following notes summarize the major methods and assumptions used in
estimating the fair value of financial instruments:
Cash and Cash Equivalents
The carrying amount approximates fair value due to the relatively short
period to maturity of these instruments.
Letters of Credit
The fair value of the Letters of credit is based on fees currently charged
for similar agreements.
Short-Term and Long-Term Debt
The fair value of the Company's long-term debt is estimated based on the
quoted market prices for the same or similar issues if available or based on the
present value of expected cash flows at rates currently available to the Company
for borrowings with similar terms.
The carrying amounts and fair values of the Company's financial instruments
at December 31, 1996 were:
<TABLE>
<CAPTION>
1996
----------------------------
CARRYING FAIR
VALUE VALUE
------------ ------------
<S> <C> <C>
Cash and cash equivalents (including restricted cash)... 80,960,696 80,960,696
Letters of credit....................................... -- 25,000
Long-term debt.......................................... 210,410,259 208,583,264
</TABLE>
(13) SUBSEQUENT EVENT
On January 17, 1997, the Company acquired 100% of the outstanding capital
stock of Cybergate, Inc. in exchange for 1,030,000 shares of common stock plus
up to an additional 150,000 shares if certain performance goals are achieved.
Cybergate, a Florida based Internet services provider, delivers high-speed data
communications services. The acquisition will be recorded using the purchase
method of accounting.
F-21
<PAGE> 133
AMERICAN COMMUNICATIONS SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER
DECEMBER 31, 30, 1997
1996 (UNAUDITED)
------------ ------------
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents..................................... $ 78,619 $ 149,874
Restricted cash............................................... 2,342 29,570
Accounts receivable, net...................................... 2,429 10,703
Other current assets.......................................... 1,203 3,742
-------- ---------
Total current assets....................................... 84,592 193,889
-------- ---------
Networks, furniture and equipment, gross........................ 144,403 250,363
(less: Accumulated depreciation)........................... (8,320) (23,358)
-------- ---------
136,083 227,005
Deferred financing fees......................................... 8,380 26,034
Restricted cash, less current portion........................... -- 45,375
Goodwill (net of accumulated amortization)...................... -- 7,546
Other assets.................................................... 982 756
-------- ---------
Total assets............................................... $230,038 $ 500,605
-------- ---------
Liabilities, Redeemable Stock, Options and Warrants and
Stockholders' Equity
Current Liabilities
Accounts payable.............................................. $ 33,587 $ 8,589
Accrued liabilities........................................... 4,132 14,586
Notes payable -- current portion.............................. 872 1,446
-------- ---------
Total current liabilities.................................. 38,591 24,621
-------- ---------
Long Term Liabilities
Notes payable................................................. 209,538 449,507
Other Long Term Liabilities................................... -- 267
Dividends payable............................................. 6,946 --
-------- ---------
Total liabilities.......................................... 255,075 474,395
-------- ---------
Redeemable stock, options and warrants.......................... 2,000 53,793
-------- ---------
Stockholders' Equity/(Deficit)
Preferred stock, $1.00 par value, 186,664 shares authorized
and designated as 9% Series A-1 Convertible Preferred
Stock, 186,664 and 0 shares, respectively, issued and
outstanding................................................ 187 0
Preferred stock, $1.00 par value, 277,500 shares designated as
9% Series B Convertible Preferred Stock, authorized,
277,500 and 0, respectively, issued and outstanding........ 278 0
Common Stock, $0.01 par value, 75,000,000 shares authorized,
6,784,996 and 35,926,902 shares, respectively, issued and
outstanding................................................ 68 364
Additional paid-in-capital.................................... 54,870 134,133
Accumulated deficit........................................... (82,440) (162,080)
-------- ---------
Total stockholders' equity/(deficit)............................ (27,037) (27,583)
-------- ---------
Total Liabilities, Redeemable Stock, Options and Warrants and
Stockholders' Equity/(deficit)................................ $230,038 $ 500,605
-------- ---------
</TABLE>
See accompanying notes to unaudited condensed consolidated interim financial
statements.
F-22
<PAGE> 134
AMERICAN COMMUNICATIONS SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
($ IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
------------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1996 1997 1996 1997
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues..................................... $ 2,812 $ 16,055 $ 5,239 $ 35,847
Operating Expenses
Network, development and operations........ 3,709 10,642 6,052 28,668
Selling, general and administrative........ 5,674 18,156 16,060 47,975
Non-cash compensation expense.............. 174 500 1,706 1,324
Depreciation and amortization.............. 2,401 6,621 4,717 16,077
----------- ---------- ----------- ----------
Total Operating Expenses..................... 11,958 35,919 28,535 94,044
Loss from operations......................... (9,146) (19,864) (23,296) (58,197)
Non-operating income/expenses
Interest and other income.................. (1,460) (2,815) (5,093) (3,893)
Interest and other expense................. 6,011 12,915 13,653 25,336
----------- ---------- ----------- ----------
Net loss before minority interest............ (13,697) (29,964) (31,856) (79,640)
Minority interest............................ 96 0 353 0
----------- ---------- ----------- ----------
Net loss..................................... (13,601) (29,964) (31,503) (79,640)
Preferred stock dividends/accretion.......... 1,007 2,489 3,024 3,584
----------- ---------- ----------- ----------
Net loss to common stockholders.............. $ (14,608) $ (32,453) $ (34,527) $ (83,224)
----------- ---------- ----------- ----------
Net loss per common/common equivalent
share...................................... $ (2.18) $ (0.90) $ (5.22) $ (3.45)
----------- ---------- ----------- ----------
Average number of common/common
equivalent shares outstanding................ 6,703,579 36,228,568 6,613,543 24,139,630
----------- ---------- ----------- ----------
</TABLE>
See accompanying notes to unaudited condensed consolidated interim financial
statements.
F-23
<PAGE> 135
AMERICAN COMMUNICATIONS SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
1996 1997
------------- -------------
<S> <C> <C>
Cash Flow from Operating Activities
Net Loss............................................................ $ (31,503) $ (79,640)
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and amortization..................................... 4,311 15,610
Interest deferral and accretion................................... 13,182 19,268
Amortization of deferred financing fees........................... 1,074 1,767
Provision for doubtful accounts................................... 177 1,236
Loss attributable to minority interest............................ (353) --
Noncash compensation.............................................. 1,706 1,324
Changes in operating assets and liabilities:
Restricted cash related to operating activities................ 1,360 (2,603)
Trade accounts receivable...................................... (1,491) (9,509)
Other current assets........................................... (1,651) (2,540)
Other assets................................................... 246 226
Accounts payable............................................... 5,657 (24,998)
Accrued financing fees......................................... (1,542) --
Other accrued liabilities...................................... 1,337 10,455
--------- --------
Net cash used in operating activities............................... (7,490) (69,404)
--------- --------
Cash flows from investing activities
Restricted cash related to network activities..................... (2,300) --
Purchase of furniture and equipment............................... -- (8,216)
Investment in marketable securities and other..................... 63,422 --
Network development costs......................................... (78,528) (95,635)
--------- --------
Net cash used in investing activities............................... (17,406) (103,851)
--------- --------
Cash flows from financing activities
Issuance of notes payable......................................... 73,913 1,492
Issuance of common stock.......................................... -- 40,702
Issuance of Redeemable Preferred Stock and warrants............... -- 70,855
Issuance of Senior Notes.......................................... -- 220,000
Issuance of Series B Preferred Stock.............................. 275 --
Payment of notes payable.......................................... -- (1,134)
Payment of deferred financing fees................................ (4,211) (19,421)
Restricted cash related to financing activities................... -- (70,000)
Warrant and stock option exercises................................ 390 2,016
--------- --------
Net cash flow provided by financing activities...................... 70,367 244,510
--------- --------
Net increase in cash and cash equivalents........................... 45,471 71,255
Cash and cash equivalents -- beginning of period.................... 57,348 78,619
--------- --------
Cash and cash equivalents -- end of period.......................... $ 102,819 $ 149,874
========= ========
Supplemental disclosure of cash flow information
Dividends declared with preferred stock........................... $ 3,024 $ 3,584
========= ========
Decrease in accrued redeemable warrant cost....................... $ 505 $ --
========= ========
Increase in goodwill.............................................. $ -- $ 8,119
========= ========
</TABLE>
See accompanying notes to unaudited condensed consolidated interim financial
statements.
F-24
<PAGE> 136
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
Effective December 31, 1996, the Company changed its fiscal year from a
twelve month period ended June 30, to a twelve month period ended December 31.
The consolidated financial statements include the accounts of American
Communications Services, Inc. ("ACSI" or the "Company") and its majority-owned
subsidiaries. All of the Company's subsidiaries are wholly owned with the
exception of the Louisville, Fort Worth, El Paso, Greenville and Columbia
subsidiaries, in which the Company has a 92.75% ownership interest. All material
intercompany accounts and transactions have been eliminated in consolidation.
The consolidated balance sheet as of September 30, 1997, the consolidated
statements of earnings for the three and nine months ended September 30, 1997
and 1996, and the consolidated statements of cash flows for the nine months
ended September 30, 1997 and 1996 have been prepared by the Company, without
audit. In the opinion of management, all adjustments, which include normal
recurring adjustments necessary to present fairly the financial position,
results of operations and cash flows at September 30, 1997, and for all periods
presented, have been made. Certain amounts in the consolidated statements have
been reclassified to conform to the 1997 presentation. Operating results for the
three and nine months ended September 30, 1997 are not necessarily indicative of
the operating results for the full year.
Certain information and footnote disclosure normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. The Company believes that the disclosures
provided are adequate to make the information presented not misleading. These
financial statements should be read in conjunction with the audited financial
statements and the related notes included in the Company's 1996 annual report to
shareholders.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS AND RESTRICTED CASH
Pursuant to Statement of Financial Accounting Standard No. 115 (FAS 115),
"Accounting for Certain Investments in Debt and Equity Securities", the
Company's short- and long-term debt securities and marketable equity securities
are accounted for at market value. The fair market value of short- and long-term
investments is determined based on quoted market prices for those investments.
The Company's marketable securities have been classified as available for sale
and are recorded at current market value with an offsetting adjustment to
stockholders' equity (deficit).
The Company's investments consist of commercial paper, U.S. Government
Securities and money market instruments. Commercial paper has maturities of 90
days or less. The fair market value of such securities approximates amortized
cost. At December 31, 1996 and September 30, 1997, cash equivalents consists of
government securities and overnight investments.
The Company has provided performance bonds and letters of credit in various
cities in connection with its operations, resulting in a restriction of cash
amounting to $2.3 million and $4.9 million at December 31, 1996 and September
30, 1997, respectively. In addition, at September 30, 1997, the Company has
approximately $70 million of cash restricted to fund the first five interest
payments of its 13 3/4% Senior Notes due 2007 issued in July 1997 (the "2007
Notes") resulting in total restricted cash of $74.9 million, of which $29.6
million has been classified as current. The face amount of all bonds and letters
of credits was approximately $6.2 million as of December 31, 1996, and $8.3
million as of September 30, 1997.
NETWORKS, EQUIPMENT AND FURNITURE
Networks, equipment and furniture are stated at cost less accumulated
depreciation and amortization. Costs capitalized include expenses associated
with network engineering, design and construction, negotiation
F-25
<PAGE> 137
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS -- (CONTINUED)
of rights-of-way, obtaining legal and regulatory authorizations and the amount
of interest costs associated with the network development.
Provision for depreciation of networks, equipment and furniture is computed
using the straight-line method over the estimated useful lives of the assets
beginning in the month a network is substantially complete and available for use
and equipment and furniture are acquired.
The estimated useful lives of the Company's principal classes of assets are
as follows:
<TABLE>
<S> <C>
Networks:
Fiber optic cables and installation costs........... 20 years
Telecommunications equipment........................ 3-7 years
Interconnection and collocation costs............... 3-10 years
Leasehold improvements.............................. Life of lease
Furniture and fixtures.............................. 5 years
Capitalized network development costs............... 3-20 years
</TABLE>
DEFERRED FINANCING FEES
Deferred financing fees include commitment fees and other costs related to
certain debt financing transactions and are being amortized using the effective
interest method over the initial term of the related debt.
REVENUE RECOGNITION
Revenue is recognized as services are provided. Billings to customers for
services in advance of providing such services are deferred and recognized as
revenue when earned. The Company also enters into managed services agreements
with certain customers. Under such agreements the Company provides use of
Company owned equipment, collocation and network access services. Revenue is
recognized on a monthly basis as these services are provided to the customer.
EARNINGS (LOSS) PER COMMON SHARE
The computation of earnings (loss) per common share is based upon the
weighted average number of common shares outstanding. The effect of including
common stock options and warrants as common stock equivalents would be
anti-dilutive and is excluded from the calculation of loss per common share.
USE OF ESTIMATES
The preparation of the consolidated 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 dates of the consolidated
financial statements and the reported amounts of revenue and expenses during the
reporting period. Actual results may differ from those estimates.
CONCENTRATION OF CREDIT RISK
The Company receives a significant portion of its revenues from a small
number of major customers, particularly the long distance telecommunications
companies that service the Company's markets. The Company provides managed
services to certain Internet service providers. Such companies operate in a
highly competitive and uncertain environment.
F-26
<PAGE> 138
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3: FINANCING ACTIVITIES
To date, the Company has funded the construction of its networks and its
operations with external financings, as described below.
AT&T CREDIT FACILITY
In October 1994, the Company entered into the AT&T Credit Facility pursuant
to which AT&T Credit Corporation has agreed to provide up to $31.2 million in
financing for the development and construction of fiber optic local networks by
five of the Company's subsidiaries. In connection with each loan made under the
AT&T Credit Facility, AT&T Credit Corporation purchased 7.25% of the capital
stock of the funded subsidiary, and ACSI pledged the other shares and the assets
of the subsidiary to AT&T Credit Corporation as security for the loan. As of
June 30, 1997, an aggregate of $31.2 million had been borrowed under these
agreements. Principal amounts payable on the AT&T Credit Facility during 1997
are approximately $872,000.
The Company has entered into negotiations with AT&T Capital Corporation to
roll-up the five existing loan agreements comprising the AT&T Credit Facility
into one loan agreement to be entered into with the Company, and to be secured
by the existing assets of the Company (including the stock, but not the assets,
of certain of the Company's subsidiaries) (the "New AT&T Facility"). The Company
expects the New AT&T Facility to otherwise be on terms substantially similar to
those of the existing AT&T Credit Facility. The maximum aggregate amount of
credit available under the proposed New AT&T Facility will not exceed $35.0
million as defined by the Company's existing indentures. AT&T Credit Corporation
has issued to each of the Company's Subsidiaries that are parties to the AT&T
Credit Facility a waiver through November 30, 1997, of compliance by such
subsidiaries with certain covenants contained therein. Such covenants are not
expected to be included in the New AT&T Facility.
9% SERIES A CONVERTIBLE PREFERRED STOCK
In October 1994, the Company completed the private placement of 186,664
shares of its 9% Series A Convertible Preferred Stock, par value $1.00 per share
(which was later exchanged for Series A-1 Preferred Stock that was converted
into 7,466,560 shares of Common Stock simultaneous with the completion of the
Offering) with accompanying warrants to purchase an aggregate of 2,674,506
shares of Common Stock, for an aggregate consideration of $16.8 million (before
deduction of estimated offering expenses), including the conversion of $4.3
million of outstanding debt. Of the warrants sold in October 1994, warrants to
acquire 1,491,222 shares of Common Stock were exercised by a principal
stockholder for an aggregate exercise price of approximately $100,000. The
Series A Preferred Stock was converted into an aggregate of 7,350,160 shares of
common stock simultaneously with the completion of the April Offering discussed
below.
9% SERIES B CONVERTIBLE PREFERRED STOCK
In June 1995, the Company completed a private placement of 227,500 shares
of its Series B Preferred Stock with accompanying warrants to purchase an
aggregate of 1,584,303 shares of Common Stock, for an aggregate consideration of
$22.8 million. In addition, in November 1995, the Company completed a private
placement of 50,000 shares of its Series B Preferred Stock together with the
exercise of accompanying warrants to purchase 214,286 shares of Common Stock to
a principal stockholder for an aggregate consideration of $4.7 million. The
Series B Preferred Stock was converted into an aggregate of 9,910,704 shares of
Common Stock simultaneously with the completion of the April Offering discussed
below.
F-27
<PAGE> 139
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS -- (CONTINUED)
2005 SENIOR DISCOUNT NOTES (2005 NOTES)
On November 14, 1995, the Company completed an offering of 190,000 Units
(the "Units") consisting of $190,000,000 principal amount of 13% Senior Discount
Notes due 2005 (the "2005 Notes") and warrants to purchase 2,432,000 shares of
the Company's common stock at a price of $7.15 per share (the "2005 Warrants").
The 2005 Notes will accrete at a rate of 13% compounded semi-annually to an
aggregate principal amount of $190,000,000 by November 1, 2000. Thereafter,
interest on the 2005 Notes will accrue at the annual rate of 13% and will be
payable in cash semi-annually on November 1 and May 1, commencing May 1, 2001.
The Company received net proceeds of approximately $96,105,000 from the sale of
the Units. The value ascribed to the 2005 Warrants was $8,684,000.
2006 SENIOR DISCOUNT NOTES (2006 NOTES)
On March 21, 1996, the Company completed an offering of $120,000,000 of
12-3/4% Senior Discount Notes due 2006 (the "2006 Notes") resulting in net
proceeds of approximately $61,800,000. The 2006 Notes will accrete at a rate of
12-3/4% compounded semi-annually, to an aggregate principal amount of
$120,000,000 by April 1, 2001. Thereafter, interest on the 2006 Notes will
accrue at the annual rate of 12-3/4% and will be payable in cash semi-annually
on April 1 and October 1, commencing on October 1, 2001. The 2006 Notes will
mature on April 1, 2006.
ACQUISITION
On January 17, 1997, the Company acquired 100% of the outstanding stock of
Cybergate in exchange for 1,030,000 shares of Common Stock plus up to an
additional 150,000 shares if certain performance goals are met. The acquisition
has been accounted for using the purchase method and, therefore, the Company's
consolidated financial statements include the results of operations of Cybergate
from the date of acquisition. The purchase price of $8,755,000 plus transaction
expenses of approximately $500,000 has been allocated to assets and liabilities
acquired based on their fair values and goodwill of approximately $8,400,000 has
been recorded. The goodwill is being amortized on a straight line basis over a
ten year period.
COMMON EQUITY (APRIL OFFERING)
On April 15, 1997, the Company consummated the issuance and sale of
5,060,000 shares of Common Stock (inclusive of the May 14, 1997 exercise by the
underwriters of their overallotment option) at a price per share of $5.00 in an
underwritten public offering, and the issuance and sale directly to certain of
its principal stockholders of 3,600,000 shares of Common Stock at a purchase
price of $4.70 per share (together, the "April Offering"). Total net proceeds to
the Company from the April Offering were approximately $40 million.
In addition, the Company recently completed additional financings,
described below.
14-3/4% REDEEMABLE PREFERRED STOCK (UNIT OFFERING)
On July 10, 1997, the Company consummated the private placement of 75,000
units, (the "Unit Offering"), consisting of its 14-3/4% Redeemable Preferred
Stock due 2008 (the "Redeemable Preferred Stock") and warrants to purchase
shares of common stock. The Company received net proceeds of approximately $67
million from the sale of these units. Each unit includes a warrant to purchase
80.318 shares of ACSI common stock subject to an increase of 22.645 additional
shares of common stock in the event that the Company fails to raise net proceeds
of at least $50 million through the issuance and sale of its qualified capital
stock on or before December 31, 1998. Dividends on the Redeemable Preferred
Stock will accrue from the date of issuance, are cumulative and will be payable
in arrears on March 31, June 30, September 30 and
F-28
<PAGE> 140
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS -- (CONTINUED)
December 31, commencing September 30, 1997. Dividends may be paid, at the
Company's option, on any dividend payment date either in cash or by the issuance
of additional shares of preferred stock, provided however, that after June 30,
2002, to the extent and for so long as the Company is not precluded from paying
cash dividends on the Redeemable Preferred Stock by the terms of any then
outstanding indebtedness or any other agreement or instrument to which the
Company is subject, the Company shall pay the dividends in cash. The company is
required to redeem all the Redeemable Preferred Stock outstanding on June 30,
2008 at a redemption price equal to 100.00% of the liquidation preference
thereof, plus, without duplication, accrued and unpaid dividends to the date of
redemption.
2007 SENIOR NOTES (2007 NOTES)
On July 18, 1997, the Company completed the private placement of $220
million of 13-3/4% Senior Notes due 2007. The Company received net proceeds of
approximately $209 million from the sale of the 2007 Notes, of which,
approximately $70 million has been placed in escrow solely to fund the first
five interest payments or otherwise for the benefit of the holders of the 2007
Notes. The 2007 Notes bear interest at 13-3/4% compounded semi-annually in
arrears, payable on January 15 and July 15 each year, commencing on January 15,
1998. The notes mature on July 15, 2007. The 2007 Notes will not be redeemable
at the option of the Company prior to July 15, 2002, except that any time prior
to July 15, 2000, the Company may redeem up to 35% of the aggregate principal
amount of the 2007 Notes with the net proceeds from one or more equity offerings
of the Company, at a redemption price equal to 113.75% of the aggregate
principal amount thereof on the date of the redemption, subject to other
conditions.
12 3/4% JUNIOR REDEEMABLE PREFERRED STOCK
On October 16, 1997, the Company completed the private placement of $150
million of 12 3/4% Junior Redeemable Preferred Stock due 2009 ("Junior
Redeemable Preferred Stock"). The Company received net proceeds of approximately
$145.6 million. Dividends on the Junior Redeemable Preferred Stock will accrue
from the date of issuance, are cumulative and will be payable quarterly, in
arrears, on January 15, April 15, July 15 and October 15 of each year commencing
January 15, 1998. Dividends may be paid, at the Company's option, on any
dividend payment date, either in cash or by the issuance of additional shares of
Junior Redeemable Preferred Stock with an aggregate liquidation preference equal
to the amount of such dividends; provided; however, that after October 15, 2002,
to the extent and for so long as the Company is not precluded from paying cash
dividends on the Junior Redeemable Preferred Stock by the terms of any agreement
or instrument governing any of its then outstanding indebtedness, the Company
shall pay dividends in cash. The Company is required to redeem all the Junior
Redeemable Preferred Stock outstanding on October 15, 2009 at a redemption price
equal to 100% of the liquidation preference thereof, plus, without duplication,
accrued and unpaid dividends to the date of redemption.
NOTE 4: NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 128 (FAS 128), "Earnings Per Share," which
is required to be adopted for annual financial statement periods ending after
December 15, 1997. Earlier application is not permitted. FAS 128 requires
companies to change the method currently used to compute earnings per share and
to restate all prior periods. While the Company does not know precisely the
impact of adopting FAS No. 128, the Company does not expect that the adoption
will have a material effect on the Company's consolidated financial statements.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 129 (FAS 129), "Disclosure of Information
about Capital Structure." The Company is required to adopt the provisions of
this Statement for fiscal years ending after December 15, 1997. This Statement
F-29
<PAGE> 141
AMERICAN COMMUNICATIONS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS -- (CONTINUED)
continues the previous requirement to disclose certain information about an
entity's capital structure found in APB Opinions No. 10, "Omnibus
Opinion -- 1966," No. 15, "Earnings per Share," and FASB Statement No. 47,
"Disclosure of Long-Term Obligations," for entities that were subject to the
requirements of those standards. As the Company has been subject to the
requirements of each of those standards, adoption of FAS No. 129 will have no
impact on the Company's financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (FAS No. 130), "Reporting Comprehensive
Income." FAS No. 130 established standards for the reporting and display of
comprehensive income and its components in the financial statements. The Company
is required to adopt the provisions of the Statement for fiscal years beginning
after December 15, 1997. Earlier application is permitted; however, upon
adoption the Company will be required to reclassify previously reported annual
and interim financial statements. The Company believes that the disclosure of
comprehensive income in accordance with the provisions of FAS No. 130 will not
impact the manner of presentation of its financial statements as currently and
previously reported.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (FAS No. 131), "Disclosure about Segments
of an Enterprise and Related Information." FAS No. 131 requires the Company to
present certain information about operating segments and related information,
including geographic and major customer data, in its annual financial statements
and in condensed financial statements for interim periods. The Company is
required to adopt the provisions of the Statement for fiscal years beginning
after December 15, 1997. Earlier application is permitted; however, upon
adoption the Company will be required to restate previously reported annual
segment and related information in accordance with the provisions of FAS No.
131. The Company has not completed its analysis of the impact on the financial
statements that will be caused by the adoption of this Statement.
F-30
<PAGE> 142
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY
SECURITY OTHER THAN THE SECURITIES TO WHICH IT RELATES, NOR DOES IT CONSTITUTE
AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY
CIRCUMSTANCES OR IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF NOR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Additional Information................ i
Documents Incorporated by Reference... i
Summary............................... 1
Risk Factors.......................... 14
Use of Proceeds....................... 26
Capitalization........................ 27
Unaudited Pro Forma Condensed
Consolidated Financial Data......... 28
Selected Consolidated Financial
Data................................ 31
Exchange Offer........................ 32
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 39
Business.............................. 49
Management............................ 66
Certain Transactions.................. 74
Principal Stockholders................ 75
Description of Certain Indebtedness... 76
Description of the Preferred Stock.... 79
Description of Capital Stock.......... 100
U.S. Federal Income Tax Consequences
of the Exchange Offer............... 104
Plan of Distribution.................. 104
Legal Matters......................... 105
Experts............................... 105
Change in Independent Public
Accountants......................... 105
Glossary.............................. 106
Index to Financial Statements......... F-1
</TABLE>
======================================================
======================================================
---------------------------------------------
PROSPECTUS
---------------------------------------------
$150,000,000
[ACSI LOGO]
OFFER TO EXCHANGE ITS
12 3/4% JUNIOR REDEEMABLE
PREFERRED STOCK
DUE 2009, WHICH HAS BEEN
REGISTERED UNDER THE
SECURITIES ACT OF 1933,
AS AMENDED, FOR ANY AND ALL
OUTSTANDING SHARES OF ITS 12 3/4%
JUNIOR REDEEMABLE PREFERRED STOCK
DUE 2009
DECEMBER 23, 1997
======================================================
